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The Uniform Law Commission Has Given States a Clear Path to Approach Bitcoin

States wanting to pursue a licensing approach have been handed the best possible path to encouraging digital currency innovation by a trusted body of lawmakers. 

This article originally appeared in CoinDesk.

The Uniform Law Commission (ULC), a private body of lawyers and legal academics, has voted to finalize and approve a uniform model law for the regulation of virtual currency businesses.

Now an official model for states to follow, I'm hopeful that over the next year, we'll see state after state pass this language as legislation. For states with badly drafted regulations (like the New York "BitLicense") or vague money transmission statutes that may or may not cover bitcoin businesses (like in California), this new legislation would be a major improvement and a huge win for our community.

For one thing, the model act's language is explicitly clear on what types of digital currency businesses are and are not regulated.

In many states, poorly written or outdated legal language that does not account for the properties of open blockchain networks has created legal gray areas for entrepreneurs. Whether or not they even need licenses is often open to interpretation – a looming prospect that hangs over the head of anyone trying to build a business in those states.

Sensible definitions

So, what's to like? Under the ULC's model act, precise and sensible definitions are laid out that specifically encompass only businesses models in which a third party takes control of user funds, because only in those situations can that third party then lose or steal the funds.

Therefore, any licensing system meant to protect consumers should only cover those businesses and exclude all others. An example can help explain how this could work in practice.

Imagine someone earning bitcoins by running a node on the Lightning Network. The node operator is helping hold some bitcoin transactions off-chain until they eventually are settled on the bitcoin blockchain. Prior to settlement, the node operator is part of a multi-sig payment channel that is holding those bitcoins. There is no way the node operator can steal or otherwise lose those coins.

So, should they be licensed?

Under California’s money transmission law, the determination is based on whether or not the business is "receiving money for transmission." And under New York's BitLicense, the question is whether the business is "receiving virtual currency for transmission or transmitting virtual currency, except where the transaction is undertaken for non-financial purposes and does not involve the transfer of more than a nominal amount of virtual currency."

Neither of those rules cleanly accounts for the Lightning Network arrangement, which means they are open to interpretation by the regulator. Suddenly, simply running a Lightning node could require you to hire a lawyer and go through an expensive process just to figure out if you need to go through an even more expensive licensing process.

Clearer picture

Under the ULC model act, that gray area is totally eliminated.

It is clearly spelled out that licensure is only required of companies that have control of a customer’s cryptocurrency, with control defined as the "power to execute unilaterally or prevent indefinitely a virtual currency transaction."

A Lightning Network node does not have that power, so they are not covered. Easy.

But it isn't just about Lightning Network nodes. You can run any sort of activity through this test and come up with an easy answer about whether it would be regulated. If you are a bitcoin exchange holding people’s bitcoins for them? Yes, you have control, you need a license.

But with almost anything else, you don't. Try the test with mining, software wallet development, core development, key recovery services and running a full node. In all those cases you cannot "unilaterally execute or indefinitely prevent" transactions with someone else's bitcoins; you just can't and therefore you are excluded from the regulation.

Try running any of those activities through California or New York's tests, and you will end up with more questions than answers.

The ULC model act also has a clear exemption for people or businesses using digital currencies on their own behalf. That means over-the-counter traders, token creators, miners selling their rewards, or people helping their family members acquire some digital currencies are all clearly free of any restrictions.

Regulatory clarity like this has been the stuff of dreams for digital currency entrepreneurs for years now. Coin Center and others have made modest progress approaching states one by one, although, more often than not, our victories have been helping a state turn a very unsound approach into a slightly less unsound approach.

Now, with the passage of the ULC's model act, states wanting to pursue a licensing approach have been handed the best possible path to encouraging digital currency innovation by a trusted body of lawmakers.

Based in Washington, D.C., Coin Center is the leading non-profit research and advocacy center focused on the public policy issues facing cryptocurrency and decentralized computing technologies like Bitcoin and Ethereum. Our mission is to build a better understanding of these technologies and to promote a regulatory climate that preserves the freedom to innovate using permisionless blockchain technologies.