How to Keep N.Y.'s BitLicense from Squelching Innovation

The New York State Department of Financial Services has made history by becoming the first state to propose a regulatory framework specifically for digital currencies. However, many digital currency businesses have expressed serious concerns about superintendent Benjamin Lawsky's proposed "BitLicense" regulations.

Complying with the regulations is likely to be very expensive. Some businesses have even said that it would be well beyond their means to comply; and if they can't comply, they can't operate. However, there may be a way to lower the cost of compliance while ensuring that digital currency businesses meet DFS requirements.

The public comment period saw a groundswell of industry support for a safe harbor provision that would exempt small businesses from needing to apply for a BitLicense. A free pass or exemption sounds ideal to start-ups and small businesses that are strapped for cash. But the Department has hinted in many public statements that an outright safe harbor provision is unlikely.

"We want to make sure that even if you are a start-up that you're doing certain things," Lawsky said in an October 2014 speech at Cardozo School of Law. Regardless of the size of the company, regulators are responsible for ensuring that all digital currency businesses have protections in place to prevent criminals from using their products or services to launder illicit funds.

As an alternative to a safe harbor provision, the Chamber of Digital Commerce has proposed a nonprofit incubator that would help small businesses meet the DFS requirements while bringing the cost of compliance down.

Under this plan, companies eligible for safe harbor would be placed under the supervision and oversight of the nonprofit incubator, as opposed to the DFS. This self-regulatory incubator would assist companies in developing robust compliance programs that meet the DFS's regulatory requirements and objectives, such as safety and soundness, anti-money-laundering compliance and consumer protections. This would allow digital currency companies to afford the cost of compliance and preserve ongoing innovation and capital formation.

In addition, given how rapidly the industry is evolving, the Chamber of Digital Commerce urges the DFS to include a provision for the regular review of BitLicense requirements. Some of the assumptions made today going into the regulation may be very different one or two years from now. So it would make sense to review the final regulation every six months to a year "to ensure that it appropriately reflects the state of the industry at the time of the review," as we wrote in our public comments.

This provision is especially important because Lawsky is expected to step down from the DFS this year. New leadership may not place a high priority on digital currency. There needs to be some mechanism in place that ensures the DFS will come back and review the regulations. Furthermore, if the BitLicense is not reviewed within a specific time frame, the Chamber of Digital Commerce suggests it should sunset, or terminate.

Digital currencies and their underlying technologies are evolving rapidly. In this environment, the DFS, like other state and federal regulators, face a particular challenge in understanding what functional elements of the technology should and should not be regulated. It is vital that small businesses have some leeway.

A self-regulatory incubator would achieve this goal by providing an on-ramp for start-ups while meeting the industry's call for a safe harbor and appeasing the goal of protecting consumers and the safety and soundness of the financial system.

Perianne M. Boring is the founder and president of the Chamber of Digital Commerce, a Washington-based trade association representing the interests of the digital asset community. Follow her on Twitter @PerianneDC.