BILL ANALYSIS                                                                                                                                                                                                    Ó






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          |SENATE RULES COMMITTEE            |                       AB 1326|
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                                   THIRD READING 


          Bill No:  AB 1326
          Author:   Dababneh (D)
          Amended:  8/18/15 in Senate
          Vote:     21  

           SENATE BANKING & F.I. COMMITTEE:  7-0, 7/15/15
           AYES:  Block, Vidak, Galgiani, Hall, Hueso, Lara, Morrell

           SENATE APPROPRIATIONS COMMITTEE:  6-1, 8/27/15
           AYES:  Lara, Bates, Beall, Hill, Leyva, Mendoza
           NOES:  Nielsen

           ASSEMBLY FLOOR:  55-22, 6/3/15 - See last page for vote

           SUBJECT:   Virtual currency


          SOURCE:    Author
          
          DIGEST:   This bill establishes a framework for the licensing  
          and regulation of virtual currency businesses by the Department  
          of Business Oversight (DBO), effective July 1, 2016.

          ANALYSIS:    Existing law provides for the Money Transmission  
          Act (MTA), administered by DBO (Division 1.2 of the Financial  
          Code), which establishes a framework for the licensing and  
          regulation of money transmitters, as specified (Financial Code  
          Sections 2000 et seq.).  The MTA defines money transmission as  
          selling or issuing payment instruments, selling or issuing  
          stored value, or receiving money for transmission (Financial  
          Code Section 2003).

          This bill:








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          1)Creates a new division under the Financial Code to regulate  
            virtual currency businesses, effective July 1, 2016 (Division  
            11), as follows:

             a)   Defines virtual currency as any type of digital unit  
               that is used as a medium of exchange or a form of digitally  
               stored value.  

             b)   Provides that virtual currency does not include any of  
               the following:

               i)     Digital units that are used solely within online  
                 gaming platforms, with no market or application outside  
                 of those gaming platforms.

               ii)    Digital units that are used exclusively as part of a  
                 consumer affinity or rewards program.

               iii)   Digital units that can be redeemed for goods,  
                 services, or for purchases with the issuer or other  
                 designated merchants, but cannot be converted into, or  
                 redeemed for fiat currency. Fiat currency is defined as  
                 government-issued currency that is designated as legal  
                 tender through government decree, regulation, or law,  
                 that customarily refers to paper money and coin and is  
                 circulated, used, and accepted as money.

             c)   Defines virtual currency business as maintaining full  
               custody or control of virtual currency in California on  
               behalf of others.  

             d)   Prohibits a person from engaging in any virtual currency  
               business in California unless that person is licensed under  
               Division 11 of the Financial Code or is exempt from  
               licensure under that division, as specified.

             e)   Requires virtual currency business licensees to provide  
               a specified disclosure to consumers informing them of the  
               potential risks of virtual currency and instructing them on  
               how to file complaints with DBO.  Additionally requires  
               licensees to provide receipts to consumers upon completion  
               of virtual currency transactions, as specified.  








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             f)   Requires licensees to maintain levels of capital that  
               the Commissioner of DBO (commissioner) determines are  
               sufficient to ensure the safety and soundness of the  
               licensees, and to maintain consumer protection and their  
               ongoing operations.  Additionally requires licensees to  
               maintain bonds or trust accounts in United States dollars  
               for the benefit of their consumers, in forms and amounts  
               specified by the commissioner.

             g)   Authorizes the commissioner to examine the business and  
               branch office of each licensee, whether in California or  
               outside the state, to ascertain whether the business is  
               being conducted in a lawful manner and whether all virtual  
               currency held or exchanged is properly accounted for.   
               Provides the commissioner with broad authority to bring  
               enforcement action against a licensee or a person required  
               to be licensed, who does not hold such a license.

             h)   Requires each licensee to submit an annual report  
               regarding its business and operations, as specified, and to  
               submit an annual audit report to the commissioner, prepared  
               by an independent certified public accountant or  
               independent public accountant, as specified.   

             i)   Authorizes the commissioner to levy fees and assessments  
               on licensees sufficient to cover the commissioner's costs  
               to administer the virtual currency law and provide a  
               reasonable reserve for contingencies.  

             j)   Authorizes, in lieu of many of the aforementioned  
               requirements, a person or entity conducting virtual  
               currency business with less than $1 million in outstanding  
               obligations, whose business model represents no or low risk  
               to consumers, as determined by the commissioner, to apply  
               for and be granted a provisional virtual currency license.   
               Grants the commissioner full discretion to prescribe the  
               terms and conditions applicable to a provisional licensee  
               and to suspend or revoke a provisional license, as  
               specified.  Provides that a provisional license is  
               effective for two years and may be renewed by the  
               commissioner.  Requires a provisional licensee to notify  
               the commissioner within 15 days after it surpasses the $1  
               million threshold and to apply for a virtual currency  
               license within 30 days following that notice.  







