Bitcoin Regulation in the US — July 2015

I'd like to give you a little overview now about Bitcoin regulation in the United States where things stand right now in July of 20 fish and there are a couple of reasons to do this and to be thinking about this now one is that we've just seen this past spring the first big case where a Bitcoin related company now ripple isn't actually a Bitcoin company uses a separate cryptocurrency and a separate protocol but a Bitcoin ish company ripple was smashed with the gigantic fine by our friends at the Financial Crimes enforcement Network for operating without a money transmitter license it is the first case like this very highly publicized ripple we've seen is very promising and very innovative and yet they were operating without a license now this lack of having a money transmitter license and the regulatory environment in general around cryptocurrency related businesses leads to an awful lot of uncertainty for investors for people who want to get into startups in this area and for developers and so a number of states are trying to address this problem by coming up with uniform regulations that will be clear and consistent and that will help solve some of the ambiguities around cryptocurrency business regulation the first that i'll talk to you about is New York State's bit license program and this is justin issued in jun 2015 by the New York State Department of Financial Services and basically the New York State bit license requires most bitcoin-related businesses or other distributed virtual currency type businesses to require a license if they want to operate in New York now in internet of course if you want to operate anywhere you pretty much need to be licensed in the places that require licensing because once you put the on switch on so to speak and you are in the internet and you are global you're subject to the regulations of all of the jurisdictions where people can access you so in effect by setting up this bit license requirement for our companies operating in New York given that New York is a very big seat with a gigantic global city at the core of its economy pretty much you're ensuring that almost all Bitcoin related businesses will have to get this bit like here are the five main areas that New York State's bit license regulation covers they basically have to do with consumer protection which is making sure that customers funds and customers rights are respected in the transactions that they place in any bitcoin-related business they cover anti-money laundering this is the thing that comes from the bank secrecy act that has to do with verifying the identity of people who conduct transactions and who send money through electronic means they involve capital adequacy and that has to do with the amount of money that you have on hand if you're a business especially a business that takes in deposits and then lets out deposits or that is moving money making sure you have enough money to cover any any drawers on your system that might come up in a given day you need to have enough money in your own account if say all of your customers one day 25 to take their money out of your system that's capital adequacy the rules also cover changes in ownership so if you have a start-up and then you sell it to Google what happens to customers funds and it covers cyber security so if there are any incidences of hacking what are you doing to protect customers phones what are you doing to protect your system in the event that something goes wrong but just consider for a minute why we need these regulations in the first place and think about that a business like coinbase does and some of you experimented the coin base and the labs in this class what coinbase does is it takes your money and then it digitally send your money to other people you need to ask yourself what could go wrong with the system like with any kind of electronic means of money transmission so let's have a little scenario we have me on the left and you on the right and I'm going to send you some money now in a cash environment it's pretty easy I give you cash it's a push payment you get the cash end of story but what if we have bills bitcoins start up here a company that's going to facilitate this transfer of money from me to you electronically using a payment rail using a payment system but I build to facilitate that transaction what could happen then well first of all if it's a bitcoin-related startup probably what's going on is you're let's say I'm putting money into the system and then it goes to bills Bitcoin startup where it's converted into Bitcoin which then goes via the block train via this new payment rail to you that's basically how a lot of systems like coinbase work especially if you are you are putting money into the system using your credit card or debit card or PayPal or something else to then get some Bitcoin to then send to other people let's think about all the things that can go wrong first of all there might be a problem with the transmission mechanism there might be a problem with this rail that I filled maybe I built some kind of interface that allows you to send money via the block chain but my interface things for the miners aren't settling transactions fast enough and we've experienced that in that in this class where there have been some pretty significant lags and settlement time for the network goes down or the electricity goes goes out or my system is hat any number of things can happen that can interfere with that rail so the way I might break down what else might happen well the premise of this kind of system is that I have a store or thick coin that I'm too I'm converting dollars into when i'm going to facilitate this transaction for these two parties but what if I don't really have any what if I don't have enough to cover all the transactions what if there's one day when all the people decide to draw all their money out at the same time and I simply don't have enough money to cover all of their outstanding balances what if one of the parties the transaction is a bad guy what if one of the parties the transaction is a criminal well I'm not a bank and I haven't done know your customer or if you diligence on my client so there's no way for me to know about that and furthermore what if the recipient is also a bad guy well again unless I'm collecting data and information on all of the clients in my system there's no way for me to know about it and I may be liable for the actions that they conduct by using my new payment system to send their ill-gotten gains and finally what if one day I get taken over like somebody else by this cartoon what if I get taken over what recourse what rights do my existing clients and customers have without any kind of you know licensing regime or any kind of regulations around how these entities are going to operate sort of an open question as to what could happen my customers who have money