Viewpoint: Virtual Currency State Roundup
By David Beam, Kathryn Baugher, Jeremy McLaughlin and Christopher Shelton, K&L Gates LLP
Virtual currency service providers are bringing virtual currency to the masses. A few years ago, you needed to be tech-savvy to pay with a bitcoin. Now, a plethora of providers let anyone who can operate a computer buy, pay with and get paid with virtual currency.
Figuring out the best way to regulate these service providers has been hard. Financial regulators say that regulation is needed. So do many service providers. Many state regulators have concluded that their states’ money transmitter laws apply to some virtual currency services. But many of these regulators also realize that the rules under money transmitter laws do not always mesh well with some aspects of virtual currency. As a result, the search for a more appropriately tailored regulatory regime is on.
This article summarizes some of the proposals at the state level to regulate virtual currency. This article has four parts. Part I explains why it can be uniquely hard for virtual currency service providers to follow money transmitter laws. Part II discusses the alternative frameworks proposed by the Conference of State Bank Supervisors (CSBS) and the Uniform Law Commission. Part III describes some statutes and rules that have been enacted or proposed. Finally, Part IV comments on these developments.
I. Challenges Associated with Operating a Virtual Currency Business under Existing State Money Transmitter Laws
Most state money transmitter laws do not expressly mention virtual currency transactions. However, the drafters of many state money transmitter laws recognized that new forms of value might arise in the future. They drafted their laws to capture future forms of value that did not even exist at the time. For example, about 20 states regulate the transfer of “monetary value,” not just “money.” Monetary value typically is defined as “a medium of exchange, whether or not redeemable in money.” This definition is the one used in the Uniform Money Services Act (UMSA). The official comments to the UMSA explain that the definition of monetary value “must remain flexible to allow regulators to deal with emerging forms of monetary value … on a case-by-case basis.” The comments say that the term medium of exchange “connotes that the value that is being exchanged be accepted by a community, larger than the two parties to the exchange.” Thus, the comments note that a certain type of value “might not constitute a medium of exchange when first introduced, but might evolve into a more commonly accepted form of payment and would become a medium of exchange.” Most virtual currencies at least aspire to be a “medium of exchange” under this definition. Service providers that receive and transfer these virtual currencies potentially get swept up by money transmitter laws that use these (or similarly broad) definitions. Some administrators of centralized virtual currencies also might be “selling” or “issuing” monetary value in the form of stored value. Selling or issuing stored value requires a license in most states.
The drafters of the UMSA and many other state laws were prescient enough to anticipate forms of value like virtual currency when they drafted definitions. But it is not clear that they considered fully how the substantive rules for money transmitter licensees would apply to virtual currency service providers. The rules under money transmitter laws do not always make sense when applied to virtual currency transactions. Service providers operating under these laws may find compliance to be challenging.
For example, the “permissible investment” rules in money transmitter laws present a particular problem. These rules exist under most money transmitter laws. They generally require a licensee to hold certain assets, at all times, with a market value equal to or greater than the aggregate amount of the licensee’s outstandings throughout the U.S. In this context, an “outstanding” is an amount owed by the licensee due to the receipt of monetary value for transmission or the issuance of stored value. An outstanding might be owed to the person who provided the monetary value or a designated recipient.
The assets that can serve as permissible investments vary by state. However, virtual currencies do not expressly qualify as permissible investments in most states. Regulators in some states have the discretion to permit virtual currency to be treated as a permissible investment. However, regulators in other states arguably do not have this authority.
This presents a dilemma. If a licensee’s obligation to deliver virtual currency is an “outstanding” under money transmitter laws, then holding virtual currency equal to the amount of the obligation would appear to be a prudent practice. However, this prudent practice might not satisfy permissible investment rules. For example, suppose a licensee receives 100 bitcoins from a customer. The licensee must make 100 bitcoins available to the customer or a recipient that the customer designates. If the licensee holds 100 bitcoins in its reserves to back up this outstanding, it will ensure that it has the 100 bitcoins it needs when it’s required to pay the obligation. However, holding bitcoin reserves might not literally satisfy the permissible investment requirements triggered when the licensee received 100 bitcoins from the customer. Instead, under many money transmitter laws, the licensee is required to hold permissible investments equal to the dollar value of 100 bitcoins.
