Hot Takes

The OCC has just taken another step toward a national fintech charter.

Today it released a draft of the licensing manual supplement that will be used by fintech companies digital currency and blockchain companies among them to understand and engage in the process of becoming a chartered special purpose national bank (often called a Fintech Charter).

The draft manual echos and clarifies previous statements from the OCC specifying that they have legal authority to charter a company that merely provides access to a payment system (even if it doesn't take deposits or make loans). The draft manual reads:

a special purpose national bank that conducts activities other than fiduciary activities must conduct at least one of the following three core banking activities: taking deposits, paying checks, or lending money.

And then, as we've asked for in previous letters, it goes on to elaborate on what paying checks means in the modern world:

issuing debit cards or engaging in other means of facilitating payments electronically may be considered the modern equivalent of paying checks.

The draft manual also delves into a topic we focused on in our most recent comment letter: under existing interpretation and law is there a broad category of bank-permissible activities which could be used to describe the range of activities in which digital currency companies engage? The OCC helpfully points a perspective applicant in the right direction through a succession of footnote references to past interpretations (the same past laws and interpretations we described in our most recent comment). These include:

buying and selling exchange, coin, and bullion [12 USC 24]

which is one possible route for appraising the purchase or sale of digital currency to customers as a bank-permissible activity. The manual also describes:

establishing and operating a messenger service (12 CFR 7.1012), acting as a finder (12 CFR 7.1002)

which is a pretty good description of running a full node or a lightning node. It also cites:

acting as a finder (12 CFR 7.1002),

which is what a digital currency exchange is doing when it connects buyers and sellers on their platform. It also cites:

producing and selling software that performs a service the bank could perform directly (12 CFR 7.5006).

which is a great match for hosted wallet design and services, e.g. a high tech version of safekeeping activities banks have provided for centuries in the form of safe deposit boxes and other custodial services.

We're thrilled that the OCC is making this process as transparent as possible, and even doing a bit of hand-holding to help innovators (who are better versed in bits than bonds) understand and navigate the chartering process.

If you’d like to read more about how a charter may be relevant to digital currency companies take a look at our most recent letter to the OCC. And look out for our next comment! Even though licensing manuals are not usually subject to a public comment process, the OCC has asked for continued feedback from the community.

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The Winklevoss Bitcoin ETF has been rejected by the SEC.

The first of several attempts to create an exchange traded fund based on cryptocurrency tokens has failed in its bid for regulatory approval.

Coin Center executive director Jerry Brito had this to say:

“The Winklevoss ETF proposal was rejected because the SEC found that the significant markets for Bitcoin tend to be unregulated overseas markets that are potentially subject to price manipulation. But this creates a chicken and egg problem. How do we develop well-capitalized and regulated markets in the U.S. and Europe if financial innovators aren’t allowed to bring products to market that grow domestic demand for digital currencies like Bitcoin?”

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We explained open blockchains at the FTC’s FinTech forum today.

This morning the Federal Trade Commission held the latest event in its series of FinTech forums and it focused on Artificial Intelligence and Blockchains. The half-day workshop was designed to bring together industry participants, consumer groups, researchers, and government representatives, to examine the ways in which these technologies are being used to offer consumers services, the potential benefits, and consumer protection implications as these technologies continue to develop.

Coin Center director of research Peter Van Valkenburgh opened up the blockchain portion of the agenda with a talk that clearly defined of the term “blockchain,” taking care to clarify the distinction between open and closed blockchain networks, and highlighting the characteristics of various consensus mechanisms and what they mean for what different types of blockchains can do. He then joined a panel discussion with other experts from the space. More information about the event and Peter’s slides are available here.

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An opinion piece in The Hill today tells the SEC to reject the listing of Bitcoin ETFs and it's very misguided.

Penned by Georgetown business professor Jim Angel, the article is almost as alarmist as it is pessimistic.

While he writes that “Informed investors should be allowed to make their own investment decisions without interference from a nanny-state government,” Angel nevertheless argues that investors should be denied the opportunity to decide to invest in Bitcoin ETFs. The reason, he says, is that Bitcoin ETF applications have not disclosed that “criminal activities are the primary use of Bitcoin.” Unfortunately, Angel doesn’t cite any evidence for this proposition, just some personal anecdotes.

No doubt there are illicit uses of Bitcoin, but as law enforcement officials have said time after time, it’s a challenge they are more than capable of meeting. While Angel says that “Bitcoin is a payment system ideally suited to the black market,” I think the dozens of criminals now behind bars because law enforcement used Bitcoin’s blockchain to track them would disagree. Bitcoin is not as anonymous as is often portrayed. And it certainly isn’t the cause of ransomware as Angel implies.

If every company whose products were used illicitly by criminals had to disclose as much in their securities filings, drug companies might have to state that a large proportion of pain killers end up on the black market, banks would have to disclose how their accounts are routinely used by criminals to launder billions of dollars, and maybe even car companies would have to say that their vehicles are used for getaways. It’s not clear retail investors would be any better denied the opportunity to invest in drug companies, banks, or auto firms because they don’t disclose this on SEC forms, but that’s what Angel suggests for Bitcoin ETFs.

