U.S. Regulators & Your Cryptocurrency: State Money Transmission Laws

By: Steve Masur

In part one of this series, I provided an overview of the US regulatory landscape that impacts cryptocurrency businesses.  This article resumes the topic and focuses on state money transmission laws.

State money transmission laws present stifling hurdles to cryptocurrency innovators operating in the US. As it stands now, 53 state and US territories have 53 different sets of money transmission regulations on the books.

Besides the fact that there are so many different sets of regulations, there are other complicating factors.

• Most are ‘extraterritorial’ – meaning you have to obtain a license in every jurisdiction in which you have or solicit customers;
• Many of the agencies that administer and enforce the regulations lack an understanding of blockchain and cryptocurrency businesses; they also lack the mandate, funds and willingness to engage with unfamiliar business models;
• The regulations require you to obtain a license before you engage in the restricted activity, and the process of obtaining licenses can take years, if you’re lucky enough to get them at all;
• The consequences for failing to comply are potentially severe, and violators face both state and federal criminal penalties, including up to five years in jail and millions in penalties, simply for operating without a license

It gets worse. The biggest problem these statutes pose to cryptocurrency businesses is that they were written long before the dawn of blockchain ten years ago, and, with few exceptions, it’s difficult, if not impossible, to determine whether those laws apply to cryptocurrency businesses.

How did we get here? Unlike federal money transmission laws, which are concerned primarily with money laundering and counter-terror financing, state money regulations exist to protect consumers. Until recently, businesses that transmitted money from one person to another had to take custody of the money in order to pass it along. The concern was that these businesses would lose or steal the money, and so laws were passed to protect against that. So, although they’re called “money transmission” laws, the activity they seek to regulate is actually the act of having custody over someone else’s money. And how is “custody” defined? It often isn’t, because when the laws were written, it was clear what was meant by the “transmission of money” and it was equally clear that it required “custody.”

Most companies in the cryptocurrency space don’t ever take custody of someone else’s cryptocurrencies in the traditional sense – in the sense that they can lose or steal it. Miners don’t, nor do software developers, non-custodial wallet providers or non-custodial exchanges. Yet all are burdened by state money transmission laws because all of them, arguably, somehow facilitate the “transmission of money.”

So what is a responsible cryptocurrency business that intends to operate in the US to do?  Until regulators provide clarity, the only option is to hire a law firm to consider the laws of all 53 jurisdictions and then apply for licenses in those jurisdiction where a license is potentially required. This process costs hundreds of thousands of dollars a year, a cost beyond the reach of all but the most well-funded startups.  The other option, of course, is to avoid operating in the US altogether, a path many are choosing to take.

Among the initiatives underway to fix this problem, the following two appear the most promising.

Regulation of Virtual Currency Businesses Act

The Uniform Law Commission (ULC) is a non-profit made up of lawyers and legal academics that drafts model laws in the hopes that states will adopt those models, thereby bringing about more uniform regulations. In November 2017 the ULC published a final version of its Regulation of Virtual Currency Business Act.

This model act substantially clarifies what virtual currency activity requires licensure, in large part by defining key words that are undefined in current regulations. For example, the acts of exchanging, storing and transferring all are based on having “control.” And “control” is defined as the “power to execute unilaterally or prevent indefinitely a virtual currency transaction.” This is well-crafted verbiage that mirrors the concept of “custody” in current regulations. In other words, when it comes to virtual currency activity, only actors that can execute unilaterally, or prevent indefinitely, a transaction, are in a position to lose or steal another’s virtual currencies.

Since the ULC only proposes laws, states must now adopt the model act. Unfortunately, this will likely take many years, assuming they adopt the model act at all. The Uniform Commercial Code (UCC), which is the most well-known model act created by the ULC, took about 10 years to be adopted by nearly all the states. That was in the late 50’s and early 60’s when things moved a bit more slowly, so perhaps we’ll see the model act get adopted in less than the decade it took before.

But however long it takes, the model act represents a significant accomplishment because it presents a clear-headed, informed and balanced framework to regulators who, like most everyone else, are struggling to understand cryptocurrencies.

Office of the Comptroller of the Currency (OCC): Federal Preemption

The OCC is a bureau within the Department of the Treasury, and is the federal agency that charters and regulates national banks. When a bank is chartered by the OCC, it is no longer subject to the various state laws. In other words, the OCC’s regulations preempt conflicting state regulations.

In December 2016, the OCC announced it would consider applications from financial technology companies to become special purpose national banks. The idea is that, by receiving a charter from the OCC, these companies could avoid conflicting state money transmission laws. The chief proponent of the initiative was OCC head Thomas Curry, who stepped down last year before the initiative could be finalized. Although it was initially left for dead after Curry’s departure and has been challenged by several states alleging that it exceeds the OCC’s authority, earlier this month the OCC said it expects to publish its position on the fintech charter initiative soon.

Were the OCC to create a path for fintech companies to receive a federal charter, it would be most helpful to companies that acknowledge they are subject to the various state licensure requirements. It would not help the many cryptocurrency companies that don’t believe they should have to comply with state regulations in the first place. Asking those companies to undergo the process of obtaining, and complying with, a national charter would not be a welcome solution to their dilemma. Relief for them in the form of federal preemption would require Congress to create a safe harbor, and with legislators now turning their attention to mid-term elections, it’s unlikely that this will get their attention anytime soon.