A bit of a longer post today after some big and pretty good BitLicense news today: Superintendent Ben Lawsky discussed the NYDFS’s revised BitLicense proposal for regulating virtual currencies at the Bipartisan Policy Center down in DC.

Lawsky reiterated his belief in the technology’s potential, including the capacity to bank the underbanked, facilitate remittances, protect against identity theft, and even touched on the 2.0 potential like non-currency applications (e.g. title transfer). More importantly, he expressed his faith that blockchain innovations could force incumbents to “up their game” and offer better, faster, cheaper services themselves.

I’ll have more to say once I’ve combed through the full guidelines (they’ll be released later this week or early next), but for now, here are some highlights from his prepared remarks…

Clarifying Scope:

The new BitLicense better defines the scope of activity and parties who would require a BitLicense. The revised regs will show that developers of wallet software, speculative users/investors, merchants, and miners are all off the hook when it comes to licensing. As Lawsky said, NYDFS is in the business of “regulating financial intermediaries…not software development.” No surprises there, and as expected, the revised proposal doesn’t cover customer loyalty programs, rewards, and gift cards denominated in fiat currency, either.

Lawsky did seem to acknowledge that some of the proposed regulations (particularly those concerning cyber-security) were more strict than those faced by incumbents, but tried to explain that away by claiming that it was “primarily because we are actually considering using them as models for our regulated banks and insurance companies.” Other than this line of reasoning (which I find colossally stupid and backwards: let’s layer on enhanced expensive regs to the innovators to see if it works on too-big-to-fail institutions!), I think Lawsky and his team reined themselves in and put forth a good faith second draft that is workable, fair, and dare I say, smart.

That’s because they made a few critical changes.

Substantive Changes:

We Got Our On-Ramp — Positive Surprise

Bitcoin custodians and exchanges will be the parties most affected by the BitLicense, but critically, the NYDFS plans to offer a two year “transitional license” to those start-ups that are just getting off the ground. This begs the question, “what does a transitional BitLicense look like?”, but the mere fact that there will be some exemptions made for fledgling start-ups is fantastic…if you start a bitcoin business that requires licensing, you’ve got two years to demonstrate value and traction to raise your venture capital round.

I agree with Lawsky’s point that: “There is a basic bargain that when a financial company is entrusted with safeguarding customer funds and receives a license from the state to do so — it accepts the need for heightened regulatory scrutiny to help ensure that a consumer’s money does not just disappear into a black hole.” You’ve got two years to demonstrate you are building a potential world-class business. If you can’t, you probably don’t deserve to hold other people’s money.

We Got Counter-party KYC Requirements Reined In — Positive Surprise

This one is the really big deal. It means that bitcoin as an interoperable payment rail is actually legal. And it wasn’t clear cut that this would actually get changed. According to Lawsky, NYDFS “eliminated a requirement that licensees are required to obtain the addresses and transaction data for all parties to a transaction, and must now only obtain that information for their own customers or account holders and, to the extent possible, for counterparties to the transaction. [my emphasis added] Ultimately, we determined that the original requirement simply would not be workable in the virtual currency context.”

This means that Coinbase, Xapo and Circle aren’t on the hook to know the identity behind every single blockchain.info or similar wallet to which a user sends money. But in the future, they might need to make reasonable efforts to collaborate with one another on sub-accounting (crucial for tax purposes anyway), and information sharing that demonstrates when one person is sending money to herself or to another person. They aren’t banning transactions to any unverified or unidentified addresses, though, and turning bitcoin into a libertarian version of Venmo.

We Got the Definition of “Control Parties” Narrowed — Positive Surprise

Boring, but important, especially how many bitcoin angels are independently wealthy from their early bitcoin investment gains: BitLicense applicants don’t need to subject their angel backers to a regulatory proctological exam for the mere crime of being an early supporter. As Lawsky explained, “Licensees may apply to the Department for a determination that certain specific parties should not be deemed to be control parties by the Department — if they are truly not involved in the day-to-day or major management decisions of the company. That provision is important for helping encouraging angel investment in virtual currencies — since when an individual is deemed a control person; it triggers a whole host of, often very fulsome, requirements that may not be necessary if they are not managing the company.”

