The Care and Feeding of the Crypto Ecosystem: New State Licensing is a Win
Author: Susan Joseph, SusanJosephLLC and Diversity in Blockchain, Inc. Editor: Barry Seeman, Bear Run Partners, LLC
This article does not provide legal advice or create an attorney/client relationship. This article is for informational purposes only and not for the purpose of providing legal advice. You should contact your own legal counsel to obtain advice with respect to any particular issue or problem raised in this paper. Furthermore, all services providers acknowledged or highlighted in this paper are there for discussion purposes and should not be construed as an explicit endorsement of their services. Any service provider should be engaged solely after you have performed and resolved adequate due diligence and have agreed to contracted services.
This article is based upon the experiences and observations of a crypto-seasoned attorney, Susan Joseph, and an experienced financial professional, Barry Seeman. Both contact details are found at the end of the article.
Regulators are Nurturing Innovation
Like many immature markets, the crypto-marketplace witnessed a roller coaster of engagement for cryptocurrencies and digital assets. They have cycled from being red hot to facing a crypto-winter and are now fighting back for a legitimate place at the investment table. As both a potential inhibitor to growth and an enhancer to the structure, cryptocurrencies and digital assets fall under the purview of numerous government regulators. Some of these regulators are a part of Federal oversight, while others are specific to acting on behalf of their state. The current overriding truth is that both federal and state regulators are actively engaged, and most are striving to understand the issues surrounding these assets and enact rules and guidelines in order to nurture innovation.
Many believe that regulators have stood in the way of blockchain and cryptocurrency industry development, as they have been slow, and sometimes obscure in their release of rules pertaining to the formation and trading of these assets. This is far from the truth, and an unfair view. The reality is there is frustration that the industry is not developing as quickly as many had anticipated and blaming regulators for impeding development makes little sense. The technology itself is emerging, and it will take time for it to fully develop. And with all emerging technologies, the regulators need to be educated upon these developments before making any assertive ruling in the space. Their engagement in the development of markets is critical for the promotion of a sound marketplace. One need only to look at the activities of the CFTC, SEC, FinCEN, etc. on the federal level, and certain states such as New York and Wyoming to see the level of engagement.
Growth pains will abound as the technology matures and finds its way. During this exciting and uncertain period of trial and error, consumers and industry alike need reasonable protections that can be enforced and evolve as the sector develops. Regulators recognize this and are meeting this challenge by crafting appropriate rules that enable an innovation environment to best serve its citizens. Let’s look specifically at Wyoming and New York State to see how regulators have addressed innovation.
The Wyoming SPDI
Recently Wyoming announced banking rules effective October 1, 2019 that create a new banking category called Special Purpose Depository Institutions (“SPDI”). SPDIs are non-lending banks that can accept deposits, provide payment services, custody, and apply to become a member bank of the Federal Reserve system among other things (Chapter 12, 13–13–103(b) (i)-(f). The SPDI was created with crypto/digital asset businesses in mind. Enhanced Digital Custody regulations that apply to the SPDIs were just released the week of November 4, 2019 (Chapter 19). These new regulations are critical rules that can potentially help the industry innovate.
How Can the Wyoming SPDI Help the Cryptocurrency and Digital Asset Industry?
Virtual currency transmission businesses are governed by both FinCEN and state money transmitter or equivalent law. These types of businesses must register under federal rules and be licensed under state money transmitter laws (if applicable) in each state that they operate. States may require costs, bonding, minimum net worth, and certain disclosures ranging from financial reporting and experience, audited financial statements, litigation and bankruptcy proceedings, to background checks and fingerprinting.
The practical result is virtual currency businesses will need to obtain licenses under a patchwork of different state regimes. With 50 states, this can be a confusing and complicated process. Moreover, sometimes the state licenses may be difficult to obtain. Meeting regulatory requirements can be onerous, time consuming and expensive, and may be downright prohibitive. A more streamlined approach would be very helpful.
How does a business “scale” in this regulatory environment? One solution may be to create a Wyoming SPDI that can be recognized across nearly all states. A Wyoming SPDI is a state-chartered bank, which relies on a long history of legal precedent pertaining to interstate banking laws. In practical terms, it is anticipated that a business will be able to obtain an SPDI license and then have that SPDI entity approved in approximately 42 states without additional licensure, and in the remaining states it may need to apply to the state regulator to open a branch or obtain a money transmitter license. Due to banking parity rules, it is believed that an institution with this type of banking license is likely to be recognized in nearly all states. Each state still maintains its ability to approve and control what comes into its borders, subject to interstate banking rules and multi-state compacts. It is important to point out that these institutions must meet and maintain certain capital requirements and bank grade compliance practices. This type of regulation offers strong consumer and institution protection. As contemplated, it creates a streamlined approach and may allow nearly-national footprints to be established, thus potentially offering a business the ability to regulatorily scale.
