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NYDFS encourages virtual currency licensees to use blockchain analytics tools for sanctions and AML compliance
On April 28, NYDFS announced new guidance on virtual currency entities that are establishing the use of blockchain analytics tools. NYDFS explained that virtual currency activities can involve, among other things, different sources, destinations, and types of funds flows than are found in more traditional, fiat-currency contexts. Such characteristics of virtual currencies can create compliance challenges, but also can present new possibilities for new technology-driven control measures. In the guidance, NYDFS outlined expectations for New York State-regulated virtual currency companies, including: (i) establishing control measures that may leverage blockchain analytics; (ii) augmenting due diligence controls; (iii) conducting transaction monitoring of on-chain activity; and (iv) conducting sanctions screening of on-chain activity. NYDFS also emphasized "the importance of risk-based policies, processes, and procedures to identify transaction activity involving virtual currency addresses or other identifying information associated with sanctioned individuals and entities listed on the SDN List, or located in sanctioned jurisdictions."
As previously covered by InfoBytes, NYDFS issued a framework outlining industry best practices for state-regulated property/casualty insurers writing cyber insurance, which provided guidance for effectively managing cyber insurance risk. The framework is the first guidance released by a U.S. regulator on cyberinsurance. NYDFS noted it has “engaged with external stakeholders to inform this new guidance and continues to conduct significant outreach to state, federal and international regulators; industry; and other experts in the field to ensure New York maintains a robust regulatory regime and remains a destination for virtual currency companies to operate.”
DFPI concludes MTA licensure not required for direct purchase and sale of cryptocurrency
Recently, the California Department of Financial Protection and Innovation (DFPI) released a new opinion letter covering aspects of the California Money Transmission Act (MTA) related to the purchase and sale of virtual currency. The redacted opinion letter examines whether a Company that offers customers the opportunities to deposit fiat currency to a Company account and then draw down that balance to purchase virtual currency from the company requires MTA licensure. The Company explained that virtual currency is purchased from a third party and is transferred to the customer’s Company-issued virtual currency wallet where it can then be stored, transferred to an external wallet, or sold for fiat currency. When a customer later wants to sell the purchased virtual currency for fiat currency, the transaction occurs in a similar fashion. The Company stated that “virtual currency sales to customers are from the Company’s own inventory,” and that for purposes of the opinion, DFPI “assumes these sales occur independently of the Company’s own transactions with third parties.”
DFPI concluded that because the Company’s activities are limited to directly purchasing and selling cryptocurrency to customers, it does not require an MTA license because it does “not involve the sale or issuance of stored value or receiving money for transmission.” Specifically, DFPI stated that because the “customer’s fiat currency balance in the Company account does not meet the definition of stored value” and because “funds in that account can only be used for virtual currency purchases from the Company or transferred out to the customer’s external bank account,” the closed loop stored value “does not constitute issuance of stored value that is regulated under the MTA.” DFPI reminded the Company that its determination is limited to the presented facts and that any change could lead to different conclusions.
OCC launches consumer financial health discussion series
On April 22, the OCC announced an upcoming quarterly discussion series focusing on consumer financial wellbeing. The first event in the Financial Health: Vital Signs series will occur on April 28 and focus on minority ownership of cryptocurrency. Future events will feature discussions with acting OCC Comptroller Michael J. Hsu and other academic, community, and industry leaders. The discussion series will be livestreamed and open to the public.
NYDFS to collect assessment fees from licensed virtual currency businesses
On April 9, the New York governor signed S. 8008-C, which enacts the state’s 2023 fiscal year budget and requires, among other things, NYDFS to start charging a new assessment fee to all virtual currency businesses licensed in New York in order to cover the costs associated with their oversight and “defray operating expenses.” Specifically, Section 206 is amended to read: “The expenses of every examination of the affairs of any person regulated pursuant to this chapter that engages in virtual currency business activity shall be borne and paid by the regulated person so examined, but the superintendent, with the approval of the comptroller, may in the superintendent’s discretion for good cause shown remit such charges.” The amendments do not specify a specific assessment amount, however regulated companies engaged in virtual currency business activity “shall be assessed by the superintendent for the operating expenses of the department that are solely attributable to regulating such persons in such proportions as the superintendent shall deem just and reasonable.”