Bitcoin Can Sit on a Bitcoin Company’s Balance Sheet — Positive Surprise

Another big one for BitLicensed companies is that there will be a common-sense loosening of the restrictions on the types of financial assets they may hold. (“Virtual currency may now count toward licensees’ capital requirements.”) I’m not sure how much of a surprise this one was, because it was pretty far out there in the first place, but at least initially, bitcoin companies couldn’t hold virtual currencies as collateral — which would have opened them up to a whole host of liabilities and limited their capacity to self-insure or hedge their currency exposure. No longer a concern.

Still Up in the Air:

I’ll do a follow-up post once I read the full regs, but it doesn’t look like multisig (multi-institution custody in particular) is going to be clearly addressed, and the loose language around KYC for counter-parties and the “to the extent possible” guidance raised some red flags for me. To be continued.

An Anti-Incumbent Streak:

Perhaps as interesting as the updates to the BitLicense themselves: Lawsky’s frank discussion of the financial system virtual currencies may eventually disrupt. After touching upon the key revisions we should expect in the BitLicense, Lawsky discussed “a much broader evolution occurring before our eyes in payments technology.” He sounds like a man who is more openly friendly to the virtual currency industry than Wall Street.

Read for yourselves:

“When considering the evolution of the payments system, it may be useful to think of it in the following way. 1) You can build entirely new tracks to connect different stations to one another, or 2) You can update the existing tracks in order to make travel faster and more reliable. Virtual currencies would fall into the former category of new tracks connecting consumers and businesses, but there is also an existing sets of tracks in the payment world in desperate need of repair and improvement.

One example is the Automated Clearing House (ACH) system that banks often use to transfer customer money to one another. I think it would shock most consumers to learn that — at its core, despite modest improvements — the ACH system has changed little since it was created four decades ago in the 1970s. And that is why — as recent press reports have noted — it generally takes you longer to transfer money electronically than it would to physically transport that cash to another state or country. Indeed, many consumers are perplexed that, in a world where information travels around the globe in a matter of milliseconds, it can often take several days to transfer money to a friend’s bank account.

So, in other words, in an age of smart phones and on-demand technology, we have a disco-era payments system.

Even many new entrants into the mobile and app-based payments world — who are doing some truly interesting work — largely have to build their technology on top of that ossified, existing system. So, what is the cause of that startling market failure to innovate within the legacy bank payments system?

Some people blame regulators’ focus on rooting out money laundering. They say that faster payments technology will make it impossible or extremely difficult to spot fraud and illegal activity.

However, I think that explanation is largely a red herring.

Preventing money laundering at banks is, of course, critical. Indeed, it has been one of the top priorities of our Department. But I do not believe that finding a solution to that issue represents an insurmountable problem. That is particularly true in an age where we are able to shoot a robot spacecraft into the atmosphere and land it safely on a comet several worlds away. It is also belied by the experience of other countries, where payments between banks can settle within a matter of hours or even minutes.

I think a more likely explanation is that what we are seeing in the payments world is the classic type of market failure that exists in a monopoly-like system — where existing entrants have little incentive to innovate and are instead content to continue extracting unjustified rents from consumers. The technology exists to change the system for the better, just not the will.

That is not to say that regulators are blameless. When you have a monopoly-like system — with very high barriers to entry — it is the regulator’s job to prod their institutions to overcome that collective action problem. In other words, it is sometimes the regulator’s job to serve the public interest by pushing market actors to do what those market actors are unwilling to do themselves.

Indeed, I think that the current market failure in the payments system is, in part, why there has been so much excitement about virtual currency technology. Virtual currency could have the potential to force the existing, legacy payments system to up its game in a significant way.

It is, of course, important not to be Pollyannaish about these types of things — as is sometimes the tendency among tech evangelists. Virtual currencies such as Bitcoin are a very, very long way from being a credible challenger to banks or the existing payments system. (Though the imprimatur of financial regulation will probably help.) But I think virtual currency could eventually cause some amount of self-reflection in the legacy financial system. And it may even cause some banks to confront the Blockbuster Video problem.

The problem that in an age of heightened consumer expectations for real-time, digital payments, if banks fail to innovate, they could eventually face a real challenge. Blockbuster Video stores used to be on virtually every corner in of our country. But with the emergence of Netflix, they practically disappeared overnight. Money is, of course, a different animal from something like video or music technology.

The financial crisis notwithstanding, I think most people still feel more comfortable entrusting an old, well-established, FDIC-insured bank with their money, rather than a tech start up. That said, if banks continue to torpedo even modest updates to the payment system, they ultimately do run at least some risk of facing the Blockbuster Video problem. Our children, and our children’s children, will not hesitate to bank digitally. They will demand speed and efficiency in the payments world.