This might be manageable if bitcoin did not go up in value after the licensee received the bitcoins from the customer. The licensee could liquidate the 100 bitcoins and hold the cash in reserves (either in the form of cash or other type of permissible investment). The licensee can then use these assets to buy bitcoins in the future when it needs them. The licensee probably will hold bitcoin reserves—acquired with its own assets rather than customer funds—to manage its short-term obligations. However, with careful reserve management the licensee should be able to ensure that it always has sufficient bitcoins to honor outstandings with a modest reserve surplus.
The potential problem arises if bitcoin rises in value. Suppose bitcoins are worth $200 at the time the customer delivered the 100 bitcoins to the licensee. The licensee will liquidate these bitcoins and hold $20,000 in permissible investments to back up its outstanding to this customer. If bitcoin subsequently doubles in value, the licensee has an obligation to make $40,000 worth of bitcoins available to its customer—but only $20,000 in permissible investments.
There would have been no problem if the licensee had been permitted to count bitcoins as permissible investments. The licensee could hold 100 bitcoins in its virtual vault. No matter what happens to bitcoin values—up or down—the licensee will always have bitcoins sufficient to meet its outstanding to this customer.
So how do licensees solve this problem? One short-term solution would be to double-back outstandings. Bitcoins received from customers are held in reserve. The licensee also holds a portfolio of assets equal to the value of its oustandings that qualify as permissible investments. The downside of this is that the licensee must tie up funds raised from investors to meet the permissible investment requirement. As the licensee grows or bitcoin rises in value, the licensee will need to raise funds to grow its permissible investment portfolio. The portfolio might provide investors with a decent return on investment, so raising funds might not be impossible. The licensee might even issue preferred stock to investors that want exposure to assets that qualify as permissible investments and use the float on the permissible investments to pay the dividends. But all of this is unnecessarily cumbersome. Bitcoin entrepreneurs should be able to focus on raising capital to develop bitcoin services. Additionally, this excess capital requirement will be a barrier to entry for many startups.
This assumes that state regulators enforce literal compliance with the permissible investment requirements. A short-term solution is for regulators to exercise discretion to allow virtual currency service providers to count virtual currency as permissible investments. Regulators in some states have the authority to allow a licensee to count certain assets as permissible investments even if the assets do not meet the statutory definition. Even regulators who lack this explicit authority can, in theory, exercise their enforcement discretion not to require literal compliance with the permissible investment rules. But regulator discretion is not a permanent solution. Virtual currency service providers need a predictable and explicit set of rules tailored to their businesses.
II. Proposals for a Uniform Regime
Two entities are seeking to issue proposals for a uniform regulatory regime for virtual currency service providers: the CSBS and the Uniform Law Commission.
CSBS is a voluntary organization of financial regulators. Its members hail from all 50 U.S. states, the District of Columbia and U.S. territories. CSBS published a draft version of the CSBS Model Regulatory Framework for Virtual Currency Activities (Framework) in December 2014 for public comment. CSBS issued the final Framework in September 2015.
The Framework is not a uniform law that can be copied and pasted into statute books. Rather, it is a guide for policymaking on the state level.
- Definition of Virtual Currency
The Framework provides the following definition of virtual currency:
Virtual Currency is a digital representation of value used as a medium of exchange, a unit of account or a store of value, but does not have legal tender status as recognized by the United States Government. Virtual Currency does not include the software or protocols governing the transfer of the digital representation of value. Virtual Currency does not include stored value redeemable exclusively in goods or services limited to transactions involving a defined merchant, such as rewards programs.
