Known for its tech-friendly environment and home to many of the world’s largest technology companies, California’s passage of its Digital Financial Assets Law has sent shockwaves through the cryptocurrency community. The law, which mandates that businesses dealing with cryptocurrencies such as Bitcoin and Ethereum must acquire a “bitlicense” from the state’s financial regulators, will become effective in July 2025 after Gov. Gavin Newsom signed the bill in October.
This legislation has sparked robust debate and concern within the crypto world, with critics arguing it could suffocate innovation and force crypto-related companies to relocate out of the Golden State. That has been the case since the state assembly unanimously passed it in 2022. Back then, Newsome declined to sign it into law. He expressed concern that this version of the bill aimed at a comprehensive digital asset licensing and regulatory infrastructure was not flexible enough to adequately address the dynamic NFT, cryptocurrency, and blockchain industries. Newsom’s about-face indicates he has grown tired of waiting for the federal government to develop national laws overseeing emerging technologies.
It directs California’s Department of Financial Protection and Innovation to draft laws that a wide range of entities, including cryptocurrency exchanges, trading platforms, custodians, stablecoin issuers, mining operations, and decentralized finance protocols, must obey in order to operate within the state. To obtain the requisite license, these organizations must implement stringent Know-Your-Customer (KYC) and Anti-Money Laundering (AML) protocols, maintain bonding and minimum capital reserves, submit regular reporting audits, and disclose transaction data, and establish robust cybersecurity standards.
Furthermore, the law imposes a temporary ban, until 2028, on licensed enterprises dealing with unregulated stablecoins such as Tether. This provision is seen as a significant step in fostering transparency and accountability within the volatile crypto market.
The law, which is drawing comparisons to New York’s BitLicense system, signifies the ongoing struggle between crypto innovators and regulators and sets a new precedent for the rest of the nation.
New York’s Attempt
Introduced in 2015, the BitLicense is a pioneering regulation that governs virtual currency activities in New York. This business license is issued by the New York State Department of Financial Services (NYSDFS) and applies to companies or individuals involved in any Virtual Currency Business Activity within the state or with a New York resident.
The BitLicense was spearheaded and designed by Benjamin Lawsky, the first Superintendent of Financial Services in New York, in July 2014. Entities with a charter don’t require an explicit BitLicense but can engage in virtual currency activities through limited-purpose trust charters approved by the NYDFS.
However, since its inception, BitLicense has been a point of contention in the blockchain sector. Critics argue that the regulations are overly burdensome and hold cryptocurrency startups to more rigorous standards than traditional financial establishments. The stringent requirements and expenses associated with obtaining a BitLicense have reportedly led to an exodus of cryptocurrency startups from New York to jurisdictions perceived as more accommodating.
To address these concerns and make the licensing process more accessible, New York regulators introduced a more lenient framework on June 25, 2020. Prospective licensees can now partner with an existing BitLicense holder to gain dedicated guidance on structure, capital, systems, and personnel requirements. This collaborative approach aims to help overcome “actual or perceived hurdles” in obtaining the BitLicense.
However, this change doesn’t guarantee a smooth licensing process. Existing license holders may not have the time or inclination to guide an applicant through the rigorous process. Furthermore, applicants may still face significant expenses, with costs estimated to start at $100,000 and increase when considering application fees, legal costs, and compliance rules.
Despite these challenges, the BitLicense regime represents a significant milestone in the regulation of virtual currencies. It provides a clear regulatory framework for companies and individuals involved in Virtual Currency Business Activity, offering a degree of legal certainty and consumer protection in an industry often characterized by volatility and risk.
California Takes the Lead
While similar to New York’s attempt to regulate the industry, California’s version may prove less onerous and more productive. Insiders, at least, seem willing to give it a chance and have expressed several reasons that they will be able to work within its strictures:
- Lessons Learned: California’s law leverages experiences and new research that has come to light since New York’s law was passed.
- Inclusion and Clarity: California’s approach is seen as more comprehensive than New York’s, which many see as overly restrictive on crypto business models. Regulatory uncertainty has been a major challenge for the crypto industry. California’s law provides clear guidelines
- Consumer Protection: Robust consumer protection measures and anti-fraud requirements, such as KYC and AML protocols, bonding and minimum capital reserves, and regular reporting audits. Provide enhanced market stability, attract more institutional investors, and foster consumer confidence in digital assets.
Some crypto purists, however, argue California’s requirements could prove just as burdensome as those on the East Coast and exert a similar stifling effect on innovation. They believe the high costs of licensing, audits, and compliance will deter startups and developers.
They express dread over demanding data transaction and holdings reporting and question whether it is even necessary to license decentralized protocols. They fear that non-custodial wallets, decentralized app creators, node operators, and other web3 participants may get swept up in regulations they view as overly broad.
Despite the controversy, California likely perceives these regulations as cementing its leadership in crypto oversight. As crypto penetrates deeper into finance and Web3, states are increasingly compelled to establish guardrails against volatility and misconduct. California’s legislation may serve as a model for the standard to come. At the federal level, moves by the SEC and CFTC to assert authority have met resistance from Bitcoin advocates. Internationally, approaches differ too. Singapore chose a more open regulatory posture to attract crypto companies, while China and India opted for hard bans.
As cryptocurrencies continue to grow in popularity and integration into the financial system, debates over optimal governance will persist. Different jurisdictions will promote contrasting regulatory philosophies based on their priorities and local political dynamics. However, through collaboration and open-mindedness, balanced oversight can emerge that protects consumers without sacrificing innovation.
The core tension lies in balancing libertarian ideals of decentralization with pragmatic safeguards against volatility and misconduct. Crypto purists often see regulation as anathema, conjuring images of bureaucratic red tape and barriers to entry. But lax oversight can leave consumers vulnerable to scams, hacks, and price swings without recourse. The solution lies in nuance, not absolutism.
With prudent guidance, consumer welfare and crypto liberties need not be mutually exclusive. Regulators should ensure rules are narrowly tailored to prevent demonstrable harm, rather than blanket mandates that penalize legitimate activities. Ongoing input from technical experts and industry stakeholders can help strike the right compromises. There will always be improvements to make as the technology and applications evolve, requiring continued openness to evidence-based revisions.
California’s bitlicense law represents one attempt at balancing competing imperatives, though aspects remain controversial. However, its subsequent evolution and enforcement will set an influential precedent. If paired with regulatory restraint and flexibility, California can pioneer oversight that embraces innovation while reining in abuse. While challenges persist, a measured approach presents a viable path forward for crypto governance. But it requires wisdom, nuance, and willingness to find common ground from both sides.
Gamma Law is a San Francisco-based Web3 firm supporting select clients in complex and cutting-edge business sectors. We provide our clients with the legal counsel and representation they need to succeed in dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.