BILL ANALYSIS                                                                                                                                                                                                    Ó



                                                                    AB 1326


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          Date of Hearing:  May 13, 2015


                        ASSEMBLY COMMITTEE ON APPROPRIATIONS


                                 Jimmy Gomez, Chair


          AB  
          1326 (Dababneh) - As Amended April 20, 2015


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          Urgency:  No  State Mandated Local Program:  YesReimbursable:   
          No


          SUMMARY:


          This bill creates a licensing and regulatory regime for entities  
          engaged in the business of virtual or digital currency with the  
          Department of Business Oversight (DBO).  In summary, this bill:


          1)Broadly defines "virtual currency" to include any digital unit  
            used as a medium of exchange or a form of digitally stored  
            value, or is incorporated into payment system technology,  
            whether traded through a centralized administrator or fully  
            decentralized.  The bill exempts virtual currencies used  
            exclusively within online gaming platforms or customer rewards  








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            programs that cannot be redeemed or converted into fiat  
            currency.


          2)Defines "virtual currency business" as storing, holding,  
            maintaining custody, or controlling virtual currency on behalf  
            of others, or providing version or exchange services into  
            other currency, whether fiat or virtual, or other value.  The  
            bill exempts federal, state, and municipal government  
            entities; certain state, federal, and foreign banks and credit  
            unions; licensed money transmitters; and merchants and  
            consumers in the ordinary course of purchases and sales of  
            goods and services, and their agents.


          3)Requires an applicant to pay the Commissioner of DBO  
            (Commissioner) the following nonrefundable fees: $5,000  
            initial application fee; $3,500 application fee for licensure  
            and approval to acquire control of a licensee; $2,500 annual  
            renewal license fee; and $125 annual license fee for each  
            branch office.


          4)Allows the Commissioner to levy assessments each fiscal year,  
            on a pro rata basis, against licensees in an amount sufficient  
            to meet the Commissioner's expenses in administering this  
            section and provide a reasonable reserve for contingencies.


          5)Authorizes the Commissioner to establish capital requirements  
            for licensees; requires licensees to exercise reasonable  
            oversight of its agents, keep records of agent reviews, and  
            include contractual compliance requirements for any authorized  
            agents.


          6)Requires licensees to file annual audit reports with the  
            Commissioner within 90 days of the end of each fiscal year,  
            and quarterly financial statements, verified by 2 principal  








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            officers, within 45 days of the end of each fiscal quarter.


          7)Authorizes the Commissioner to examine the business and any  
            branch office of any licensee to ascertain compliance,  
            requires licensees to furnish to the Commissioner, upon  
            request, any or all accounts, books, and other records; and  
            requires licensees to maintain any records as required by the  
            Commissioner for a minimum of 3 years.


          8)Requires licensees to report to the Commissioner within 5  
            days: any bankruptcy petition or other proceeding for  
            insolvency, dissolution, or reorganization; any proceeding to  
            revoke or suspend its virtual currency business license in  
            another jurisdiction; any cancellation or impairment of bond  
            or trust accounts; or any felony charges against a director or  
            executive. 


          9)Authorizes the Commissioner to issue formal and informal  
            guidance on compliance with the licensing regime, and make  
            that advice publicly accessible online. 


          10)Provides the Commissioner with broad authority to issue  
            orders and enforce virtual currency rules against licensees  
            and nonlicensees, including revocation of licenses under  
            specified circumstances and assessing civil penalties against  
            violators; and creates felonies for certain unlicensed  
            activities and intentional misrepresentation of activities.


          11)Requires licensees to make certain disclosures to consumers;  
            establishes regulatory rule-making authority with the  
            Commissioner to implement the requirements of the licensing  
            regime.










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          FISCAL EFFECT:


          Estimated annual GF administrative costs to DBO of approximately  
          $3.3 million to establish, manage, and enforce the licensing  
          regime, eventually offset by application, renewal, and location  
          fees as well as pro rata assessments to offset administrative  
          costs.


          COMMENTS:


          1)Purpose.  According to the author, this bill is designed to  
            ensure entities that manage virtual currency or offer virtual  
            currency exchange are operated in a sound manner and protect  
            consumers' virtual currency from potential loss.  This bill  
            also provides regulatory certainty for virtual currency  
            businesses, especially those that have applied for money  
            transmission licenses or remain unsure where their business  
            model fits into existing regulatory regimes.