The Framework encourages states to adopt this common definition “to clarify the scope of their statutes and promote consistency over state lines.”
One notable aspect of this definition is that it excludes “the software or protocols governing the transfer of the digital representation of value.” Among other things, this appears to expressly exclude the use of blockchain technology for purposes other than virtual currency from the scope of regulation.
- Activities Subject to Regulation
The Framework states that: “It is CSBS policy that entities performing activities involving third party control of virtual currency should be subject to state licensure and supervision like an entity performing such activities with fiat currencies.” The Framework then states that the following are the “minimum” virtual currency activities that should be regulated “when carried out on behalf of another”:
- Sovereign currency for virtual currency or virtual currency for sovereign currency
- Virtual currency for virtual currency
- Services that facilitate the third-party exchange, storage and/or transmission of virtual currency (e.g., wallets, vaults, kiosks, merchant-acquirers and payment processors).
The Framework includes a number of specific exceptions from coverage.
- Licensing Requirements
The Framework recommends that entities engaging in virtual currency activities be licensed at the state level. It suggests that applicants for licenses would be required to provide details of their business plan; details of their banking arrangements; and information about their “owners, directors and key personnel,” apparently including background checks for these individuals.
The Framework rejects calls for an “on ramp” in which startup companies that have low volumes or limited business activities would be exempted from licensing. The CSBS maintains that “consumers can be harmed by entities regardless of size.” It also says that it would be too complex to develop rules governing an “on ramp” system.
- Financial Strength and Stability Requirements
The Framework notes that “it is important that virtual currency companies, like other regulated financial services companies, show sufficient financial strength to maintain sound operations and to protect consumers/customers should the company experience financial distress.”
The Framework borrows several of the tools that have long been used to ensure the financial stability of money transmitter licensees. These include net worth and capital requirements; a requirement to maintain a surety bond; and requirements to hold “permissible investments.” It calls for regulators to have flexibility in how they structure these requirements.
The Framework acknowledges the issue, discussed above, that arises when a licensee is required to hold fiat currency-denominated permissible investments to match virtual currency outstandings. The Framework says that a virtual currency company could have permissible investments denominated in fiat currency. But it also says that some of the licensee’s permissible investments might be denominated in the virtual currency. This is because “virtual currency is volatile and consumer funds must be protected, but for reserve purposes the volatility is pegged when using a like kind store of value.”
The Framework says that a virtual currency company could demonstrate that it holds the necessary permissible investments through “(i) Cryptographic proof of reserves; (ii) Independently audited reserve accounts; (iii) Segregated accounts; or (iv) Funds held in trust by third parties.”
Additionally, the Framework calls for “policies, procedures, and documentation for disaster recovery, emergency preparedness plans, and customer access to funds in the event of failure.”
- Consumer Protection Requirements
The Framework calls for a number of measures to protect individual consumers:
- Required consumer protection policies and documentation of such policies
- Holding an actual amount of virtual currency in trust for customers and ensuring that amount is identifiable separately from any other customer or virtual currency business entity holdings
- Required policies and documentation of complaints and error resolution
- Required receipt to consumers with disclosures regarding exchange rates
- Required disclosures to consumers about risks that are particular to virtual currency
- Required disclosure of virtual currency insurance coverage, which at a minimum includes notice that virtual currency is not insured or otherwise guaranteed against loss by any governmental agency
- Public disclosure of licensing information and agency contact information
Although the Framework requires a consumer disclosure regarding insurance, it does not include any substantive requirements regarding insurance coverage: “CSBS has not included cyber insurance in the final framework, but encourages continued exploration of insurance and other market based risk management solutions. As the market for such cyber-risk management solutions continues to evolve, it may be appropriate for state regulators to consider such coverage in evaluating a firm’s overall cybersecurity protections.”
