On April 17, 2018, the New York State Attorney General (“NYAG”) sent a “Virtual Markets Integrity Initiative Questionnaire” to 13 companies operating virtual currency trading platforms. The questionnaire consists of 34 questions covering a number of topics, including ownership and control, operation and fees, trading policies and procedures, outages and other suspensions of trading, internal controls, and privacy and money laundering.  

The NYAG questionnaire addresses the issues of suspicious trading, market manipulation, the operation of bots and automated trading systems, use of and access to non-public trading information, and safeguards to protect customer funds from theft and fraud, among other risks.

The questionnaire represents the NYAG’s most visible venture into cryptocurrency regulation, already occupied since 2015 by another state agency, the New York State Department of Financial Services (“DFS”). Three years ago, DFS instituted its BitLicense framework, which requires companies engaged in certain virtual currency business activities involving New York state or its residents to complete a detailed license application and maintain ongoing compliance with a comprehensive set of rules relating to cybersecurity policies, procedures, consumer protections, asset safeguarding, anti-money laundering, regulatory exams, and reporting requirements.

A comparison of the NYAG questionnaire against BitLicense requirements reveals significant subject matter overlap. In addition, several of the questionnaire recipients have been granted either a charter or license by DFS to operate their cryptocurrency businesses in New York, fueling fears in the cryptocurrency industry that excessive regulation will become the “coin” of the realm. It is not clear whether the questionnaire represents the first step toward creation of a comprehensive enforcement program, as the NYAG only has stated that it plans to make the information it receives public in some form with the goal of bringing transparency and accountability to the crypto marketplace.

The industry would likely view with disfavor another New York state regulator on the beat, as DFS’ BitLicense regime already has drawn criticism. Industry participants have contended the regulation places heavy burdens on crypto-related businesses. In response, Queens Assemblyman Ron Kim has introduced legislation he claims will ease bureaucratic burdens and give consumers and businesses the confidence necessary for widespread adoption of cryptocurrency in New York. DFS maintains, however, that change is not necessary and that regulatory presence is a good thing for the industry. DFS Superintendent Maria Vullo has asserted that the regulatory certainty and protections brought about by BitLicense have helped licensed companies attract customers, investors, and potential partners.

New York is not alone in its efforts to regulate cryptocurrency, with states like Texas, North Carolina, New Jersey, and Massachusetts taking steps to regulate crypto exchanges and initial coin offerings. As is often the case with new financial regulations, some states may be waiting to take their cues from the federal government. Since his appointment in May 2017, Securities and Exchange Commission Chairman Jay Clayton has issued public statements on the need to provide clarity with respect to the regulation of cryptocurrencies. In addition, the SEC reportedly has issued frequent dozens of subpoenas and requests to companies in the crypto space seeking information regarding the booming market for initial coin offerings as the agency continues to articulate guidance as to when cryptocurrencies and digital token pre-sales will be treated as securities. Last month, the U.S. Department of the Treasury Financial Crimes Enforcement Network published a letter indicating it regards cryptocurrency sellers and exchanges as money transmitters subject to its regulations, while a federal court deemed cryptocurrencies commodities subject to oversight by the U.S. Commodity Futures Trading Commission in Commodity Futures Trading Commission v. McDonnell, 287 F. Supp. 3d 213, 228 (E.D.N.Y. 2018).

While state and federal financial regulators generally operate in separate spheres, it appears authorities are at least united regarding the need to strike the right balance between appropriate regulation and the responsible growth of this nascent industry. Such harmony would be welcomed by cryptocurrency firms like industry leader Coinbase, Inc., a company with first-hand experience with the challenge of answering to multiple regulators. Coinbase navigated the BitLicense application process in early 2017, received a NYAG questionnaire last week, and is currently in talks with the SEC about registering as a licensed brokerage firm and electronic-trading platform.