As readers may recall, California previously attempted to enact a “Digital Financial Assets Law” with the introduction of AB 2269 in February 2022. In relevant part, AB 2269 proposed (1) a stringent licensing requirement for entities engaging in or holding themselves out as being able to engage in “digital financial business activity” with or on behalf of California residents and (2) substantial ongoing reporting and operational obligations, both of which California modeled after New York’s “BitLicense” requirements for virtual currency businesses.

Fortunately, Gov. Newsom vetoed AB 2269 in September 2022, claiming the measure to be too premature. In his communications surrounding the veto, Gov. Newsom emphasized his goal of making California a “transparent regulatory environment” that can foster responsible innovation and consumer protection within a “rapidly evolving federal regulatory picture.” As a result, the industry prepared itself for only a temporary reprieve from digital assets regulation, with a coordinated effort between California and federal regulators to oversee digital asset business activities to follow. Unfortunately, it seems that California chose to reintroduce an amended version of the Digital Financial Assets Law, AB 39, instead.

Similar to its predecessor bill, AB 39 provides that, on and after July 1, 2025, “a person shall not engage in digital financial asset business activity, or hold itself out as being able to engage in digital financial asset business activity, with or on behalf of a resident,” unless (1) the person is licensed; (2) the person submits an application on or before July 1, 2025, and is awaiting application approval; or (3) the person is exempt from licensing. See new Cal. Fin. Code § 3201. The term “digital financial asset business activity” is defined to mean “(1) [e]xchanging, transferring, or storing a digital financial asset or engaging in digital financial asset administration, whether directly or through an agreement with a digital financial asset control services vendor[;] (2) [h]olding electronic precious metals or electronic certificates representing interests in precious metals on behalf of another person or issuing shares or electronic certificates representing interests in precious metals[;] (3) [e]xchanging one or more digital representations of value used within one or more online games, game platforms, or family of games for either of the following: (A) A digital financial asset offered by or on behalf of the same publisher from which the original digital representation of value was received [or] (B) Legal tender or bank or credit union credit outside the online game, game platform, or family of games offered by or on behalf of the same publisher from which the original digital representation of value was received.” The term “digital financial asset” is defined to mean “a digital representation of value that is used as a medium of exchange, unit of account, or store of value, and that is not legal tender, whether or not denominated in legal tender,” with certain limited exemptions. See new Cal. Fin. Code §§ 3102(g) and (i). Importantly, please be advised that AB 39 includes stablecoins within the scope of the term “digital asset,” and new Cal. Fin. Code §§ 3601 to 3605 prescribe certain regulatory obligations for digital financial asset business activities related to stablecoins.

In addition to the above-described licensing requirement, please note the following about AB 39:

• AB 39 authorizes the Department of Financial Protection and Innovation (“DFPI”) to conduct examinations of a licensee.
• AB 39 requires a licensee to maintain, for all digital financial asset business activity with, or on behalf of, a resident for 5 years after the date of the activity, certain records, including a general ledger maintained at least monthly that lists all assets, liabilities, capital, income, and expenses of the licensee.
• AB 39 authorizes the DFPI to take an enforcement measure against a licensee or person that is not a licensee but has engaged, is engaging, or is about to engage in digital financial asset business activity with, or on behalf of, a resident in any certain instances, including the licensee or person materially violates the provisions of AB 39, a rule adopted or order issued under AB 39, or a law of California other than AB 39 that applies to digital financial asset business activity of the violator with, or on behalf of, a resident. AB 39 also authorizes the DFPI to prescribe civil penalties for such violations.
• AB 39 requires licensees, before engaging in digital financial asset business activities with any resident, to make certain disclosures to such residents, including schedules of fees and charges that may be assessed, the manner by which fees and charges will be calculated if they are not set in advance and disclosed, and the timing of the fees and charges.

As we understand the state of play, it seems very likely that this measure will pass this year. It is our sincere hope that the California legislature continues to refine AB 39 to address some of its more problematic provisions. To give just one example of such a provision, AB 39 authorizes the DFPI to take enforcement action against a person that “is about to engage” in digital financial asset business activity without defining how close such a person must be engaging in the activities to be “about to engage.” With such a low bar for the DFPI to meet before taking enforcement action, new and innovative companies seeking to engage in virtual currency business activities would, in essence, develop their proposed business plans in California at their own risk. Such a provision very much undermines the “transparent regulatory environment” that Gov. Newsom advocated for in his veto of AB 2269.

It will be important for entities engaged in virtual currency business activities to consult the bill’s full text to determine how the new law will affect their business operations.

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