- Cybersecurity Requirements
The Framework includes the following cybersecurity requirements:
- Required cybersecurity program and policies and procedures
- Customer notification and reporting requirements for cybersecurity events
- Where necessary, cybersecurity audit requirements, with flexibility for state regulators to determine the appropriate level of the audit based on business model and activity levels
The original draft of the Framework included a more stringent requirement for a third-party cybersecurity audit of all virtual currency requirements, but the final Framework “was modified to provide more flexibility,” given “this can be costly and potentially premature for startups.”
- Anti-Money Laundering
The Framework calls for states to impose the following requirements related to AML:
- Implementation and compliance with BSA/AML policies, including documentation of such policies
- Compliance with applicable federal BSA/AML laws and recognition of state examination and enforcement authority of BSA/AML laws
- Verification of service user identity
The Framework does not appear to add any significant new AML requirements beyond what’s required by federal law: “Commenters all agreed that the anonymous nature of virtual currency transactions raises new challenges for detecting and monitoring fraud and other illegal activity. However, the commenters also agreed that existing federal BSA/AML policies are sufficient.”
- Banking Relationships
The Framework acknowledges that virtual currency companies “may face challenges obtaining bank accounts for transactional purposes.” But it rejects calls for “bright line rules regarding regulated activity to help with banking relationships.” Instead, “state regulators believe that banks must evaluate existing and potential customer relationships based on the risks particular to a given customer.” Because of this approach, the Framework does not include any rules that would assist virtual currency companies in gaining access to the banking system.
- General Compliance Requirements
The Framework includes a number of general compliance requirements common to regulated companies: designation of a chief compliance officer, written compliance policies and procedures, sending periodic reports to regulators and recordkeeping requirements. The Framework also has provisions on licensee oversight of agents. Virtual currency companies would be subject to examinations, investigations and enforcement actions by state regulators.
The Uniform Law Commission (ULC) Drafting Committee on Regulation of Virtual Currencies also is preparing a proposal for uniform state regulation. At its first meeting in October 2015, the committee considered an initial working draft of a uniform law for regulation of virtual currency service providers. The current working title is the Regulation of Virtual Currencies Act (Draft RVCA).
The Draft RVCA is in an extremely early stage and likely to change substantially before it is finally adopted by the ULC.
- Definition of Digital Currency
Despite its name, the Draft RVCA uses the term digital currency instead of virtual currency. (Digital currency is the preferred term in the industry. We would have used it in this article, except for the fact that most of the laws and proposals we cover use the term virtual currency.) The Draft RCVA’s basic definition of digital currency is “any type of digital unit that is used as a medium of exchange and that operates like currency in some environments, but is not legal tender and does not have the attributes of real currency.” The definition goes on to provide that the term should “be broadly construed to include” decentralized and centralized units of exchange. The definition also says it encompasses units of exchange that can “be created or obtained by computing or manufacturing effort.” The definition specifically excludes:
- Units of value for gaming platforms that cannot be used outside the platform;
- Points under rewards and loyalty programs;
- Digital units that cannot be converted into legal tender or used as a substitute for real currency;
- Digital units associated with prepaid cards.
- Licensing Requirement
The Draft RVCA would require a license either to “engage in any digital currency business” or to “advertise, solicit or hold itself out as providing digital currency.” Digital currency business activity is defined as the following (if engaged in as a business activity):
- Issuing or circulating a digital currency or having the authority to redeem or withdraw the same
- Exchanging digital currency for or converting digital currency to fiat currency or another type of digital currency
- Receiving more than a nominal amount of digital currency for transmission or transmitting more than a nominal amount of digital currency
- Storing, holding or maintaining custody or control of digital currency for others
- Buying and selling digital currency as a customer business
- Exchanging digital currency as a customer business
- Controlling or administering a digital currency
The following activities are specifically excluded:
- Development or dissemination of software related to digital currency activity
- Provision or sale of prepaid access
- Acting as a dealer in foreign exchange or
- Obtaining digital currency to purchase goods or services
Various kinds of entities are exempt from the licensing requirement, including banks.
