Unveiling a series of proposed new virtual currency regulations for New York state—which will likely be copied by other states and potentially federal regulators as well—Benjamin M. Lawsky, the superintendent of the New York State Department Of Financial Services, said that virtual currency startups need room to experiment and new proposals will grant them that slack.
The proposal envisions "additional flexibility for virtual currency startups to innovate, while at the same time maintaining our commitment to protecting consumers and rooting out illicit activity," Lawsky told attendees at the Bipartisan Policy Center on Regulating Virtual Currencies and Payments Technology in Washington, D.C., on Thursday (Dec. 18). "The revised regulation will offer a two-year transitional BitLicense, which may be issued to those firms who are unable to satisfy all of the requirements of a full license, and will be tailored to startups and small businesses. That transitional BitLicense will help provide start-ups an on-ramp as they build up their operations."
Among other key changes that Lawsky outlined:
- Developers Free To Code Away. "The revised regulation will clarify that we do not intend to regulate software development. For example, a software developer who creates and provides wallet software to customers for personal use will not need a license. We are regulating financial intermediaries. We are not regulating software development."
- Rewards Won't Be Punished. "Customer loyalty programs, rewards, and gift cards denominated in fiat currency will not fall under the BitLicense. Some commenters believed that the regulation could be read to encompass those activities, but it does not."
- Miners, Investors, Merchants Need Not Apply. "Virtual currency miners will also not be required to obtain a BitLicense. Individuals who are solely purchasing and holding onto virtual currency as a personal investment will also not be required to obtain a BitLicense. Additionally, we are making clear that merchants who accept virtual currencies as payment for goods and services – and their customers – will not be required to obtain a BitLicense, if that is the only virtual currency activity in which they engage."
- Getting Control Of Who's In Control. "Licensees may apply to the Department for a determination that certain specific parties should not be deemed to be control parties by the Department – if they are truly not involved in the day-to-day or major management decisions of the company. That provision is important for helping encouraging angel investment in virtual currencies, since when an individual is deemed a control person, it triggers a whole host of, often very fulsome, requirements that may not be necessary if they are not managing the company."
- Record-Keeping Shortened, Detail Rules Lessened. "We have shortened the proposed record-keeping requirement for licensees from ten to seven years. We have also eliminated a requirement that licensees are required to obtain the addresses and transaction data for all parties to a transaction and must now only obtain that information for their own customers or account holders and, to the extent possible, for counterparties to the transaction."
- Capital Change. "A broader range of financial assets, including virtual currency, may now count toward licensees’ capital requirements."
Lawsky argued that these changes are needed given the huge changes in payments overall. "Our statutory and regulatory schemes for money transmitters were written long before there was an Internet – let alone virtual currencies – and were in need of updating," he said.
The chief regulator rattled off quite a few disruptive advantages he sees coming from Bitcoins and other virtual currencies—advantages that demand wholesale changes to the regulatory environment.
Those advantages "include providing the capacity to send money all over the world to people in countries without a modern banking system. Virtual currencies could help bring down the cost of international remittances significantly. Virtual currency transactions also do not require people to provide their credit card information in financial transactions, and that could potentially help reduce the chances of identity theft and related frauds," Lawsky said. "There is also the fascinating idea of creating so-called programmable currencies, which could allow consumers and businesses to securely transfer something of value besides money to another party—say the deed to a piece of property—over the Internet. Virtual currencies could, as a broader matter, push banks and other financial institutions to up their game when it comes to considering and implementing new payment technologies."
The chief regulator for the state that includes Wall Street said these rules may extend far beyond New York state's borders. He has been in discussions with federal and other state regulators about implementing similar rules throughout the country.
"We need to make sure we stay coordinated. It would be kind of nutty in the long term if New York's got one set of standards and the OCC's got another set of standards and (U.S.) Treasury thinks there should be a third set," Lawsky said during a question-and-answer session after the speech. "I think the process that should take place, especially if you believe in the states as a laboratory of democracy. If a state comes up with a couple of new interesting ideas that make cyber security exams even better, hopefully the stuff that we got right can be adapted in some way. But we all need to work together to come up with a way to have something fairly uniform for our institutions."
