On February 4, 2015, the New York Department of Financial Services (NY DFS) issued a revised proposed regulation for certain virtual currency activities. In response to comments received on its initial draft, NY DFS has revised almost every one of the now 22-section draft proposed regulation. Review the original draft regulation.

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 proposed by NY DFS is sometimes called a “BitLicense.”

Many of the NY DFS proposed regulatory changes appear to be clarifications, such as the changes to the definition of “Virtual Currency Business Activity.”  Although transmission of virtual currency remains a “Virtual Currency Business Activity” that would require a license, a new exclusion has been added in circumstances in which: “Transmission is undertaken for non-financial purposes and does not involve the transfer of more than a nominal amount of Virtual Currency.”  NY DFS also revised the definition of Virtual Currency with some new exclusions:  (a) gift cards that are usable at a single merchant or group of merchants or service providers that potentially but not necessarily are able to be redeemed for the same type of funds that were used to purchase or load onto the card; and (b) digital units that can be redeemed for goods, services, discounts or purchases from the issuer or from designated merchants, but cannot be redeemed for either virtual or fiat currency.

NY DFS added a new exception for the license requirements for any merchant or consumer who holds virtual currency for investment purposes.

NY DFS has also revised the now-fifteen requirements for a license application. The Department has added a new type of license for those who cannot meet all of the regulatory requirements for a standard license. This new license is called a “conditional license” and is a renewable, two-year license, which can subject the licensee to heightened regulatory review, including more frequent examinations. NY DFS has also specified that the license application fee is $5,000.

Rather than specifying how licensees can invest any retained earnings and profits, NY DFS now proposes capital requirements that permit licensees to hold these funds in virtual currency, among other permitted investments—although all investments must be in proportions acceptable to the Superintendent.

With respect to books and records, NY DFS changed the proposed recordkeeping requirements so that licensees must retain the names, physical addresses, and account numbers  of the party or parties to any transaction that are customers or account holders of the licensee. The licensee must retain that information for other parties to the transaction only “to the extent practicable.”  NY DFS also shortened the proposed retention period from 10 years to 7 years.

NY DFS has also revised the cybersecurity requirements. Rather than require licensees to enclose hardware in locked cages, the revised proposal would require audit trails to demonstrate that the licensee is limiting electronic and physical access permissions to the hardware. NY DFS also replaced a requirement for source code reviews with a proposed requirement relating to application security. This new requirement would mandate that licensees have procedures, guidelines, and standards “reasonably designed to ensure the security of all applications” that the licensee uses—and that they must be reviewed and updated at least annually.

NY DFS deleted a provision in the draft regulations that would have permitted customers who are victims of fraud to claim compensation from any “trust account, bond or insurance policy maintained by the Licensee.”  NY DFS also deleted a provision that would have required the Licensee, when opening an account for a new customer and prior to entering into an initial transaction for, on behalf of, or with such customer, to disclose to the customer the Licensee’s liability to the customer under any applicable federal or state laws, rules or regulations.

Comments on the new proposed regulation will be accepted for 30 days from the date of publication in the New York Register.