NYDFS Superintendent Adrienne A. Harris issued a press release the same day praising the budget adoption as it now allows the Department to collect supervisory costs from licensed virtual currency businesses as it does for banking and insurance companies. Noting that “New York was the first to start licensing and supervising virtual currency companies,” Harris said that the “new authority will empower the Department to build staff with the capacity and expertise to best regulate and support this rapidly growing industry.”
Virginia allows banks to provide virtual currency custody services
On April 11, the Virginia governor signed HB 263, which permits banks in the Commonwealth to provide customers with virtual currency custody services “so long as the bank has adequate protocols in place to effectively manage risks and comply with applicable laws.” Before offering virtual currency custody services, banks must conduct a self-assessment process to carefully examine the risks involved in offering such services, which includes: (i) “implement[ing] effective risk management systems and controls to measure, monitor, and control relevant risks associated with custody of digital assets such as virtual currency”; (ii) confirming adequate insurance coverage for such services; and (iii) maintaining a service provider oversight program to address risks to service provider relationships as a result of engaging in virtual currency custody services. Banks may provide virtual currency custody services in either a fiduciary or non-fiduciary capacity. If a bank provides such services in a nonfiduciary capacity, the bank will “act as a bailee, taking possession of the customer’s asset for safekeeping while legal title remains with the customer” (i.e. “the customer retains direct control over the keys associated with their virtual currency”). Should a bank provide services in a fiduciary capacity, it must “require customers to transfer their virtual currencies to the control of the bank by creating new private keys to be held by the bank.” The bank will have “authority to manage virtual currency assets as it would any other type of asset held in such capacity.” HB 263 takes effect July 1.
Hsu discusses stablecoins, pushes for crypto banks
On April 8, acting Comptroller of the Currency Michael J. Hsu discussed stablecoin policy considerations in remarks before the Institute of International Economic Law at Georgetown University Law Center. Hsu called for the establishment of an “intentional architecture” for stablecoins developed along the principles of “[s]tability, interoperability and separability,” as well as “core values” of “privacy, security, and preventing illicit finance.” According to Hsu, one way to mitigate blockchain-related risks would be to “require that blockchain-based activities, such as stablecoin issuance, be conducted in a standalone bank-chartered entity, separate from any other insured depository institution [] subsidiary and other regulated affiliates.” Hsu also emphasized the need to evaluate whether stablecoin issuers should be required “to comply with a fixed set of safety and soundness-like requirements (as is the case with banks)” or be allowed to pick from a range of licensing options.
Additionally, Hsu raised the question about how separable stablecoin issuers should be. “Blockchain-based money holds the promise of being ‘always on,’ irreversible, programmable, and settling in real-time,” he explained. “With these benefits, however, come risks, especially if commingled with traditional banking and finance.” Specifically, Hsu cited concerns that a bank’s existing measures for managing liquidity risks associated with traditional payments “may not be effective for blockchain-based payments,” which could conceivably accumulate over a weekend and “outstrip a bank’s available liquidity resources.” Hsu also raised concerns related to the current “lack of interoperability” should stablecoins expand from trading to payments, and stressed that “[i]n the long run, interoperability between stablecoins and with the dollar—including a [central bank digital currency]—would help ensure openness and inclusion.” He added that this “would also help facilitate broader use of the U.S. dollar—not a particular corporate-backed stablecoin—as the base currency for trade and finance in a blockchain-based digital future.”
FDIC instructs banks to provide notification when engaging with crypto assets
On April 7, the FDIC released FIL-16-2022, titled “Notification of Engaging in Crypto-Related Activities,” instructing banks that intend to engage in, or that are currently engaged in, any activities involving or related to crypto assets (also referred to as “digital assets”), to notify the FDIC of their intent and to provide “all necessary information that would allow the FDIC to engage with the institution regarding related risks.” The FDIC noted that, though it “supports innovations that are safe and sound,” the agency is “concerned that crypto assets and crypto-related activities are rapidly evolving, and risks of this area are not well understood given the limited experience with these new activities.” According to the FDIC, crypto-related activities “may pose significant safety and soundness risks as well as financial stability concerns,” digital asset activities “present risks to consumers,” and insured depository institutions “face risks in effectively managing the application of consumer protection laws and regulations” related to these “new and changing crypto-related activities.” The letter also specified that a bank should promptly "notify the appropriate FDIC Regional Director” of “information necessary to allow the agency to assess the safety and soundness, consumer protection, and financial stability implications” of digital asset activities. The FDIC will review the information and provide relevant supervisory feedback.
