The New York Department of Financial Services (NYDFS) has released a preliminary draft of its upcoming regulations around Bitcoin – and, surprise, surprise, they’re a huge mess.
The new regulations, which would apply to the New York State region, place a number of restrictions on Bitcoin institutions operating inside New York, or doing business with New York citizens. The most notable restriction is the necessity for NY-based Bitcoin exchanges and Bitcoin-selling services to get a “BitLicense,” which will likely be similar to the licensing process for banks and money transfer services. The NYDFS also bans fractional reserve exchange operation, requires exchanges to be bonded to the NYDFS’s satisfaction, and reserves the right to perform spot security audits of Bitcoin businesses.
This is all relatively reasonable from a regulatory perspective, and restrictions that most observers expected. These restrictions will raise the cost of doing business and raise the barrier to entry for startups, but are not, in themselves, incredibly odious. They may even help to provide an environment in which Gox-style collapses are less likely (presumably the intent of the regulation in the first place). The larger issue, however, is the final rule for Bitcoin institutions: Bitcoin users in NY can no longer be anonymous.
Under the new rules, any Bitcoin merchant, exchange, or payment processor must keep records of the name and location of all of their customers for perusal by the state, and must report to the state if any of the names match the list of people that the Treasury is suspicious of. The businesses are also required to suspend the accounts of users that they feel might be engaging in fraudulent activity, and contact the authorities (exactly the sort of requirement that causes PayPal to shut down accounts in a random, untransparent fashion, producing the frustration that drives many users to Bitcoin in the first place).
This stipulation has a number of ugly consequences. We might start with the question of why the state of New York feels the need to know every time its residents buy or trade money, without even a breath of criminal suspicion. What, exactly, do they suspect the average New Yorker of? To make matters worse, the law actually makes it illegal for New Yorkers to use a Bitcoin tumbling service to anonymize their money after the initial purchase. Furthermore, the law has a host of deleterious, unintended consequences. Online Bitcoin businesses have no reliable way of verifying the identity and location of their users, meaning that Bitcoin businesses in NY must use physical offices with physical ID checks when dealing with private citizens, and cannot conduct web commerce. Take a moment to think about the absurdity of outlawing Bitcoin businesses from using the internet.
It gets worse: The requirement of accountholder verification might extend to businesses operating outside of the state of New York interacting with New York residents. In other words, if a New Yorker wants to use the BitcoinTip bot on Reddit, that would be illegal, not just for the New Yorker, but also for the operators of BitcoinTip, which would drastically increase the barrier to entry for Bitcoin-based web services all over the world, forcing them to identify and block New York-based users from their services if they don’t want to have action taken against them by the State of New York, limiting exactly the sort of innovation that Bitcoin was intended to facilitate.
There are a number of other problems with the law (companies aren’t allowed to keep any profits in the form of cryptocurrency), but nothing that even remotely measures up to the problems created by the account verification requirements.
Financial Services Superintendent Benjamin M. Lawsky, one of the drafters of the new rules, described the regulation on Reddit’s /r/bitcoin like this:
“We have sought to strike an appropriate balance that helps protect consumers and root out illegal activity – without stifling beneficial innovation. Setting up common sense rules of the road is vital to the long-term future of the virtual currency industry, as well as the safety and soundness of customer assets.”
The proposed rules will be officially published on July 23 (six days from today), after which there will be a 45-day grace period, during which the NYDFS will take public comment, and possibly revise the legislation based on those comments. Lawsky gave an initial AMA on Reddit in February about the proposed regulation, which attracted significant attention, much of it surrounding the anti-privacy clauses of the legislation, and much of it very negative.
Lawsky went on to note:
“We recognize that – as the first state to put forward specially tailored rules for virtual currency firms – continued public feedback will be an important part of finalizing this regulatory framework. We look forward to carefully and thoughtfully reviewing public comments on our proposal.”
As matters stand, the proposed law is a nightmare for Bitcoin users all over the world, and for New Yorkers in particular. With any luck, the NYDFS will take some of that feedback into account in its revisions, and weaken or remove the anti-privacy clauses of the proposed law. For those of you with opinions on the proposed rules, you can contact the Superintendent of the NYDFS here.