Remarks of Benjamin M. Lawsky, Superintendent of Financial Services for the State of New York, on the Regulation of Virtual Currencies at the New America Foundation in Washington, DC
February 11, 2014
As Prepared for Delivery
This is a particularly well-timed event.
As you may know, the New York State Department of Financial Services (DFS) just completed an extensive set of hearings on the regulation of virtual currencies.
And today’s event represents a good opportunity to share some of what we heard, as well as our Department’s initial thoughts on the path forward for regulation.
Before I do that, though, I wanted to begin with some background on DFS and our work on virtual currency regulation.
Indeed, one of the first questions we often get asked about this topic is: “Why is a state regulator looking at this?” Or, “Isn’t this solely a national, or even international, issue?”
As for background on DFS, Governor Andrew Cuomo proposed creating our agency two years ago through the merger of two existing state agencies with long histories: the New York State Banking Department (which was founded in 1851) and the New York State Insurance Department (which was established in 1859).
So we’re – at once – both new and old.
Governor Cuomo served as New York Attorney General during the financial crisis – when significant gaps and weaknesses in financial regulation had devastating consequences for our economy.
As such, in creating DFS, Governor Cuomo charged us with an important mission: He wanted us to serve as a modern, unified financial regulator that can adjust and adapt to a constantly evolving financial world.
While I don’t think anyone would call virtual currency a systemic risk at this point, it does represent a good example of the necessity of innovation (not only in the technological sphere), but also in financial regulation.
DFS – like other state financial regulators – are responsible for oversight of what are called “money transmitters.” If you’re not familiar with that term, Western Union and Moneygram are two of the largest examples.
Indeed, when people say the word money transmission, they usually think of – if anything at all – firms that were formed more than 150 years ago when our country was still exploring the western frontier.
I seriously doubt that the people who wrote those statutes ever contemplated the notion of the Internet; let alone crypto-currencies; let alone a crypto-currency based on an internet meme featuring a dog.
Nonetheless, DFS has serious concerns that certain virtual currency firms may be engaging in money transmission – which would mean that our Department has a specific legal responsibility to license, examine, and regulate those firms if they are offering their services to New Yorkers.
Moreover, there have been serious and documented concerns (which I’ll discuss in greater detail later), about the use of virtual currencies for illicit activity and money laundering.
As such, in August 2013, our Department launched an extensive inquiry into the appropriate regulatory guardrails to put in place for virtual currency firms.
Over the last six months, we have had dozens and dozens of meetings with a wide range of industry participants. We have spoken to leading academics and law enforcement officials. And we have reviewed thousands of pages of documents, reports, and other materials.
After doing that initial work, we believed that an important next step in our inquiry was to hold public hearings.
Those hearings took place on January 28 and 29 in New York City. We held five different panels. And witnesses delivered more than eight hours of testimony.
The goal of those hearings was to provide a 360-degree view of this new and constantly evolving industry – both its promise and its potential pitfalls.
We sought to bring together a diverse group of witnesses with an array of different perspectives.
We believed that it was important to hear from law enforcement and regulators.
But we also wanted to bring in investors, technologists, merchants, and a number of other individuals on the ground floor of this fledging industry to provide their views.
Those hearings, I think, served two important purposes in moving our regulatory efforts forward.
First, they provided us with a good opportunity to convene and question some of the leading figures in the virtual currency and law enforcement community. From a regulatory perspective, that is extraordinarily helpful in thinking through these complicated issues.
Second, and perhaps even more importantly, the hearings also generated a significant amount of additional public discussion surrounding the subject of how to regulate this new financial technology.
At DFS, we try to approach emerging issues in financial regulation – such as virtual currencies – with a healthy dose of humility.
Ultimately, it’s our expectation that the information we have gathered in our fact-finding effort will allow us to put forward, during the course of 2014, a proposed regulatory framework for virtual currency firms operating in New York.
I believe we would be the first state in the nation to do so. Clearly, when it comes to virtual currencies, regulators are in new and unchartered waters.
And when we move forward, we want to make sure that we have heard a broad range of voices and that we are armed with the most forward-looking thinking.
To that end, we streamed the hearing on our agency’s website. And more than 14,000 people from 117 different countries tuned in. And less than half of those people were in the United States. (It probably won’t surprise you to learn that isn’t the typical audience for our public hearings.)
And it was very heartening to us that the hearings produced a number of very thoughtful blogs, articles, op-eds, and other posts from people who weren’t in the room, which discussed the path forward on virtual currency regulation.
We recognize that New York and other regulators have a very challenging task in front of us.
We have to determine the appropriate licensing, examination, and collateral requirements for the virtual currency industry. In doing so, our objective is to provide appropriate guardrails to protect consumers and root out money laundering – without stifling beneficial innovation.
That’s a tough balance to strike, but we’re trying to proceed in a careful and thoughtful manner.
