Things are looking up for Bitcoin’s biggest regulatory hurdle

How the OCC and states like Illinois are taking strategic, sensible approaches to promising new financial technologies.

This week we filed two regulatory comments in proceedings (with the Treasury Department’s Office of the Comptroller of the Currency and the Illinois Department of Financial and Professional Regulation) that could have a big positive impact on Bitcoin and digital currency policy. To explain, lets get a feel for the problem.

When’s the last time you had to get 50 of something? Not $50 or 50 Bitcoins, I mean 50 of something tangible, hard-to-find, unique, and non-fungible. Think about your driver’s license and how difficult the DMV can be; imagine going to 50 different DMVs and getting 50 different driver’s licenses. What if you had to get 50 different licenses just to be able to drive across the country? What if you also had to convince each DMV office that you would drive safely even though you were going to be driving in a hovercraft instead of a car? Sounds like someone’s sick idea of eternal damnation, no? Welcome to your life as a digital currency compliance professional!

Yes, to operate a custodial bitcoin business legally in the US with US customers, you’ll generally need a bunch of licenses. So, if you ever wonder why we at Coin Center are always going on about the “state licensing problem” facing bitcoin startups, just think of this

Only slower.

And we’re not just impatient or eager to see the laws simply disappear; we also want good policy. Asking for no regulation is both unrealistic and could leave some consumers unprotected. But here’s the thing: our 50 state licensing system is slow, complicated, and its also may not be the best bet for keeping us safe. As we wrote in our recent OCC comment:

This can be the case because each individual state will generally be concerned only with the activities of licensed firms that touch their own citizens, rather than the systemic health and risk profile of the licensee as a whole. This is a particularly odd regulatory approach for businesses that, by virtue of the Internet, are almost assuredly global in the scope of their operations. For example, in Alabama, a money transmission licensee need only prove a minimum net worth of $5,000 and obtain a surety bond of $10,000 in order to satisfy the capital and liquidity protections mandated by that state’s money transmission laws. At best this may be barely sufficient to protect customers in Alabama, and in general it appears severely disjointed from the realities of the modern payments and financial services industry.

So how do we fix this?

Well, the OCC provides one possibility in its paper, Exploring Special Purpose National Bank Charters for Fintech Companies, and our comment urges them onward: create a single, federal regulatory regime for companies that want to become limited purpose digital currency banks (yes! banks!), and be sure that those regulations preempt state licensing requirements.

Illinois’ proposed Virtual Currency Guidance offers another route, and our comment congratulates them on a sensible light touch approach that will avoid prematurely regulating purely digital currency based activities as money transmission.

In general our comments applaud both agencies on their foresight and sensitivity to the issues facing this technology, but they also go further. To the OCC, we explain how digital currency business activities are, likely, already within the scope of so-called “bank-permissible” activities as interpreted by the OCC in past determinations:

Safekeeping digital currency for a customer is the functional equivalent of a traditional bank’s safekeeping and custodial services. Hosting a digital currency wallet, as an activity, is indistinguishable from providing a cryptographic key escrow service. The sin qua non of digital currency possession is knowledge of a private key that mathematically corresponds to a public key or address that has received digital currency payments according to a distributed ledger, e.g. a blockchain. Hosted wallet providers in the digital currency industry develop and maintain technological infrastructure that can safeguard the cryptographic keys and credentials necessary for a customer to transact using her digital currency, and enable her to sign transaction messages—thereby transferring her digital currency to another person—using these keys at will. Providing such a cryptographic key escrow service is an activity that the OCC has interpreted as part of the business of banking since 1998.

And we also spend a number of pages describing the real benefits promised by this technology:

Approving digital currency companies to operate under a national bank charter will spur innovation, enhance American competitiveness within the global financial technology sector, improve protections for consumers of digital currency services, and promote the development of tools and platforms that can bolster financial inclusion.

If you want to learn more, or if banking regulation is just your idea of a ripping-good evening read: check out our in-depth comment.

We first met with the Illinois DPFR back in January of last year. They were genuinely interested in digital currency technology (we had some great discussions about security, public key cryptography, and blockchain identity tools). Also, they were willing to develop a cautious and pro-innovation approach to regulation. We described the landscape of regulatory options (as you’ll find on our tracker) and recommended the approach taken by Texas and Kansas, who do not require licenses from purely digital currency companies.

We’re happy to report that the Proposed Guidance follows the Texas and Kansas approach, and even goes a bit further. The department has wisely sought to carefully described and enumerate a list of activities that will not be treated as money transmission. We are thrilled to see that so many low risk, infrastructure-building services will be explicitly outside the scope of licensing. As we write in our comment letter,

We are thankful for the clear and concise manner by which the Guidance enumerates those activities which do and do not qualify as money transmission. This is no easy feat given the breadth of statutory language and the wide variety of new activities that digital currencies can facilitate. We agree, in particular, that mining, merchant processing, multi-sig wallet provision, mere transfer of digital currency by itself, and digital currency for digital currency exchange, are not a good fit for classification as money transmission under the laws of Illinois, and we appreciate the care taken to explain these categories of activity and their status as unregulated under existing money transmission law.

Digital currencies, the networks that power them, and the brilliant developers and entrepreneurs that create and maintain them have had their fair share of encumbrances here in the US, but as our comments this week explain and encourage, things are looking up; that DMV line may be moving a bit faster after all.