The advent of the Internet led to rampant piracy, the proliferation of porn and illegal gambling, easier criminal communications, anonymous harassment, as well as new kinds of confidence scams. Could you imagine if the government in the early 1990s took advice like that of Mr. Angel? Advice that amounts to, “Please look only at the potential costs of this technology and ignore all the potential benefits because they’re too unproven and uncertain.” (That advice might have looked a little like this.) We would be much, much poorer today.

Luckily the government then dismissed techno-pessimists like Angel and, at the time, Newsweek columnist Clifford Stoll, who wrote this timeless piece in 1995. Instead the federal government adopted the optimistic view that we could embrace the promise of technology while mitigating its risks where needed. This was the basis for the Clinton Administration’s policy toward the Internet, and it should be what guides the SEC as it makes its decisions on Bitcoin ETFs.

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Terrorist use of cryptocurrencies is not a major risk.

That’s the message from David Carlisle, formerly of the U.S. Department of the Treasury’s Office of Terrorism and Financial Intelligence, in a report for the Royal United Services Institute, an international defense and security think-tank in London.

He writes that “information on terrorists’ use of cryptocurrencies is limited and anecdotal,” and that it is uncertain whether cryptocurrencies will become a major funding tool given that “terrorists already have a number of reliable financing streams, which show little sign of drying up.”

The report goes through the few reported anecdotes and argues for a measured reaction. “Treating cryptocurrencies as an exceptional threat," he writes, ”creates the misleading impression that more conventional financial products are not already equally, or more, vulnerable to terrorist exploitation."

With all this in mind, his policy prescription is spot on:

[B]anning Bitcoin or other cryptocurrencies could stifle important innovations that could enhance financial services. While it is still far from clear how significant an impact cryptocurrencies will have, a number governments, including the UK’s, are keen to enable innovation in the sector.

Cryptocurrencies have particularly vocal champions among some proponents of financial inclusion, or expanding financial services to the world’s poor. Cryptocurrencies’ peer-to-peer nature enables transfers to occur at reduced cost compared to credit card transactions and other established payment methods that rely on numerous intermediaries.

Proponents argue cryptocurrencies could play a role in helping the unbanked to access cost-effective financial services.

Virtual currencies therefore offer governments a test case in harnessing the promise of technological innovation while also managing financial crime risks that are still only taking shape.

Countries should pursue a sensible approach. They should ensure their law enforcement agencies have the necessary resources and skills to uncover related illicit activity; and they can work to improve information sharing with their foreign counterparts on joint investigations. [… ] As with any new technology, awareness of risks is critical. But overreaction and panic in this early stage in cryptocurrencies’ history would be misguided.

This is the approach that Coin Center has been promoting for over two years, and it’s at the heart of the Blockchain Alliance’s mission to ensure that law enforcement has the knowledge about cryptocurrencies that will allow them to react appropriately to the limited risks posed.

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One of bitcoin's best bets for sound regulation is about to wrap up.

We’re optimistic about the final meeting of the ULC committee drafting a model virtual currency law. This process began all the way back in October of 2015, and since then the drafting committee–a group of super sharp law professors and legal minds–has met on four separate occasions across the US, from Chicago to Palo Alto, Washington DC to the Twin Cities. The product of all these efforts is the URVCBA (the Uniform Regulation of Virtual Currency Businesses Act). It may not be the most elegant name but the substance of this model law is shaping up to be streamlined and on-point.

Most importantly, as drafted, it carefully circumscribes the set of business activities dealing in virtual currencies like bitcoin and ether that require any sort of license from state banking regulators. That careful specification was designed with legislative language from our Framework for State Regulation of Virtual Currencies, language that clearly limits the licensing requirements to truly custodial businesses who hold other people’s valuables.

In preparation for this final meeting in Chicago, we’ve again submitted written comments (and I’m on a plane as we speak to advocate in person). Most of our recent comment letter is nitpicking, ensuring that essential definitions dealing with what it means to have “control” of other people’s virtual currency are as clearly and justiciably drafted as possible. These key definitions should ensure that no individual or business acting on its own behalf (buying or selling own virtual currency for its own purposes) or providing bitcoin or ethereum software or services that do not involve taking custody of other people’s bitcoin or ether (e.g. software wallet developers, miners, stakers, full nodes, lightning nodes, multi-sig key recovery providers, smart contract oracles etc.) are ever required to be licensed by a state banking regulator in order to engage in those activities.

We are also weighing in on the dual licensure question, insisting that companies who already have money transmission licenses in several states (all of the larger US-based exchanges) should not need to obtain a separate virtual currency license. Fifty licenses is already a lot (and, as we’ve said, we hope the OCC’s Fintech charter can relieve some businesses of that burden) but 100 is simply absurd. There are a few other details in our comment related to minimum capital and solvency requirements; if that sort of thing is your bag, take a look at our full letter.

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Hawaii’s issue with Bitcoin businesses has an obvious and easy solution.

