New York Proposes Virtual Currency Licensing and Regulatory Framework

by Ballard Spahr LLP

The New York Department of Financial Services (DFS) recently proposed a regulatory framework for virtual currency firms. In doing so, New York is the first state to propose a specially tailored regulatory framework for virtual currency. While other states currently regulate virtual currency, such regulation is based on existing statutory framework generally applicable to currency transmitters or similar industries.

As proposed, licensing and substantive regulatory requirements will apply to firms covered by the regulations. The newly dubbed "BitLicenses" will be required for entities engaged in any of the following types of virtual currency activities:

  • Receiving or transmitting virtual currency on behalf of consumers
  • Securing, storing, or maintaining custody or control of virtual currency on the behalf of customers
  • Performing retail conversion services, including the conversion or exchange of fiat currency or other value into virtual currency, the conversion or exchange of virtual currency into fiat currency or other value, or the conversion or exchange of one form of virtual currency into another form of virtual currency
  • Buying and selling virtual currency as a customer business, as opposed to personal use
  • Controlling, administering, or issuing a virtual currency (not including virtual currency miners)

The proposed regulations exempt from the licensing requirement:

  • Entities chartered under the New York Banking Law to conduct exchange services and approved by the DFS to engage in virtual currency business activities
  • Merchants and consumers that utilize virtual currency solely for the purchase or sale of goods or services

For the purpose of the regulation, the term "virtual currency" is defined as:

"[A]ny 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. Virtual Currency shall be broadly construed to include digital units of exchange that (i) have a centralized repository or administrator; (ii) are decentralized and have no centralized repository or administrator; or (iii) may be created or obtained by computing or manufacturing effort. Virtual Currency shall not be construed to include digital units that are used solely within online gaming platforms with no market or application outside of those gaming platforms, nor shall Virtual Currency be construed to include 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 and/or other designated merchants, but cannot be converted into, or redeemed for, Fiat Currency."

The proposed regulations include several interesting requirements for BitLicense holders:

  • Custody and Protection of Consumer Assets – To the extent a licensee secures, holds, stores, or maintains custody or control of virtual currency on behalf of another person, the proposed regulations require that the licensee hold virtual currency of the same type and amount as that which is owed or obligated to the other person. However, the regulations do not specify to what extent, or under what circumstances, the licensee would be obligated to guarantee or compensate a consumer for losses incurred. In the same general aim, the proposed regulations further require that licensees maintain a surety bond or trust account (in an unspecified amount), and prohibit encumbering assets held on behalf of another person in any way.
  • Capital Requirements – The proposed regulations set forth an indefinite capital requirement for license holders. It appears from the regulation that each licensee's minimum capital requirement will be determined independently, based on a number of factors, including:
    1. The composition of the licensee’s total assets, including the position, size, liquidity, risk exposure, and price volatility of each type of assets
    2. The composition of the licensee’s total liabilities, including the size and repayment timing of each type of liability
    3. The actual and expected volume of the licensee’s virtual currency business activity
    4. Whether the licensee is already licensed or regulated by the superintendent under the Financial Services Law, Banking Law, or Insurance Law, or otherwise subject to such laws as a provider of a financial product or service, and whether the licensee is in good standing in such capacity
    5. The amount of leverage employed by the licensee
    6. The liquidity position of the licensee
    7. The financial protection that the licensee provides for its customers through its trust account or bond
  • Investment Restrictions – The proposed regulations only permit a licensee to invest its retained earnings and profits in the following types of high-quality, investment-grade permissible investments, with maturities of up to one year, denominated in U.S. dollars: certificates of deposit issued by federal or state-regulated financial institutions; money market funds; state or municipal bonds; U.S. government securities; or U.S. government agency securities.

The regulatory framework also includes provisions covering recordkeeping, examination and supervision by the DFS, financial reporting, anti-money laundering compliance, cybersecurity programs, consumer protection disclosure requirements, and handling of consumer complaints.

The proposed regulations were published in the New York State Register on July 23, 2014, and have a 45-day comment period.

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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