Last year, we surveyed a range of executives and investors to gauge their views on the use, risks and regulation of cryptocurrencies, and seventy-two percent (72%) of respondents agreed that the cryptocurrency industry does not have a well-grounded understanding of the application of existing regulation of financial markets or financial services. However, a recent announcement by the New York State Department of Financial Services (NYSDFS) to establish a new Research and Innovation Division may be a positive step in providing appropriate regulatory clarity.
In a press announcement on July 23, 2019, New York State’s Department of Financial Services (NYDFS) Supervisor Linda A. Lacewell announced the establishment of a new Research and Innovation Division. The announcement stated that the new Research and Innovation Division will, alongside the other NYDFS divisions (including the insurance division; banking division, financial frauds and consumer protection division, capital markets division, and real estate division), be responsible for licensing and supervising virtual currencies, assess new efforts to use technology to address financial exclusion, identify and protect consumer data rights, and encourage innovations in the financial services marketplace to preserve New York’s competitiveness as a financial innovation hub.
New York State has been a leader in adopting regulations to keep up with the evolving financial services landscape, including the popularization of virtual currencies. New York first enacted 23 NYCRR 200.3 in 2015 (the “BitLicense Regulations”), which prohibits any individual from engaging in any virtual currency business activity without a license and established the requirements for those engaging these activities to obtain a “BitLicense.” Further guidance from NYDFS adopted a broad interpretation of what business activities would be subject to a license. In a FAQ, the NYDFS describes that, subject to certain exceptions, anybody engaged in any of the following activities is required to obtain a BitLicense: virtual currency transmission; storing, holding, or maintaining custody or control of virtual currency on behalf of others; buying and selling virtual currency as a customer business; performing exchange services as a customer business; or controlling, administering, or issuing a virtual currency.
One goal of the BitLicense regime is to limit the fraudulent and abusive practices that are more common in the early-stage startups that create and operate cryptocurrencies. Each licensee is required to meet a number of requirements to apply for and maintain a BitLicense. The BitLicense regulations establish a number of requirements for licensees, including: appointing a Chief Information Security Officer (CISO) to establish and maintain an effective cybersecurity program to protect the confidentiality, integrity, and accessibility of its’ data; providing an annual report to the NYDFS; and submitting quarterly financial statements and audited annual financial statements. The BitLicense regulations further restricts each licensee from introducing new products, services, or activities, or make material changes to existing products, services, or activities without the superintendent’s approval. While these requirements are stringent, an organization obtaining a BitLicense is then qualified to operate and offer its services in the state of New York and gains legitimacy as a player in the cryptocurrency industry.
The NYSDFS has come under fire for substantial delays and inefficiencies in processing applications under the BitLicense regime, with some applicants waiting nearly three years for approval. In addition to providing clarity to the BitLicense Regulations, the establishment of the new Research and Innovation Division may address these immediate concerns by providing both the necessary staff and the technological expertise necessary to process applications.
As virtual currency technology and similar technologies evolve and new use cases emerge, regulators across the country will need to stay on top of these developments to protect consumers and avoid a repeat of the turbulent financial market climate that resulted from the initial cryptocurrency boom in 2017 and subsequent cryptocurrency crash in 2018. While there is significant focus on cryptocurrency regulation, perhaps the more important function of the new Research and Innovation Division will be to anticipate and assess the impacts of these technologies on consumers and the financial services industries. NYDFS hopes that the new Research and Innovation Division will be an essential to improving the ability of the NYSDFS to regulate this rapidly changing technological landscape related to virtual currencies and maintain New York’s standing as the financial capital of the world and the center for financial innovation.