California Crypto Rush – or Crypto Bust? – All things FinReg

New cryptocurrency legislation awaits California Governor Gavin Newsom’s signature after passing the California Assembly on August 30, 2022. If signed into law, California’s Digital Financial Assets Act would create sweeping requirements that would, among other things, mandate that exchanges of digital assets and crypto companies obtain licenses to operate within the state of California, but not until January 2025, as detailed below. Many observers have compared the new California legislation to the New York State BitLicense regulation, which was passed in 2015.

New license requirements

The legislation will introduce new licensing requirements. Pursuant to the Act, a person must be licensed by the California Department of Financial Protection and Innovation (DFPI) to engage in “digital financial asset business activity” with a California resident (ie, a person domiciled in California or physically located in California for more than 183 days out of the previous 365 days, a person who has a place of business in California, or a legal representative of a person who is a resident of California).

• The legislation defines “digital financial asset” to mean “a digital representation of value used as a medium of exchange, unit of account or store of value, and which is not legal tender, whether or not it is legal tender at face value.” However, it does not include as a digital financial asset (1) a transaction in which a seller provides, as part of an affinity or rewards program, value that cannot be taken away or exchanged with the seller for legal tender, bank or credit union. credit or a digital financial asset; or (2) a digital representation of value issued by or on behalf of a publisher and used exclusively within an online game, gaming platform or family of games sold by the same publisher or offered on the same gaming platform.
• The legislation further defines “digital financial asset activity” to mean one of the following:
  • Exchange, transfer or store a digital financial asset or engage in a digital financial asset (ie, issue a digital financial asset with the authority to redeem the digital financial asset for legal tender, bank or credit union credit, or another digital financial asset) , either directly or through an agreement with a provider of digital financial assets.
  • Holding electronic precious metals or electronic certificates representing interests in precious metals on behalf of another person or issuing shares or electronic certificates representing interests in precious metals.
  • Exchange of one or more digital representations of value used in one or more online games, game platforms or game families for one of the following: (1) a digital financial asset offered by or on behalf of the same publisher from which the original digital representation of value was received or (2) legal tender or bank or credit union credit outside of the online game, game platform or game family offered by or on behalf of the same publisher from which the original digital representation of value was received.

The scope of the California legislation is similar to the New York BitLicense regulation; However, California law additionally includes persons holding on behalf of another person or issuing electronic precious metals or electronic certificates representing interests in precious metals.

The legislation does not apply to activities generally governed by the US Securities and Exchange Commission or the California Corporate Securities Law or to the extent that law conflicts with the Electronic Fund Transfer Act of 1978. A person who performs certain activities, such as contributing connection software or computing power for securing a network that records transactions with digital financial assets or to a protocol that regulates the transfer of the digital representation of value is not covered by the legislation.

Other exemptions will be available under legislation; for example, a person is exempt from the legislation if the person (1) only provides data storage or security services for a digital financial asset business and does not otherwise conduct a digital financial asset business on behalf of another person; (2) provides only to a person who is otherwise exempt from the law a digital financial asset as one or more enterprise solutions that are used exclusively among each other and that does not have an agreement or relationship with a California resident who is the end user of a digital financial asset; (3) uses a digital financial asset, including creating, investing, buying, selling or obtaining a digital financial asset as payment for the purchase or sale of goods or services, solely on the person’s own behalf for personal, family, household or academic purposes; or (4) engages in digital financial asset business activities with, or on behalf of, California residents that would reasonably be expected to be valued, in the aggregate, on an annual basis at $50,000, among other exclusions.

New Oversight of Stablecoin Activities

In addition, the Legislation will prohibit certain activities involving stablecoins unless (1) the issuer of the stablecoin is licensed under the Legislation or is a bank, and (2) the issuer of the stablecoin at all times owns eligible securities (i.e. currency eligible security or foreign currency qualified security) that has an aggregate market value calculated in accordance with US GAAP of no less than the aggregate amount of all outstanding stablecoins issued or sold in the US. The stablecoin restrictions will be phased out and out of business on January 1, 2028.

Exams, record keeping and reporting?

Under the Act, DFPI may conduct an investigation of a licensee without notice and such person will be required to pay the costs associated with such an investigation. The legislation also introduces various record-keeping requirements, such as a monthly ledger showing all assets, liabilities, capital, income and expenses of the licensee. Licensees will be required to keep specific types of records for at least five years and report to the DFPI within 15 days of certain events.

Enforcement Actions

DFPI will be able to take enforcement action against licensees, or those subject to licensing requirements but not licensed, with prescribed civil penalties of up to $100,000 for each day a person breaches the requirements.

Other types of enforcement action permitted by law will include one of the following:

• Suspension or revocation of license
• Ordering a person to cease and desist from conducting any digital financial asset business with, or on behalf of, a California
• Asking a court to appoint a receiver for the assets of a person conducting a digital financial asset business with or on behalf of a California resident
• Ask a court to issue temporary, preliminary or permanent injunctions against a person who conducts a digital financial asset business with, or on behalf of, a California resident
• Assess a penalty
• Restoring the security and initiating a plan to distribute the proceeds for the benefit of a California resident who is injured by a violation of the law or a California law other than the law applicable to the conduct of business in digital financial assets with, or on behalf of, resident of California
• Imposing necessary or appropriate conditions on the conduct of digital financial asset business activity with, or on behalf of, a California resident
• Seeking damages on behalf of a California resident if DFPI shows economic injury due to violation of the law

Additional requirements

Licensees will be subject to disclosure requirements, including providing a fee schedule to California residents that discloses the fees and charges the licensee may assess, the manner in which the fees and charges will be calculated if they are not determined in advance and disclosed, and the timing. of the fees and charges.

Licensees must establish and maintain policies and procedures for, among other things, an anti-money laundering program, a business continuity plan, an information security program and an operational security program.

Public reaction

The legislation’s sponsor, Assemblyman Timothy S. Grayson, issued a statement about his efforts. “The excitement around cryptocurrency and digital financial assets is palpable. . . . While the novelty of cryptocurrency is part of what makes investing exciting, it also makes it riskier for consumers because cryptocurrency businesses are not adequately regulated and not need to follow many of the same rules that apply to everyone else. This bill will provide consumers with basic but necessary protections and will promote a healthy cryptocurrency market by making it safer for everyone.”

But the legislation has its opponents. In an open letter to the California legislature, the Blockchain Association stated that the BitLicense “would make it impossible for many stablecoin issuers to operate in California due to the licensing requirements placed on these entities regardless of whether they ‘operate’ in the state. Stablecoins act as a important bridge between traditional finance and the digital asset economy, and their success is a key prerequisite for the success of the entire crypto ecosystem.” The Blockchain Association also warned that New York State’s BitLicense regulation created a regulatory environment too challenging for startups or smaller crypto companies to survive, and that “California should not repeat New York’s mistakes.”

Whether the law creates a “crypto rush” or is a bust remains to be seen. Governor Newsom has until September 30, 2022 to sign the bill into law.