The SPDI is an Innovation Created by Regulators
Reasonable innovation is occurring through new laws. It takes time to be thoughtful and get it right. Let me say this again in all CAPS AND BOLD.
THE SPDI IS A NEW SOLUTION WITH REASONABLE RULES OF THE ROAD THAT MIGHT ENABLE THE INDUSTRY TO BETTER OPERATE BECAUSE IT ENABLES REGULATORY SCALE. THIS SOLUTION WAS INVENTED BY REGULATORS WITH TECHNOLOGISTS AND INDUSTRY INPUT.
The NY BitLicense
The New York Department of Financial Services (“NYDFS”) took the bull by the horns in 2015 and pioneered the BitLicense that allows cryptocurrency businesses to operate within New York State or to engage with New York residents. The application check list can be found here. Before the BitLicense was implemented, much public input and debate was sought. An article written by Davis Polk summarizes some of this discussion.
NYDFS Innovated by Creating the BitLicense
Whether you like the BitLicense or not, NYDFS stepped up to the plate to put a framework together so businesses dealing in and with virtual currencies could operate with certainty and consumers could be protected. NY regulators acted at the outset of this industry to help move it forward.
There have been plenty of articles complaining about the difficulty of obtaining a BitLicense. Approximately 18 businesses have been licensed under this regime to date. Businesses have left New York State claiming the BitLicense process is too time consuming, requires too much disclosure and is onerous. Not all agree. Firms like Gemini have chosen to operate in New York. They understand that meeting these tough regulations might make them a clear winner for both consumers and institutions in the battle of which crypto exchange to choose. To that end, earlier this year, Gemini advertised with slogans on taxis and New York City subways that said “crypto needs rules.”
NYDFS Continues to Evaluate its Approach to the Blockchain Sector
New York State regulators have actively listened to the crypto and blockchain industry. Recently, NYDFS Superintendent Linda Lacewell said the agency was looking into the BitLicense. As proof of this, a new Research and Innovation Division was created in July to oversee internal transformation and market innovation. It will, among other things, house the division for licensing and supervising virtual currencies. Further, a task force composed of technologists, consumers, institutional and retail investors, representatives of enterprises and academics was formed that will evaluate if/how the law serves New York individuals and businesses located in the state. Reports will be issued by December 15, 2020 that will include an industry overview and proposals on how the state may best regulate, define or use cryptocurrencies. It may be that tweaks will be made to the process. The report will also look at mining costs and energy impact, taxation, and cryptocurrency trading activities.
Blockchain technology in general has broad applications and it is good to see regulators looking at it holistically. It is clear that New York State is taking this sector seriously and continues to commit to serve it.
Wyoming and NY Regulators Support this Business Sector
Comments have been made that the Wyoming SPDI may be a backdoor to operate in New York State without obtaining a BitLicense, if the SPDI obtains NYDFS permission to open a branch in New York. This may be true. Some of these articles are careful to point out that NYDFS still has the ultimate authority to approve SPDI branches within the state.
States are charged with and need to reasonably protect their citizens via regulations regarding cryptocurrencies. Tussles between states seeking to entice businesses to find a home within their borders and protect their citizens is nothing new. Consumers and businesses win when there is competition and choice in a market. There is no need to create a “rock em sock em robots” atmosphere. Too often this sector is its own worst enemy. New and creative ways to accomplish goals to further the industry should be applauded.
Conclusion
Both New York State and Wyoming regulators are actively engaged to help support the blockchain industry. Early on New York State licensed this industry to protect consumers and spur responsible industry growth. Wyoming created a framework that hopefully will allow this sector to flourish. The point of these regulations is to make this sector safe for consumers, promote responsible innovation, and create accountability and a framework from which entities may operate. Recognition should go to the regulators for stepping up to innovate while protecting their constituencies. With Thanksgiving coming, let us all say, “thank you.”
For more information on these subjects, please contact:
Author: Susan Joseph: sjoseph@susangjoseph.com / www.susangjoseph.com
LinkedIn: www.linkedin.com/in/susangjoseph/
Twitter: @SusanJoseph1786
Editor: Barry Seeman at barry.seeman@bearrunpartners.com / www.bearrunpartners.com