My guess is that banks will eventually adjust. It is in those institutions’ long-term interest to do so — both from a financial and an existential perspective. And they will probably co-opt or acquire some of the most promising technology after a period of trial and error. Regulators, for their part, will have to keep up and find ways to permit innovation and improvements, while protecting against money laundering. But if banks do not make significant progress soon, regulators should consider actively pushing for, or even perhaps mandating, improvements.

That is not typically the way regulators like to operate. It is generally better to let the market make these types of determinations. But at a certain point, enough is enough. And four decades of slow-to-non-existent progress in the bank payments system seems like fair warning.”

Does this sound like an enemy of Bitcoin or of the “monopolistic” financial establishment? I’ve always thought Lawsky was more friend than foe.

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Today’s Tid Bits

New York Regulator Outlines Changes to Bitcoin Rules

http://dealbook.nytimes.com/2014/12/18/new-york-regulator-outlines-changes-to-bitcoin-rules/

Benjamin Lawsky, New York’s top financial regulator, outlined revisions to the BitLicense proposal today, clarifying several topics. Bitcoin miners and software developers would not need to apply for operating licenses, customer loyalty programs, would also not be subject to the BitLicense. Bitcoin start-ups will be subject to a two-year transitional BitLicense rather than the full license, and companies will no longer be required to obtain the addresses and transaction data for all parties involved in a bitcoin transaction. Mr. Lawsky’s office will publish the revised rules “in the coming days,” which will then be subject to another 30-day comment period. Which means the official regulations could not be finalized till the end of 2015.

PeerNova Raises $8.6 Million to Refocus on Enterprise Blockchain Applications

http://www.coindesk.com/peernova-raises-8-6m-blockchain-applications/

PeerNova raised $8.6m in new funding as it seeks to pivot from being a bitcoin mining enterprise to blockchain software solutions firm. The Series A investment was led by Mosaik Partners, and also included Steve Case and Crypto Currency Partners. PeerNova formed in May of his year, when HighBitcoin and CloudHashing merged. PeerNova’s future business plans are aimed as blockchain-based innovations that will “permeate throughout the technology industry.”

Aspen Institute CEO: Bitcoin Micropayments Will Change Banking

http://www.coindesk.com/aspen-institute-ceo-bitcoin-micropayments-will-change-banking/

Walter Issacson, author and CEO of the Aspen Institute, believes the advantages offered by “disruptive technologies” such as bitcoin will shape the payments space 2015. Isaacson acknowledged payment innovations like Apple Pay as a step forward, but praised bitcoin more for its underlying technology. Issacson believes that bitcoin has caught on because of it’s potential in micropayments, and he believes, it will only continue to grow in popularity in the new year.

GAW Miners Altcoin Launch Sparks Speculative Frenzy

http://www.coindesk.com/gaw-miners-altcoin-launch-sparks-speculative-frenzy/

GAW Miners launched a new altcoin, paycoin, this weekend, with 12m paycoins already pre-mined for the company’s investment partners and customers. Leaving only 500,000 paycoins available for public mining. Currently, GAW Miners is in the process of shifting from a cloud mining-based business model to a cryptocurrency payment service. The company also continues to face accusations of misleading its customers and fraud. The launch of paycoin represents the company’s move away from mining and toward its new services like digital currency e-commerce solutions.

Draper University’s Bitcoin Course Enrolls 2,000+ Students

http://cointelegraph.com/news/113136/draper-universitys-bitcoin-course-enrolls-2000-students-highlights-increasing-demand-for-crypto-educational

Since its launch early October, the free “Bitcoin Basis” course on Draper University, Tim Draper’s entrepreneurship school, has enrolled over 2,000 students. The course is split in to seven sections, which are aimed at providing fundamental knowledge on Bitocin, such as the blockchain. The course offers conventional lectures, expert interviews, and global industry outlooks and business opportunities.

Future Unclear for Romanian Bitcoin Exchange as Users Withdraw Funds

http://www.coindesk.com/future-unclear-romanian-bitcoin-exchange-users-withdraw-funds/

BTCXchange, Romania’s only order-book bitcoin exchange, has ordered all users to withdraw funds from the platform by Friday, 19th December due to security reasons. BTCXchange has an estimated 3,000 accounts and 50 BTC in daily volume. The exchange closure will not affect its partner, Netopia mobilPay’s ability to allow merchants to accept bitcoin, since BTCXchange did not handle processing on behalf of retailers.

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