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          2)Provides that an MTA licensee who wishes to engage in a  
            virtual currency business without a virtual currency license  
            must seek permission to do so from the commissioner.   
            Authorizes the commissioner to approve such requests, as  
            specified, and clarifies that the commissioner may require a  
            licensee granted such approval to increase its surety bond or  
            amount of eligible securities above those required under the  
            MTA, or impose any additional conditions on the authorization,  
            as specified.  

          3)Authorizes a licensee in good standing under the virtual  
            currency law to apply to the commissioner to convert its  
            license into a MTA license, as specified.

          Background

          Definition. Virtual currency, also called digital currency, has  
          been defined by several different financial authorities.  One of  
          the most comprehensive definitions was developed by the European  
          Banking Authority (EBA) in 2014.  In its Opinion on Virtual  
          Currencies, issued July 4, 2014, the EBA defined virtual  
          currency as "a digital representation of value that is neither  
          issued by a central bank or a public authority, nor necessarily  
          attached to a fiat currency, but is accepted by natural or legal  
          persons as a means of payment and can be transferred, stored or  
          traded electronically"  
          (http://www.eba.europa.eu/documents/10180/657547/EBA-Op-2014-08+O 
          pinion+on+Virtual+Currencies.pdf).  

          Bitcoin is perhaps the most well-known among virtual currencies,  
          but other virtual currencies exist, including Ripple, Stellar,  
          Litecoin, Darkcoin, Peercoin, Primecoin, Dogecoin, and others.   
          Increasing numbers of companies are offering services that  
          support the use of virtual currencies (e.g., Coinbase, Circle,  
          BitGo, Bitnet, Blockstream, Chain.com, Gem, Mirror, Xapo, and  
          others).  This bill establishes a regulatory framework intended  
          to cover certain companies that offer services which support the  
          use of virtual currencies; it does not purport to regulate the  
          developers of existing or new virtual currencies.

          Other state regulations.  In June, 2015, New York became the  
          first state in the country to finalize rules for virtual  
          currency companies.  New York defines virtual currency as "any  







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          type of digital unit that is used as a medium of exchange or a  
          form of digitally stored value" and states that the term should  
          be broadly construed to include digital units of exchange that  
          have a centralized repository or administrator, are  
          decentralized and have no centralized repository or  
          administrator, or may be created or obtained by computing or  
          manufacturing effort.  

          New York defines "virtual currency business activity" as the  
          conduct of any one of the following types of activities  
          involving New York or a New York resident:  1) receiving virtual  
          currency for transmission or transmitting virtual currency,  
          except where the transaction is undertaken for non-financial  
          purposes and does not involve the transfer of more than a  
          nominal amount of virtual currency; 2) storing, holding, or  
          maintaining custody or control of virtual currency on behalf of  
          others; 3) buying and selling virtual currency as a customer  
          business; 4) performing exchange services as a customer  
          business; or 5) controlling, administering, or issuing a virtual  
          currency.  All entities that engage in virtual currency business  
          activity and are not covered by an exemption from New York's  
          virtual currency rules are required to obtain a BitLicense from  
          the New York Department of Financial Services.  

          Because of the expansive definitions and limited exemptions  
          contained in New York's rules, those rules have been criticized  
          by many virtual currency businesses.  Several virtual currency  
          businesses have indicated they will be forced to suspend  
          business to customers based in New York, because they cannot  
          afford to operate under New York's regulatory regime.    

          Comments
          
          Regulation of an emerging industry.  AB 1326 is intended to  
          ensure that entities which store virtual currency or offer  
          consumers the opportunity to exchange their virtual currency for  
          fiat currency are operated in a safe and sound manner.  It is  
          also intended to provide regulatory certainty to companies who  
          are engaging in or planning to engage in virtual currency  
          businesses.

