California Passes New Crypto Licensing Regime With Bipartisan Support

September 5, 2022
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The California State Legislature has passed a new crypto regulation that includes wide-ranging provisions on licensing and stablecoin issuance.

The California State Legislature has passed a new crypto regulation that includes wide-ranging provisions on licensing and stablecoin issuance.

Under the Digital Assets Financial Law, any person that engages in “digital asset business activity” with or on behalf of a California resident will be required to obtain a state-specific licence.

To obtain a licence, applicants must provide details of all current and former business activities conducted within the last five years.

This includes details of products and services, associated websites and social media pages, principal places of business, current or projected user bases and specific marketing targets.

Details of supervisory policies and procedures must also be provided, including controls for business continuity, disaster recovery, fraud, money laundering and terrorist financing.

Once a licence is obtained, the bill authorises California’s Department of Financial Protection and Innovation (DFPI) to conduct examinations of the licensee at any time and requires that licensees maintain their records of digital asset business activity for at least five years.

This includes a “general ledger” showing all assets, liabilities, capital, income and expenses that must be posted at least once a month.

Based on an existing law — the California Financial Information Privacy Act (CFIPA) — licensees must also maintain operational security and information security standards with regard to non-public personal data.

Under the new law — which uses the same definition as the CFIPA — a licensee will be classed as a “financial institution” and their business activities as “financial products or services”.

If a person other than a licensee engages in digital asset business activity with or on behalf of a resident, the DFPI can apply civil penalties, including fines of up to $100,000 per day.

In the California Assembly, the bill received 71 yes votes, nine abstentions and zero no votes. In the Senate, the bill received 31 yes votes and six no votes — all from Republicans.

California Governor Gavin Newsom now has until September 30 to sign or veto the bill. If signed, the law will come into effect on January 1, 2025.

Make stablecoins stable again

The second key area of the Digital Assets Financial Law is its provisions on stablecoins.

Under the new law, licensees will only be allowed to handle stablecoins that are issued by another licensee or by a state-chartered or federally-chartered bank.

This applies to any business activity involving stablecoins, including their storage, transfer and exchange.

Secondly, if a licensee is to handle a stablecoin, it must meet predefined reserve asset criteria.

Specifically, the issuer of a stablecoin must “at all times” own eligible securities whose total market value is no less than the total value of outstanding stablecoins issued within the US, and calculated using generally accepted accounting principles (GAAP).

In other words, stablecoins must be fully backed at all times, and issuers must not operate on a fractional reserve basis.

The law includes a clause that renders all of its stablecoin provisions “inoperative” as of January 1, 2028, although no indication is given of any replacement or subsequent provisions.

The stablecoin provisions in the Digital Assets Financial Law are broadly in line with those in Japan’s new stablecoin law and with the EU’s Market in Crypto-Assets Regulation, also known as MiCA.

Industry reception

Although the Digital Assets Financial Law received bipartisan support among legislators, its reception from industry stakeholders has been mixed.

Robert Herrell, executive director of the Consumer Federation of California (CFC), a sponsor of the bill, hailed it as a major step towards ensuring safety and integrity in the crypto-asset markets.

“In an era of rampant division and partisanship, it is worth noting that both parties strongly agree with protecting consumers in the wildly volatile digital asset and cryptocurrency space,” he said.

“Licensing companies in this sector of the economy is a modest, reasonable and inevitable next step to properly protect consumers and cryptocurrency investors

“This is one of the most important actions Califnora can take this year and would place California back in a leadership role in consumer protection and the innovation economy.”

However, the US-based Blockchain Association took a different view, arguing that the new law will stifle innovation and drive digital asset investment away from California.

“The bill creates shortsighted and unhelpful restrictions that would impede crypto innovators' ability to operate and push many out of the state,” the association said in a statement.

“The bill's licensing provisions are designed to install the same type of onerous licensing and reporting regime that has stunted the growth of the crypto industry and limited access to safe and reliable crypto products and services in New York.

“Additionally, it would make it impossible for many stablecoin issuers to operate within the state — a rapidly growing sector within the crypto industry set to generate significant economic activity and bring countless jobs to the state.”

The association has called on Governor Newsom to veto the bill and return to the more crypto-friendly principles outlined in his blockchain executive order signed in May this year.

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