As Federal Agencies Organize, U.S. States Continue to Lead in Regulating Digital Assets
A guest essay from Kara Kuchar & Steve Cummings, of Schulte Roth & Zabel LLC, discusses Biden's "whole-of-government" approach to crypto reg.
On March 9, 2022, the Biden administration issued a much anticipated executive order regarding digital assets, which called for "the first-ever, whole-of-government approach to addressing the risks and harnessing the potential benefits of digital assets and their underlying technology."
While its reception has been mixed, one comment – from New York State Department of Financial Services (NYDFS) Deputy Superintendent Dan Sangeap on LinkedIn – raised an interesting question: after almost eight years of letting states craft their own crypto policies, "what's the rush" at the federal level?
An NYDFS deputy superintendent highlighting New York's virtual currency framework is not in itself surprising. What is surprising is how it mirrored congressional republicans pointing to New York cryptocurrency regulation as an example of how the federal government is lagging behind the states.
Specifically, during the U.S. House of Representatives' hearing on the president's Working Group's Report on Stablecoins, Rep. Warren Davidson, a Republican congressman from Ohio, referenced that the NYDFS had already been regulating stablecoins for years, and that the federal government was "seven years late."
Indeed, many of the state money transmission laws provide a regulatory licensing framework for stablecoins. Although the Biden administration is attempting a "whole-of government" approach, it's likely that states, in both the short and long term, will continue to play an active role in regulating the global crypto industry.
Even with the March 9, 2022 executive order, well-respected crypto industry leaders – such as Ari Redbord of TRM Labs – still believe that "much-needed action from Congress probably won't be happening soon." This pessimism also extends to the recently unveiled Responsible Financial Innovation Act, which is already considered merely "a starting point for a dialogue."
While anecdotal, these comments underscore the vital role the states play in regulating the cryptocurrency space. And the importance of state regulation has grown not only due to federal inaction but also perceived policy reversals at the federal level (e.g., a top national banking regulator putting the brakes on new crypto charters for a period of time). Innovation is happening below the federal level.
With this in mind, those interested in innovation should look not only to federal efforts but also to the states, primarily New York, Wyoming and Florida.
New York
New York is arguably the most prolific crypto regulator, if for longevity alone. The NYDFS has been overseeing New York's cryptocurrency market for seven years, having been tasked with regulating virtual currency in 2015. In addition, the NYDFS has been credited with being the first to have a comprehensive licensing and regulatory regime in the U.S. tailored to virtual currency activity.
In these seven years, the NYDFS has drawn more than its fair share of criticism, ranging from crypto entities that fled New York to avoid the BitLicense, to the former superintendent herself. With that said, others have touted NYDFS as being "pivotal in bringing fresh money into the crypto space through regulatory approvals."
Independent of its supporters and detractors, the BitLicense regime has stood firm and appears to be stronger than ever.
In fact, not only has the legislature recently authorized NYDFS to "assess" virtual currency firms – which should aid NYDFS in further growing the virtual currency unit – but "more money and jobs are still flowing into New York than any other city, making it the de facto crypto capital of the U.S."
Moreover, NYDFS Superintendent Adrienne Harris has stated that improving the BitLicense is one of her top priorities, and she has not only already hired additional staff this year to help streamline the process, but she also plans to triple the size of the virtual currency unit by the end of the year.
Wyoming
While New York may have longevity and institutional prestige, Wyoming has been trying to establish itself as a leader in the crypto space.
The Wyoming legislature has enacted multiple blockchain-related laws, including a legal framework for recognizing decentralized autonomous organizations (DAO). Most notably, Wyoming created a new type of charter, the Special Purpose Depository Institution (SPDI), to "focus on digital assets, such as virtual currencies, digital securities and digital consumer assets." According to Wyoming, four SPDI charters have already been approved.
It is unclear, however, if these four SPDIs have begun operating. Specifically, there have been reports that none of the four approved SPDIs had yet received the necessary certificates of authority to operate. It would appear that this is still the case, based on information from each entity's website.
Florida
Like Wyoming, Florida has been trying to position itself as the next cryptocurrency – and financial – capital of the U.S. So much so that, in a not-so-subtle jab at the iconic Wall Street Bull, Miami Mayor Francis X. Suarez unveiled "The Miami Bull" at Bitcoin 2022. While much has been said about the Miami Bull, more should be said about the steps Florida is taking to make itself more crypto friendly, most noticeably legislation to remedy the Espinoza problem.
For reference, the Espinoza problem refers to State v. Espinoza, a 2019 Florida court ruling which held that any two-party transaction involving cryptocurrency in Florida would require the seller to have a money transmitter license.
Some have painted efforts to reform Espinoza as being sponsored by the industry, but such criticism minimizes the inconsistencies that Espinoza poses. The Espinoza holding rendered Florida an outlier, with most states requiring licensure where a third party intermediary is also present.
It is for this reason that Espinoza has been panned by the industry, as well as by the commissioner of the very agency responsible for enforcing Espinoza, Florida's Office of Financial Regulation. In response to industry concerns, legislation was recently passed by Florida legislators and signed by the governor, which creates a legal distinction between two parties buying, selling or trading cryptocurrencies versus transactions facilitated through an intermediary. The changes will become effective on January 1, 2023.
States-led is good
The push by states to fill the regulatory vacuum has not been without criticism. A common refrain is that the patchwork of state regulation makes compliance efforts cumbersome. A more recent complaint is that states have become unknowing, or willful, stooges for the crypto industry. What these criticisms miss are the potential benefits that state regulation brings.
State regulation can bring further clarity and on a large scale, can even provide some measure of uniformity. With each additional state that issues guidance or no-action letters stating when virtual currency activity is – or is not – regulated as money transmission, industry participants are provided further clarity.
Moreover, as certain approaches to regulation gain traction among the states, an organic type of uniformity can develop across the patchwork, ultimately bringing certain outliers back into the fold (e.g., Florida joining other states in regulating crypto activity as money transmission only when there is a third party intermediary present).
The patchwork of state regulation can also serve as a source of "healthy and protective regulatory redundancy." While redundancy is not often viewed in a positive light, one can posit that the presence of numerous regulators can better absorb the shocks posed by partisan administration changes when compared with their federal counterparts.
Here to stay
Furthermore, there are several signs suggesting that state regulators will continue to play a key role in cryptocurrency regulation. While the Federal Government has tended to neglect state regulation in the past, in its April 7, 2022 alert, the Federal Deposit Insurance Corporation urged its regulated entities to also notify state regulators of their crypto-related activity.
Senator Pat Toomey's Stablecoin TRUST Act also mentions state regulators and "[p]reserves the state-registered money transmitter status for most existing stablecoin issuers." And from the private sector, Paxos – one of three entities granted a National Trust Bank charter by the OCC for cryptocurrency-related activities – has publicly stated that it has no intention of abandoning its New York charter.
Only time will tell if Biden's "whole of government" approach to virtual currency regulation is successful. But consumers, industry and other interested parties should take comfort in knowing that the patchwork of state virtual currency regulation is still going strong, particularly in New York, Wyoming and Florida.
– Kara Kuchar & Steve Cummings
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