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Update to Cryptocurrency Article

By Fred H. Miller

In the May 2018 issue of the Oklahoma Bar Journal an article by Kaimee K. Tankersley, Ashley Davis and Alexander Ah Loy titled “Legal and Regulatory Developments Arising From The Growth of Cryptocurrency” discussed those developments on the federal level and among the states, but concluded its discussion of state regulation as of November 2017. The purpose of this section note is to update that part of the article.

The National Conference of Commissioners on Uniform State Laws, or the Uniform Law Commission (ULC) for short, is a state-funded organization of practicing lawyers, judges, legislative staff and law professors founded in 1892 at the suggestion of the American Bar Association. It studies and then drafts and seeks enactment of uniform state laws. Oklahoma has been a member for many years whose delegates are selected by the governor, the House and the Senate. Some of its well-known products Oklahoma has enacted include the Uniform Commercial Code, various business organization acts and numerous family law acts.

Last year, after careful study and the involvement of members of the industry and participants in cryptocurrency (aka virtual currency) transactions, the ULC approved an act entitled the Uniform Regulation of Virtual Currency Businesses Act (URVCBA). This year at its annual meeting in July, the ULC was expected to approve a companion act that will provide tested commercial rules for virtual currency transactions.

The benefit of the URVCBA as opposed to merely amending so-called money transmission statutes (MTAs), which only deal with transmission of legal tender, as a general rule are:

  • MTAs are not uniform, the uniform act when enacted will make the law substantially the same among exacting states,
  • The uniform act will lead to cooperation among state regulatory agencies and contains reciprocity provisions to reduce the regulatory burden for interstate businesses,
  • The uniform act is specifically focused on virtual currency transactions and thus affords certainly to businesses; indeed, it is supported by virtually all industry participants,
  • The uniform act contains far more consumer/user protections than do MTAs, and further coordinates with federal laws; it also contains extensive enforcement powers for the state regulatory agency, and
  • The uniform act contains provisions that foster innovation and the trial of various business models before the full burden of licensing occurs.

A brief summary of the two proposed acts follows.

URVCBA regulates persons, wherever located, that conduct or offer to conduct virtual currency business activity for residents of the enacting state and who have control of virtual currency.1

Virtual currency business activity consists of:

  • The exchange of virtual currency for other virtual currency or for fiat currency or bank credit, or vice versa,
  • The transfer of virtual currency by crediting it to the account of another person, moving it from one account of the person to another account of the same person, or relinquishing control of it to another person, or
  • Storing virtual currency.2

Virtual currency is a digital representation of value that is used as a medium of exchange, unit of account or store of value and is not fiat currency whether or not it is denominated in fiat currency. Virtual currency does not include:

  • A transaction in which a merchant grants as part of an awards program value that cannot be taken from the program or exchanged for fiat currency, bank credit, or other virtual currency, or
  • A digital representation of value issued and used solely within an online game or family of games offered on the same game platform.3

The URVCBA does not regulate:

  • Virtual currency itself,
  • Person to person transfers without the use of an intermediary virtual currency business,4 and
  • Whether virtual currency is subject to: escheat laws, the treatment of virtual currency as a security or a commodity, or virtual currency business that is de minimus, defined as not in excess of $5,000 in volume per year.5

OTHER STATE/FEDERAL LAWS APPLICABLE TO VIRTUAL CURRENCY
Most states have money transmitter laws. As enacted they govern transfers of fiat currency, but several states are in the process of amending these laws to also cover virtual currency, for example Hawaii. Aside from a lack of uniformity, this results in pushing a square peg in a round hole even if various but often lesser user protections are added.

On the federal level, the Bank Secrecy Act (BSA) is like state money transmitter laws and the Financial Crimes Enforcement Network (FinCEN) has issued an “interpretive guidance” governing persons creating, obtaining, distributing, exchanging, accepting or transmitting virtual currencies. As under URVCBA, “users” (essentially persons who obtain virtual currency to purchase goods or services) are not money service businesses and are not subject to BSA regulation. An “administrator” (a person engaged as a business in putting into circulation virtual currency with the authority to withdraw it), and an “exchanger” (a person engaged as a business in the exchange of virtual currency for fiat currency, funds or other virtual currency), are money services businesses and are subject to MSB registration, reporting and record keeping under the federal law, unless a limitation or exemption applies.

This is important because a) a state should not both amend its money services statute and also enact the URVCBA – it should enact the URVCBA as the better design and recognize it coordinates with the money services statutes (see §703), and b) a business doing virtual currency business activity in a state that has amended its money services statute but not enacted the URVCBA, which some opponents of any regulation seem to be arguing for, unless the business recognizes the change, may be liable under 18 U.S.C. §1960.

As noted, the URVCBA exempts businesses whose annual volume of virtual currency business activity is $5,000 or less per year. This allows persons who engage in only minor activity perhaps to develop a business model or for research, and who pose little risk if unregulated, to engage in virtual currency activity without regulatory burden.

Similar considerations may apply to a business that wants to test a business model in a particular market or for some other valid business reason does not want to go “whole hog” in a particular state. Because the business nonetheless poses risk to users, the URVCBA does not exempt the business but if the expected annual volume does not exceed $35,000 allows a “license light” approach called “registration” in §207. However, this approach comes with a two-year time limit.

