New York State Department of Financial Services Revokes Crypto Exchange’s Safe Harbor to Operate Without BitLicense

The New York State Department of Financial Services revoked the authority of Bittrex, Inc. to operate a virtual currency business involving New York or a NY resident effective April 11, 2019. The firm had been conducting business in New York pursuant to a “safe harbor” granted by NYSDFS while its application of August 10, 2015, for a NY BitLicense and its application of July 27, 2018, for a NY money transmitter license were pending.

NYSDFS denied Bittrex’s license and revoked its authority to conduct a virtual currency business in New York, saying the firm could not “demonstrate it will conduct its business honestly, fairly, equitably, carefully and efficiently” as required by applicable law and rules.

In response, Bittrex issued a written statement saying it was “saddened and disappointed” by NYSDFS’s action.

Under NY law and rules, persons engaging in a virtual currency business involving New York or NY persons must typically have a NY BitLicense and a money transmitter license. The BitLicense requirement was adopted in 2015. In 2018, New York amended its rules for persons engaged in a virtual currency business to require a program for monitoring for fraud, including manipulation. (Click here for background on NY BitLicense requirements in the article “New York BitLicense Regulations Virtually Certain to Significantly Impact Transactions in Virtual Currencies” in a July 8, 2015 Advisory by Katten Muchin Rosenman LLP. Click here for additional information on the 2018 augmentation of requirements for persons conducting a NY virtual currency business in the article “NYS Financial Services Regulator Ups the Obligations of State-Licensed Virtual Currency Entities” in the February 11, 2018 edition of Bridging the Week.)

According to NYSDFS, Bittrex’s current anti-money laundering and economic sanctions compliance program are inadequate; it was not certain that Bittrex followed its own guidelines in approving digital tokens for trading on its own platform; and Bittrex would not commit to comply with NYSDFS’s capital requirements. In connection with the firm’s AML program, NYSDFS indicated that Bittrex lacked adequate policies and procedures; may not have employed an AML compliance officer with adequate experience who evidenced an appropriate level of authority and effectiveness; did not adequately train employees; and may not have had adequate independent testing of its AML program, all of which are required under applicable rules.

Bittrex vehemently disputed NYSDFS’s findings, but acknowledged that it was on a “journey to improving and maturing our compliance function.” The firm noted that “[c]orporate responsibility is in our DNA and our commitment to regulatory and compliance guidelines is second to none.” In response to NYSDFS’s claim that Bittrex was unwilling to commit to meet the Department’s financial requirements the firm claimed that “NYDFS imposed capitalization requirements in excess of that of any other state despite Bittrex’s industry leading security and cold storage procedures.”

Under NYSDFS’s order, in addition to suspending its NY business by last week, Bittrex is required to wind down or transfer existing positions of NY residents by June 9, 2019.

Separately, NYSDFS granted a BitLicense to Bitstamp USA Inc., a subsidiary of Bitstamp Ltd. Under its license, Bitstamp is authorized to enable its customers to buy and sell bitcoin and other designated cryptocurrencies, as well as facilitate transfer of funds onto the Ripple network, issuing Ripple balances in US dollars and select non-US fiat currencies, as well as other virtual currencies. According to a statement by Bitstamp, the firm “has always embraced regulatory efforts which focus on transparency and accountability that help expand the industry.” Bitstamp’s approval marked the 19th approval by NYSDFS of a company to engage in a virtual currency business in New York.

In other legal and regulatory developments involving cryptoassets:

