Plus ça change…NYDFS releases final BitLicense regulations

The New York State Department of Financial Services (NYDFS) released final BitLicense regulations on June 3, 2015, almost eleven months after the initial BitLicense proposal was issued.  The initial proposal went through two rounds of public comment and revision; however industry participants and commenters were largely disappointed by the limited scope of the changes made in the final version.

The NYDFS released the original BitLicense proposal in July 2014 after a lengthy inquiry process, during which it sent subpoenas to numerous industry participants and held public hearings in January 2014.  The original proposal imposed safety and soundness, consumer protection and anti-money laundering requirements on persons engaging in virtual currency business activities largely based on New York’s existing money transmitter laws.    However, the proposal also went beyond traditional money transmitter regulations by imposing additional anti-money laundering, cyber-security, and information technology requirements, many of which appeared to have been based in part on federal requirements applicable to banks.  We analyzed these requirements in an earlier PLA post.

Due to the unprecedented scope of the proposal, as well the NYDFS being the first state financial regulator to draft specialized regulations governing virtual currency activities rather than applying existing financial services laws, the original proposal garnered widespread interest from the public.  Nearly 3,800 comments were submitted, many of them criticizing the chilling effect that the BitLicense requirements would have on the nascent virtual currency industry.  In comparison, the Consumer Financial Protection Bureau’s proposed federal prepaid card regulations released in December 2014 received just over 6100 public comments.

In response to the comments received, the NYDFS issued a revised BitLicense proposal in February 2015.  The revised proposal made several important changes, including the following:

• Added exemptions for:
  • “Closed” virtual currencies such as gaming and loyalty points;
  • Open-loop and closed-loop gift cards;
  • Bitcoin 2.0 activities undertaken for non-financial purposes;
  • Utilization of virtual currency by consumers for investment purposes.
• Allowed the NYDFS superintendent to:
  • Grant a conditional license to an applicant that does not otherwise satisfy all of the BitLicense requirements;
  • Relieve a person from the application and due diligence requirements applicable to persons having control over the BitLicensee;
• Reduced the recordkeeping requirements with respect to transaction counterparties to require collection of their names, account numbers and physical addresses only to the extent practicable;
• Reduced the annual cyber security audit requirement to an annual review by the BitLicensee’s chief information security officer, rather than requiring a third-party source code review of internally developed software.

The revised regulations were generally well-received, with many commenters noting the Department’s responsiveness to criticisms of particularly onerous or unworkable requirements in the original BitLicense.  However, commenters continued to express reservations over the burden imposed by the regulatory framework generally and called for additional exemptions for startup companies and de minimis virtual currency transactions.  These comments remained unheeded in the final revisions to the BitLicense, which largely consist of clarifications to existing defined terms and provisions.  Among the few changes of note are the following:

• Addition of a materiality condition to the requirement to obtain the superintendent’s prior written approval for any plan or proposal to introduce or change a product, service, or activity.
• Clarification that directors and officers are not automatically deemed to be control persons.
• Removal of the requirement to file suspicious activity reports (SARs) with the NYDFS, to the extent duplicative of an obligation to file SARs with FinCEN.

The final BitLicense regulations will become effective upon filing with the Department of State and publication in the New York State Register.  As the adopted regulations prohibit engaging in specified virtual currency business activities involving New York or a New York resident without a BitLicense, virtual currency businesses issuing, administering or trading virtual currencies, or performing an exchange, intermediary or custodial role in virtual currency transactions that are either domiciled in New York or engaging in such activities with New York residents should start preparing to either file a BitLicense application, or terminate any business or customer relationships with New York residents.