          2)Bitcoin, Briefly.  The best known virtual currency is Bitcoin,  
            though it is neither the first nor the only example.  Bitcoins  
            is a decentralized, digital currency that allows users to  
            transact directly, without an intermediary.  Transactions are  
            encrypted to preserve integrity and pseudonymous, and all  
            transactions are recorded and verified in a public ledger  
            known as the block chain.  The block chain and its integrity  
            are maintained by thousands of independent users known as  
            miners, who offer computational power to verify and record  
            transactions.  Miners are rewarded for this effort with  
            newly-created bitcoins.  This core system has proven robust  
            during its six years of operation, with no successful hacking  
            attempts to date.


            A number of companies offer bitcoin management and credential  








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            storage applications for consumers, merchants, and traders,  
            the most consumer-facing of which are known as digital or  
            bitcoin wallets.  Digital wallets hold the cryptographic key  
            credentials needed to transact in bitcoins, and are essential  
            intermediaries in any bitcoin transaction.  Bitcoin managers  
            may also offer currency exchange services with a number of  
            different fiat currencies.  A number of high-profile attacks  
            on bitcoin intermediaries have recently drawn the attention of  
            regulators with respect to the overall security of transacting  
            in digital currencies.  While these attacks have not  
            compromised the integrity of the bitcoin system itself, they  
            have resulted in a number of bitcoin thefts (accomplished by  
            accessing the cryptographic keys) and disruptions to  
            intermediary activity.


          3)Other Regulation Efforts.  Following the first issue of  
            regulations by the New York State Department of Banking on  
            virtual currencies, the Conference of State Banking  
            Supervisors formed a task force to examine state regulation of  
            payment systems and seek consistent regulation among states  
            for certain areas.  The task force engaged with a number of  
            industry participants, state and federal regulators, and other  
            stakeholders, and recommended that activities involving third  
            party control of virtual currency, including transmitting,  
            exchanging, holding, or otherwise controlling virtual  
            currency, should be subject to state licensure and  
            supervision.  Some industry participants believe AB 1326 could  
            serve as a model for regulation in other states.


            The US Department of the Treasury's Financial Crimes  
            Enforcement Network (FinCEN) also issued interpretive guidance  
            on the application of the federal Bank Secrecy Act to users,  
            administrators, and exchangers of virtual currencies.  As part  
            of the guidance, FinCEN concluded virtual currencies do not  
            have legal tender status in any jurisdiction, and are not  
            "real currencies" for purposes of the Act, meaning that pure  
            exchangers of virtual currency for fiat currency are not  








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            subject to foreign exchange dealer regulations.  However, the  
            FinCEN guidance did clarify that businesses engaged in  
            accepting and transmitting virtual currency and/or buying and  
            selling virtual currency may be "money transmitters" under  
            current regulations, and subject to the reporting and  
            recordkeeping rules that apply to money services businesses.


          4)Of Silk and Coin.  The Silk Road case drew international  
            attention to bitcoin and its potential to facilitate illicit  
            activity.  Silk Road was an online black market for trading in  
            illegal drugs that utilized the anonymizing software Tor in  
            conjunction with bitcoin to facilitate anonymous sales and  
            purchases.  Bitcoin transactions are pseudonymous in that  
            transactions are not recorded by name.  Transactions are  
            recorded in a distributed, public ledger, however, and can be  
            traced to individuals and computers, unlike traditional cash.   
            Use of anonymizing software, which disguises the identity of a  
            computer and/or user, allows a person to transact with  
            effective anonymity.


            It is the combination of Tor and bitcoin that made Silk Road  
            possible.  Cash remains a far more common means of transacting  
            in illicit activity than digital or virtual currencies.  As  
            noted above, standard bitcoin transactions can ultimately be  
            traced to individuals and computers, and bitcoin's protection  
            against duplication arguably makes it more stable than  
            traditional cash.  However, certain intermediaries that manage  
            and facilitate digital currency transactions may have  
            significant vulnerabilities, and this bill is intended to form  
            a regulatory framework to mitigate those problems.















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          Analysis Prepared by:Joel Tashjian / APPR. / (916)  
          319-2081