It is hard to say precisely what the future holds for virtual currency and its associated technology. Currently, there is not widespread adoption of virtual currencies among the general public. And some doubt whether there will ever be.
The recent issues at Mt. Gox, for example, have prompted some financial commentators to write Bitcoin’s obituary. Or to at least question the viability and reliability of virtual currency technology.
But there might be – at the very least – a kernel of something here that has a profound impact on the future of payments technology and the financial system. Regulators are not always the experts on such matters, but my gut is that it’s likely. And that’s why we want to proceed in a careful and thoughtful manner.Next Steps
With that in mind, I’d like to share some of our takeaways from the hearing.
At DFS, we are increasingly coming to the conclusion that simply applying our existing money transmission regulations to virtual currency firms is not sufficient.
As we have noted previously, certain aspects of virtual currency do not fit neatly into the traditional categories we think of in financial regulation – such as banking, insurance, or the like. In many ways, it’s neither fish nor fowl.
We do not have to throw out all of our existing rules for money transmitters or banks, which have generally served consumers well when vigorously enforced. Indeed, certain aspects of virtual currency could dovetail with existing regulations.
That said, our agency will likely have to proceed with issuing some form of specially tailored BitLicense that adapts those rules to the world of virtual currency.
As with most regulatory endeavors, however, the devil is in the details.
To that point, I want to outline a few of the questions we are grappling with right now in the immediate wake of our hearing when it comes to crafting specially tailored BitLicense requirements.
We have some initial thoughts on these matters, but – given the open source nature of virtual currency technology – it seems appropriate for us to outline some of the issues we’re considering publicly at an early stage in the hopes of spurring additional public debate.
My hope is that we’ll see another round of blogs, articles, and posts discussing the questions I’m about to pose.
Consumer Education and Disclosures
Let me start with consumer education and disclosures.
It seems fairly clear to us that a strong set of specially tailored, model consumer disclosure rules should be required of virtual currency firms.
There are, of course, potential risks for consumers associated with many different types of financial products – not just virtual currencies.
But, let's face it, crypto-currencies are unlike pretty much anything an average consumer has ever used before.
Right now, for the most part, it appears that Bitcoin and other virtual currencies are primarily the province of sophisticated, technologically savvy, early adopters.
If virtual currencies ultimately garner wider adoption among the general public, it will be important for consumers to be armed with the information they need to make the financial choices that are best for them.
For example, consumers should be aware that many virtual currencies do not provide for chargebacks – meaning that transactions are, for the most part, irreversible. In other words, there is generally no “money back guarantee” for crypto currencies.
Consumers should also be warned about the importance of keeping their “private keys” private – as well as the potential consequences if they fail to do so.
Given the irreversibility of most transactions, if a consumer has their private key stolen, they could potentially lose their virtual currency irretrievably.
Moreover, consumers should be informed – up-front – about the documented volatility of virtual currency and the potential for loss of dollar-denominated principal if they hold onto that virtual currency for an extended period of time. (This is something that most mutual funds do.)
Those are just a few examples of potential consumer disclosures for virtual currency firms. There are, of course, others that could be crafted. But the broader concept is what’s important.
We’ve found in other areas of the financial world that strong, clear, concise disclosures are critical to earning the long-term trust and confidence of consumers. And virtual currency is no exception.
Safety and Soundness Requirements
I think enhanced disclosure requirements are likely something that most people can agree on.
But there are some other more challenging questions that we have to address, including capital, collateral, net worth, and investment requirements.
Traditional money transmitters and banks have to abide by certain net worth and permissible investment requirements to help ensure that they are operating in a safe and sound manner.
They, for example, need to have a large enough capital buffers on their balance sheets to absorb unexpected losses and financial shocks without going under.
They are also limited in the types of investments they can hold – so they are not taking reckless risks with customer money in the search of windfall profits.
Virtual currency firms should abide by similar requirements. But the question for regulators is how we structure those rules in light of the fact that the virtual currencies these firms hold are not denominated in dollars or other forms of traditional currency.
Moreover, that issue is further complicated by the fact that the value of virtual currencies relative to traditional currencies can fluctuate significantly on a day-by-day or even hour-by-hour basis.
We need to consider questions like whether we have to create a new yardstick for measuring how well-capitalized the firms we ultimately regulate are.
Or whether virtual currencies themselves should be allowed as permissible investments.
Net worth, capital, and permissible investment requirements are among the most important consumer protection requirements we can put in place as regulators.
We have seen instances where exchanges and other virtual currency firms have frozen redemptions for extended periods of time, which can be very damaging to consumer confidence.
The long-term strength of the virtual currency industry will require robust safety and soundness requirements – so customers have faith that their money won’t get caught in a virtual black hole.
And if we get those rules right, perhaps we can make New York and the United States a magnet for legitimate, well-regarded exchanges and other virtual currency firms.
