A Simple Way Bitcoin Businesses Can Cut Compliance Costs

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Becoming a licensed money transmitter throughout the U.S. is a time intensive and costly process many Bitcoin businesses are struggling with. But the costs of compliance could be cut substantially with the proactive step of hiring in-house compliance officers. 

Without an in-house officer, some in the digital currency community estimated they would spend on regulatory compliance range between $7 million and $10 million due to the cost of hiring a consultant, legal fees and other expenses.

"The [money transmitter] licensing process is an expensive process…but if you have the appropriate in-house resources it's cheaper than hiring a consultant or lawyer," says Robert Pargac, director of global investigations and compliance at Navigant Consulting. "Theoretically you could get all state licenses over an 18 month period [and spend] south of $500,000."

An in-house compliance professional or attorney with several years' experience will draw an annual salary of between $100,000 and $200,000, and these employees will be able to craft a successful financial business plan with an adequate compliance program regulators want to see, Pargac says.

License application fees are usually in the ballpark of $5,000 per state, making it possible for businesses to get licensed nationwide for about $250,000, Pargac says. Companies will then need to add on another $250,000 for travel and other expenses, he says.

Companies that have a large law firm take care of all the licensing requirements might see costs eclipse $1 million, says Judith Rinearson, a partner at Bryan Cave LLP and a recognized authority in payment systems and electronic payments. With in-house compliance officers, the licensing process itself usually costs $300,000 to $500,000, she says.

Rinearson, who testified during the New York State Department of Financial Services BitLicense hearings, says businesses that hire an in-house compliance officer will also benefit from these professionals handling monthly, quarterly or annual examinations. Some companies that work internationally hire several compliance officers for specific regions, such as Europe and Asia, she says.

Bitcoin exchanges such as Coinmkt, Kraken (run by Payward Ltd.) and Coinsetter (still in private beta) are working to obtain state licenses to start accepting U.S.-based customers. Coinbase, a Bitcoin wallet service provider that works with Silicon Valley Bank, provides exchange capabilities for U.S. residents but does so by connecting with exchanges such as Slovenia-based BitStamp.

Bitcoin businesses must also anticipate capital requirements that vary by state.

These responsibilities include surety bonding requirements, which depend on the assets and creditworthiness of the company. To get a bond, startups must have some type of liquid asset, such as U.S. dollars or securities.

The company must also find a broker to underwrite the bond, who will charge between 2% and 10% a year, says Mike Whalen, a partner in Goodwin Procter LLP’s financial services group.

In the case of New York, which usually requires a $500,000 surety bond, paying a broker 3% would correlate to $15,000 annually. Brokers working with Bitcoin businesses may charge a higher percentage since these businesses are considered high-risk, Whalen says.

Another capital requirement is a minimal shareholder's equity or net worth.

"The way the statutes are written, [companies] will need to have their net worth figured partially in [government-issued] currencies," says Rinearson. "States may take some percentage of Bitcoin or a company's cryptocurrency pool of assets and give them credit for it" toward the net worth requirement.

The last capital requirement Bitcoin businesses will need to think about is permissible investments, or making sure they have funds on hand to pay customers when they want to make a withdrawal. Rinearson says these should be denominated in the cryptocurrency a business is trading and/or holding for customers.

But what's really keeping Bitcoin businesses from working in the U.S. is the amount of clarification still needed on federal and state laws. While states usually follow the Financial Crimes Enforcement Network's guidance of licensing digital currency companies under existing money transmitter laws, "not all states are mandating that a Bitcoin company be licensed as a money transmitter," says Scott Scher, president of RecruitScreen, LLC and a compliance expert.

New York, for example,  is working on shaping digital currency-specific rules.  The state began requesting applications from digital currency exchanges this week.

Scher recommends that companies write a letter to their state banking commission to get an opinion on whether or not the business is considered a money transmitter. These responses usually take a few weeks to a few months to receive, he says.

On the federal level, Fincen is also responding to inquiries from businesses. Andre De Castro, who operates a digital currency company RightClick LLC, reached out to Fincen in May 2013 and received an administrative ruling in January. Fincen said that De Castro's company, which will buy and sell bitcoin as an investor using proprietary software, would not be considered a money services business.

While there have been increasing efforts by Bitcoin companies to proactively reach out and work with regulators on the federal and state levels, Pargac says he's still waiting for a leader to emerge.

For Bitcoin to be used in a mainstream capacity these issues will have to be resolved, says Pargac. Many people point to the recent failure of MtGox, formerly one of the largest Bitcoin exchanges, to show just how important regulation is.

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Compliance Technology Law and regulation Digital banking