  • Representatives Propose New Legislation to Carve Out Utility Tokens From Application of Securities Laws: Multiple US Congressmen introduced the “Token Taxonomy Act” to exclude from the definition of “security” under US securities laws “digital tokens,” namely cryptoassets that do not constitute a financial interest in a company or partnership. As proposed, the Securities and Exchange Commission and all states would be prohibited from enacting any requirement mandating the registration of digital tokens as securities. The proposed law would also require the SEC to adopt rules to provide for good control locations for any digital token that might be a security, as well as for the Internal Revenue Service to clarify the tax treatment of certain events involving virtual currencies.
  • Developer of Decentralized Computing Network Files Reg A+ Offering for SEC Approval: Blockstack Token LLC filed an offering statement with the SEC related to its proposed offering of up to 295 million Stacks Tokens. Through this offering, the firm hopes to raise up to US $50 million to further the development of the Blockstack decentralized computer network and decentralized applications. Blockstack filed its offering statement pursuant to Regulation A+, which provides an exemption from SEC and state registration requirements for smaller companies that meet certain eligibility, disclosure and reporting requirements. (Click here for details regarding Reg A+.) Blockstack expects that, if approved, its offering will be “the first SEC-qualified token offering of its kind” to rely on Reg A+.
  • Coordinator of National Financial Regulators Publishes Directory of International Crypto Regulators: The Financial Stability Board published a list of national regulators of cryptoassets worldwide and briefly described how each overseer interfaces with digital assets. Last year, the FSB published a report concluding that cryptoassets do not currently pose any material risks to global financial stability, but should be monitored vigilantly in light of the speed of market developments. (Click here for background in the article “International Financial Regulator Coordinator Says Crypto-Assets Currently Pose No Threat to Financial Stability” in the October 14, 2018 edition of Bridging the Week.) Established in 2009, the FSB is an international organization comprising representatives of national authorities responsible for financial stability in material international financial centers. The FSB monitors and makes recommendations about the global financial system.

Memory Lane and My View: In September 2018, the New York Attorney General issued a report claiming that trading platforms for cryptocurrencies often (1) engaged in several lines of business that may pose conflicts of interest; (2) have not implemented “serious efforts to impede abusive trading activity”; and (3) have “limited or illusory” protection for customer positions. Moreover, the report named three cryptocurrency platforms that it alleged might have been operating unlawfully in New York at the time, and said it referred these platforms to the NYSDFS for possible further action. However, no public enforcement or other action by the NYSDFS has been announced against any identified firm since the NY AG report.

The NY AG’s report followed a voluntary request for information sent to 13 cryptocurrency platforms earlier last year.

Just as the NY AG report appeared at the time to be a damning public indictment of multiple cryptoasset exchanges without the ordinary protection afforded defendants in judicial processes, NYSDFS denial of Bittrex’s license transformed what should be private interactions into public theater. It may well be that NYSDFS was justified in its bottom-line determination, but the public way it excoriated Bittrex seems inappropriate.

That being said, a fundamental flaw of founders and promoters of both permissioned and permissionless blockchain networks is they all presume their system design is the best. Although such persons may, for permissionless systems, espouse the benefit of peer-to-peer non-intermediated transactions through “disruptive” decentralized, cryptographically secure networks, such a benefit only exists for transactions on a specific blockchain. They do not exist for transactions across blockchains, such as exchanges of one digital asset for another or for interactions involving the real world, such as exchanges of fiat currency for a digital asset. These cross-blockchain network transactions today require third-party intermediation as different digital networks are generally not natively interoperable.

As a consequence, it is not unexpected that regulators seek to impose minimum qualifications on such intermediaries to protect customers, and it is equally not unexpected that many of such intermediaries in the relatively new cryptoasset industry have little or no experience dealing with experienced financial regulators. As Bittrex acknowledged about its own situation, “[We are] a young innovative company that believes in the future of blockchain technology. Bittrex will continue to mature its compliance program because we believe in being good corporate citizens, and because we believe in the rule of law. We will continue to work with the many other regulators, and we will continue to take constructive feedback to improve our ability to be the corporate citizens we have set out and committed to be.”

Hopefully, as the cryptoasset industry continues to evolve, regulators and legitimate industry participants will continue to work together to ensure an appropriate environment for customers without resorting to inflammatory front page headlines and public shaming absent fraud or other purposely nefarious conduct.

(Click here for additional information regarding the AG’s findings in the article “NY Attorney General Says Investors Risk Abusive Trading and More on Crypto Platforms” in the September 23, 2018 edition of Bridging the Week.)

 

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