In the speech, he spoke often of the need for financial regulations to be seriously overhauled and modernized.
"Virtual currency sits at the crossroads of a more lightly regulated technology sector and more heavily regulated financial sector. To the extent that there are some specific areas of the regulation that are somewhat stronger or more robust for virtual currency firms than those for other financial institutions – such as our cyber security rules – that is primarily because we are actually considering using them as models for our regulated banks and insurance companies," he said. "One example is the Automated Clearing House (ACH) system that banks often use to transfer customer money to one another. I think it would shock most consumers to learn that – at its core, despite modest improvements – the ACH system has changed little since it was created four decades ago in the 1970s. And that is why – as recent press reports have noted – it generally takes you longer to transfer money electronically than it would to physically transport that cash to another state or country."
He elaborated on those consumer expectations. "Many consumers are perplexed that, in a world where information travels around the globe in a matter of milliseconds, it can often take several days to transfer money to a friend’s bank account. So, in other words, in an age of smart phones and on-demand technology, we have a disco-era payments system," Lawsky said. "And that is a problem, as much as we all love disco. Even many new entrants into the mobile and app-based payments world – who are doing some truly interesting work – largely have to build their technology on top of that ossified, existing system."
Lawsky then tried to address the blame question.
"What is the cause of that startling market failure to innovate within the legacy bank payments system? Some people blame regulators' focus on rooting out money laundering. They say that faster payments technology will make it impossible or extremely difficult to spot fraud and illegal activity. I think that explanation is largely a red herring," he said. "Preventing money laundering at banks is, of course, critical. Indeed, it has been one of the top priorities of our department, but I do not believe that finding a solution to that issue represents an insurmountable problem. That is particularly true in an age where we are able to shoot a robot spacecraft into the atmosphere and land it safely on a comet several worlds away. It is also belied by the experience of other countries, where payments between banks can settle within a matter of hours or even minutes."
A more likely explanation, he said, is that "what we are seeing in the payments world is the classic type of market failure that exists in a monopoly-like system – where existing entrants have little incentive to innovate and are instead content to continue extracting unjustified rents from consumers. The technology exists to change the system for the better, just not the will. That is not to say that regulators are blameless. When you have a monopoly-like system – with very high barriers to entry – it is the regulator’s job to prod their institutions to overcome that collective action problem. In other words, it is sometimes the regulator’s job to serve the public interest by pushing market actors to do what those market actors are unwilling to do themselves."
This change will take a long time, though, and even the most successful of the virtual currencies—Bitcoin—is at a very early stage. "Virtual currencies such as Bitcoin are a very, very long way from being a credible challenger to banks or the existing payments system, though the imprimatur of financial regulation will probably help. But I think virtual currency could eventually cause some amount of self-reflection in the legacy financial system," he said.
Lawsky then drew a parallel to the issues that destroyed the Blockbuster Video chain. "The problem that in an age of heightened consumer expectations for real-time, digital payments, if banks fail to innovate, they could eventually face a real challenge. Blockbuster Video stores used to be on virtually every corner in of our country. But with the emergence of Netflix, they practically disappeared overnight. Money is, of course, a different animal from something like video or music technology. The financial crisis notwithstanding, I think most people still feel more comfortable entrusting an old, well-established, FDIC-insured bank with their money, rather than a tech start up. That said, if banks continue to torpedo even modest updates to the payment system, they ultimately do run at least some risk of facing the Blockbuster Video problem. Our children, and our children’s children, will not hesitate to bank digitally. They will demand speed and efficiency in the payments world."
He said that he thinks most financial players will make the painful changes.
"My guess is that banks will eventually adjust. It is in those institutions' long-term interest to do so – both from a financial and an existential perspective. And they will probably co-opt or acquire some of the most promising technology after a period of trial and error. Regulators, for their part, will have to keep up and find ways to permit innovation and improvements, while protecting against money laundering," he said. "But if banks do not make significant progress soon, regulators should consider actively pushing for, or even perhaps mandating, improvements. That is not typically the way regulators like to operate. It is generally better to let the market make these types of determinations. But at a certain point, enough is enough. And four decades of slow-to-non-existent progress in the bank payments system seems like fair warning."