In March 2013, the U.S. Financial Crimes Enforcement Network (FinCEN) issued a statement that convertible virtual currency administrators and exchangers would be considered money transmitters and would be required to register as such with FinCEN.  It was just a matter of time before states that licensed money transmitters would take action to specifically subject such activities to state regulation.  In July, New York State was the first state out of the box, with the New York Department of Financial Services (NY DFS) issuing proposed regulations requiring licensing of certain virtual currency activities.  Access the proposed rule. Comments will be accepted through September 6, 2014.

Proposed Regulatory Scheme

Proposed Part 200 of the NY DFS Regulations (not the Banking Regulations), “Virtual Currencies,”  proposes a comprehensive “BitLicense” licensing and supervision regime over persons engaged in “Virtual Currency Business Activity,” a term which is defined to include the following categories of activities involving New York or a New York Resident:

  1. receiving Virtual Currency for transmission or transmitting the same;
  2. securing, storing, holding, or maintaining custody or control of Virtual Currency on behalf of others;
  3. buying and selling Virtual Currency as a customer business;
  4. performing retail conversion services, including the conversion or exchange of Fiat Currency [i.e., government-issued legal tender] 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; or
  5. controlling, administering, or issuing a Virtual Currency.

“Virtual currency”  is defined as any 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.”  The term is to be broadly construed and would include both centralized  and decentralized repositories or administrators.  Exempted are digital units used solely with gaming platforms, or  customer affinity or rewards programs utilized solely to make purchases with the designated issuers or merchants.   The term “digital unit” does not appear to be otherwise defined.

Differences from FinCEN’s Approach

There are differences between the FinCEN approach and New York State’s approach to regulation of virtual currency.  Under FinCEN’s regulations, the definition of “money transmission services” includes the transfer of both real and convertible virtual currencies, by including the transfer of “currency, funds or other value that substitutes for currency.”  FinCEN takes the position that an administrator or exchanger of virtual currency which (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason, is a money transmitter under its regulations and must register as a money services business.  Such registration triggers the requirement to, among other compliance responsibilities, establish an anti-money laundering compliance program and report suspicious transactions.  An “administrator” is a person who is engaged in the business of issuing and redeeming virtual currency.  An “exchanger” is a person engaged in the business of exchanging virtual currency for real currency, funds or other virtual currency. Access the March 2013 FinCEN Guidance.

Money Transmitter Regulation in New York

Under the New York Banking Law, money transmitters are fully regulated and licenses are required for any person “engaged in the business of selling or issuing checks, … or receiving money for transmission or transmitting the same.”  A “check” includes checks, money orders or “other instrument for the transmission or payment of money.”  Similar to money transmitters under the Banking Law and regulations, under the proposed NY DFS rule, persons engaged in virtual currency business activity are required to be licensed, maintain a certain level of capital and liquidity, receive approval for changes of control and mergers, preserve records, and submit periodic reports.  However, the proposed regulations go beyond the money transmitter statute to specifically propose the designation of a compliance officer and a chief information security officer.  In addition, a detailed cyber security program must be established.

NY DFS Went a Different Way

Instead of using the New York Banking Law as the basis for the proposed rule, the NY DFS relied on the authority of the New York Financial Services Law that was enacted in 2011 to combine the New York Insurance and Banking Departments.  Under section 102 of the Financial Services Law, one of the goals of the new agency is to “provide for the regulation of new financial services products.”  Financial services products include most financial products or services sold to consumers.

As to why the NY DFS relied on its general authority as opposed to the New York Banking Law’s money transmitter statute, the agency stated in its formal notice of the proposed rule in the New York State Register that it had considered amending existing law but “decided not to pursue that alternative because of the widespread and potentially unforeseen ramifications such modification would have on the financial services industry and currently regulated entities.”