- Requirements for Licensees
The Draft RVCA would impose various requirements on licensees that mirror the requirements imposed on money transmitter licensees. Licensees would be required (among other things) to procure surety bonds (or alternative security devices), maintain a certain net worth (the amount of which remains to be proposed), submit to examinations and file periodic reports.
The Draft RVCA also would require licensees to hold permissible investments equal to the aggregate amount of:
- All outstanding digital currency transfers the licensee has been instructed to make by the owners of the private keys identifying the addresses of the digital currency to be transferred; and
- All digital currency private keys it has in its custody.
The Draft RVCA also would provide regulators with broad flexibility to decide on the kinds and combination of assets that may serve as permissible investments, but it has a placeholder for the types of assets that may qualify as permissible investments. A note for the placeholder explains that an open question is whether to mimic the UMSA’s list of permissible investments or adhere to the more flexible approach advocated by the CSBS.
III. Proposed and Enacted State Legislation/Regulation
Not all state legislators and regulators have been waiting patiently for the CSBS’s recommendations. Legislation and regulations have been proposed or enacted in a number of states. In Part III, we discuss some of these proposals and enactments.
A. Enacted Rules and Statutes
New York is the only state to have comprehensive regulations aimed specifically at virtual currency. These rules were adopted by the New York Department of Financial Services (DFS) on June 3, 2015. Under the rules, a license is required to engage in any Virtual Currency Business Activity, defined as any of the following activities involving New York or a New York resident:
- Receiving virtual currency for transmission or transmitting virtual currency, except where the transaction is undertaken for non-financial purposes and does not involve the transfer of more than a nominal amount of virtual currency;
- 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.
Transmission is “the transfer, by and through a third party, of virtual currency from a person to a person . . . .”
A licensee is subject to quarterly and annual reporting requirements, disclosure requirements and extensive AML and cybersecurity requirements. Licensees are required to “maintain at all times such capital in an amount and form as the superintendent determines is sufficient to ensure the financial integrity of the Licensee and its ongoing operations based on an assessment of the specific risks applicable to each Licensee” as well as a surety bond or trust account. The regulations avoid the permissible investments problem identified above, however, by permitting licensees to meet the capital requirement with “cash, virtual currency, or high-quality, highly liquid investment-grade assets, in such proportions as are acceptable to the superintendent.”
Connecticut recently amended its Money Transmission Act to address virtual currency. The new legislation requires a money transmitter applicant to specify in its application whether its money transmission activities “will include the transmission of monetary value in the form of virtual currency.”
The legislation allows the commissioner discretion to deny a money transmitter application if the applicant intends “to engage in the business of transmitting monetary value in the form of virtual currency” and it presents undue risk to consumers. Alternatively, the commissioner may impose additional requirements, restrictions or conditions on such an applicant. The legislation also requires such applicants to hold a surety bond in an amount determined by the commissioner. The Connecticut Money Transmission Act grants the commissioner authority to approve the use of “other investments” to meet the permissible investment requirement.
The Texas Money Services Act requires a license to “engage in the business of money transmission.” Money transmission is defined as “the receipt of money or monetary value by any means in exchange for a promise to make the money or monetary value available at a later time or different location.” The statute defines money or monetary value as “currency or a claim that can be converted into currency through a financial institution, electronic payments network, or other formal or informal payment system.”
In April 2014, the Texas Department of Banking issued guidance on the application of the Money Services Act to virtual currency activities. The guidance distinguishes between (a) centralized virtual currencies, which it explains are created and issued by a specified source and rely on an entity with some form of authority or control over the currency, and (b) decentralized virtual currencies, which are not created or issued by a particular person or entity, have no administrator and have no central repository. For centralized virtual currencies, the guidance concludes that the department will have to make individual licensing determinations. For decentralized currencies, however, the guidance concluded that some, but not all, virtual currency activities are subject to the Money Services Act.
