New York is considering groundbreaking legislation that the state’s attorney general calls the “strongest and most comprehensive set of regulations on cryptocurrency in the nation.”

Attorney General Letitia James said the cryptocurrency industry lacks national oversight and regulation, making it prone to criminal conduct. Her proposed package of cryptocurrency regulations would “increase transparency, eliminate conflicts of interest, and impose commonsense measures to protect investors, consistent with regulations imposed on other financial services,” per a press release from the Attorney General’s office.

The bill strengthens the New York State Department of Financial Services’ (DFS) regulatory authority, providing it with extensive oversight of the digital asset industry and authorizing it to license digital asset brokers, marketplaces, investment advisors and issuers before they could engage in business in New York. DFS is already a significant presence in a number of industries, including finance, banking, and insurance, and seems to be a natural home for such regulation in New York. The proposed bill also would grant the Attorney General power to impose civil penalties of $10,000 per violation, per individual, or $100,000 per violation, per firm, along with the power to pursue restitution, damages, and penalties, and the ability to shut down businesses engaging in fraud and illegality.

Perceived Conflicts of Interest in the Cryptocurrency Industry

The legislative package also targets perceived conflicts-of-interest throughout the cryptocurrency industry, by addressing and, in some instances, preventing:

• common ownership of crypto issuers, marketplaces, brokers, and investment advisers and preventing any participant from engaging in more than one of those activities;
• crypto brokers and marketplaces from trading for their own accounts;
• marketplaces and investment advisers from keeping custody of customer funds;
• brokers from borrowing or lending customer assets; and
• referrals from marketplaces to investment services for compensation.

These provisions, in theory, would help foster confidence in the cryptocurrency industry and the individuals and entities that create, promote, trade and offer cryptocurrencies to the marketplace.

Calls for Increased Transparency in Cryptocurrency Industry

Addressing the general need for additional transparency in the marketplace, the bill would require digital asset companies and marketplaces to adhere to standards similar to those mandated of traditional finance companies, including:

• undergoing mandatory independent auditing and publishing audited financial statements;
• providing investors with material information about issuers, including risks and conflict-of-interest disclosures;
• establishing and publishing listing standards; and
• registering and reporting their interest in any issuer whose crypto assets they promote.

While it may generally be true that cryptocurrencies differ from traditional financial products and fiat currency, the ability of the creators and promoters of these projects to profit from insider transactions and opaque financial disclosures is a well-known risk. While experienced and savvy cryptocurrency industry participants know to be aware of these issues, regulatory oversight in this space, like SEC oversight of investment offerings and DFS oversight of financial institutions, can serve to promote and increase confidence in the industry. Indeed, many projects already provide significant disclosures that align, in whole or in part, with these proposed mandates; whether the industry as a whole will embrace top-down disclosures, however, remains to be seen.

Additional New York Proposed Cryptocurrency Regulations

Maintaining the theme of aligning cryptocurrency with traditional financial institutions and products, the bill would also:

• require brokers to know essential facts about their customers;
• require crypto brokers and marketplaces to only conduct business with firms that comply with Know Your Customer provisions (a potential hot button issue, in light of the cryptocurrency industry’s history of, and preference for, anonymity);
• ban use of the term “stablecoin” to describe or market digital assets unless they are backed 1:1 with U.S. currency or high-quality liquid assets as defined in federal regulations; and
• require platforms to reimburse customers who are the victims of unauthorized asset transfers and transfers resulting from fraud.

These provisions make sense from the perspective of the regulator, but will likely meet resistance from cryptocurrency enthusiasts, given the purported anonymity of cryptocurrency has long been a key factor of its adoption from its earliest days – even among those who are not and do not intend to commit illegal acts. Given the practical difficulties of complying with Know Your Customer obligations in cryptocurrency, most industry participants will likely need to improve their customer identification programs to protect against fraud.

Additional New York Cryptocurrency Enforcement Actions

These proposed regulations mark the next (but not unexpected) step in New York’s rise in prominence in cryptocurrency regulatory leadership. In fact, Attorney General James has taken several enforcement actions against cryptocurrency companies in the past year, with many of those actions related, in some form or fashion, to the topics and issues covered by the proposed regulations, including actions against Kucoin, CoinEx and Celsius.

In March, she filed These regulations contain many provisions that are expected and reasonable, as well as some that would reflect a change in cryptocurrency regulation and governance. Some may feel the moves are a case of over-regulations, but, with the proliferation of blockchain and cryptocurrencies and the ever-increasing presence of scammers, it may be that New York’s regulations and broad reach may become the high water mark for oversight that the industry needs to gain legitimacy and widespread adoption.