The new cryptocurrency legislation awaits signature from California Governor Gavin Newsom after it is passed by the California Assembly on August 30, 2022. If signed into law, the California Digital Financial Assets Act would create sweeping requirements that would, among other things, mandate that digital asset exchanges and crypto companies obtain licenses to operate in the State of California, but not before January 2025, as more fully detailed below described. Many observers have compared the new California legislation to New York State’s BitLicense ordinance, which was passed in 2015.
New license requirements
The legislation would introduce new licensing requirements. Under the law, a person would have to be licensed with the California Department of Financial Protection and Innovation (DFPI) to engage in “digital financial asset business activities” with a California resident (ie, a person who is a California resident or physically resident in California for). more than 183 days in the previous 365 days, a California resident or a legal representative of a California resident).
- The legislation defines “digital financial assets” as “a digital representation of value used as a medium of exchange, a unit of account, or a store of value that is not legal tender, whether denominated in legal tender or not.” However, a digital financial asset (1) does not include a transaction in which a merchant provides value as part of an affinity or rewards program that cannot be taken from or exchanged with the merchant for legal tender, a bank, or a credit union and credit or a digital financial asset; or (2) a digital representation of value issued by or on behalf of a publisher and used solely within an online game, gaming platform, or game family sold by the same publisher or offered on the same gaming platform.
- The legislation further defines “digital financial asset business” as any of the following:
- Exchanging, transferring, or storing a digital financial asset, or engaging in the management of digital financial assets (i.e., issuing a digital financial asset with authority to redeem the digital financial asset for legal tender, a bank or credit union loan, or other digital financial asset), either directly or through an agreement with a provider of control services for digital financial assets.
- Holding electronic precious metals or electronic certificates representing interests in precious metals on behalf of another person or issuing shares or electronic certificates representing interests in precious metals.
- Exchange of one or more digital representations of value used in one or more online games, gaming platforms, or gaming families for any of the following: (1) a digital asset offered by or on behalf of the same publisher that provided the digital original Value Representation was obtained, or (2) legal tender or bank or credit union credit outside of the online game, gaming platform, or family of games offered by or on behalf of the same publisher from which the original Digital Value Representation was obtained.
The scope of California legislation is similar to New York’s BitLicense ordinance; however, California law additionally covers persons who hold or issue electronic bullion or electronic certificates representing interests in bullion on behalf of another person.
The legislation does not apply to activities generally governed by the US Securities and Exchange Commission or the California Corporate Securities Law, or to the extent the law conflicts with the Electronic Fund Transfer Act of 1978. A person who performs certain activities, such as B. the provision of connectivity software or computing power to secure a network that records transactions in digital financial assets, or to a protocol that governs the transmission of the digital representation of value, are not covered by the legislation.
Other exclusions would be possible within the framework of legislation; For example, a person is exempt from the legislation if the person (1) provides only data storage or security services to a company that conducts digital financial asset business and does not otherwise conduct digital financial asset business on behalf of another person; (2) makes a digital financial asset available as one or more enterprise solutions for use solely with one another only to a person who is otherwise exempt from the legislation and who has no agreement or relationship with a California resident end-user of a digital financial asset ; (3) uses a digital financial asset, including creating, investing, buying, selling, or acquiring a digital financial asset as payment for the purchase or sale of goods or services, solely on the individual’s own behalf for personal, family purposes , household or academic purposes; or (4) engages in digital financial asset business activities with or on behalf of California residents that are reasonably expected to be valued at, but not limited to, $50,000 in aggregate annually.
New oversight of stablecoin activity
In addition, the legislation would prohibit certain stablecoin-related activities unless (1) the issuer of the stablecoin is licensed under the legislation or is a bank and (2) the issuer of the stablecoin owns eligible securities at all times (i.e., any US currency eligible security). or foreign currency eligible security) having a total market value, calculated in accordance with U.S. generally accepted accounting principles, of not less than the aggregate amount of all of its outstanding stablecoins issued or sold in the United States. The stablecoin restrictions would expire and expire on January 1, 2028.
Audits, records and reporting?
By law, the DFPI could conduct an audit of a licensee without notice, and that person would have to bear the costs associated with such an audit. The legislation also introduces various record-keeping obligations, such as: B. A monthly ledger listing all assets, liabilities, capital, income and expenses of the licensee. Licensees would be required to retain certain types of records for a minimum of five years and report to the DFPI within 15 days of certain events.
The DFPI would be able to take enforcement action against licensees or those subject to license requirements but not licensed, with prescribed civil penalties of up to $100,000 for each day an individual violates the requirements.
Other types of enforcement action permitted under the legislation include any of the following:
- Suspension or Revocation of a License
- Ordering a person to cease and desist from doing business in digital financial assets with or on behalf of a California person
- Application for Appointment of a Liquidator for the Assets of a Person Conducting Digital Financial Asset Transactions with or on Behalf of a California Resident
- Requesting a court to issue a temporary, provisional, or permanent injunctive relief against any person conducting business in digital financial assets with or on behalf of a California resident
- assessment of a penalty
- Recovering security and initiating a plan to distribute proceeds for the benefit of a California resident who has been violated by a violation of any statute or law of California, other than the law applicable to conducting digital financial asset business with or on behalf of , a California resident
- To impose necessary or appropriate conditions for conducting digital financial asset business activities with or on behalf of a California resident
- Applying for compensation on behalf of a California resident when the DFPI establishes economic loss as a result of a violation of the law
Licensees would be subject to disclosure requirements, including providing California residents with a Schedule of Fees disclosing the fees and charges that Licensee may charge, the manner in which fees and charges will be calculated if they are not predetermined and disclosed, and the schedule of fees and charges.
Licensees would be required to establish and maintain policies and procedures for an anti-money laundering program, a business continuity plan, an information security program, and an operational security program, among other things.
Legislative supporter Timothy S. Grayson made a statement about his efforts. “The excitement surrounding cryptocurrency and digital financial assets is palpable. . . . While cryptocurrency’s newness is part of what makes investing exciting, it also makes it riskier for consumers, as cryptocurrency companies are not properly regulated and don’t have to follow many of the same rules that apply to everyone else. This law will provide consumers with basic but necessary protections and promote a healthy cryptocurrency market by making it safer for everyone.”
But the legislation has its critics. In an open letter to California lawmakers, the Blockchain Association stated that the BitLicense “would make it impossible for many stablecoin issuers to operate in California because of the licensing requirements imposed on these companies, whether based within the state ,operate’. Stablecoins serve as an important bridge between traditional finance and the digital asset economy, and their success is a key enabler for the success of the entire crypto ecosystem.” The Blockchain Association also cautioned that New York State’s BitLicense regulation creates a regulatory environment that was too challenging for startups or smaller crypto companies to survive and that “California should not repeat New York’s mistakes.”
Whether the law creates a “crypto frenzy” or is a bust remains to be seen. Governor Newsom has until September 30, 2022 to sign the law into law.