California Legislature Proposes Virtual Currency License

by Perkins Coie

On February 27, 2015, California Assembly member Matt Dababneh (D – Encino) introduced AB 1326, which would require virtual currency businesses to be licensed by the Department of Business Oversight (DBO).  To get licensed, businesses must pay $5,000 to register, provide detailed information (including audited financials for the most recent year) and keep a specified amount of funds (established case by case by the Commissioner of the DBO) in certain types of investment-grade permissible investments, which excludes virtual currencies.

The bill purports to cover any person that engages in California in the business of virtual currency.  The bill defines virtual currency as any type of digital unit that is used as a medium of exchange or a form of digitally stored value or that is incorporated into payment system technology.  The bill goes on to say that virtual currency should be broadly construed to include digital units of exchange that (1) have a centralized repository or administrator, (2) are decentralized and have no centralized repository or administrator, or (3) may be created or obtained by computing or manufacturing effort.

The bill is intended to be broad in scope and does not distinguish among the various different types of virtual currency companies or business models that exist today.  There is no discussion of mining companies or software companies or any of the other types of virtual currency companies as there is in the BitLicense proposal from New York, for example, or in the FinCEN guidelines relating to virtual currency.  Also, the operative clause of the California bill is missing a key verb, which makes it more difficult for a company to decide it’s not covered.  The bill could have been more targeted if the clause included an operative verb (or string of verbs) such as “the business of exchanging virtual currency” or “the business of receiving and transmitting virtual currency.”  It will be quite challenging in practice to decide whether a company is “in the business of virtual currency.”

The bill contains a number of exemptions, including for banks and other financial institutions that engage in the business of virtual currency.  Other significant exemptions include:

  • a merchant or consumer that utilizes virtual currency solely for the purchase or sale of goods or services;
  • companies in the business of providing digital units that are used solely within online gaming platforms with no market or application outside of those gaming platforms; and
  • companies in the business of providing digital units that are used exclusively as part of a customer affinity or rewards program, and can be applied solely as payment for purchases with the issuer or other designated merchants, but cannot be converted into, or redeemed for, fiat currency.

The bill is presumably not intended to cover at least certain non-currency use cases, such as when a de minims amount of virtual currency is used to tokenize an asset like a share of stock for purposes of tracking transfers of the tokenized asset on a distributed ledger.  The bill would, however, seem to cover tokenized assets to the extent either the underlying virtual currency or the tokenized asset is used as a medium of exchange or the underlying virtual currency is viewed as a store of value.

While the bill exempts companies that are licensed money transmitters under other provisions of the state’s existing Money Transmission Act, it doesn’t expressly say whether a company licensed under or exempted from this proposed new Virtual Currency Division of the Financial Code would also need to be separately licensed as a money transmitter under any other provisions of the Money Transmission Act.

Although the fee is steep for startup companies, it is likely not prohibitive and most of the other requirements could also be met.  One notable exception is the requirement to provide audited financial statements for the most recent fiscal year.  This requirement alone would effectively preclude new startup companies from engaging in the business of virtual currency in California, by definition to the extent it is interpreted to require at least a year of operations, and as a practical matter given the costs associated with an audit.  Even startup companies that have received venture funding typically do not engage an audit firm in the early years while every dollar is needed for product development and marketing.  The bill does provide the Commissioner of the DBO the discretion to waive any of the requirements for licensure.  Thus, as a practical matter, the fate of California’s virtual currency startup community would be in the hands of the Commissioner of the DBO.

We are paraphrasing the bill here, and we encourage everyone to read this short bill it in its entirety.  The bill will not be heard until early April.  At that time it will be assigned to an appropriate policy committee, presumably the Banking and Finance Committee chaired by Mr. Dababneh, as well as the Assembly Appropriations Committee.  Comment letters regarding the bill should be mailed to Mr. Dababneh and the relevant committee members once the appropriate policy committee is determined.  If it passes both committees, it would then be voted on by the Assembly and then the Senate and ultimately would need to be signed into law by the Governor.  While passage of the bill is certainly not imminent, those who want to provide input on the bill should begin preparing their letters now.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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