A variety of businesses engaging in virtual currency business activity are excluded, basically to avoid overlapping regulation. These include:

  • Activity to the extent subject to the Electronic Fund Transfer Act, the SEC Act, the Commodities Exchange Act or state blue sky laws,
  • Activity by the U.S., a state, or an agency or instrumentality of either or of a foreign government,
  • Banks,
  • Persons who essentially only supply operational support,
  • Attorneys and title insurance companies providing escrow services, and
  • Secured or lien creditors enforcing their debts.6

Before engaging in or holding itself out to engage in virtual currency business activity with or on behalf of a resident of an enacting state, a business must be licensed in the enacting state or in another state with which the enacting state has a reciprocity agreement.7

To apply for a license from the enacting state, an applicant must provide among the following:

  • Legal name and address, and the same for officers and certain others;
  • Description of current and former businesses;
  • Any criminal convictions and proceedings;
  • Any litigation, arbitration and the like proceedings;
  • Any bankruptcy, receivership and like proceedings;
  • Addresses to contact the business;
  • Insurance information;
  • Information about the form and structure of the business;
  • Any registration with FinCEN;
  • Employment experience of officers and certain others; and
  • The applicable fee.8

An applicant must:

  • Meet security, net worth and reserve requirements.9
  • Meet recordkeeping requirements.10
  • File interim reports.11 Also reports on any change in control12 and reports on any merger or consolidation.13
  • Make required disclosures to residents, including among other matters fees and charges, any insurance coverage, whether a transaction is irrevocable, liability for unauthorized mistaken or accidental transfers, error resolution rights, information about a transfer, any right to stop payment, and that virtual currency is not legal tender.14
  • Maintain virtual currency of customers in its control and not subject to it claims of creditors.15
  • Maintain policies and procedures for or against a) information security, b) business continuity, c) disaster recovery, d) fraud, e) money laundering, or the funding of terrorist activity and f) to ensure compliance with applicable laws.16

To alleviate the burden of multistate licensing, the URVCBA allows a business operating in a number of states two options.

The first option if the enacting state adopts it, is to use the Nationwide Multistate Licensing System developed by the Conference of State Bank Supervisors and file an application with the registry. The applicant also must notify the enacting state agency and submit to it:

  • The license history from each state in which the applicant is licensed to conduct virtual currency business activity,
  • The applicable fee,
  • Documentation of compliance with security and net worth requirements, and
  • A certification of compliance with the URVCBA enacted in the state.

The second option, if the registry option is not available or used, if the state agency determines that the state in which the business already is licensed has a law substantially similar (or more protective of the rights of users), is to file a notice stating the intent to rely on reciprocal licensing, a copy of the license from the other state, license history, the fee, documentation of compliance with security and net worth requirements, and a certificate of intent to comply with the act.17

The URVCBA provides the state agency with a wide range of administrative enforcement tools including authority to conduct examinations,18 license suspension or revocation of a license or registration, cease and desist orders, receivership, injunctive relief, civil penalties, ability to recover on the security required under Sec. 204 and imposition of conditions on continued activity.19

There is no private right of action under the act, the rational being that providing one might prompt inconsistent rulings since the subject is new and administrative enforcement is likely to be more consistent. But if a violation of the act would furnish a cause of action under other law, that is not curtailed,20 nor is criminal prosecution under other law precluded.

Virtual currency is a type of intangible personal property. Existing commercial law may characterize it as a payment intangible for classification as collateral under UCC Article 9, but little else is clear as the applicability of the Article 9 rules do not fit virtual currency well. Moreover, whether UCC Article 2 applies to the exchange or sale of virtual currency or ancient bailment law applies well to a custodial transaction, is doubtful at best. To amend those laws to accommodate virtual currency would be impracticable. Characterizing virtual currency as a financial asset to fit in the indirect holding system under UCC Article 8 Part 5, and the resulting application of the rules not only of Article 8 but also Article 1 and a clear path under Article 9, is the approach being used in a proposed companion act scheduled to be completed by the Uniform Law Commission this summer.

One may question whether such a companion act is needed as submitting virtual currency as a financial asset by agreement of the user and the securities intermediary is possible now. However, to do so much drafting of the agreement to obtain a workable fit makes this a less attractive approach.

Expect at most a few states in 2018; more after studies in 2019.

Both proposed acts will be introduced in a number of states in 2019.

ABOUT THE AUTHOR
Fred H. Miller is professor emeritus at the OU College of Law, where he joined the faculty in 1966. He graduated in 1959 from the University of Michigan and received his J.D. from the same university in 1962. He has served as commissioner from Oklahoma to National Conference of Commissioners on Uniform State Laws since 1975, and is also former executive director, chair of the Executive Committee and past president of the conference.

1. Sec. 103(a).
2. Sec. 102(25). Other more specialized activity includes a) engaging in virtual currency administration b) holding electronic precious metals or electronic certificates representing interests in precious metals or issuing the latter or c) exchanging digital representations of value within one or more online games for virtual currency offered by the same person from whom the digital representations were received or fiat currency or bank credit outside the game. Activity can involve virtual currency that has a centralized repository or that is decentralized and that uses the “blockchain,” such as in the case of Bitcoin. We will focus on the latter.
3. Sec. 102(23).
4. Sec. 103(b)(7).
5. Sec. 103(b)(8).
6. Section 103.
7. See §102(11) defining that term.
8. Sec. 202.
9. Sec. 204.
10. Sec. 302. See also Sections 303-304.
11. Sec. 305.
12. Sec. 306.
13. Sec. 307.
14. Sec. 501.
15. Sec. 502.
16. Secs. 601 and 602.
17. Sec. 203.
18. Sec. 301.
19. Secs. 401-406.
20. Sec. 407.

Originally published in the Oklahoma Bar Journal -- OBJ 89 pg. 40 (August 2018)