Push for cryptocurrency rule in California sees momentum after FTX debacle

An effort to regulate cryptocurrency in California will unfold again this year after Governor Gavin Newsom (D) vetoed a similar bill in September amid concerns the measure could conflict with other state efforts .

The collapse of FTX and other turmoil in the cryptocurrency market last year created a new sense of urgency about building protection around cryptocurrencies.

“FTX’s misleading, unethical, and possibly illegal business practices have severely damaged the credibility of an entire industry,” said Charles Belle, executive director of the Blockchain Advocacy Coalition, a California-focused group that has been pushing for pro-blockchain policy. “The industry needs regulatory clarity now more than ever.”

But separate and ongoing regulatory work by the Newsom administration could complicate any legislation.

“There’s no slowdown here,” said Russ Heimerich, deputy communications secretary for the California Business, Consumer Services and Housing Agency, which oversees the Department of Financial Protection and Innovation. “DFPI is working very hard to protect consumers and lay the groundwork for meaningful and thoughtful recommendations.”

The Newsom administration wants to make sure any new cryptocurrency regulations are implemented deliberately, with some thought given to potential federal standards. A key issue may be how well the new legislation accommodates the work the DFPI is already doing.

A separate, and perhaps more immediate, problem is the government budget deficit. Newsom cited the cost of increased regulation of cryptocurrencies in his veto message last year, when the state was more cash-strapped. Lawmakers are now being warned not to go overboard with costly legislative proposals as the state faces a projected budget deficit of $22.5 billion.

Another try

Assemblyman Timothy Grayson (D), who chairs the Banking and Finance Committee, will reintroduce the regulatory language under AB 39, which he filed earlier this month with a brief description. He will add the details later.

Grayson is changing the fit from last year’s version to allay some industry concerns. Many of the planned components, which he shared in an interview, will be the same as the AB 2269 that Newsom vetoed.

Starting in 2025, the bill states that companies in the digital financial assets space should be licensed under the DFPI. Licensees should provide information to consumers about a rate schedule, consumer grievance procedures, and other information. Based on its risks, licensees should also maintain a surety or trust account, in addition to equity, as a form of insurance.

While this year’s measure will propose some lighter requirements, cryptocurrency exchanges would still need to meet certain consumer protection standards, such as disclosing conflicts of interest or mitigating risks. One difference is that they would be allowed to self-certify. AB 39 would also create a new path for those with New York cryptocurrency licenses to get approved faster in California. New York was the first state to establish a regulatory platform for digital currency.

“It’s a lot easier,” Grayson said. “We are trying to show that we are willing to work. It’s not about banning. It’s about responsible innovation.”

Other planned changes, however, tighten some regulations and may not be as industry-friendly.

The ban on unbacked “stablecoins” was a sticking point for the industry last year. In the new bill, this would become permanent instead of expiring in 2028, as envisaged in last year’s bill. Consumer protection would also go into effect a year earlier, in 2024, and there would be more emphasis on getting live customer service over the phone, Grayson said.

Cryptocurrency organizations are demanding more flexibility, instead of a one-size-fits-all approach, from all licensees. Regulations and licensing requirements should be tailored to the risk of certain products or businesses, they said.

“Digital assets are innovative and dynamic. Therefore, legislation should define them based on their underlying assets or use cases,” said Scott Talbott, senior vice president of government affairs for the Electronic Transactions Association. “This approach will enable legislation to encourage innovation and protect customers”.

Grayson said he is open to further discussions, adding that it is early in the legislative session.

Laying the foundations

Heimerich said the Newsom administration is complying with federal regulations as the DFPI does its job.

There will likely be revisited efforts on regulating cryptocurrencies at the federal level, although a divided Congress and the fallout from the FTX scandal make further regulation uncertain.

At the state level, the DFPI has laid the groundwork. It has gathered input from stakeholders for a set of “consumer protection principles,” according to a December report. It is implementing a cryptocurrency-specific consumer complaint process and putting together a voluntary market monitoring request process. The timing of those efforts has yet to be determined, a spokesman said.

According to the report, the department will also issue cryptocurrency-related guidelines to state-licensed banks and credit unions in March.

“It’s not like we’re taking a very quiet, slow-moving approach to this,” Heimerich said when asked if the turmoil in the cryptocurrency market calls for more urgency. “We’re working very hard right now to work with consumer groups, to work with stakeholders to lay the groundwork. We can work fast, but also be deliberate.”

Consumer advocates say regulations are needed now. “Real people get hurt,” said Robert Herrell, executive director of the Consumer Federation of California. “If there’s anything we’ve learned in the last year and a half, it’s that the longer you wait to get a proper licensing and regulatory regime in place, the more people get hurt.”

Supporters of Grayson’s bill will have to contend with the cost of creating a regulatory framework given the state’s budget deficit. Newsom said last year such a scheme could cost “tens of millions of dollars.”

Grayson said failing to protect consumers in the cryptocurrency market is even more costly. “I’m really optimistic overall, especially working with the administration, because I know and I’m confident that the governor and I actually share very similar goals,” he said.

There’s more

Grayson’s bill won’t be the only measure this year in California addressing digital assets. Assemblywoman Laurie Davies (R) introduced AB 76, which would simply add blockchain-based transactions to the money laundering offense. He had mentioned the FTX scandal in a press release announcing his bill.

While not as ambitious as rolling out a regulatory framework, Davies’ bill would fill a loophole and be just as important to protecting Californians, said Michael Fern, who helped create the bill and is a member of the Conference of California Bar Associations.

“Sometimes this is the best way to change the law is not to take huge bills that are really complicated and hundreds of pages long, but instead to find the simple solution,” he said.

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