The New York Department of Financial Services (DFS) recently issued proposed regulations for businesses that deal with “virtual currencies,” defined by the U.S. Department of the Treasury as a medium of exchange that operates much like traditional currency, but only in some environments. Virtual currencies are gaining in prominence as an alternative to fiat currencies like the dollar and the euro, although they have been highly controversial. New York appears to be one of the first states to take serious steps towards regulating businesses that perform virtual currency transactions for customers.
Bitcoin is probably the most famous virtual currency, but it is far from the only one. The currency only exists in the online world, having no physical representation like actual coins or bills. The process by which new Bitcoins are created, known as “mining,” involves performing increasingly complex computer calculations. Bitcoin has grown as a form of payment for goods and services online, but it is also the subject of scrutiny based on allegations that it is used for illegal online purchases, such as drugs and identity theft information.
Bitcoin is treated somewhat like a commodity by some people, as suggested by the fact that the value of one Bitcoin is typically expressed in terms of U.S. dollars. Online exchanges allow people to exchange various other currencies for Bitcoins. As of mid-November 2014, one Bitcoin is worth about $400. One presumably happy Norwegian man discovered in late 2013 that the $27 worth of Bitcoins he purchased in 2009 had appreciated in value to about $886,000.
In August 2013, a U.S. federal judge ruled that Bitcoin is a form of currency, in a case that accused a defendant of running a Ponzi scheme based on Bitcoins. SEC v. Shavers, No. 4:13-cv-00416, mem. op. (E.D. Tex., Aug. 6, 2013). The largest Bitcoin exchange in the world, Tokyo-based Mt. Gox, declared bankruptcy in February 2014 after hundreds of millions of dollars’ worth of Bitcoins disappeared from its servers. These events may have given added urgency to DFS’ regulation efforts.
DFS sent subpoenas in August 2013 to 22 businesses and investors that dealt in Bitcoins, seeking information on their funding sources, consumer-protection and anti-money laundering measures, and investment strategies and pitches. In July 2014, it issued a proposed “BitLicense” regulatory framework that would apply to companies that receive, transmit, exchange, or store virtual currency on behalf of customers. 2014-36 N.Y. St. Reg. 29 at 14. The proposed regulations are, according to DFS, geared towards protecting consumer assets, ensuring that transactions made on consumers’ behalf are documented and traceable, ensuring that consumers receive adequate disclosures and have avenues for making complaints, providing for adequate cybersecurity measures, and preventing money laundering.
In public remarks about the proposed regulations in October 2014, the Superintendent of Financial Services clarified that only companies that exchange virtual currency will be required to obtain BitLicenses, not software developers or individual users. He announced in November that the regulations would include a “Transitional BitLicense,” which would allow some flexibility for startups and small businesses for a limited initial time period.
Samuel C. Berger is a business attorney who represents businesses and entrepreneurs in a wide range of legal matters in New York and New Jersey. We offer fixed-fee legal-service packages that help our clients understand their rights and obligations under the law, and that allow them to operate their businesses both efficiently and effectively. To speak to a member of our skilled and experienced legal team, contact us today online or at (212) 380-8117.
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Photo credit: By Mrnett1974 (Own work) [CC-BY-SA-3.0], via Wikimedia Commons.