          Many within the virtual currency industry want California to  
          lead the nation in enacting a law which encourages innovation  
          and allows startups to be established and grown without undue  







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          regulatory interference.  They point to New York's rules as  
          problematic for their industry and want California to enact an  
          alternative regulatory framework to which other states can look  
          when crafting their own laws.  Others would prefer that  
          California give the virtual currency industry more time to  
          evolve before deciding whether to regulate it.  

          Unresolved issues.  A variety of interested parties have  
          expressed strong opinions regarding a variety of issues  
          addressed by this bill.  Two issues remain extremely  
          contentious.  

          First, there is no consensus to date regarding the way in which  
          "virtual currency business" should be defined.  At present, this  
          bill defines virtual currency business as "maintaining full  
          custody or control of virtual currency in California on behalf  
          of others."  While most industry participants believe that this  
          bill's definition is vastly superior to the very broad  
          definition used by New York, some have criticized this bill's  
          definition as being too vague.  For example, the term "full  
          custody and control" can be a challenging concept to interpret  
          when applied to a virtual currency business that offers a  
          virtual currency wallet which requires multiple parties to  
          independently approve a withdrawal before it can be authorized.   
          Some suggest that no single entity has full control over the  
          wallet in this situation, because multiple parties must  
          independently agree to a withdrawal before it can be made.   
          Others counter that all of the entities in this situation have  
          full control, because each can independently prevent a  
          withdrawal by failing to authorize it.  Clarification of this  
          bill's definition of virtual currency business, either in  
          statute or through regulation, will be critical if this bill  
          becomes law.  

          Another issue of great importance to the regulated community,  
          whose details remain the subject of controversy, is the  
          availability and nature of a regulatory framework specifically  
          directed toward start-ups.  Colloquially, industry members argue  
          that two programmers tinkering with code in a basement should  
          not be regulated in the same manner as a multi-million dollar  
          company with thousands of customers. To address this concern,  
          the July 6th amendments added language authorizing the  
          commissioner to award provisional licenses to small businesses  
          determined by the commissioner to pose low or no risk to  







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          consumers.  The July 6th amendments give the commissioner sole  
          control to determine which rules will apply to each provisional  
          license holder.  The expectation is that businesses awarded  
          provisional licenses will be able to operate under a less  
          expensive and less restrictive regulatory scheme than larger or  
          riskier businesses, although the details of the regulatory  
          scheme(s) applicable to provisional licensees will be left to  
          the commissioner to decide.  

          Although one might suspect that most industry participants would  
          welcome the availability of a less costly, less restrictive  
          license for certain start-ups, several small businesses reached  
          out to the author's office, requesting an even less restrictive  
          regulatory scheme than the one added to this bill on July 6th.   
          These businesses would prefer registration to licensure and  
          would prefer to substitute a set of best practices applicable to  
          all registrants for the business-specific rules that AB 1326  
          authorizes the commissioner to apply.

          FISCAL EFFECT:   Appropriation:    No          Fiscal  
          Com.:YesLocal:   No

          According to the Senate Appropriations Committee, first-year and  
          ongoing costs of $3.5 million (Special Fund*) to establish,  
          manage, and enforce the licensing and regulatory regime,  
          estimated to be offset in whole or in part by application  
          renewal, and location fees as well as pro rata assessments to  
          offset administrative costs. First-year costs are potentially  
          not fully covered by licensing fees given the estimated number  
          of applications, and could be borne by the General Fund. The DBO  
          anticipates ongoing costs will be fully offset by the  
          application, renewal, and location fees, as well as the pro rata  
          assessment authority provided for in this measure.

          *Financial Institutions Fund


          SUPPORT:   (Verified8/27/15)


          Coinbase
          Coin Center
          Electronic Transactions Association








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          OPPOSITION:   (Verified8/27/15)


          Electronic Frontier Foundation
          The Copia Institute


          ARGUMENTS IN SUPPORT:      Coin Center is a nonprofit research  
          and advocacy center focused on public policy issues affecting  
          decentralized digital currencies, such as Bitcoin.  The  
          organization supports AB 1326, because this bill acknowledges  
          that virtual currency businesses may have business models that  
          do not involve money transmission and should not be required to  
          hold money transmission licenses.  "Decentralized digital  
          currencies, such as Bitcoin, are an exciting new innovation with  
          a great many potential uses - from simple value transfer, to  
          property title and copyright ownership recordation, identity  
          management, and even the creation of self-executing contracts.   
          Some uses of digital currency technology look exactly like money  
          transmission, an activity that requires licensing in California  
          as in almost every other state.  However, many other possible  
          uses of the technology have little or nothing to do with money  
          transmission and pose little or no risk to consumers.  A smart  
          approach to regulating digital currency businesses would  
          distinguish between these possible uses and only require  
          licensing for those who engage in activities that are truly like  
          traditional money transmission.  AB 1326 - better than any other  
          legislative proposal we have seen - accomplishes this.  As a  
          result, it preserves important consumer protections while not  
          saddling cutting-edge innovation with unjustified regulatory  
          burdens."  

