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Thursday, July 17, 2014

New York Attacks Bitcoin: Episode One

New York State's new proposed regulations on virtual currency (e.g., Bitcoin) may drive new virtual currency founders out of the state and soon make it hard for any New Yorker to buy or sell Bitcoin.  (Bitcoin accounts for approximately at least 90% of the trading volume of all virtual currencies worldwide.)

In the name of consumer protection, one wonders if this is just another regulation that will lead to eventual domination of an emerging field by large multinationals (which as licensed banks are exempt from the regulations), who may eventually end up hiring the very same regulators in the symbiotic revolving door between big business and big government.

The regulations are proposed and have not even been officially issued by the state's Department of Banking and Finance. Official date of issuance is July 24, 2014, and that starts an official 45-day comment period.

The major impact of the "bitlicense" regulations will require anyone in the business of buying and selling virtual currency to a  "New York person" to get a state-issued bitlicense. Some of the regulations largely mirror the state requirements for regular banks. However, as bitcoin businesses are on the internet, there is the concern about cybersecurity. The "bitlicense regulations" do not only cover cryptocurrency exchanges but also impose some requirements which for startups and small businesses are absolutely draconian in expense (both in time and money) in relation to the size of business conducted. These requirements include the institution of written anti-money laundering, know-your-customer and cybersecurity policies as well as the requirements to report "suspicious" transactions. These are serious undertakings.

For sake of comparison, these are the requirements otherwise imposed on commercial banks.  This isn't a problem for established banks, which as I mentioned before, will be exempt from the regulation. To put things in perspective, if you want to start a commercial bank in New York, the state actually advises that new banks doing business in Metropolitan New York City have at least $50 million in net capital.

As a lawyer who does regulatory interpretation, I have to candidly wonder whether the burden of these regulations makes it worth it for a bitcoin business to either stay in New York or accept business from "New York persons" which makes that business, no matter where it is located, subject to the New York regulation.

Perhaps most critical is the question: What is a "New York person" under the regulation?  It is any person or entity who "resides in" or "is located" or "has a place of business" or "conducting business" in New York State. 

Now, what does it mean to "reside in" the state?

The New York tax regulations specify that all your income is subject to state tax if you live in the state more than half the year. Hmmmm. Where is that definition here? (Answer: It's not here.)  What does that mean? I interpret it to mean -- and this deserves official clarification -- that residing at all in New York makes you a New York person.  Any part-time residence (even if lived in far less than 183 days) may make you subject to the regulation as a customer (and businesses not licensed can't touch you, as I explain below). I do not interpret this as the New York tax resident standard, whereby part-time residents are taxed full-time if they are in the state more than 182 days out of the year. This is the regulation forcing wealthy people to count their days, diary their entire calendar for the year and even assiduously flee the state before the stroke of midnight or arrange for flights arriving after the stroke of midnight to save a few days. I interpret this as the "tag" rule: any quasi-permanent contact with New York makes you subject to the new rules and you could feel the impacts I outline below.  Residing part-time in New York could make you subject to the rule as a customer, meaning businesses might not touch you (just as some stock brokerages will only handle customer accounts for people living in certain states where they are licensed).  And of course, any trust, corporation or other entity with any connection to New York, even a satellite office, becomes subject to the regulation whether it is engaged in the exchange business or other specified "virtual currency business activity."

The initial reaction to this regulation -- which has only been proposed and is likely to be sharply contested -- is that it may drive some bitcoin vendors out of the state, for the simple reason that the rest of the world and certainly neighboring states have no such requirement.  

There is another possibility: big institutions ("Big Finance") will either be exempt (which they would be if they already are licensed by the state ("chartered") to conduct exchange services, or they will get the licenses. Generally, larger institutions are able to absorb the formidable costs of regulation and applying for licenses. This may soon transform Bitcoin into the domain -- at least within New York -- of Big Finance, but smaller competitors will have the option of moving to competition-friendly or regulation-free states or countries.  (I expect to hear plenty of conspiracy theorists saying these regulations are designed to lock down the Bitcoin sector for Big Finance.)

Another danger: As a "coin" or unit of virtual currency is really just a bit, that is, a unit of data, and a bit used as a coin and a bit used for storing information is really just the same thing with the nature of the item being really no different, then this leads to draw one of two possible conclusions: One, the regulation means (but fails so far) to regulate Bitcoin on the basis of how it is used and not what it is, or two, the regulation really does mean to regulate Bitcoin in its form as units of data. (Admittedly, there is a third possibility: the regulation was just poorly drafted. I don't think that is likely.)

If the regulation is truly intended to reach the latter interpretation, then Bitcoin cannot be used or exchanged in New York except for consumer-to-business merchant commerce.  Any other uses of Bitcoin or other blockchain based technologies are subject to the act's requirements. This means that Bitcoin cannot be used as a database for any exchange or storage of information, because, well, information has value. Especially and particularly in our information society. That is because Section 200.2(m) of the regulation defines "virtual currency" as:
"...any type of digital unit that is used as a medium of exchange or a form of digitally stored value or that is incorporated into payment system technology."
What is the impact on regular New Yorkers? I think New Yorkers will eventually have no problem buying Bitcoin; they may have less competition and prices (spreads) may be cartel-like in their uniformity, they may not particularly like doing business with any big institution and the character of the still-early-stage Bitcoin community in New York may transform. (Or flee.)

Think of it as the mom-and-pop stand-alone coffee shop suddenly being surrounded and undercut on price, hours and ancillary services by a certain international coffee chain. 

That is the initial take on the impact on the still very small Bitcoin industry. But what about the impact on regular people who just want to buy and invest in Bitcoin?

That, my friends, is the major problem: The regulations do not only cover doing business in New York. They affect anyone in the world doing business with someone living in New York State.  They make New Yorkers a hot potato. The regulations don't just discourage Bitcoin startups and prompt them to leave for an unregulated (for now) climate. They essentially prevent those startups, no matter where located, from taking New Yorkers' bitcoin business (but the large institutions can come right in, and that may be exactly what is intended).

A different problem with the regulations is the requirement that anyone "controlling, administering or issuing" a virtual currency has to get a state license ("bitlicense").  This is sure to drive any virtual currency innovators out of New York. Want to develop an alternative virtual currency? Why bother with the New York regulations when most other states -- or countries -- are not even looking at regulating virtual currency?

The indirect but foreseeable consequence of the regulations is that restricting or discouraging Bitcoin through regulation will reduce the amount of any virtual currency floating around in commerce. This will affect (adversely, because the effect is never net positive!) any New York merchants whose business depends in any substantial part on Bitcoin.

As for myself -- Eric Dixon the lawyer, Eric Dixon LLC -- I am admitted to practice in New Jersey as well as New York, my 20 years of experience (I am a 1994 graduate of Yale Law School) mean I can waive into most states without taking their bar exams, and I would likely be welcomed to practice by most countries in the world. This may affect where I do business.  The impact on you -- if you need to move, I can move with you.  And if you want me to handle the regulations, we can certainly talk.  The regulations do not kill you if you are in New York, but you need to know what you are facing in order to have access to the New York market.  Email me at edixon@NYBusinessCounsel.com. 




1 comment:

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