BitLicenses, MTLs, and Trust Charters

Crypto regulation is difficult and contentious. The SEC has been wrestling with crypto entities for a long time, but other regulators have also set up hoops on centralized crypto companies in an attempt to protect consumers. Today we will review the licenses needed for a centralized crypto custodian to operate in the United States: the BitLicense, the VCBA, the Money Transmitter License, and trust charters. We will look at the merits and limitations of various configurations of these licenses and try to decipher their aims, impositions, and consequences.

The BitLicense is New York’s (and the U.S.’s) first license for businesses that want to transmit, custody, issue, exchange, or buy and sell cryptocurrencies to fulfill orders from a customer-facing product. It was first adopted in 2015 after being proposed and drafted by the New York State Department of Financial Services (NYDFS). It aims to extend the protections consumers are guaranteed in the regular banking system to crypto products: capital requirements, tax verifications, contingency plans, and the maintenance of a surety bond or trust are just a small fraction of the conditions needed to receive a BitLicense. The total cost of getting a BitLicense is unclear as capital requirements are not disclosed before the filing process. However, given that the minimum surety bond available to custodians sits around $500,000, it is safe to say BitLicenses are a multi-million dollar ordeal. As with most licenses, the BitLicense is state-specific and only exists in New York.

New York trust charters are another tool companies can use if their business involves cryptocurrency activity and will get them roughly the same power as a BitLicense. However, NYDFS recommends that business that engage directly with consumers get a BitLicense, meaning some business with both institutional and consumer products need both licenses.

What about the rest of the states? Louisiana is the only other U.S. state that has a specific license for cryptocurrency regulation. In 2020, Louisiana passed the Virtual Currency Business Act (VCBA) based on the Uniform Law Commission's Uniform Regulation of Virtual-Currency Businesses Act (URVCBA.) The first VCBA applications opened on January 1, 2023 and the rules came into effect on July 1, 2023. To operate in all remaining states companies to for Money Transmitter Licenses, another multi-million dollar undertaking.

The BitLicense was faced with harsh criticism from the crypto industry for its high standards. Not only is it difficult for a company to afford the license, it also limits business activities to a very short list of greenlisted assets. This led to the ‘Great Bitcoin Exodus’ in New York as major centralized players like Kraken left the state in order to avoid the new regulation. However, plenty of companies also chose to stay and get the necessary licensure. The companies that left likely could have afforded the licenses and were demonstrating their political stance on government interference in the crypto industry rather than acting our of necessity.

So, has the BitLicense been useful? The BitLicense did manage to protect New Yorkers from FTX and Celsius, among other now defunct crypto operations. While the standards to get a BitLicense are hard to meet, they are very standard mechanisms for protecting end users in traditional finance. It should also be noted that decentralized crypto companies routinely rely on overseas entity creation to function, and thus are not really affected by the BitLicense. So, even though some people have claimed the BitLicense will bring an end to decentralized DeFi, that is not the case. Decentralized protocols can’t really be shut down, in theory, and so long as their registered entity is not American there should not be any problems. The larger problem with licensure in fintech is the incredible challenge faced by companies requiring a national trust charter. But that is an issue for another post!