Blockchain crosses the impressive two million wallet mark, doubling since January. The US Consumer Financial Protection Bureau is now open for complaints agains virtual currency businesses (hooray for Big Brother!) before most people even know what to complain about. ChangeTip added a ton of functionality to its tipping apps. And, oh boy am I excited to have wrapped up the draft for BitLicense Paper #3…A very meaty BitLicense Paper coming your way this afternoon. As usual, there are bound to be areas in which this can be improved before actual submission to NYDFS given that I am acting as researcher, writer and editor here. So don’t be bashful or pull punches in critiques.Today, I attempt to eviscerate arguments which support the regulation of new virtual currency issuances. Let me know how you think I did.Dear Mr. Lawsky and Mr. Syracuse:This is the third letter of detailed public comments that I am submitting to your department in response to the recently issued BitLicense proposals. Now that I have summarized my key concerns, I would like to provide additional details surrounding my objections to specific provisions, along with suggested solutions or modifications. As with the first two, I would also like to reiterate that I do not represent any company, group or individual other than myself.In this letter, I would like to continue to address the concerns I share with many from the broader Bitcoin community regarding the BitLicense’s overly broad definition of regulated “Virtual Currency Business Activity”. In my last letter, I discussed the troublesome inclusion of open source wallet software providers under the BitLicense. Today, I would like to highlight another important area of innovation that would be suffocated under the current proposals: newly-issued, alternative virtual currencies.Under Section 200.2 n5, it appears that anyone associated with the launch or growth of an alternative currency would be required to apply for a BitLicense, despite the fact that such activity consists merely of releasing software protocols on the internet, and is therefore protected against regulation as free speech under the 1st Amendment. As attorney Sean King eloquently described in a separate letter to your department:“Protocols are language, and language is undeniably speech. Both the Ninth Court of Appeals (Bernstein v. United States) and the Sixth Circuit Court of Appeals (Junger v. Daley) have explicitly ruled that computer source code is free speech that is protected by the First Amendment. We have no reason to believe that courts would likely conclude otherwise with regard to Bitcoin’s open source protocols, which is nothing more than computer source code.”King goes on to make a thorough argument against any BitLicense regulations that curb individual speech, with which I agree wholeheartedly. However, I will leave that nuanced discussion to others who are better versed in the relevant law. Instead, I would prefer to explain why the inclusion of newly issued, controlled or administered alternative currencies under “Virtual Currency Business Activity” would ultimately stifle innovation and economic growth in New York, endanger consumers, drive new businesses and ideas outside of the state (and possibly even the country), and prove impossible to actually enforce.For starters, it is unclear what exactly constitutes “administering, controlling or issuing a new Virtual Currency” under the department’s proposals. In my previous letter, I outlined the logistical issues of regulating open source software and the futility of actually attempting to enforce such regulations. As with open source bitcoin wallet software, it would be impossible to actually prevent any individual or group from releasing, maintaining or contributing to an open source virtual currency code. Yet it appears that those responsible for making updates to the Bitcoin core protocol or any other existing virtual currency protocol would be required to first seek approval from the NYDFS in order to make such changes legally in New York State.It is important for the department to clarify whether those working on the Bitcoin core or alternative virtual currency protocols in New York State must suspend their development activities until the software has been granted a BitLicense by the department.The likely answer would appear to be “no”, so I ask that the department clarify to which virtual currency protocols Section 200.2 n5 currently apply, and how such determinations will ultimately be made in the future. Even if the department decides that it will arbitrarily extend Section 200.2 n5 to include all virtual currency protocols created after the date the BitLicenses go into effect, I ask it to clarify whether the restrictions on unlicensed issuances would extend to any new update (or “fork”) of an existing protocol, as these would be nearly identical to the creation of an entirely new virtual currency.In spirit, it seems that Section 200.2 n5 may be an honest attempt to regulate the proper issuance of new virtual currencies by specific companies or groups who stand to benefit financially from such crowd-sales. Here, the NYDFS does have valid concerns concerning consumer and investor protections with respect to ponzi, pyramid, or other “pump-and-dump” schemes perpetrated by fraudsters whose primary motivation is to profit at the expense of the less sophisticated. However, as I suggest above, such regulation is difficult to define, much less properly enforce, and it may be infeasible for even the most honest developers to comply with such vague provisions.I believe that the NYDFS could more appropriately regulate new virtual currency issuances by simply requiring the “BitLicensed” organizations responsible for currency exchange and custodianship to demonstrate reasonable, good faith diligence efforts surrounding the viability and integrity of any new virtual currencies available on their platforms. For example, a New York-based exchange might face limitations on the type of virtual currencies for which they make markets, based on those currencies’ respective market capitalizations and daily trading volumes.This approach would not eliminate global trading platforms that make markets for thinly traded virtual currencies, but it would establish New York State as a haven for the exchange of much safer and thoroughly vetted virtual currencies. Furthermore, this approach would allow new virtual currencies to operate unencumbered in their “beta” forms, while creating a firewall between unsophisticated investors and high-risk new issuances. This would appear to be the virtual currency analog of security listings and de-listings that already occurs every day on regulated stock exchanges.Limiting the scope of regulation surrounding new virtual currency issuances to exchanges and custodians offers the best of all possible worlds to the NYDFS and other authorities, consumers and investors, and the broader virtual currency industry.Without modifications, however, the current proposals would weaken the strength and resilience of virtual currency technology by effectively outlawing the “testing ground” for future innovations in the financial services capital of the world, New York.The department’s proposals seems to suggest that the very existence of bitcoin and other alternative virtual currencies may have been considered illegal were its guidelines established at the time of those currencies’ creation. (After all, the creators of the underlying protocols did not first apply for licensing in New York!) Nevertheless, since the department has noted and even expressed cautious optimism surrounding the positive innovative potential that virtual currencies present to existing financial services institutions and consumers, it seems that this is a mere drafting issue.If the NYDFS recognizes the benefits of incumbent virtual currency technologies, it seems logical that the department should also recognize the potential of new virtual currencies which may be issued in the future.Alternative virtual currencies like Litecoin, Dogecoin, Peercoin, Nextcoin, Ripple and their future peers, allow for experimentation and stress testing of new concepts in virtual currency protocols that are valuable in fortifying the strength of all block chain technologies. For example, Litecoin and Peercoin have given developers insights into how the issuance of new currencies might be more equitably and efficiently distributed. Thinly-traded alternative currencies have yielded invaluable case studies in how bitcoin itself might fend off or mitigate the damage from a theoretical “51% attack” in which a bad actor attempts to hijack the network. Other future alternative currencies may uncover solutions related to complex issues like chargebacks, price volatility, or even the digitization of sovereign currencies.In short, the very best of alternative virtual currencies make these technologies less risky and more valuable to consumers, businesses, and investors - not the other way around.Finally, although Bitcoin is the most popular virtual currency technology today, alternative virtual currencies should not necessarily be relegated to second-tier status.Since the NYDFS first shared its initial draft proposals with the broader virtual currency community mere weeks ago, there have been two new highly acclaimed virtual currency protocols released into existence. The first, Ethereum, has actively denied that its “tokens” represent any type of security or currency, as those tokens will merely facilitate the execution of smart contracts via the Ethereum protocol. The second, Stellar, may resemble a currency more closely, and yet its underlying protocol focuses more specifically on connecting “gateways” which already act as regulated financial institutions. Should either of these protocols cease to be available legally to developers and institutions in New York state?It seems that a secondary goal of Section 200.2 n5 may be to restrict virtual currency organizations from circumventing existing federal securities issuance regulations. However, issues related to “securitization” of virtual currencies appears to fall well outside the purview of the NYDFS. Infrastructure is already in place at the federal level to properly determine whether any of these experimental currencies or tokens should fall under the umbrella of more heavily regulated securities or commodities.Unless the department’s regulatory powers have expanded to include oversight of new securities issuances, such activity appears to falls outside the scope of its responsibilities as a banking and insurance services overseer. The department should therefore defer to the experts at the SEC and CTFC to make legal determinations regarding the legality or necessary regulation surrounding such issuances.As with the regulation of open source bitcoin wallet software, the department’s intended regulation of new virtual currency issuances would prove impossible to enforce, and counterproductive to its own goals, while resulting in a mass migration of jobs and innovation outside of New York and possibly even the US. In fact, virtual currency innovators who choose to test novel concepts by creating new alternative currencies have already chosen to migrate outside of the United States. Ethereum, Monetas, Open Transactions, and SafeCoin, are just several early examples of successful virtual currency technology projects that are thriving overseas thanks in part to fears surrounding US regulatory uncertainty.To stem this tide and in light of my other points above, I recommend that the department eliminate Section 200.2 n5 from its definition of “Virtual Currency Business Activity” and instead focus its efforts on regulating the interactions between BitLicensed exchanges and custodians and fledgling or high-risk virtual currencies. I also ask that the NYDFS demonstrate restraint and defer to the SEC, CTFC and other federal organizations when it comes to the regulations of virtual currency crowd-sales.I hope you will take this letter into consideration, and look forward to working with the department on future iterations of its proposals.Sincerely,Ryan Selkis