The New York State Department of Financial Services issued subpoenas to 22 emerging payments players, including many that handle the digital currency Bitcoin, demonstrating that new payments models have not yet found their place in the eyes of the law.
The DFS is asking for information about anti-money laundering and consumer protections from businesses such as bitcoin exchanges, and it is looking into the strategies of their investors, says a source familiar the matter. It is also looking at Dwolla, which handles payments in conventional currencies but attracted attention in May for holding funds associated with Mt. Gox Bitcoin exchange.
The subpoenas came at a time when there seemed to be more clarity in how bitcoin businesses are regulated. The Financial Crimes Enforcement Network issued guidance in March defining these companies as money services businesses, and last week a federal judge asserted that Bitcoin is considered a currency under current law.
But current law might not be enough.
"DFS is also considering whether it should issue new regulatory guidelines specific to virtual currencies rather than simply apply existing money transmission regulations. As such, we could also move forward with new guidelines that are tailored to the unique characteristics of virtual currencies," a public memo by Benjamin Lawsky, superintendent of financial services at the DFS, states.
Bitcoin businesses that received a subpoena include BitPay, a Bitcoin payment processor; Coinbase, a Bitcoin wallet provider; and ZipZap Inc., a cash payment network that's part of the new self-regulating organization on virtual currency.
These companies did not respond to inquiries requesting comment. Dwolla says it is consulting legal advice.
Investors the DFS targeted include Andreessen Horowitz, Boost VC Bitcoin, Winklevoss Capital Management and Google Ventures. Boost VC Bitcoin is an incubator currently involved with a number of Bitcoin startups including BitWall, a microtransactions content monetization company that plans to launch sometime this month.
"Typically, these types of subpoenas require firms to produce documents within two to three weeks," says Adam Shapiro, director with the Promontory Financial Group, LLC. "Even if a recipient does not believe it needs to be regulated as a money transmitter in New York, it will achieve a better outcome by cooperating with the process and entering into a dialogue with the New York Department of Financial Services about how it can best respond to the subpoena."
The DFS "is trying to determine if these parties are doing money transmission and need to obtain licensing," says Terry Maher, an attorney at Baird-Holm LLP.
New York is one of the most notoriously stringent states, along with California, Illinois and Ohio, for obtaining money transmitter licensing, says Maher. He is familiar with a business whose application has been pending for 18 months. New York requires detailed information on business models, financial statements, personal information about officers and compliance programs.
Some Bitcoin exchanges have arduous and time-consuming registration requirements, but these processes are usually in an effort to abide by Know Your Customer rules enacted by Fincen. For example, consumers signing up for a Mt. Gox account usually have to wait about two weeks before they are set up.
The DFS probe resembles the governments attention to E-Gold several years ago. E-Gold is an online currency platform that supports international money transfers. The government started looking into several shady users of E-Gold and after 7 years wrapped up their investigation, reported Wired in 2009. The FBI indicted E-Golds creator, Douglas Jackson, on federal charges of money laundering, conspiracy, and operating as an unlicensed money transmitter. Jackson pleaded guilty to the charges and received hefty fines plus 36 months of supervised release with six months house arrest.
While Bitcoin's regulatory situation over the past several months looks similar to that of E-Gold, Bitcoin businesses more often follow the model of foreign exchange businesses, which do not require money transmitter licenses in New York, Maher says. As such, they may not fall under New York's money transmitter rules, Maher says, citing the states earlier descriptions of money transmitters and foreign exchanger businesses.