New York Sees Bitcoin as a Catalyst for Modernizing Regulation

It's still unclear what New York's planned "BitLicense" actually is, but the New York Department of Financial Services says its license is meant to encourage Bitcoin businesses to operate and innovate in the state.

Bitcoin businesses include companies that exchange the digital currency for government-issued currency, store it in wallets that facilitate its use or help merchants accept payments. However, since Bitcoin wasn't created by a government, it has sometimes been seen as operating outside the law. Several state and national regulators have made moves to bring Bitcoin and other digital currencies under their oversight.

The New York department plans to create a BitLicense sometime in 2014, said Benjamin Lawsky, superintendent of the NYDFS, during the first in a series of hearings in Manhattan, but he also says he doesn't want to stifle the fledgling technology.

Bitcoin and other cryptocurrency technology could force the traditional payment industry to innovate and make payments faster and less costly, says Lawsky. Digital currency could allow payments to take place as fast as sending an email, he says.

Fred Wilson, a principal partner at Union Square ventures, said during a panel discussion at the hearing that creating a safe harbor organization to allow Bitcoin startups a period to begin operating without all the proper state licenses would "encourage people to be compliant."

Bitcoin businesses could simply register with this organization to let the state know they are operating and working on obtaining proper state licenses, Wilson says.

The idea was echoed by several other panelists, including Cameron and Tyler Winklevoss, and Lawsky seemed receptive to the idea. The Winkelvoss twins, who came to prominence through their lawsuit against Mark Zuckerberg over Facebook, are investors in the digital currency and businesses that handle it.

But Lawsky and other NYDFS panelists said just knowing they're operating isn't enough. Businesses in the safe harbor would still need to demonstrate a basic level of compliance.

Some of these Bitcoin startups are two-, three- or four-person teams, and "it's very hard for them to do what JPMorgan Chase does," says Wilson. "I think there needs to be an on-ramp to regulation that is inviting for young companies to embrace regulation."

Most panelists concluded that current regulation for money transmitters is sufficient for Bitcoin businesses. Further action should be light-handed so as not to stifle the innovation, they said.

The NYDFS "is cognizant of not imposing the same compliance costs" on big banks as on smaller community banks, so it understands the plight of Bitcoin startups being regulated under the same laws as big banks and money transmitters, Lawsky says. Lawsky has had to work with community banks that, as began hiring more compliance officers than loan officers - that practice won't work for newer businesses, he says.

The Financial Crimes Enforcement Network issued guidance in March 2013 categorizing exchangers and administrators of virtual currency as money services businesses. Bitcoin businesses that fit into this model must register with Fincen and follow Know Your Customer and Anti-Money Laundering rules. Those businesses must also obtain licenses in the states they operate in.

But these regulations were written a long time ago when things moved slower, Lawsky says, and the NYDFS is looking to modernize regulations for the digital age. The department has begun thinking about what reviews should look like and who it should employ, he says.

Lawsky wants the NYDFS to be the first in the nation to create a state regulatory framework for virtual currency firms.

Especially in light of this week's indictment of a Bitcoin Foundation director for alleged money laundering, "it's critically important to put up guard rails," says Lawsky.

Many of the investors on the panel say that the indictment of the director, Charlie Shrem, shows existing regulation is sufficient to allow law enforcement agencies to bring charges against suspects.

But while Bitcoin continues to be stained by its reputation as a currency for illicit activities, "I've seen a change in the character of people being involved in Bitcoin," says Jeremy Liew, partner at Lightspeed Ventures Partners, during the hearings. "The Bitcoin community is moving in the direction of greater legitimacy."

Lawsky also asked the panel how banks are reacting to Bitcoin.

"Banks are interested in doing business with Bitcoin [businesses] but are worried about the regulatory risks," Liew says.

Wilson says banks are starting to embrace Bitcoin. Big industries "accept new technology like the five stages of grief, and we're getting close to that acceptance stage," he says.