This week Coinbase, one of the world’s largest and most trusted digital currency companies, announced that it would be suspending operations in Hawaii. The move follows a decision made by the state’s Division of Financial Institutions to impose unreasonable solvency requirements on the company. Coinbase’s Juan Suarez describes the situation:

In September of last year the DFI informed Coinbase that it imposed a policy which would set Hawaii apart from nearly every other state in America and which will make it impossible for Coinbase to operate there: Coinbase and other digital currency businesses will be required to maintain cash reserves (or similar, liquid assets referred to as “permissible investments”) in an amount equal to the aggregate face value of digital currency funds held on behalf of customers. In other words, if Coinbase holds one bitcoin for a Hawaii customer, the practical outcome of this policy will require Coinbase to also hold the equivalent cash value of that bitcoin, currently well over $1,000, as redundant collateral.

This policy is obviously untenable. No digital currency business — and frankly, no commercially viable business anywhere — has the capital to supplement every customer bitcoin with redundant dollar collateral.

Coinbase is being asked to hold not only their customer’s bitcoin, but also the equivalent value in cash (or some other liquid asset). Unfortunately Hawaii does not recognize digital currencies as an acceptable liquid asset for this purpose. That means Coinbase has a reserve requirement at least double that which would be expected of any other business that holds customer funds. Clearly this is a huge burden to place on a small startup in a burgeoning industry. It should come as so no surprise that Coinbase chose to leave the state rather than attempt to comply with such an onerous rule.

Solvency requirements are an important consumer protection tool and permissible investments rules help businesses manage those requirements. In our State Digital Currency Principles and Framework we lay out how and why these rules need to be updated to reflect the modern technology landscape:

To protect consumers, Digital Currency Transmitters, as with licensed money transmitters, should be required to have sufficient capital reserves on hand to guarantee the solvency of the institution. In money transmission licensing, these reserves can usually be satisfied by holding cash. California, for example, lists cash as an eligible security for the purposes of capital requirements in money transmission licensing. Allowing the transmitter to hold cash avoids a situation where the business must hold illiquid assets alongside and in duplication to any liquid (i.e. cash) assets held in order to quickly make good on outstanding payment orders. Digital currency transmitters should face similar standards. If the business holds digital assets in the form and amount deposited by their customer, it should not also have to hold duplicative reserves in some other form.

Bitcoin and its fellow digital currencies are inherently liquid assets that must be recognized as permissible investments. Cryptocurrency solvency can be proved instantly and in real-time, which could make them superior to even cash for this purpose. States which do not see this will find themselves falling behind the times.

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What does the future of cryptocurrencies and open blockchains look like?

Coin Center director of research Peter Van Valkenburgh joined the Blindspot Podcast to discuss the status of these technologies and what to keep an eye out for on the horizon. The conversation sheds light on the potential for innovation unlocked by open blockchain networks, and why it is so important that the freedom to use them be preserved.

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The hedge fund Numerai is going to issue its own cryptotoken, and this article nails the policy issues.

It doesn't hurt that they quoted me, but--in all seriousness--the two primary risks inherent in app-coin issuance are well flagged: securities regulation and buggy smart-contract code. And, on the securities question, the article focuses, appropriately, on the Howey test and whether there is an issuer-investor relationship here: 

First: securities law. The Numeraire is one of a slew of new cyptocurrencies that have been released in the last year or so that have piqued the interest of Andreessen Horowitz, USV and other venture capital firms and entrepreneurs — and they’re generating real money for their developers. In 2016, according to cryptocurrency research firm Smith + Crown, 64 tokens were released in what are commonly called “initial coin offerings,” raising $103 million, enabling these efforts to bypass venture funding.
However, Peter Van Valkenburgh, research director at Coin Center, an advocacy group focused on the public policy issues facing cryptocurrencies, says that, unlike some other new tokens, the Numeraire would likely not be considered a security. “If they’re giving them out to people who submit trading strategies or perform some sort of useful work, it’s not a speculative investment relationship between the putative issuer and putative investor,” says Van Valkenburgh. “It’s really more like someone being paid for contributing something, more like a wage in a giant decentralized corporation. … It wouldn’t be that different from rewarding people with points.”

Numerai's work here is a great example of how app-coins and open blockchain networks may be able to streamline the provision of public goods and enhance transparency in financial markets. Read the whole article.

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We taught Congress about Bitcoin vs Blockchain.

The Congressional Blockchain Caucus, which we helped kick off a couple of weeks ago, held its first briefing on blockchain technology yesterday. The event was full to standing room only as lawmakers and their staff gathered to build their understanding of these technologies. Coin Center director of research Peter Van Valkenburgh demystified the buzzword “blockchain technology,” giving attendees a better sense of the difference between permissionless blockchain networks, like Bitcoin or Ethereum, and the private blockchain networks being experimented with by corporations around the world. As we’ve stressed before, understanding this distinction is essential to understanding the critical role that open networks will play in the future of internet infrastructure and business innovation. Joining Peter on the panel were Reuben Bramanathan of Coinbase, Mark Wetjen of the DTCC, and it was moderated Robin Weisman of Coin Center.

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