          Coinbase is the world's leading Bitcoin service provider.  "We  
          believe AB 1326 brings greater regulatory certainty for digital  
          currency businesses, provides necessary protections for  
          consumers, and creates a nurturing environment for small  
          startups to build their businesses in the Golden State.   
          Moreover, it eliminates a regulatory 'grey zone' that currently  
          exists for our industry and gives businesses greater clarity.   
          As a California based company, we are happy to see the state  
          leading the nation in creating policy that will foster  
          technological innovation and economic growth."








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          Coinbase is particularly supportive of the provisional licensing  
          that AB 1326 authorizes.  Provisional licensing "provides small  
          digital currency startups or those with limited consumer  
          exposure the ability to start and operate their businesses with  
          an unencumbered runway.  This section provides these businesses  
          a low barrier to entry by means of registration, self-certified  
          compliance with risk based performance standards, and a low fee.  
           From there, they can focus on building and growing solutions  
          for consumers and not worry about overly burdensome regulations  
          and related expenses.  While Coinbase would not be eligible for  
          this licensing due to our relative size, we strongly support the  
          inclusion and believe it's extremely important to the overall  
          health of the ecosystem.  This provision will help seed the next  
          round of the nation's most groundbreaking and innovative  
          technologies companies, and make California one of the nation's  
          most attractive places for digital currency businesses to grow  
          and thrive."

          ARGUMENTS IN OPPOSITION:The Copia Institute, a Silicon  
          Valley-based think tank, writes, "At this stage of the game,  
          creating licensing regimes and putting permission barriers on  
          innovation is very, very premature.  Everyone is still figuring  
          out just what the blockchain is good for, and it's a long and  
          varied list... We should be very wary about deciding to put  
          layers of government bureaucracy on things that can be  
          accomplished in the code itself....Silicon Valley was built on  
          permissionless innovation, especially on the internet.  Saddling  
          new core infrastructure like Bitcoin and the blockchain with a  
          permission-based framework sets the wrong tone entirely, and  
          virtually ensures that Silicon Valley won't be home to the  
          leading innovators in this new and exciting space."

          The Electronic Frontier Foundation opposes AB 1326 on the  
          grounds that this bill is premature, technically inaccurate in  
          spots, and will do more harm than good.  "Virtual currencies are  
          still developing, and this bill threatens to both stunt the  
          growth of this innovative industry and hamper the enthusiasm  
          driving consumer interest.  Also, privacy and free speech are  
          central issues in the virtual currency space, which the bill  
          fails to adequately consider."  

          ASSEMBLY FLOOR:  55-22, 6/3/15
          AYES:  Alejo, Bloom, Bonilla, Bonta, Brown, Burke, Calderon,  
            Campos, Chau, Chiu, Chu, Cooley, Cooper, Dababneh, Daly, Dodd,  







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            Eggman, Frazier, Cristina Garcia, Eduardo Garcia, Gatto,  
            Gipson, Gomez, Gonzalez, Gordon, Gray, Roger Hernández,  
            Holden, Irwin, Jones-Sawyer, Lackey, Levine, Linder, Lopez,  
            Low, Mathis, McCarty, Medina, Mullin, Nazarian, O'Donnell,  
            Perea, Quirk, Rendon, Ridley-Thomas, Rodriguez, Salas,  
            Santiago, Mark Stone, Ting, Weber, Wilk, Williams, Wood,  
            Atkins
          NOES:  Achadjian, Baker, Bigelow, Brough, Chang, Chávez, Dahle,  
            Beth Gaines, Gallagher, Grove, Hadley, Harper, Jones, Kim,  
            Maienschein, Mayes, Melendez, Obernolte, Olsen, Patterson,  
            Steinorth, Wagner
          NO VOTE RECORDED:  Travis Allen, Thurmond, Waldron

          Prepared by:Eileen Newhall / B. & F.I. / (916) 651-4102
          8/30/15 19:27:49


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