While billions of dollars have been stored in virtual currencies such as Bitcoin few rules exist to govern their use, leaving consumers at risk and opening channels for illicit activities such as money laundering.

This is about to change as New York State is establishing groundbreaking regulations that would make virtual currency exchanges more accountable and require more disclosure from all parties to a transaction involving a digital currency.

Related: Bitcoin Hits the Big Time: Now Regulators Are Interested

However, the proposed new regulations are also raising concerns that the rules could stifle the development of the digital money.

“It just doesn’t fit with the technology, and it’s impossible” to comply with the proposed disclosure rules, said Jaron Lukasiewicz, founder and chief executive of Bitcoin exchange Coinsetter. “I think it’s also a complete invasion of privacy.”

The consumer risks are potent and cybercriminals using virtual currencies to conduct their operations have already done significant harm. Earlier this year, the collapse of Mt. Gox, a Bitcoin exchange in Tokyo, left users with $400 million in losses from alleged theft by hackers.

After Mt. Gox’s bankruptcy, U.S. and state regulators have stepped up efforts to protect American consumers using digital money. In March, the Internal Revenue Service required taxpayers to report Bitcoin gains as they would returns on equity investments, surprising many just weeks before the April filing deadline.

Last month in New York, Benjamin Lawsky, the state’s superintendent of financial services, set in motion a 45-day public comment period on the state’s proposed rules, which would be the first in the nation designed to rein in virtual currency use and abuse.

“We have sought to strike an appropriate balance that helps protect consumers and root out illegal activity – without stifling beneficial innovation,” Lawsky said when announcing the comment period.

As proposed, New York would distribute “BitLicenses” to businesses that provide exchange services and digital wallets, or online currency storage, for consumers.

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Related: Why States Want a Bite of Bitcoin and Other Virtual Currencies

New York-based licensees would have the following responsibilities if the regulations take effect as proposed:

• Licensees must report names, addresses and other identifying information of all parties involved in a transaction and must detail the value and a description of all transactions.

• Licensees must report any transaction that suggest or facilitate criminal activity, by submitting suspicious activity reports to regulators.

• Licensees aren’t allowed to do business with “shell entities” that have no physical location.

• Exchanges must hold dollar-denominated bonds or trust accounts to back customer assets in a proportion to be specified by the state.

• Any significant business changes, including the introduction of new products or services, must be approved in advance by the state.





Critics say the rules would impinge on Americans’ Constitutional rights and would be too costly. They also say federal authorities should be the ones to design any additional regulations for the global market. Advocates such as the Bitcoin Foundation have asked for more time to review the proposal and demanded disclosure of the state’s underlying research into the matter, and a public petition seeking more time to comment is also circulating, with some 500 signatures already.

Related: Bitcoin’s Road to Mainstream Acceptance Just Got Rockier

The proposed rules may also make it harder for people to start new exchanges and could force established businesses to seek new investors and capital infusions.

“Only the financially connected will be granted BitLicenses and allowed to play in this new crypto-currency game,” David Reischer, a Bitcoin investor in New York who co-founded the LegalAdvice website, wrote in an email.

However, even critics of the proposal say the process will help digital money gain ground among skeptical consumers and merchants.

“Any recognition by a government institute takes Bitcoin one step further to public acceptance,” Ofir Beigel, the Tel Aviv-based founder of the 99Bitcoins blog and no fan of the proposal, said by email.

Despite his views that the state’s proposal focuses on wrong issues, Lukasiewicz of Coinsetter is excited by the regulatory step forward, which will provide some clarity and a legal basis for the industry. “Right now, it’s always difficult to know what you can and cannot do,” he said.

He simply wishes the proposed regulations would be less complex. “It’s cryptography; it’s not rocket science,” he said.

Claire Davidson is a staff writer at NerdWallet, a website devoted to helping consumers make smart financial decisions. In addition to writing about personal finance, Claire enjoys reading, playing Scrabble and running. Ask her questions on Twitter: @ideclaire7

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