On June 3, 2015, New York became the first state in the United States to issue regulations for virtual currency licenses. The final regulations differ only slightly from the revised draft regulations issued by the New York State Department of Financial Services (NY DFS) in February, which we had previously covered.
By way of background, virtual currencies, sometimes called digital currencies or cryptocurrencies, do not exist in tangible form, but rather are purely digital. Users transfer them from an encrypted computer file known as a “wallet” either directly to merchants and other third parties, or by way of third party exchanges. Virtual currencies are not issued or backed by any government. Their value is determined from online exchanges and can fluctuate significantly. The best known example of a cryptocurrency is called a Bitcoin, which was created in 2009. The license described by the NY DFS regulation is sometimes called a “BitLicense.”
The key definitions in the final regulation are those for virtual currency and virtual currency business activity:
- “Virtual currency” is (subject to certain limited exemptions) any type of digital unit that is used as a medium of exchange or a form of digitally stored value, and includes 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; and
- “Virtual currency business activity” (which would subject the relevant business to licensing, with a few limited exemptions) is the conduct of any one of the following types of activities involving New York or a New York resident:
- receiving virtual currency for transmission or transmitting virtual currency (except where the transaction is undertaken for non-financial purposes and does not involve the transfer of more than a nominal amount of virtual currency)
- storing, holding, or maintaining custody or control of virtual currency on behalf of others;
- buying and selling virtual currency as a customer business;performing exchange services as a customer business; or
- controlling, administering, or issuing a virtual currency (the development and dissemination of software in and of itself does not constitute virtual currency business activity).
Note that these definitions do not include the following activities:
- Digital units that are used solely within an online gaming platform, and that cannot be used outside that platform or converted into fiat (government-issued) currency or real-world goods, services, discounts, or purchases;
- Digital units that can be redeemed for goods, services, discounts or purchases as part of a customer rewards or affinity program, where they cannot be converted into fiat currency; and
- Prepaid (gift) cards that are issued in fiat currency and are only reloadable with fiat currency.
In his speech announcing the new regulations, Superintendent of Financial Services Benjamin Lawsky, who will be leaving the agency this month, stressed that New York has “no intention of being a regulator of software developers—only financial intermediaries.” Consistent with that statement, he said that “companies will not need prior approval for standard software or app updates—only for material changes to their products or business models.”
A material change or materially new product, services or activity is described by Section 200.10 of the new regulation. The new regulation’s focus is on the effect of the change, rather than on any specifically enumerated activity or percentage change from the original:
A “materially new product, service, or activity” or a “material change” may occur where:
(1) the proposed new product, service, or activity, or the proposed change may raise a legal or regulatory issue about the permissibility of the product, service, or activity;
(2) the proposed new product, service, or activity, or the proposed change may raise safety and soundness or operational concerns; or
(3) a change is proposed to an existing product, service, or activity that may cause such product, service, or activity to be materially different from that previously listed on the application for licensing by the superintendent.
Superintendent Lawsky also noted that companies would not need NY DFS approval for each new round of venture capital funding.
In addition, while the final regulations still require establishment of a detailed anti-money laundering program, the NY DFS eliminated a requirement for companies to file suspicious activity reports regarding these transactions if the licensee is already subject to such reporting requirements under federal law.
As we previously reported, on May 6, 2015, the NY DFS authorized itBit Trust Co. LLC to engage in the business of a limited purpose trust and to act as a virtual currency exchange. It will not need to also obtain a BitLicense but will need to comply with the final regulations.
Norton Rose Fulbright has just published the first chapter of a global legal and regulatory guide to cryptocurrencies. The guide will be published in a series of chapters covering a range of legal and regulatory issues relating to cryptocurrencies. You can download the first chapter and register to receive subsequent chapters here.