The Federal and State regulation of Cryptocurrencies, Crypto Exchanges, and Trading businesses
Traders of digital assets and cryptocurrencies have mostly operated state money transmission laws, as business was mostly limited to exchanging currencies such as bitcoin and ether. State regulators determined that only licensed money transmitters could engage in those activities, while New York State initiated the BitLicense. To operate a national scale, crypto exchanges and trading businesses have had to secure many state permits.
As a means of raising capital for startup companies, initial coin offerings (ICOs) came to the attention of the Securities Exchange Commission (SEC), with the Commission stating marketed tokens were investment contracts and securities under the 1933 Securities Act. As the sale of unregistered securities is a violation of federal law, the SEC launched ICO investigations and enforcement actions. SEC recognized many U.S.-based cryptocurrency platforms elected to be regulated as money transmission services, but that regulatory framework was not designed for these trades. In order to get protections offered by the federal securities laws and SEC oversight when trading cryptocurrencies that are securities, investors need to use a platform or entity registered with the SEC, such as a national securities exchange, alternative trading system or broker-dealer.
The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) states that a developer that sells convertible virtual currency, including in the form of ICO coins, in exchange for another type of value that substitutes for currency is a money transmitter. The same conclusion applies to an exchange that sells ICO coins or exchanges them for other currency or value. Although FinCEN’s regulations exempt entities registered with the SEC from registering with FinCEN as a money-services business, that exemption does not extend to state money transmission laws requirements. The Uniform Money Services Act enacted by Alaska, Arkansas, Texas, Hawaii, Iowa, North Carolina, Puerto Rico, South Carolina, the U.S. Virgin Islands, Vermont, and Washington expressly exempts SEC-registered broker-dealers and clearing agencies from money transmitter license requirements, but other states do not. New York’s BitLicense regulations do not contain an exemption for registered broker-dealers, and is not clear that registered broker-dealers are exempt from licensing and other requirements in the BitLicense rules.
It is suggested that the SEC consider precluding by regulation the application of state money transmitter laws to SEC-registered broker-dealers and other trading platforms for cryptocurrencies and assets that qualify as securities under federal law. Other virtual currency businesses that are more traditional money transmission could continue to be regulated by states. There are limited adverse impacts to this approach as broker-dealers and other registered entities under SEC must meet strict anti-money laundering and consumer protection requirements. This approach could also provide regulatory stability for cryptocurrencies, and ease overall regulatory requirements at the state level.
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