Updated: Crypto Regulation Is On The Horizon In Sunny California

January 16, 2020
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UPDATE (7/20/20): The California DBO expansion described in this article has since been quietly placed on hold, most likely due to the need to focus on COVID-19 priorities. More details here, we will update this page if anything changes.

A proposed expansion of California’s Department of Business Oversight would mean big changes to how cryptocurrency businesses are regulated in the state.

California’s budget might not make the morning coffee shop talk for most us, but cryptocurrency money services businesses/money transmitters operating in the state might want to tune into this one.

A recent story in the Sacramento Business Journal focuses on a piece of Governor Gavin Newsom’s budget proposal that vastly increases the state’s ability to enforce consumer financial protections.

Specifically, it calls on the state to enforce regulations of the federal Consumer Financial Protection Bureau (CFPB) “that have been paralyzed at the federal level,” i.e., rolled back by the current administration.

What does this mean for cryptocurrency business in California?

Coupled with forthcoming cryptocurrency regulation in the form of AB 1489, we’re going to make an educated guess that California is putting their money where their mouth is when it comes to regulating cryptocurrency.

But what will this impending regulatory environment look like? How quickly can we expect hypothetical changes to take place? How will things be different from other tough regulatory jurisdictions, like New York?

We make some more educated guesses below.

Consumer Financial Protection In California Is About To Change Big Time

California Department of Business, Gavin Newsom - BitAML BlogThe most significant takeaway from the Sacramento Business Journal article (reported by Mark Anderson), and the reason for our hypothesis, is Governor Newsom’s proposal to reconfigure the state’s Department of Business Oversight (DBO).

Under the new budget proposal, the DBO will undergo a “rebranding,” and expand significantly in size and scope. It will be called the Department of Financial Protection and Innovation, and receive just over $10 million in funding for over 40 new positions. Over the next few years, the budget allocation will increase to nearly $20 million, with nearly 100 new positions added to meet the department’s consumer financial protection mandate.

Why does this matter?

Because by building consumer financial protections into the latest budget proposal, the state is showing us they are so serious about it, they’re proposing to dedicate major resources to it.

That’s not all.

Three Big Hints Pointing To Cryptocurrency

Though cryptocurrency is never mentioned explicitly, there are several other hints that its regulation will become a major focus of the newly-rechristened department.

One, the DBO’s own website states that the purpose of its expansion is to “extend state oversight to important financial-services providers not currently subject to state supervision.” This includes everything from state-chartered banks to payday lenders as well as money transmitters, which as we have covered in some detail, is how cryptocurrency businesses are almost universally recognized by regulators.

Two, the effort would “empower the department to provide consumers greater protection from predatory practices” as part of their new mission, as well as apply more pressure to markets to “identify patterns of abuse.”As is well-documented by now, the cryptocurrency market experiences no shortage of financial crime. California alone has seen several high-profile stories of money laundering, wire fraud, and extortion in just the last year alone.

Third, the regulation of new and innovative financial technologies (including cryptocurrency) is already seen as a given, and not just because “Innovation” is in the title.

From Anderson’s article, emphasis ours:

“As part of this restructuring, we understand that there will be increased emphasis on consumer protection and innovation relative to financial technology and products,” said Beth Mills, spokeswoman for the California Bankers Association. 

Cryptocurrency fits under this purview. And though, again, it is never mentioned by name, the industry certainly wouldn’t be considered an exception by any means.

What Does Cryptocurrency Regulation In California Look Like?

California is currently considered a “no action” state, meaning that the state does not require cryptocurrency MSBs to comply with any specific state regulations (note that federal AML compliance is still expected in “no action” states).

We’ve long warned that “no action” is not a sustainable model, and that business owners in the crypto space need to maintain healthy, open dialogs with state regulators.

Why is this important?

Because state regulation is a “when,” not an “if.” It’s simply inevitable. But open dialogue is important because gives the crypto industry a chance to play a role in shaping regulation.

State regulation is one of the biggest open questions facing the crypto space in the coming years, and California has been signaling their intent to answer that question for their state for some time.

Two bills are currently under consideration in the California state legislature, one of which is the aforementioned AB 1489, a comprehensive piece of legislation that seeks to apply specific regulation to cryptocurrency.

How Strict Are AB 1489’s Proposed Regulations?

Given its scope, AB 1489 has sometimes been compared to New York’s infamous BitLicense, though we consider this an error.

The BitLicense is often criticized for being too strict and too reactionary, to the point where for many money transmitters, doing business in New York is either extremely difficult or downright unfeasible.

While it’s probably fair to argue that the New York Department of Financial Services (NYDFS) moved too quickly, leading the BitLicense to stumble out of the gate, someone has to be “first.”

To wit, other state regulators who watched this process unfold have taken note. They understand that they will need to allocate resources to support cryptocurrency regulation; they need adequate staff to process applications, licenses, and manage the dialog with prospective licensees.Hopefully you’re beginning to see how this connects to California’s proposed Department of Financial Protection and Innovation.

Getting It ‘Right’

It seems clear that the DBO’s expansion and “rebranding” positions the state to manage new regulations for the cryptocurrency industry.

But the good news here is that it looks like they want to get it right.

Reactionary policymaking like the BitLicense or confusing guidance like the recent Travel Rule controversy DO cause a great deal of pain for entrepreneurs and business owners operating in good faith.

From a regulatory and compliance perspective, California is doing what it’s supposed to do to get it right; they’re taking deliberate steps to assess their needs.

“We’ve long warned that ‘no action’ is not a sustainable model, and that business owners in the crypto space need to maintain healthy, open dialogs with state regulators.”

We mentioned before that California has seen its fair share of cryptocurrency crime, but state regulators are also well aware that there are a lot of big cryptocurrency financial institutions in California that provide a lot of jobs and a lot of revenue.

If they’re prudent, they’re factoring this into their regulatory plans.

While state regulation of cryptocurrency is inevitable, it benefits both businesses and the regulators to get their ducks in a row first. It looks like California is trying to do just that.

The new name of the agency is a signal — pointing towards taking an active role in looking at innovative fintech, like cryptocurrency. 

Key Takeaways For Crypto Business In California

The budget allocation, in addition to bills like AB 1489 currently being reviewed, suggests California is getting serious about resources, licensing, and enforcement in the cryptocurrency space.

We wouldn’t be surprised to see job postings on the DBO’s website soon seeking individuals with subject matter expertise and experience in innovative financial technology products and services (read: cryptocurrency).

The takeaway here is just to follow this story; it’s as clear an indication as any that crypto regulation is going to see some changes in California soon.

That said, if your cryptocurrency business operates or plans to operate in California and you want to make sure you’re ahead of regulatory changes, you can reach out for a free consultation.

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