December 11, 2014

Benjamin Lawsky, superintendent of financial services for the New York State Department of Financial Services, speaks on the process his department is undertaking in figuring out how to regulate virtual currencies. 

Cardozo Law Tech Talk Looks Closer at Bitcoin Regulation

By Janice Weber

October 14, 2014

The second installment in the Cardozo Law Tech Talks series focused on the theme of Regulating Digital Currency: BitLicense and the Internet of Value. The Honorable Benjamin Lawsky, superintendent of financial services of the New York State Department of Financial Services, was there to share with the audience the progress of governmental efforts to both encourage and fairly regulate this burgeoning new financial medium in New York State.

In his introduction to the Tech Talk, which was held on October 14, 2014, Dean Matthew Diller said, “The emergence of virtual currency brings our system of finance and financial regulation to new frontiers and raises a whole new set of questions about what is required to safeguard the integrity of our financial markets and institutions in this changing world.”

The Jacob Burns Moot Court Room was packed for the event with a varied audience comprised of law students and faculty, state regulators and representatives of regulated entities, tech startup entrepreneurs and bankers, developers and bitcoin enthusiasts, and a very interested financial press such as the Wall Street Journal and Reuters to Coindesk and Wired, whose headline the next day summed up the cloud of concern hanging in the room: “New York’s Bitcoin Regulations May Not Kill Startups After All.” They gathered to hear from Superintendent Lawsky, a recognized leader in shaping the future of regulation in this new era, whose BitLicense regulatory approach, when finalized, may well become the model for similar legislation across other states and abroad.

Among the guests were a panel of experts assembled by Aaron Wright, director of Cardozo’s Tech Startup Clinic and noted crypto-currency expert. Members of that panel—all experts in the areas of business, technology and Bitcoin space—would later discuss the issues brought to the fore by Lawsky’s presentation.

“The advent of virtual currencies is just one aspect of the profound changes that are ongoing before our eyes,” said Lawsky. These changes have brought two powerful interests on a collision course: traditional banking institutions, which are tightly regulated and conservative, and technology, which is largely unregulated and all about innovation. “As regulators, we want innovation, we want technological advancement and the economic development it brings, but we also have a responsibility to go to the core safety-and-soundness work that the Department of Financial Services does to protect consumers: to license, examine and regulate those entities here in New York.”

Decentralized  crypto-currencies (also called virtual or digital currencies) began making waves in 2009 and quickly showed up on the Department’s radar. As the state agency charged with regulating money transmitters such as Western Union and MoneyGram, the Department is obliged to come up with appropriate “regulatory guardrails” that include this new form of currency transmission. From the beginning, they knew that appropriate regulation would require something different than retro-fitting old rules and using statutory schemes written “before anyone ever thought of the Internet, let alone crypto-currencies.” To this end, the Department launched an extensive inquiry, followed by a series of public hearings, expert testimony and (still ongoing) public comment and culminating in BitLicense, a proposed set of rules for regulating virtual currencies in the state of New York. 

“As we started getting deeper into it, we could see the power of the technology that underlies it, and an array of potential benefits.” Among those benefits was cheaper, faster money transmissions. Lawsky cited as an example the millions of remittances sent by immigrant workers to support families in the sender’s native country. Using traditional banking institutions, fees related to the transactions can strip 8 to 9 percent from every dollar, according to Lawsky, and transfers can take days to complete. In contrast, “virtual currency can be sent all over the world almost instantaneously, at a fraction of the cost.” Crypto-currency can, of course, be abused, said Lawsky, “but that’s true of our traditional banking system where we’ve seen at times broad money laundering by some of our largest institutions using regular old dollars.”

An initial regulatory framework was to be completed by the end of 2014 and put out for comment. But the dramatic collapse of Tokyo-based Mt. Gox—at the time one of the world’s largest Bitcoin exchanges—made the Department reassess the proposal and toughen the rules. As a result of the Mt. Gox collapse, hundreds of thousands of consumer’s bitcoins essentially vanished overnight. “That event highlighted the risks consumers take in trusting their money to an unregulated financial institution, whether it’s Bitcoin or any other financial product,” said Lawsky, “and that is precisely why we have financial regulation.”

The latest version of BitLicense, still out for public comment, mirrors many of the regulations applied to traditional financial institutions—much to the discomfort of many of the pioneers of decentralized virtual currencies. Members of the more radical crypto-currency community believe that many of the regulations included in BitLicense are simply unnecessary due to additional benefits and security measures that virtual currency technology can offer to secure and monitor financial transactions. 

For fledgling virtual currency startups, the cost of compliance under a strict regulatory regime could be a showstopper. “There has to be a way for startups to start up in the greatest financial center in the world without getting crushed by compliance costs,” Lawsky said. “It’s a question we struggle with: How do we enable three buddies in a garage with a great idea to get off the ground without hobbling them with this enormous initial financial burden?” The BitLicense proposal was meant to be a beginning and not an end, Lawsky cautioned, a process meant to spark vigorous public discussion about what the final regulation should look like. The most interesting and successful utilization of virtual currency—and the regulations that guide it—“have yet to be imagined by any of us.” 

Among the most pressing concerns of the audience was the scope of regulation. For example, attendees wanted to know who would be required to get a BitLicense and how the licensing requirement would affect software developers and small technology startups. Lawsky was quick to clarify: “We do not intend to regulate software or software development. We are regulators of financial intermediators; we are not regulating software development, period.” 

“When it comes to safeguarding consumers, an underregulated world of caveat emptor has never been sufficient,” Lawsky said in closing. Right now, virtual currency is at a crossroads. It’s a new world for the Department, Lawsky admitted, but “We’re struggling with it, we’re well aware of it, and we get it.”