Yellen sets out principles for regulating digital assets
On April 7, Treasury Secretary Janet Yellen outlined a broad set of principles for regulating digital assets during remarks delivered at American University’s Kogod School of Business Center for Innovation. Yellen said that the approach she described largely reflects priorities outlined in an Executive Order issued by President Biden last month, which presented a “whole-of-government” strategy to coordinate a comprehensive approach for ensuring responsible innovation in digital assets policy (covered by InfoBytes here). Emphasizing that “regulatory frameworks should be designed to support responsible innovation while managing risks—especially those that could disrupt the financial system and economy,” Yellen cautioned that regulatory frameworks must appropriately reflect these risks as banks and other traditional financial firms enter this space. Moreover, she added that “new types of intermediaries, such as digital asset exchanges and other digital native intermediaries, should be subject to appropriate forms of oversight.”
During her remarks, Yellen discussed the risks and benefits to consumer protection and financial stability associated with the growth in digital assets. While Yellen did not provide specific instructions, she outlined general principles that she believes should guide the creation of a new framework for regulating digital assets. Stressing that regulations should be “tech neutral” and “based on risks and activities, not specific technologies,” Yellen explained that consumers and businesses should be protected from fraud regardless of whether assets are stored on a balance sheet or a distributed ledger. She also stressed the importance of ensuring that the growth of digital assets does not disproportionately impact vulnerable communities or exacerbate social, racial, or economic inequities. Yellen stated that, over the next six months, Treasury will collaborate with the White House and other agencies to produce reports and recommendations addressing opportunities and challenges posed by these emerging technologies.
Idaho defines legal status of digital assets
On March 28, the Idaho governor signed HB 583, amending the Idaho commercial code’s definition and classification of digital assets. The bill classifies digital assets as intangible personal property and general intangibles under the bill. However, the bill makes a distinction between digital securities and virtual currency—both are classified as intangible personal property, but while digital securities qualify as investment property, virtual currency is not considered a security. With respect to the purchase and sale of digital assets, the bill states that digital assets “may be purchased and sold in the same manner and subject to the same laws of this state as other personal property,” and notes that an “action based on a claim of a property right, right to performance, or right of payment may not be asserted against a qualified purchaser.” The bill also addresses provisions related to perfection by possession or control, and specifies that a “person that acquires an interest in and obtains control of a virtual currency without notice of any adverse claim takes the interest in the virtual currency and in any right to payment evidenced by the virtual currency free of any adverse claim.” The bill is effective July 1.
DFPI concludes MTA licensure not required for digital asset trading platform
On March 23, the California Department of Financial Protection and Innovation (DFPI) released a new opinion letter covering aspects of the California Money Transmission Act (MTA) related to a digital asset trading platform. The redacted opinion letter examines whether the inquiring Company (a registered money services business) requires licensure under the MTA. The Company requesting an interpretive opinion operates a software platform that allows retail and institutional investors to buy and sell digital assets, including cryptocurrency, and access related services, within the platform. The letter explains that U.S. customers must fund an account on the Company’s platform prior to purchasing cryptocurrency with either fiat currency (U.S. dollars) or cryptocurrency. The letter also describes, among other things, how customers can buy from and sell to the Company cryptocurrencies on one or more cryptocurrency exchanges using the platform. In these transactions, the Company would sell or buy cryptocurrency from the customer at the selected price and settle the trade using fiat or cryptocurrency held in its own accounts. Simultaneously, the Company would execute a trade for its own benefit on the exchange offering the price selected by the customer. Customer funds would not be used to buy or sell cryptocurrency from or to the exchange. After executing a transaction, a customer may choose to withdraw all or part of the customer’s fiat or cryptocurrency from the platform, or may choose to maintain a balance to execute future transactions.
The DFPI stated that it “has not concluded whether a wallet storing cryptocurrency constitutes a form of monetary value representing a claim against the issuer and accepted for use as a means of redemption for money or monetary value or payment for goods or services.” As such, the DFPI will not require the Company to be licensed under the MTA to provide customers with an account via a proprietary software platform to transfer and store cryptocurrency in order to execute trades directly with the Company.