The growing interest in Bitcoin and other cryptocurrencies, as well as their underlying blockchain technology, has attracted the attention of state lawmakers. But as they consider imposing regulatory frameworks, legislators run the risk of hampering innovation and driving its benefits elsewhere.
Cryptocurrency and blockchain advocates believe these technologies will revolutionize the way we make payments, enter into contracts and protect our privacy. The sector has attracted over $6 billion of venture capital. Detractors express concern about blockchain’s capacity to handle large volumes of transactions. the volatility of cryptocurrency valuations, failures of Bitcoin exchanges and the use of cryptocurrency in black market activities.
Until recently, it may have been possible to dismiss the intense interest in this technology as a fad or a bubble, but a couple of recent developments suggest that cryptocurrency and blockchain are here to stay.
After spiking to almost $20,000 in late 2017, the price of Bitcoin collapsed to as low as $3,000 last year. But in recent months, Bitcoin has recovered, recently trading around $11,000. This bounce-back echoes previous price rebounds following sharp drops. The fact that Bitcoin (and other cryptocurrencies) can recover from severe price declines may suggest a level of staying power not seen with stereotypical investment fads.
Bitcoin’s valuation benefited from Facebook’s recent announcement of its Libra cryptocurrency initiative. Although Libra coins will not become available for at least a year (if at all), Facebook’s embrace of the technology and its ability to enlist support from such key financial players as Visa, Mastercard and PayPal show that cryptocurrencies have achieved a new level of credibility.
Assuming that blockchain and cryptocurrencies are here to stay, state regulation of this industry will become an important issue. Many states have adopted, or are considering, such regulation as shown in a recent survey by law firm Carlton Fields.
Below, I briefly explore the regulatory environment in the key states of California and New York.
Last year, then-Gov. Jerry Brown signed AB 2658 – a bill that creates a blockchain workgroup. The 20-member group is charged with:
- Evaluating blockchain uses, risks, benefits, legal implications, and best practices;
- Defining the term blockchain; and
- Recommending amendments to other statutes that may be impacted by blockchain.
It is required to report back to the state legislature by July 1, 2020.
Earlier this year, Assembly Majority Leader Ian Calderon proposed AB 1489 – the Uniform Regulation of Virtual Currency Businesses Act. This bill is derived from model legislation written by the Uniform Law Commission (ULC). Similar legislation has been proposed in Hawaii, Nevada, Oklahoma and Rhode Island.
According to the ULC’s frequently asked questions document on its website, the law is not intended to regulate cryptocurrencies, but rather those businesses that store, transfer or exchange them. States regulate money transmitters, businesses that engage in funds transfer, and the ULC legislation extends this regulation to firms that transfer cryptocurrencies. These regulations include registration and annual renewal requirements as well as an obligation to deposit a surety bond or other form of security with a state regulator (in California, this would be the Department of Business Oversight).
But the ULC bill excludes cryptocurrencies from its definition of legal tender even while imposing similar regulation on cryptocurrency firms. Further given the amount of disclosure required under the bill, which includes audited financial statements, proof of insurance and fingerprints for all executive officers, along with the cost of providing a security deposit, smaller startups may be dissuaded from entering the business (although the bill does exempt firms handling annual volumes of under $35,000 from its licensing regime).
The California bill is being held in committee and will not be heard until next year.
The state of New York started licensing cryptocurrency firms in 2015. Rather than pay a $5,000 non-refundable application fee and abide by 20 pages of regulations at least 10 bitcoin startups chose to stop doing business in the state.
As of early 2019, New York’s Department of Financial Services (DFS) had issued only 18 “BitLicenses,” so the loss of 10 firms appears to have been a significant hit to New York’s cryptocurrency ecosystem. Further, not all license applicants were successful. In April, for example, DFS rejected Bittrex’s application for a BitLicense, triggering a hostile exchange of press releases between the exchange and the regulator.
DFS gave Bittrex 60 days to transfer any cryptocurrency assets it was holding on behalf of New York residents. The fact that New York-based crypto investors may not be able to use the exchange of their choice might cause them to join the exodus out of the Empire State.
And it appears as though further state regulation may be on the way. In December 2018, Gov. Andrew Cuomo signed a bill creating a task force to study cryptocurrencies and blockchain. Among other things, the task force is supposed to study digital currencies’ impact on state and local tax receipts, and the energy consumption necessary for coin mining operations.
New York’s enthusiastic embrace of regulation can serve as a cautionary tale for California and other states. California’s more measured approach, rooted in uniform regulation, seems less likely to disrupt its financial technology ecosystem, but the state should consider raising licensing thresholds and relaxing the proposed regulatory regime before adopting something like the proposed AB 1489.
Both New York and California, however, might learn from a lesson from Ohio. Rather than impose onerous regulations, Ohio is trying to attract cryptocurrency entrepreneurs by making accommodative reforms. Last year, the state enacted legislation that gave blockchain-based transactions legal bearing in state courts. The state then began accepting tax payments in Bitcoin.
Several other states are also showing regulatory restraint. For example, New Hampshire passed legislation that explicitly exempts cryptocurrency exchanges from money transmitter regulation while and the Texas Department of Banking has stated that cryptocurrency exchanges are not money transmitters, and thus not subject to regulation as such.
Businesses operating on the internet have much greater freedom of movement than their brick and mortar counterparts. As blockchain and cryptocurrencies develop, states will have to compete with one another and with foreign jurisdictions to attract and retain companies in this space. Avoiding the heavy hand of overregulation is a good way to avoid losing this technology race.