New York is now the first state to consider adding a special license called a "BitLicense" for businesses that operate primarily in Bitcoin and other virtual currencies, after receiving a flood of requests from Bitcoin entrepreneurs asking how they should register.

The New York State Department of Financial Services (NYDFS) has been investigating the issue for six months, but today the agency begins a two-day hearing of testimony from experts ranging from lawyers and entrepreneurs to the Winklevoss twins, who are heavily invested in Bitcoin and Bitcoin startups.

The agency appears to be on track to introduce a special license for virtual currencies sometime this year.

"It's our expectation that the information we’ve gathered in this fact-finding effort will allow us to put forward, during the course of 2014, a proposed regulatory framework for virtual currency firms operating in New York," Benjamin M. Lawsky, the state's superintendent of financial services, said in a statement. "I believe we would be the first state in the nation to do so. Clearly, when it comes to virtual currencies, regulators are in new and unchartered waters."

"Regulators are in new and unchartered waters."

Yesterday's arrest of a prominent Bitcoin entrepreneur, Charlie Shrem of the payments facilitator BitInstant, underscores the need for regulatory clarity on virtual currencies. Many Bitcoin businesses, including exchanges and wallets, hold a customer's money in Bitcoin with the promise of giving it back to them at a later date. That means they resemble money transmitters, companies that provide financial services while stopping short of acting like a full bank.

Every state has its own rules for money transmitters, requiring different levels of record-keeping and due diligence on clients. The latter is known as the "know your customer" standard and is designed to prevent the kind of money laundering that prosecutors claim Shrem participated in. Shrem allegedly sold bitcoins to a client who then resold them to users of Silk Road, the marketplace where illegal drugs were sold. According to money-transmitter laws in most states, Shrem should not have participated in that sale and should have reported his client for suspicious activity.

States are finding that it's not so easy to shoehorn Bitcoin companies into the law

The Financial Crimes Enforcement Network (FINCEN), the federal body that regulates money transmitters, has said that Bitcoin businesses should register with the federal government using the same paperwork as PayPal, Western Union, and other transmitters. But New York and other states are finding that it's not so easy to shoehorn virtual currency transmitters into the existing law.

"They’ve realized that there are just some areas where it's not going to be an easy fit," says Judith Rinearson, a partner at Bryan Cave who specializes in money transmission and virtual currencies, and will testify at the hearing. It makes sense to craft a custom rule for Bitcoin, she says. "Something that works and makes consumers feel secure and comfortable, but at the same time not so much regulation that you're going to restrict or kill the industry or push the industry offshore."