Another issue that we heard a lot about at the hearing from both participants in the virtual currency industry and law enforcement officials is the importance of the public ledgers for Bitcoin and other types of crypto-currencies.
Many – though, not all – virtual currencies have open, publicly accessible ledgers on the internet.
And – in an ideal world, the recent issue with Mt. Gox notwithstanding – those ledgers are supposed to accurately record essentially every single transaction that has occurred in a specific virtual currency since it came in the being. (The most well-known example is the Bitcoin block-chain.)
In this way, some posit that it is more appropriate to think of many virtual currencies as “pseudonymous” rather than “anonymous.”
A regulator may not immediately know what person is associated with every single transaction. But they can see every transaction, which can be important for law enforcement in spotting red flags for further investigation.
And when coupled with appropriate know-your-customer requirements for virtual currency firms – public ledgers can help mitigate some of the documented concerns related to money laundering and this new technology.
The question, then, is should regulators require that licensed virtual currency firms only use public ledgers?
And an associated question is what to do about so-called “tumblers,” which are of particular concern to law enforcement.
Tumblers are a technology used to obscure the record and source of virtual currency transactions.
Understandably, that’s a prospect that gives pause to those officials who are charged with enforcing laws against money laundering.
But other panelists contended that tumblers could potentially have legitimate uses, such as keeping the financial information of a lawful merchant that accepts virtual currencies private from their competitors.
Given all that, should the use of tumblers among licensed firms be banned or restricted? That’s a difficult question. And we’re interested to hear from all sides as we wrestle with it.
What Point in the Chain Should Regulators Enter?
Another issue that we’re grappling with is for which points of entry in the virtual currency ecosystem should regulators provide oversight.
In other words, what types of firms and transactions should we regulate?
Miners are a vital part of the ecosystem, but some regulators have determined that they do not meet the threshold for proactive oversight.
It would also seem difficult-to-impossible, for instance, for financial regulators to provide oversight for every single, individual, peer-to-peer transaction – unless there is evidence of specific criminal or civil wrongdoing.
We do not, for instance, require policing of every single individual transaction involving cash.
But should we, as some suggest, only regulate transactions where virtual currencies are exchanged for dollars and other traditional currencies?
Given the gradual (but accelerating) growth of virtual currencies in online and brick and mortar transactions (as well as other less legitimate enterprises), that could leave a gaping loophole for misconduct if this technology gains wider adoption.
Indeed, law enforcement officials at our hearing cited the capacity of virtual currency to help “scale up” money laundering in a way that is not necessarily possible with physical cash.
When it comes to using physical cash for illegal activity – criminals are constrained in certain respects to what they can physically carry and transport. There are no such limitations when it comes to virtual currencies.
This is not say that our goal is to unduly single out virtual currency regarding these concerns.
Let’s be frank, a lot more money has been laundered through large banks than has been laundered through virtual currency. If you look at the history of DFS, you’ll see that’s something about which we are acutely aware and working aggressively to combat.
More broadly, it is simply the responsibility of regulators to be cognizant of the new and emerging risks that virtual currencies present for illicit conduct, and try and find ways to mitigate them.
Now, there are many other issues we are considering as part of our regulatory inquiry, such as the specific licensing and examination requirements for virtual currency firms.
Or whether there should be a regulatory safe harbor through which virtual currency firms – assuming they have met certain basic anti-money laundering and consumer protection requirements – can notify their regulators and keep operating during a licensing process. That was one idea raised at our hearings.
But we have a limited amount of time today and I wanted to provide a flavor of some of the things we’re thinking about.
Indeed, I think it’s clear that 2014 is going to be a critical year for the future of virtual currencies.
They are at a bit of crossroads regarding whether they will become an important part of the future financial system – or primarily a tool for illicit activity.
At this stage in our inquiry, regulators have been accused by some of having more questions than answers. But I think that’s healthy – particularly if we are being true to our stated goal of proceeding without any prejudgments.
At DFS, we’re committed to proceeding thoughtfully since virtual currency could ultimately have a number of benefits for our financial system.
It could, for example, force the traditional payments community to “up its game” in terms of the speed, affordability, and reliability of financial transactions.
I think many consumers – myself included – are perplexed that, in a world where information travels around the globe in a matter of milliseconds, it can often take several days to transfer money to a friend’s bank account.
To use a personal example, I have my credit card with a particular bank, and I also have my bank account at that same bank. And once a month I have to pay my credit card bill by transferring money from my bank account at the same bank to pay my credit card bill at the same bank. And it takes three days.
I have to leave three days to make sure the money goes from one hand of the bank to the other hand of the bank and that is a little crazy, in my opinion.
So I think it’s fair to say there’s room for additional innovation in the financial world and payments technology. And we want to be careful to get the balance right.
And that's why events and discussions like this are so important.
Thank you for the opportunity to speak with you today and I look forward to the conversation we’re about to have.