BILL ANALYSIS Ó AB 1326 Page 1 Date of Hearing: May 13, 2015 ASSEMBLY COMMITTEE ON APPROPRIATIONS Jimmy Gomez, Chair AB 1326 (Dababneh) - As Amended April 20, 2015 ----------------------------------------------------------------- |Policy |Banking and Finance |Vote:|8 - 2 | |Committee: | | | | | | | | | | | | | | ----------------------------------------------------------------- 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 AB 1326 Page 2 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 AB 1326 Page 3 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. AB 1326 Page 4 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 AB 1326 Page 5 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 AB 1326 Page 6 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. AB 1326 Page 7 Analysis Prepared by:Joel Tashjian / APPR. / (916) 319-2081