BILL ANALYSIS Ó ----------------------------------------------------------------- |SENATE RULES COMMITTEE | AB 1326| |Office of Senate Floor Analyses | | |(916) 651-1520 Fax: (916) | | |327-4478 | | ----------------------------------------------------------------- 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: AB 1326 Page 2 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. AB 1326 Page 3 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. AB 1326 Page 4 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 AB 1326 Page 5 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 AB 1326 Page 6 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 AB 1326 Page 7 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 AB 1326 Page 8 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." AB 1326 Page 9 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, AB 1326 Page 10 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 **** END ****