in the system might lose all their money in the event of a takeover so back to the bit licensed in New York State basically the regulations now say that if you were a Bitcoin type of business that's engaged in in money exchange or money transmission you have to register and get a license you need to prove that you're going to comply with the relevant regulations and generally that means you're going to have to prove that you've actually hired a compliance officer whose job it is to make sure that you're in compliance with the regulations here and whose job it is to maintain the records that might have to be given over to the authorities in case of a problem you have to conduct know your customer on your customers just like a bank would basically collecting minimal identity documentation so you know who you're dealing with and you can prevent money laundering and things like the financing of terrorism you have to ensure that you have enough reserve to cover your customers funds in the system and you have to have provisions in case of bankruptcy or changes in ownership in your company it's all pretty reasonable stuff it's a lot of stuff that that banks already do what's so interesting in this new world that we're entering with distributed ledger based payment systems is we have systems that are operating outside the banking infrastructure and so they're not covered by those same protections that banks afford let's talk a little bit about California now last year the state of california passed ad 129 a bill that declared that bitcoin and other cryptocurrencies count as lawful money and you'll see this this quotation from the bill basically explaining that at the time the law really since the 19th century had prohibited private entities from creating something that would serve the purpose of money and a t1 29 repealed that provision so private entities could start issuing something like mike that was the first thing and that basically said to the Bitcoin community and the developers involved in distributed ledger based payment systems we know what the doors open go and experiment the regulators not going to get in your way even though this looks like you're issuing money that's fine just do it we're going to let corporations and individuals put new kinds of currency into circulation to see what happens and in fact a t1 29 cited the examples of things like ours and the alternative currency movement to make its case right now there is before the state assembly a bill 8180 1326 which would create a kind of licensing requirement like the New York State fit license it would ensure the following that each licensee each entity each business that gets licensed has to maintain at all times such capital as the Commissioner determines subject to specified factors is sufficient to ensure the safety and soundness of the licensee its ongoing operations and maintain consumer protection what you see here is an effort to create something like capital adequacy for a Bitcoin related business something like what banks have to do in order to operate so they have enough funds on hand in case those are run on the bank now of course thanks are insured by the federal deposit insurance corporation these Bitcoin based businesses are not in the same way and so the proposed regulation in California would basically mandate that such businesses maintain a fun so that if there were ever anything like a run on the bank they'd have enough money to cover their consumers accounts as well as their own operations and it does it by requiring as you see in the second part of this each licensee to maintain the bond or a trust account in u.s. dollars to benefit its customers in case of trouble so it's basically saying if you're going to run you have to set up a trust account or a bond where you're putting a whole bunch of US dollars to cover customers accounts in the case of a problem and why do all this well as I said you have to do all this because these businesses are not banks banks are highly regulated entity banks are regulated by capital adequacy provisions they're regulated by the Bank Secrecy Act which is guarding against money laundering and nefarious activities that can take place during money transmission banks are insured and these bitcoin-related startups thus far don't have the same kinds of requirements and I've personally kind of wonder if the new regulatory regime that seems to be taking shape around distributed ledger based payment systems and bitcoin-related startups is going to mean that such businesses aren't going to start to look more and more like bang they're already being regulated in a way that borrows banking regulation and that compels them to do certain things that banks already have to do around customer due diligence TYC and capital adequacy standards so I wonder if these things over time are going to start to look more and more like banks but you know banks of a new sort thanks that are appealing to a new market segment thanks that maybe can be more flexible more nimble than the conventional banks we'll just have to see I also wonder if these new regulated entities will actually start to have the ability to issue their own private currency now we talked about this in the very beginning of this class when we mentioned we mentioned the period in American history when thanks especially in the Middle West and the West we're issuing private currency and in most instances that went horribly wrong the banks often didn't have the actual funds to back up the notes that they were issuing they didn't have the funds to support the loans that they were shimmy and so forth and we spoke of the era of Wildcat thank you when private currencies ran amok and really pose pretty great threats to the economies of the West so there are economic reasons why you might want to worry about this there are also political reasons why you might want to think about this right now we have a uniform state issued currency it is a symbol of sovereignty because it is freely accepted everywhere by everyone it's also a kind of symbol of democracy and equality it's governed by laws it's regulated by Congress which is elected by the will of the people and so forth so what would it mean to start having a bunch of Kwazii banks out there issuing lots and lots of private currencies and the situation right now in Greece I think gives us reason to pause and reflect for a moment on the importance of currency a the solidity and stability of the nation-state so these regulatory changes although they may seem kind of technical and our team I think actually speak to very very big questions about the nature of political community and political economy in the contemporary world I think I will wrap it up there but hopefully you now have a good overview of the current state regulation of cryptocurrencies and block chain type systems in the United States

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