Bringing Bitcoin into the regulatory fold

The New York State Department of Financial Services has published its proposed regulations in respect of the Virtual Currencies, the most famous of which is Bitcoin.  While cryptocurrencies are generally “unregulated” in the sense that in most jurisdictions they are not controlled investments (to use the UK terminology) and do not attract regulatory attention, as they become more prolific and available to a wider public, so more regulators will be looking at bringing them into the regulatory fold.

The New York proposals essentially make the transmission, custody, arranging of deals and conversion of cryptocurrencies regulated activities, requiring authorisation from the Superintendent of Financial Services.  The rules require that existing operators apply for registration within a 45 day period of the rules coming into force, and sets out in some detail how applications must be made. 

All the normal application type information needs to be provided, i.e. controllers, directors, proposed business model, assets, liabilities and projected volumes and values of transactions.  Rather than setting an empirical capital adequacy requirement, that may be imposed by the Superintendent, which is slightly alien to those of us in the UK and EU who are used to specific capital adequacy requirements. 

The New York proposals adopt many of the business principles which any of us who operate in financial services systems would recognise.  We have a regulator who wants to know about the regulated party, who it proposes to deal with, how often and in what quantum, whether or not they represent a money laundering risk and how the regulated entity proposes to keep its records. What happens when it all goes wrong, both in terms of business continuity and disaster recovery and the sorts of risk warnings which need to be provided to customers prior to their commencement of trading or using the service?  In the UK, those of us who deal with COBS, MCOBS or ICOBS will recognise a lot of the features of the New York rules.

Recent experience at DWF in writing the legal documents around a Bitcoin trading platform suggests that regulation across a number of jurisdictions is more than likely to be on its way.  Our view would be that many of the proposed rules put forward by the New York Superintendent will be rolled out in many other jurisdictions, and many of the principles which have already been applied in other platform based services are worth migrating into the cryptocurrency universe. 

The basic legal and regulatory principles are the same, and provided a platform adopts a sensible and commercial approach to its dealings with its customers, keeps effective records and adopts an open and honest approach to its regulator (come the day) then they should attract little more attention than any other trading platform.

Generally, dealings in cryptocurrencies in most jurisdictions is entirely unregulated, although a number of platforms have brought themselves voluntarily into the regulatory fold by becoming agents of others or applying for authorisation for certain activities.  The New York proposals will make this a requirement, and no doubt other jurisdictions will follow suit.  Care should be taken when forming any business plan relating to cryptocurrencies to ensure that the scope of activities is not so wide as to trigger the undertaking of other regulated activities, for example arranging deals in investments, where controlled securities are traded with settlement in a cryptocurrency; the fact that one element of the transaction is in a controlled investment brings that within the regulatory regime.

It should be noted that there are a number of underlying activities which require registration in any event, such as registration as a money transmitter in most US states and under the federal umbrella and careful attention should be paid to the requirements of each jurisdiction in which it is proposed to operate.

This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.

Richard Tall

Partner - National Head of Financial Services

I am an experienced corporate lawyer with an in-depth expertise in financial services.