NYDFS Releases Final Version of Regulations For Bitcoin Industry

Jun 4 2015 | 3:38pm ET

The New York Department of Financial Services has released the final version of its Bitlicense regulatory framework for the digital currency industry.

The move was among the final accomplishments for departing NYDFS superintendent Benjamin Lawsky, who announced his impending departure from the agency last month. Lawsky was among the first regulators to tackle the thorny issues surrounding regulation of bitcoin and other digital currencies, which are by design difficult to regulate. 

The final rules, which will not become actual law until publication in the New York State Register, cap nearly two years of work by the agency after it was determined that digital currency did not fit well into existing NY State law. 

The first version of the framework, immediately dubbed the “Bitlicense” when initially proposed in October 2014, was almost universally derided as regulatory overreach, receiving more than 4,000 formal comments submitted during the comment period. 

The agency took many, although not all, of those comments into consideration when released a revision to the rules in February 2015. That version of the Bitlicense received only 35 public comments and sought to allay the worst fears of the bitcoin industry. The final version released this week has only minor differences from that second draft, mostly relating to reporting requirements, cross-regulation requirements and investor disclosure.

Lawsky was tasked with finding the right balance between supporting development of a promising technology and fulfilling his agency’s mandate to protect the public from the dizzying array of frauds, failures and illicit activities like money laundering that have beset the bitcoin industry. 

The regulations cover “companies controlling, administering or issuing a virtual currency,” but specifically exempt firms developing blockchain applications that do not involve utilization of digital currency as a financial asset class, software developers not engaged in money transmission or exchange, miners, individual investors, merchants who accept bitcoin, and companies with a banking license. 

The exclusions address many of the criticisms of the original Bitlicense draft, which many in the digital currency ecosystem believed went too far and risked stifling the nascent digital currency industry in NY in particular and innovation in the space in general. 

However, a wide swath of the Bitcoin ecosystem will have to eventually comply with the new rules or cease doing business in New York and/or with New York residents. This includes any company taking custody of customer funds and those that exchange digital currencies for fiat ones, and requires a raft of know-your-customer and anti-money laundering reporting requirements. In addition, such firms will need to maintain compliance with New York’s rules on consumer protection, capital requirements, cybersecurity and ownership disclosures. 

Unsurprisingly, many questions remain. For instance, companies that take custody of customer funds must comply with the new rules, but the Bitlicense is largely silent on those that hold the private keys to a customer’s address. 

The new rules have also been criticized for placing heavy burdens on companies in the young industry, the vast majority of which are venture-backed startups with little legal and regulatory experience or resources. Some even find the requirements discriminatory, since they require state-level money laundering reporting, something neither banks or money transmission businesses need to do. 

However, others believe companies will adapt to the new rules and that the industry in general will benefit from the perception of legitimacy and transparency they bring, which in turn will allow greater visibility of Bitcoin’s true advantages of quickly, securely and cost-effectively processing transactions of virtually any type, size or location. 

The release comes as Wall Street becomes increasingly interested in exploring bitcoin and applications of its decentralized ledger, called the blockchain. Both the NYSE and NASDAQ are actively exploring applications of digital currency technology, while a large number of financial luminaries, including former U.S. Treasury Secretary Lawrence Summers and former JP Morgan CDO specialist Blythe Masters, have joined Bitcoin startups as either executives or advisors. 

Moreover, although divisive to those in the community, the NYDFS rules are likely to provide clarity for many Wall Street institutions who have been interested in getting involved with bitcoin, but have been unwilling to do so until the regulatory boundaries were at least marginally visible. Accordingly, many companies developing financial products for the digital currency space hope the release of the final Bitlicense will pave the way for greater institutional involvement. 

Regardless, the new rules are the first formal, broad regulatory framework for the digital currency industry, and are widely expected to form the foundation for regulatory efforts in other jurisdictions. As such, are likely to be both subject to revision over time, and seen as a landmark moment for the fledgling sector. 

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