The Texas law defines monetary value more narrowly than most other money transmitter laws that use that term. As explained above, it includes only currency or a claim that can be converted into currency through a financial institution or payment system. The department concluded that a decentralized virtual currency was neither. As a result, the department concluded that the receipt of decentralized virtual currency for transmission does not require a money transmitter license in Texas. It also concluded that exchanging one virtual currency for another was not money transmission. However, it did conclude that the receipt of fiat currency in exchange for virtual currency would constitute the receipt of “monetary value” for transmission and thus require a license.
The guidance notes that cryptocurrency businesses that conduct money transmission must comply with all applicable licensing provisions of the Money Services Act. It specifically notes that “a license holder may not include virtual currency assets in calculations for its permissible investments.”
The Washington Uniform Money Services Act (WUMSA) requires licensure “to engage in the business of money transmission.” The act defines money transmission as “receiving money or its equivalent value to transmit, deliver or instruct to be delivered the money or its equivalent value to another location, inside or outside the United States, by any means.”
In December 2014, the Washington Department of Financial Institutions (DFI) issued Interim Regulatory Guidance on Virtual Currency Activities (the “Guidance”) to explain the DFI’s views on how the WUMSA applies to virtual currency activities. The Guidance identifies three types of virtual currency-related activities that constitute “money transmission” under the WUMSA, and thus require a license:
- Exchanging sovereign currency for virtual currency, or vice versa.
- Exchanging virtual currency for virtual currency.
- Offering virtual currency wallets for storing value.
DFI has also issued a “Virtual Currency Regulation.” The regulation, however, simply repeats the Guidance’s conclusion that “digital currency is included in the definition of ‘Money Transmission’ in the [WUMSA].” It notes that “[c]ompanies wishing to transmit money for Washington residents in a digital currency form can contact DFI for a determination whether licensure under the [WUMSA] is required.”
The WUMSA is typical in requiring licensees to maintain permissible investments “of not less than the amount of the licensee’s average outstanding money transmission liability.” It also requires that “[l]icensees must hold virtual currency of the same type and value as that held by the licensee but which is obligated to consumers.” The Guidance also says that “[v]irtual currency value is not a permissible investment” for purposes of the WUMSA. Thus, the Guidance appears to require that a licensee hold virtual currency and permissible investments equal to outstandings.
B. Proposed Legislation
On Feb. 27, 2015, the Virtual Currency Act, Assembly Bill 1326, was introduced in the California Assembly. It has passed the state Assembly and is under review in the state Senate.
The most recent version of the bill (dated Aug. 18, 2015) requires a license to engage in “any virtual currency business in [California].” The term virtual currency business is defined narrowly as “maintaining full custody or control of virtual currency in [California] on behalf of others.” The bill imposes a variety of requirements on licensees, including annual renewal requirements, annual reporting requirements, disclosure requirements and a bond requirement. In an effort to combat the permissible investments problem identified above, the bill does not impose a permissible investment requirement. Instead, it requires licensees to maintain capital and a bond in amounts determined by the Commissioner of Business Oversight. The bill also allows for provisional licensees to conduct virtual currency business. To qualify for a provisional license—and thus avoid some of the more onerous license requirements—an entity must be conducting a virtual currency business with less than $1 million in outstanding obligations and have a business model that the commissioner determines presents little to no risk to consumers. The bill would take effect July 1, 2016.
There is no guidance in the bill for determining whether an entity has “full custody or control.” A Senate Committee Report concedes this definition might be difficult to apply in some situations. For example, the report notes that in some virtual currency transactions, such as a business that offers a virtual currency wallet, no single entity has full control over the virtual currency because multiple parties must independently agree to a withdrawal. The report says this will need to be clarified if the bill takes effect.
Money transmitter licensees may request an exemption from the virtual currency licensing requirement. If a virtual currency licensee plans to engage in activities covered under the Money Transmission Act, the licensee can request that the commissioner convert its license to a money transmitter license.
