New York added to its reputation for strict regulation of cryptocurrency platforms with an $18.5 million fine against the companies behind the stablecoin known as Tether and its related digital asset exchange.
The state’s reputation on financial technology, which experts say may be inaccurately based on such enforcement actions, stands in contrast with other states, such as Wyoming and Colorado, that are enacting pro-crypto legislation and conducting outreach to attract investment.
Lawyers who work with cryptocurrency companies say a patchwork of complex and divergent approaches to regulation is emerging. Some say the federal government’s lack of action on setting clear rules for fintech presents a major risk for innovators in the burgeoning industry.
“It’s still pretty messy,” said Karen Ubell, an attorney at Goodwin Procter LLP in San Francisco. Ubell advises clients on cryptocurrency issues and noted that federal and state enforcement has been robust, but neither have offered as much guidance to foster fintech.
New York sued Tether Ltd.; Bitfinex, the parent company iFinex Inc.; and related entities in 2019, alleging that Tether wasn’t truly backed 1-to-1 by U.S. dollars as the companies claimed. In February, the companies settled without admitting any misconduct. In addition to the millions of dollars in fines, the companies promised to cease all business within the state.
Dan Roeser, a litigator in Goodwin Procter’s New York office, said the Tether case wasn’t a broad indictment of fintech, but some clients don’t understand that. They tend instead to be more focused on the overall activity level of regulators rather than the outcome of any particular case, he said.
Kayvan Sadeghi, an attorney at Schiff Hardin LLP in New York, said much the same. Even though he’s been alerting clients to activity by the New York attorney general’s office for years, he said, the Tether settlement isn't as significant as it sounds considering Tether's market value of $40 billion.
New York unveiled a separate lawsuit against Coinseed Inc. last month over allegations that its initial coin offering should have been registered as securities and subject to broker-dealer registration requirements.
“Unregulated and fraudulent virtual currency entities, no matter how big or small, will no longer be tolerated in New York,” state Attorney General Letitia James said in a Feb. 17 statement regarding Coinseed. The case is pending, but James made clear that she intends to use state anti-fraud laws to prosecute cryptocurrency businesses over misconduct.
Looking to other states
Sadeghi said that even before these enforcement actions, some clients tried to avoid New York due to the requirement for most businesses dealing in cryptocurrency to register and obtain a BitLicense from the Department of Financial Services. Merchants and consumers using it as a medium of exchange are exempt, but issuers, administrators and exchange services for virtual currency must register.
While New York’s registration requirements might provide some businesses more clarity upfront, they come with costs. The BitLicense state processing fee is $5,000 and involves a 44-page application. Sadeghi estimated that the total costs including professional fees can exceed $100,000 to fulfill the registration requirements, depending on the specific situation.
Wyoming, meanwhile, has tried to welcome cryptocurrency business. The state passed more than a dozen laws aimed at providing clarity on digital asset property rights and custody rules. It also chartered special depository trust institutions to provide banking services to blockchain-focused companies.
The Wyoming Utility Token Act defined the cryptocurrency for the first time as an asset class separate from securities and commodities.
Colorado also signaled its friendly approach to cryptocurrency regulation by convening a working group to study state-chartered banking solutions for blockchain-based innovation. It also passed legislation similar to Wyoming that exempts digital tokens from its securities laws and broker-dealer rules.
The Securities and Exchange Commission, Commodity Futures Trading Commission and several federal courts have gone the other way, classifying many cryptocurrencies as subject to their jurisdiction. The New York attorney general's office on March 1 posted an "industry alert" reminding stakeholders that most cryptocurrencies are either securities or commodities under state law.
These divergent approaches can create confusion and risk for industry innovators that want to play by the rules. Some international fintech projects also await more regulatory clarity before entering U.S. markets, according to experts.
“You get more robust and resilient markets if there are clear rules of the road,” said Linda Jeng, an adjunct law professor at Georgetown and the global head of policy at fintech startup Transparent, which offers a digital platform for business-to-business payments that utilizes blockchain technology. Jeng also formerly worked at the SEC.
A small number of bad actors can give the entire industry a bad name by taking on too much risk because it’s still “the wild, Wild West,” Jeng said. “Good for New York for going after something that was so egregious."
New leadership at the SEC
Jeng, Ubell and Roeser said President Joe Biden’s pick to lead the SEC, Gary Gensler, has excited the industry.
“There is a lot of hope in the industry, knowing Gary Gensler has a deep knowledge and understanding of cryptocurrencies, but it remains to be seen whether that knowledge will transfer into additional rulemaking on cryptocurrency,” Ubell said.
Gensler, a former chairman of the Commodity Futures Trading Commission who has taught courses on blockchain at the Massachusetts Institute of Technology, was asked about cryptocurrency during a confirmation hearing before the Senate Banking Committee on March 2.
“Bitcoin and other cryptocurrencies have brought new thinking to financial planning and investor inclusion,” Gensler said. “I’d work with fellow commissions both to promote the new innovation but also, at the core, ensure investor protection.”
Gensler didn't offer any further specifics at the hearing. His confirmation was approved by the committee and is awaiting a floor vote. Even if confirmed, experts recognize that issuing cryptocurrency guidance isn’t likely to be Gensler’s first priority.
“The federal system moves slowly, and I don’t expect that to change,” Sadeghi said.
A bipartisan bill introduced in the House this month would exclude digital tokens from federal securities laws, but similar proposals introduced in prior sessions failed to garner enough support to advance.
"If we don't act quickly, the United States will be left behind. Other countries have found ways to regulate blockchain projects and, in doing so, have made themselves more attractive to entrepreneurs," Rep. Warren Davidson, R-Ohio, one of its sponsors, said in a statement. "The window is closing."