The New York Department of Financial Services has released proposed framework for its much-anticipated BitLicense, a state money transfer license for businesses operating in Bitcoin and other digital currencies.

Though the NYDFS describes its proposal as a balanced approach that does not stifle innovation, its rules might be considered too strict for many companies that want to operate in the state.

"As expected, the NYSDFS has set a very high bar that few applicants will be able to meet," says Juan Llanos, executive vice president of strategic partnership and chief transparency officer at BitReserve, a Bitcoin wallet and vault.

"There are some fundamental challenges for Bitcoin that we've known for some time, such as the obligation to fully identify both parties to a transaction," says Llanos. "That is a direct threat to Bitcoin's fungibility and creates the risk of de-anonymization, and therefore loss of privacy."

Llanos was previously the compliance officer at Unidos Financial Services Inc., a licensed money transmitter he co-founded.  "Having been in the money transfer industry for a long time, the proposal doesn't come as a surprise to me at all," he says.

Though the NYDFS rules may be strict, they establish a more welcoming environment than Bitcoin companies face in other regions. For example, in December the People's Bank of China banned the nation's financial institutions and payment companies from handling Bitcoin transactions.

"I am increasingly encouraged that the NYDFS is taking a fair approach to regulation for Bitcoin companies," says Jaron Lukasiewicz, CEO and founder of Coinsetter, a New York-based Bitcoin trading platform. "Coinsetter intends to file an application as soon as possible."

The proposed license requirements state that businesses must hold funds of the same type and amount of virtual currency owed to consumers, plus provide consumer disclosures, transaction receipts and a policy for complaints and resolution. Businesses must also verify account holders and report on suspected illicit activity or fraud as part of their efforts to abide by anti-money laundering rules.

Bond and capital requirements are specified within the proposed framework, plus companies operating in digital currency must maintain a cyber-security program. The proposal also specifies that businesses will need a compliance office and chief information security officer, and must keep extensive records.

"We have sought to strike an appropriate balance that helps protect consumers and root out illegal activity without stifling beneficial innovation," says Benjamin Lawsky, superintendent of the NYDFS, in a July 17 press release. "Setting up common-sense rules of the road is vital to the long-term future of the virtual currency industry, as well as the safety and soundness of customer assets."

Under the proposal, businesses that must obtain a BitLicense are those receiving or transmitting virtual currency on behalf of consumers; storing and maintaining control of virtual currency for customers; performing retail conversion services; buying and selling as a customer business; and administering or issuing virtual currency must follow the framework.  The rules would not apply to miners, which are the individuals who authenticate Bitcoin transactions on the blockchain, or public ledger, using specialized hardware.

Digital currency businesses will also be required to allow independent DFS examinations.

The BitLicense has been a long time coming, with Lawsky spending nearly a year investigating the decentralized cryptocurrency protocols and the businesses that utilize the payment network and currency.

After the NYDFS issued subpoenas to 22 emerging payments companies, including many that handle Bitcoin, in August 2013, Lawsky became an open proponent of Bitcoin's innovation to modernize the financial services industry.

Lawsky held a series of hearings in January where prominent Bitcoin advocates and legal experts gave testimony on the advantages and drawbacks of Bitcoin. At the heart of the debate was whether digital currency requires its own set of regulations or whether these currencies could be managed effectively under existing rules.

New York and California have been at the forefront of Bitcoin discussions, and many experts think other states will follow their examples.

New York's regulatory framework will be up for public comment and feedback for 45 days starting on July 23. Llanos says the comment period will likely be "very heated." 

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