It’s only been about a week since New York’s outgoing Superintendent of Financial Services Ben Lawsky released the long-awaited “BitLicense” rules for digital currency businesses operating in New York, but it’s not too early to try to assess the potential impact of those rules on the development of Bitcoin-related businesses and emerging financial technologies.
The primary question on everyone’s mind: Are the BitLicense regulations – the product of a nearly two-year rulemaking process – good or bad for Bitcoin? The answer: A little of both. The truth is that the BitLicense rules are a mixed bag, and how you perceive them depends to some extent on whether your glass is half-full or half-empty.
The “Glass Half-Full” Perspective
As an initial matter, the BitLicense rules represent an attempt to bring regulatory clarity and stability to an uncertain environment. Ask the entrepreneurs, engineers, venture capitalists, and bankers who are pouring their time, energy, and money into bitcoin-related businesses, and they’ll tell you that regulatory clarity is good for business. As Perianne Boring, the President of the Chamber of Digital Commerce, recently observed in another context, “Investors don’t fear regulation, they fear uncertainty.”
The BitLicense regime also confers greater legitimacy on Bitcoin. Indeed, the fact that the BitLicense rules exist at all reflects a recognition by one of the nation’s most important financial regulators that Bitcoin is here to stay and that its underlying blockchain technology is a potentially transformative force in our economy and society. With companies like Goldman Sachs, the New York Stock Exchange, and IBM now exploring the blockchain’s potential to improve everything from international securities settlement to the emerging “Internet of Things,” it’s on balance a positive development that NYDFS has crafted regulations tailored to digital currencies instead of trying to shoehorn this new technology into a set of regulations created during a bygone era.
There are a number of specific provisions, many refined based on responses to earlier drafts, that are positive, including the following:
- the rules focus on financial intermediaries – i.e., entities entrusted with safeguarding customers’ funds – while exempting software developers, retailers, and others;
- the rules do not require approval of standard software upgrades and only apply to major changes in business model or products;
- the rules require approval of changes in control, but not funding through investment rounds;
- there will be a one-stop application process for a BitLicense and money transmitter license; and
- licensed entities that file Suspicious Activity Reports with federal regulators will not have to file duplicate reports with NYDFS.
In addition, regardless of one’s opinion about the BitLicense rules themselves, those rules were the product of an open process in which regulators took seriously the views of Bitcoin companies and experts. Indeed, the final rules reflect a significant improvement over the first draft, with a number of significant changes made in response to a flood of public comments.
The “Glass Half-Empty” View
So that’s the good part. What about the other side of the (bit)coin? Critics of the BitLicense regulations have pointed to a number of features of the regime as potentially problematic, including the following:
- the arguably overbroad definition of virtual currency business activity, particularly as compared to the more circumscribed definition in California’s proposed regulations (our friends at Coin Center have done an excellent analysis on this issue);
- the imposition of cybersecurity and AML provisions that go beyond any regulations imposed on the traditional payments industry; and
- the fact that the rules impose state-level AML requirements instead of simply licensing and leaving AML regulation in the capable hands of FinCEN.
In addition, commentators have pointed to the lack of a clear, defined on-ramp for start-up companies. Indeed, one of the greatest areas of concern since the first draft of the BitLicense proposal has been the potential impact on new entrants to the market. It remains to be seen whether the costs of compliance inhibit the growth of start-ups, who are so critical to innovation in this space.
The race is on for other states to regulate digital currencies, and for better or worse, New York’s BitLicense rules will likely help shape the regulations in those other states. So critics of the BitLicense regime are working overtime to try to ensure that other states improve on, rather than simply copy, New York’s approach.
It’s About the Execution
In many ways, the blockchain today is like the Internet was 20 years ago. In the early 1990s, the earliest days of commercial exploitation of the Internet, who could have foreseen Google, Facebook, Twitter, Uber, Airbnb, Expedia, online streaming of movies and TV shows, or many of the other Internet applications that are now part of the fabric of our daily lives? That’s where we are today with the blockchain technology – a world of possibilities that most of us can’t even imagine. It’s critical that new companies be able to develop applications for that technology, and for investors to be able to fully understand the regulatory environment in which their companies are operating.
To his credit, Mr. Lawsky has recognized that the “genie is already out of the bottle” when it comes to digital currencies and other financial technology innovations. In his speech announcing the final BitLicense rules, he observed that “the technology underlying Bitcoin could be used not just as a currency, but potentially as a means to transfer all manner of personal property securely over the Internet” and that “when it comes to Bitcoin … platforms could be built upon platforms could be built upon platforms by future innovators.” With that in mind, Mr. Lawsky has said that New York’s goal was to put in place measures to protect consumers and detect illicit activities while not “doom[ing] promising new technologies before they get out of the cradle.” That is a goal everyone who supports the blockchain should embrace, but time will tell whether New York has drawn those lines in the right place.
Although he won’t be in office to implement these rules, Mr. Lawsky has recognized that the BitLicense regulations are just a starting point, and has predicted (I think correctly) that we will see a fine-tuning of those rules over the next several years as their actual impact is felt. As Mr. Lawsky noted, NYDFS “must be willing to take a hard look at how these new rules are working when they are put into practice” and must be willing to “course correct” as needed. So ultimately, whether the BitLicense rules will be good or bad for Bitcoin and the blockchain will be determined by how those rules are applied – and adjusted – over time.
More generally, the BitLicense rulemaking process underscores the value of constructive engagement and open dialogue between Bitcoin entities and regulators. Whatever your view of the BitLicense rules, there’s no question that they would have been a lot more onerous and a lot less palatable but for the ideas and input from companies and technologists and the open-mindedness of the regulators. Open dialogue and engagement will be just as important in the months and years ahead, as we see the practical impact of the regulations and as we learn whether the lines drawn by New York last week need to be moved.
Protecting Companies and Investors
For Bitcoin-related companies who may be covered by these rules, the takeaway from the announcement of the BitLicense regime, and from FinCEN’s recent enforcement action against Ripple, is clear – that compliance and AML issues need to be top of mind. This is not an area where it’s better to ask forgiveness than permission. Any company that may be impacted by these rules should get help in determining whether, or how, the rules may apply and in designing and implementing a compliance regime that will pass regulatory scrutiny while allowing the company to grow and thrive.