Engineers Perspective of The NYDFS BitLicense Regulatory Framework

A few minutes ago, Ben Lawsky from NYDFS released the Proposed BitLicense Regulatory Framework. I’m sure lots of very smart lawyers, regulators, and finance folks will have a thorough analysis of the proposal. However, I wanted to check it out to see how this proposal would affect virtual currency related implementations for engineers.

There is no doubt that this will affect business and regulatory requirements for many Bitcoin software and hardware startups. So lets look at some of the points.

Anti Money Laundering & Cyber Security

  1. Provide for independent testing for compliance with, and the effectiveness of, the anti-money laundering program to be conducted by qualified personnel of the Licensee or by a qualified outside party, at least annually – This will affect almost every Bitcoin based business. Engineers will have to implement a robust logging and auditing feature that monitors all their business’ transactions so that at the end of the year they can provide a complete log of what went on. There are many security implications for this. For one, this will most likely contain Personally Identifiable Information (PII) and will have to be kept safe. I could see potential businesses popping up just to provide this service for Bitcoin companies.
  2. Provide ongoing training for appropriate personnel to ensure they have a fulsome understanding of anti-money laundering requirements – Yeah, that won’t happen anywhere. If it does, it will be some e-learning program that everyone forgets within minutes of watching it. But hey, that’s compliance!
  3. Records of Virtual Currency transactions. Each Licensee shall maintain the following information for all transactions involving the payment, receipt, exchange or conversion, purchase, sale, transfer, or transmission of Virtual Currency: the identity and physical addresses of the parties involved, the amount or value of the transaction, including in what denomination purchased, sold, or transferred, the method of payment, the date(s) on which the transaction was initiated and completed, and a description of the transaction – This is a doozie. I think this is what will give companies the most headache. The two that give me the most pause is the fact that you have to have the physical address of the parties involved and a description of the transaction. It basically means that if you’re a BitLicense holder and you’re doing business with a person or entity, they not only have to provide you with their address but also a description of what the transaction is for. We’re already seeing this added at companies like Coinbase where whenever you take BTC out of your wallet, they ask you where it’s going. It seems quite intrusive to me and might turn away many people from Bitcoin. On the technical side of things, engineers will have to make sure that the data they collect is valid and compensate for the fact that transactions just went from simply putting in a Bitcoin address and hitting send to having to provide physical addresses and detailed descriptions. How do you validate these descriptions? There will need to be a protocol or system in place that allows merchants and businesses to whitelist Bitcoin addresses and that leads to a huge privacy issue in itself.
  4. Each Licensee shall file Suspicious Activity Reports – This is hard. Engineering this can be a total nightmare. There will be a lot of false positives and Bitcoin startups will struggle to keep up with the customer relations nightmare this might cause.
  5. Each Licensee shall establish and maintain an effective cyber security program to ensure the availability and functionality of the Licensee’s electronic systems and to protect those systems and any sensitive data stored on those systems from unauthorized access, use, or tampering. – Thank you Jesus! This is probably the most important aspect of this entire section. Unfortunately Fortune 500 businesses fail miserably at this, what makes us think Bitcoin startups with college dropouts for Engineers can do it? I actually have more faith in them than I do in the financial industry.
  6. Each Licensee shall designate a qualified employee to serve as the Licensee’s Chief Information Security Officer (“CISO”) – This is a neat idea. This expense will be huge for small Bitcoin companies. They simply cannot afford penetration tests, code reviews, and other items in this section. A huge amount of their funding may have to be spent on security which in turn might reduce time to market significantly if not done extremely efficiently.

Overall thoughts

I think NYDFS definitely took a lot of caution when writing this. It’s a thin line for sure because if they are too strict with their framework it will drive innovation and jobs out of the state and possibly this country. As a New York resident, I’m not terribly disappointed by the proposal. It seems doable. The simple fact of the matter is that most people will have no issue adhering to this BitLicense. None of the items seem to be any more intrusive than the credit card industry and the merchants still get the benefit of irreversible transactions that protect them from chargebacks and fraud.

Engineers will have their work cut out for them as they should. The security items outlined in the proposal are robust. While it will definitely increase cost from both a staffing and infrastructure perspective, it will encourage Bitcoin companies to think about security before something bad happens. Frameworks will have to be put in place to secure, audit, and monitor all virtual currency activity in an organization. This will be tough at first but I think services and tools will become available to aid businesses in doing this.

I think the Bitcoin community is innovative enough to find cost effective solutions to meet all these proposed regulations in a way that does not stifle innovation too much. However, I also think that the process to meet these regulations will “separate the men from the boys” when people start thinking about starting a Bitcoin business.

You can view the full thing here: http://www.dfs.ny.gov/about/press2014/pr1407171-vc.pdf

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