California updated its digital currency legislation and it looks great

Update – August 9, 2016: This bill has been updated with new language that we do not support. For a more recent analysis please see New California digital currency bill is a step backwards

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A new amended draft of California’s AB 1326, a bill that would specify the state’s licensing regime for digital currency businesses, was released this morning—and it’s good news for us and Bitcoin advocates everywhere. Today, we’re issuing a letter of support for the legislation. Here’s why:

You may recall that about a month ago we filed our second letter to California regarding AB 1326. Our top request was removal of language that would make exchange or conversion an activity that would require licensing. In the draft announced today, that language has been removed.

With ‘exchange’ removed, California’s definition of virtual currency business matches closely the standard we’ve set out in our State Digital Currency Framework and that we’ve been fighting for in various states since the start of this year: a company should only need a license if they have actual custody of their customer’s bitcoins. That shouldn’t include pure software designers; it shouldn’t include minority key holders in a multi-sig address; it shouldn’t include the builders of sidechains, colored coin markets, or smart-contract-based exchange and conversion services for altcoins or new blockchains.

We’ve long believed that such a circumscribed definition places digital currency companies on a level playing field with legacy money transmitters and banks: if you have custody of the customer’s money, and by extension present a risk of loss, theft, or mismanagement, then consumer protection licensing makes sense. If, on the other hand, you are innovating with these technologies in a non-custodial way, no license should be required.

The latest draft also includes an on-ramp for small startups, along the lines of the plan we’ve advocated since the BitLicense comment periods of last summer and in our state framework. This means that by meeting standards set by the legislation, a small company will be able to operate without paying the full licensing fee or meeting the full requirements of licensure.

California’s bill is now a massive step forward from the examples set by New York and Connecticut:

Unlike New York:

AB 1326 would only regulate firms with full custody, not non-custodial “exchange services,” “issuers, administrators, or controllers,” or “transmitters” whatever those words mean or could be interpreted to mean. Unlike all that other verbiage in the BitLicense, Full custody is a easy test for applicability: can you lose the customer’s money? If yes, then you should be licensed.
AB 1326 has clear exemptions for software, communications infrastructure, miners, and business to business storage and security contractors as we suggested in our first letter on the bill.
AB 1326 contains no state level anti-money laundering provisions, rightly leaving the Federal government to set uniform national standards, and avoiding the chaos that could result from 50+ unique AML regimes.
AB 1326 has an onramp for small startups that, unlike New York’s discretionary conditional license, has the criteria for applicability clearly specified in the law. In other words, it’s a clear standard and not a benefit to be arbitrarily granted at the full discretion of the regulator.

Unlike Connecticut:

AB 1326 creates clear legal language that will guide the state’s regulators in crafting licenses for this important technology, rather than leaving these important decision entirely to appointees.

As we’ve said before on this blog, digital currency licensing legislation done right can lighten rather than enlarge the compliance burden placed on innovators. AB 1326, if it passes the Senate as presently drafted, will replace the confusing obligations of traditional money transmission licensing with standards tailored to cryptocurrency technology. Low risk innovators will be clearly exempted from the need to license, custodial services will have clear and less onerous requirements, and small start-ups holding custody can function without the full license until they grow. Other states that have already passed less tailored legislation (Connecticut), or promulgated more onerous rules (New York) should take note: California is getting it right, and states waiting to take on this topic should follow its lead.