- Other States
Other states that have recently taken steps to regulate virtual currency activities have mainly done so simply by amending their existing money transmission acts to apply to virtual currency—but without tailoring the substantive requirements. For example, effective Jan. 1, 2016, New Hampshire’s money transmitter law will define monetary value to include “convertible virtual currency.” This, in turn, is defined as “a digital representation of value that: (a) [c]an be a medium of exchange, a unit of account and/or a store of value; (b) [h]as an equivalent value in real currency or acts as a substitute for real currency; (c) [m]ay be centralized or decentralized; and (d) [c]an be exchanged for currency or other convertible currency.” And a bill in Pennsylvania would simply amend the definition of “money” to include “any form of virtual currency.” The bills otherwise do not alter the substantive requirements of the respective money transmission acts.
Some bills do include provisions to modify the licensee’s obligations. A proposed bill in North Carolina would amend the definition of money transmission to include “maintaining control of virtual currency on behalf of others.” The bill would also permit the use of like-kind virtual currencies to meet the permissible investment requirement. A bill pending in New Jersey—the Digital Currency Jobs Creation Act—would create a tailored regulatory regime. The bill requires registration of any person that takes custody of digital currency for New Jersey residents as “its primary business” for more than 30 days. The bill also imposes a variety of cybersecurity, disclosure and other requirements, including a requirement that a registrant “hold digital currency of the same type and amount as that which it has custody from any New Jersey person.”
As we noted at the outset, whether virtual currency service providers should be regulated has split the virtual currency community. Many virtual currency service providers believe that regulation will lend credibility to virtual currency and foster consumer confidence in virtual currency service providers. These service providers argue that incidents like the Mt. Gox failure, in which customers lost millions, will lead consumers to decide that virtual currency is too risky unless providers are subject to government supervision. However, many people in the virtual currency community believe that government supervision is contrary to the fundamental ethos of virtual currency. People in this camp believe that virtual currency is supposed to be a monetary system operated by a community of users outside government control.
The authors take no position on the question of whether virtual currency service providers should be regulated in the first place. We do, however, believe that if governments are going to regulate virtual currency service providers, it is essential that the rules be appropriately tailored to virtual currency activities. Simply applying existing money transmitter laws to virtual currency service providers will not work.
The New York BitLicense regulation and the CSBS Framework try to address the most fundamental problems that arise when money transmitter laws are applied to virtual currency service providers. They recognize that virtual currency service providers should be required to hold virtual currency of the kind in which outstandings are denominated as reserves against outstandings—rather than dollar-denominated permissible investments. Requiring a virtual currency service provider to hold dollar-denominated investments as reserves makes little sense for a variety of reasons. Unfortunately, many of the other state proposals do not address this issue. Many simply amend the money transmitter law to apply to virtual currency without making any changes to the substantive requirements. Hopefully, the CSBS Framework will guide legislators seeking to regulate virtual currency to take a different approach.
The greatest weakness with the CSBS’s proposal is its lack of specificity. Even if every state followed the Framework, there could be huge variations in the details of individual state laws. A better approach might be a uniform law that is widely adopted by states. However, a bad uniform law could be worse than a lack of uniformity. It is too early to evaluate whether the UCL’s draft law will be the solution. The industry should watch the progress of that effort carefully and look for opportunities to shape the outcome.
David L. Beam is a partner with K&L Gates LLP, a global law firm with 47 offices on five continents. David, who is based in the firm’s Washington, D.C., office, has a national practice advising clients on compliance with state and federal laws that regulate payments in the U.S. He may be reached at firstname.lastname@example.org.
Jeremy McLaughlin is an associate in K&L Gates’ San Francisco office. He is a member of the Consumer Financial Services group, focusing on fintech, payments and privacy issues. He may be reached at email@example.com.
