New York Will Regulate Bitcoin Startups Despite Inherent Flaws

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Bitcoin investors want clarity, but clarity won’t come from New York State. On the contrary, even the wisest regulation that the New York State Department of Financial Services (NYDFS) could draft would do very little to clarify bitcoin startups’ legal obligations. The reason is simple, unlike a mom and pop shop, bitcoin startups are not local creatures. The opposite is true. One of bitcoin’s great benefits is its ability to facilitate transactions between remote actors. There is some irony to the fact that a state seeks regulation over an instrument whose very essence transcends interstate and international boundaries – bitcoin being the first truly international crypto-currency.

Clarity is Desirable but Won’t Come From New York

Once New York steps in, other states will follow. Complying with inconsistent licensing requirements from up to 50 states will be extremely burdensome. It is one thing to submit for review your financial and transactional data to one entity, it is another to comply with a unique sets of operational procedures from 50 different states.

As Marco Santori, Chairman of the Bitcoin Foundation said, state licensing requirements could “cost [bitcoin startups] millions of dollars in attorneys’ fees, ongoing bond dues, and application costs.” “Differing standards and licensing regimes from one jurisdiction to another can rapidly raise costs. Costs that are manageable for national and international firms can be prohibitive for firms that have yet to achieve scale,” he said in his testimony at the New York Hearing.

“It’s important to recognize that many of these companies are going to be two-, three-, four-person companies and that’s very different from JP Morgan Chase,” according to Fred Wilson of Union Square Ventures.

State licensing schemes once erected, would function as potent barriers to entry, diminishing the competitive landscape while burdening existing bitcoin startups with heavy legal obligations.

States are institutionally incompetent to regulate international crypto-currencies

Although regulatory clarity would be nice, such clarity cannot, by definition, come from New York. States are institutionally incompetent to regulate international crypto-currencies. Only the federal government has the ability of injecting some clarity by creating a national regulatory system. However, the federal government, through one of its agency, has signaled that it is up to the states to come up with the meat and potatoes of bitcoin regulation.

A New York License to Do What?

It is now clear that New York will regulate bitcoin startups this year.

“Ultimately, it’s our expectation that the information we’ve gathered in this fact-finding effort will allow us to put forward, during the course of 2014, a proposed regulatory framework for virtual currency firms operating in New York” Superintendent Lawsky said.

Once FinCEN, a US Treasury agency, elected to classify bitcoin exchanges as ‘money transmitters’, it logically followed that states, such as New York, would step in. Indeed, traditional money transmitters (think Western Union) are subject to federal regulations, the broad strokes, and state licenses, which fills in the details and ensure compliance. It is unfortunate, that states, not the federal government, will regulate bitcoin simply because of the awkward classification of bitcoin exchange within the preexisting framework of ‘money transmitter.’

Advantages of New York Regulation

For all the disadvantages likely to follow, some good will come of New York Bitlicense scheme. For one, tighter regulation will likely purify the market of many of its undesirable elements – criminal activities will be significantly limited. Second, regulation also means wider confidence in, and acceptance of, the digital-currency. Third, the New York regulation can serve as a laboratory for policy experimentation, and a possible blueprint for a federal law that would eventually preempt the New York scheme.

photo credit: btckeychain

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