Bitcoin supporters say New York regulations would stymie innovation

Bitcoin supporters are in an uproar over a proposal to regulate the cryptocurrency in New York, the first state to make such an effort.

The regulations, published by the New York Department of Financial Services on Thursday, would require the kind of record-keeping, cybersecurity and anti-money-laundering systems that major banks typically implement, potentially protecting the fledgling community against the kind of fraud that brought about liquidity disasters in the past.

But the regulations also would entail what bitcoin backers characterize as onerous and innovation-killing conditions, like fingerprinting and capital requirements, that would apply to all bitcoin businesses, whether they are major repositories with millions of dollars worth of deposits or small exchanges converting the currency into dollars.

"You are creating a few dangerous barriers to entry, and there is a huge glaring problem with the definition of virtual currency business activity," wrote a user on Reddit, where Benjamin Lawsky, superintendent of financial services in New York, posted a link to the draft regulations, in a nod to the currency's passionate online following.

Under the regulations as proposed, any "virtual currency business activity" must apply for a bitlicense in New York. Included in the definition are entities that store and hold bitcoins — such as the Tokyo-based Mt. Gox, which shut down in February after mysteriously losing hundreds of millions of dollars in what it claimed was a hacking attack.

After a 45-day public comment period, the Department of Financial Services will decide whether to make changes and approve the draft regulations. Another 45-day period follows before the regulations go into effect.

Controversially, the new rules cover businesses that perform "retail conversion services." This could pose a problem for smaller currency exchange shops that might help immigrants send remittances home for low fees — a use many bitcoin advocates have trumpeted.

Perhaps most problematic for bitcoin's core supporters, the rules also cover anyone who controls, administers or issues the virtual currency. 

Some bitcoin advocates refer to the latter definition as the Satoshi clause, referring to the anonymous creator of bitcoin, who went by the pseudonym Satoshi Nakamoto. In New York, critics of the regulations argue, Nakamoto would have had to apply for a bitlicense.

The application requirements are complex. Bitcoin hopefuls would need to prove their identity and submit banking details, independent background reports on their business' top officers and their fingerprints to New York's Division of Criminal Justice Services and the FBI in addition to other requirements.

Under the regulations, New York's Department of Financial Services would determine how much capital each bitcoin company must maintain, and businesses would be allowed to use their profits only on permissible investments: certificates of deposit, money market funds, state or municipal bonds or federal government securities.

The regulations would require strict cybersecurity and financial reporting requirements aimed at preventing another Mt. Gox–like meltdown, including quarterly financial statements, mandatory reviews every two years, a chief information security officer on staff and 10 years of business transaction records.

Some bitcoin advocates lambasted the regulations and suggested lobbying state officials or challenging the rules in court. They argued that the regulations would kill innovation in New York, pushing bitcoin exchanges and businesses to more favorable environments in Canada or abroad. Others pointed out that most ordinary consumers wouldn't be affected and could continue buying and exchanging bitcoins and using them to purchase goods.

In an interview with CNBC, Lawsky said he expected to adjust the regulations in response to critiques over the 45-day public comment period, which began on July 17.

"Already the Twitter traffic coming right at us is, 'What about this? What about that?' … In a way, I'm really excited," he said.

Asked whether his rules would have prevented a Mt. Gox–like meltdown, Lawsky said that was the intent and that the laws included strict cybersecurity requirements for that reason.

Bitcoin was not the only element of the financial world that suffered from vulnerabilities, he argued. "You could say that about out entire banking industry too."