Kathryn Baugher is an associate in the Washington, D.C., office of K&L Gates. She advises clients on compliance with a wide range of federal and state laws that regulate payment systems, state money services business (money transmitter) laws, and state gift and prepaid card laws. She may be reached at firstname.lastname@example.org.
Christopher Shelton is an associate in the Washington, D.C., office of K&L Gates. He advises clients on a broad range of matters related to payment systems. He may be reached at email@example.com.
In Viewpoints, prepaid and emerging payment professionals share their perspectives on the industry. Paybefore presents many points of view to offer readers new insights and information. The opinions expressed in Viewpoints are not necessarily those of Paybefore. This article is intended for general information purposes only and should not be construed as legal advice. Readers are urged not to act upon the information without first consulting an attorney.
 We use the term “virtual currency” because that is the term almost every law or proposal discussed in this article uses.
 Uniform Money Services Act (2004) § 102 cmt. 10.
 These exceptions include: “ Merchants and consumers who use virtual currencies solely for the purchase or sale of goods or services;  Activities that are not financial in nature but utilize technologies similar to those used by digital currency. For example, a cryptography-based distributed ledger system for non-financial recordkeeping would be outside the scope of this policy;  Activities involving units of value that are issued in affinity or rewards programs and that cannot be redeemed for either fiat or virtual currencies; or  Activities involving units of value that are used solely within online gaming platforms and have no market or application outside of those gaming platforms.”
 Draft RVCA § 102(8).
 Id. § 200.2(q).
 Id. § 200.2(o).
 Id. §§ 200.14(a), (b); 200.15; 200.16; 200.18; 200.19.
 Id. §§ 200.8(a), 200.9(a).
 Id. § 200.8(b) (emphasis added).
 See Press Release: “NYDFS Announces Approval of First BitLicense Application From a Virtual Currency Firm” (Sept. 22, 2015), available at http://www.dfs.ny.gov/about/press/pr1509221.htm.
 Conn. Gen. Stat. §§ 36a-595, et seq.
 See Conn. Pub. Law Act No. 15-53, § 6.
 Id. § 7.
 Id. § 8.
 See Conn. Gen. Stat.§ 36a-596(9).
 Tex. Fin. Code § 151.302(a).
 Id. § 151.301(b)(4) (emphasis added).
 Id. § 151.301(b)(3).
 Texas Department of Banking, Supervisory Memorandum 1037 (April 3, 2014).
 Id. at 1-2.
 Id. at 2.
 Rev. Code Wash. § 19.230.030(1).
 Id. § 19.230.010(18).
 Washington Department of Financial Institutions, Interim Regulatory Guidance on Virtual Currency Activities (Dec. 8, 2014), available at http://www.dfi.wa.gov/documents/money-transmitters/virtual-currency-interim-guidance.pdf.
 Washington Department of Financial Institutions, Virtual Currency Regulation, available at http://www.dfi.wa.gov/documents/money-transmitters/virtual-currency-regulation.pdf.
 Rev. Code Wash. § 19.230.200.
 AB 1326, proposed Fin. Code § 26002.
 Id. § 26000(c).
 See id. §§ 26006(g); 26023(d); 26025; 26026.
 See id. §§ 26008(a), (b).
 Id. § 26032.
 Id. § 26040.
 A.B. 1326 Bill Analysis, Senate Rules Committee, p.6 (Aug. 30, 2015).
 See id.
 AB 1326, proposed Fin. Code § 2178. The Bill contains a parallel provision in the virtual currency provisions that exempts money transmitters from the virtual currency licensing provisions. See id. § 26004(e).
 AB 1326, proposed Fin. Code § 26031.
 N.H. Ch. Law 258 (2015), amending N.H. Rev. Stat. Ann. § 399-G:1.
 Pa. House Bill 850 (2015), amending 7 Pa. Stat. § 6101.
 N.C. House Bill 289 (2015), amending N.C. Gen. Stat. § 53-208.42.
 N.J. Assembly Bill 4478 (2014).