State Hurdles Ahead on Path to More Federal Crypto Regulation

Federal financial regulators signaled Feb. 6 they want expanded authority to oversee cryptocurrency markets, which could come at the expense of state authorities.

The Securities and Exchange Commission and Commodity Futures Trading Commission are looking to close what they view as regulatory gaps in the cryptocurrency space in matters of consumer protection and transparency which they don’t have direct authority over, Chairmen Jay Clayton of the SEC and J. Christopher Giancarlo of the CFTC told the Senate Banking Committee.

One potential solution is a federal regime for licensing money transmission. Most cryptocurrency exchanges operating in the US are licensed as money transmitters at the state level, which Giancarlo told lawmakers creates a “patchwork of state regulation.”

The idea of potentially preempting existing state laws is getting a cool reception from state regulators. “If it’s something that takes authority away from the states, that would be something that we would likely have concern about,” Margaret Liu, Senior Vice President and Deputy General Counsel for the Conference of State Bank Supervisors. “However, we’re talking at the 50,000-foot level right now, and it’s always about the details.”

State regulators have already aggressively pushed backed against another potential encroachment into their regulation of fintechs, launching a court challenge against a proposed special federal charter for fintechs before the OCC even finalized the idea.

At least 45 states licensed a consumer-facing company dealing in virtual currencies in 2017, with at least 13 virtual currency-related companies submitting supervisory reporting documentation to state regulators, according to data from the Conference of State Bank Supervisors. Those companies reported approximately $7.5 billion in virtual currency trading volume in 2017, according to CSBS.

Crypto in Regulators’ Crosshairs

Regulators at all levels are looking at how to regulate cryptocurrencies, driven by Bitcoin’s volatile price fluctuations and concerns over the use of cryptocurrency for money laundering, terrorist financing or sanctions evasion. They are also intrigued by some of the promises for innovation and development through the distributed ledger technology, blockchain, that underpins cryptocurrencies.

Multiple crypto working groups have been formed but appear to be in the early stages of education and information sharing. The Treasury Department convened a group including the CFTC, the SEC, the Federal Reserve and FinCEN, the Financial Crimes Enforcement Network.

The Federal Stability Oversight Council, which includes an array of federal and state regulators, and the International Organization of Securities Commissioners are also looking at the issue.

State financial regulators do have a non-voting role on the FSOC, and coordinate frequently with federal financial services regulators on oversight and enforcement matters.

“State law in this space exists for a reason. State regulation and licensing exists for a very important reason in terms of consumer protection, as well as the integrity of the financial services marketplaces in the 50 states,” Liu said.

The states have other reasons to push back against potential preemption, said Brian Knight, Director of the Program on Financial Regulation and a Senior Research Fellow at the Mercatus Center at George Mason University. “They are concerned about the threat of losing jurisdiction, losing authority, losing licensing fees that would come with a federal money transmission license,” Knight told Bloomberg Law.

State Level Streamlining

States are already taking steps to speed up the money transmission licensing process, which could benefit new cryptocurrency exchanges.

In a Feb. 6 announcement from CSBS, seven states agreed to accept new applicants’ proposals for money transmission businesses so long as one of the other states had approved the company for a license.

While Knight credited the CSBS for trying to streamline state licensing procedures, he questioned whether the move would resolve some of the underlying complexities of state-by-state money transmitter regulation.

The different licensing standards, costs and requirements to keep up changes in every jurisdiction pose their own challenges, which don’t seem to be addressed in the initial wave of licensing coordination, Knight said.

“I’m skeptical that this is really going to move the needle sufficiently to make the difference,” he said.

To contact the reporter on this story: Lydia Beyoud in Washington at lbeyoud@bloomberglaw.com; Andrew Ramonas in Washington at aramonas@bloomberglaw.com

To contact the editor responsible for this story: Michael Ferullo at mferullo@bloomberglaw.com