Reforming Money Transmission Laws for Digital Asset Businesses: Part I
· Digital asset businesses need a uniform money transmission law with clear and consistent definitions, licensing requirements, and exemptions.
· The Lummis-Gillibrand bill gives the states 2 years to enact a uniform money transmission law, however, this proposal may be unconstitutional due to the anti-commandeering doctrine.
On June 7, 2022, Senators Lummis (R-WY) and Gillibrand (D-NY) introduced the Responsible Financial Innovation Act to create a regulatory framework for digital assets. The bill is comprehensive in scope and addresses an array of topics, ranging from tax treatment of virtual currencies to the use of the digital yuan on U.S. government devices.
Section 803 of the Lummis-Gillibrand bill deals specifically with state money transmission laws relating to digital assets, a topic of debate for regulators, innovators, and scholars who have wrestled with questions over whether the federal government or the states should oversee this business activity. Section 803 is an appropriate response to the failure of the states to address money transmission issues in a consistent and timely manner. Section 803 compels states to act quickly to establish a uniform money transmission law that would provide clarity for digital asset businesses, reduce regulatory burdens, and enhance consumer protection. However, the Section 803 mandate may not be constitutional because the anti-commandeering doctrine says that the federal government cannot require states to adopt or enforce federal law.
Section 803 is notable for three reasons:
· it directs the States to ensure uniform treatment of digital assets under state money transmission laws within 2 years after the bill’s enactment;
· it exempts non-custodial wallet providers, software and hardware developers, and persons or software that validate transactions from money transmission oversight;
· it grants authority to the Director of the Consumer Financial Protection Bureau (CFPB) to adopt rules on behalf of a state that has not enacted a uniform money transmission law for digital asset businesses within the bill’s mandated 2 year deadline.
The drafters of the bill should be applauded for their efforts to streamline state money transmission compliance for digital asset businesses. Most states have their own unique regulatory framework that oversees money transmitters, which means that complying with the different laws of all 50 states is costly and inefficient. The burden of this 50-state system gives an advantage to large firms, such as PayPal and Venmo, that can bear the costs of regulatory compliance over smaller start-up rivals.
Digital asset businesses that might be considered money transmitters include cryptocurrency exchanges, custodial wallet providers, and possibly even decentralized autonomous organization (DAO) protocols. Even though some states have defined (albeit differently) when a digital asset business is subject to money transmission laws, other states are altogether silent on the issue. Section 803 attempts to resolve this grey area by calling upon states to craft a uniform definition that lays out when digital asset businesses are subject to money transmission licensing requirements and when they are not. Section 803 also clarifies that non-custodial wallet providers, software and hardware developers, and digital asset validators are not money transmitters and therefore not subject to money transmission regulation.
A uniform state law (and uniform definition, for that matter) for digital asset money transmitters would mitigate numerous costs. To begin, there is the threshold cost of determining whether a business’ activity is even considered money transmission in the first place. Then, there are information costs for interpreting complex state-specific legal rules related to money transmission. There are also transaction costs due to different, redundant, and sometimes contradictory state-specific registration and licensure requirements, and time costs related to working with multiple regulators. Additionally, digital asset businesses must worry about the cost of ongoing compliance and search costs to keep up with regulations as they evolve. Worst of all, there is the cost of regulatory uncertainty that may chill innovation by causing decision paralysis or forcing innovators to modify their business plans to avoid run-ins with regulators.
The 2 year timeframe that Section 803 gives the states to adopt a uniform state money transmission law for digital asset businesses is promising, although there is a good argument for reducing this timeframe even further. A more general uniform state money transmission law has been discussed and debated for many years, and there have been numerous efforts to harmonize this patchwork of laws at both the state and federal level, unfortunately to not much avail.
For example, in 2020, the Office of the Comptroller of the Currency proposed a national Payments Charter that would pre-empt state law and grant a federal money transmitter license to financial services companies. So far, this initiative has stalled. In 2020, the Uniform Law Commission released the Uniform Regulation of Virtual-Currency Business Act, which, to date, has only been adopted by California. In 2021, the Conference of State Bank Supervisors (CSBS) released the Model Money Transmission Modernization Act, which includes a section on virtual currency business activity. Currently, Arizona is the only state to fully adopt the Act. Finally, in July 2022, the American Legislative Exchange Council released a draft of the Smart Cryptocurrency Rules Act, which contains a provision entitled “Reciprocity of Money Transmitter Licenses.”
This persistent activity highlights that there is broad understanding of the problem with a 50 state money licensing regulatory regime and a significant interest in reform among both regulators and legislators. Given the present availability of diverse, well-reasoned alternatives to the current system, state regulators would not have to start from ground zero in drafting a new uniform law. Section 803 also directs the states to work with the CSBS and the Money Transmission Regulators Association, which would bring organization and cohesion to the states’ efforts. Thus, a fast-tracked deadline would be a reasonable, yet necessary “stick” that states may need to accelerate beyond the discussion and drafting stage to the enactment stage.
However, there is one major issue with Section 803: Congress is telling the states what to do. To further complicate matters, Congress is also authorizing a federal agency (the Consumer Financial Protection Bureau) to adopt rules that a particular state must comply with if that state does not adopt uniform rules within a 2-year timeframe following the enactment of the Lummis-Gillibrand bill.
There are a couple of things wrong with this proposal. First, Section 803, while well-intentioned, may be unconstitutional due to the anti-commandeering doctrine, which says that the federal government cannot require states to adopt or enforce federal law. The doctrine was discussed by the Supreme Court in New York v. United States and Printz v. United States and is understood to be a restraint on congressional power. The Printz decision is particularly informative as the ruling struck down interim provisions of the Brady Handgun Violence Protection Act, a federal law that required state and local law enforcement to conduct background checks on handgun consumers. If the anti-commandeering doctrine is at play, Congress would have to develop a new alternative for money transmission law modernization.
Second, how would the delegated authority of the Consumer Financial Protection Bureau (CFPB) play out in practice? For example, which rules would the CFPB adopt? Section 803(b) states that the rules must ensure uniform treatment of digital assets under money transmission laws and must be consistent with the standards already adopted by States who have conformed with Section 803(a). On the one hand, a majority of the states may enact a singularly uniform law without any aberrations, in which case, the CFPB might also adopt the same uniform law for any outlier states. This outcome would be uncontroversial. On the other hand, states may adopt a uniform law but then add their own tweaks and amendments over time, which may ultimately give more discretion to the CFPB to act with partiality when deciding on which rules to force a certain state to adopt. It is worth noting that the adoption of a uniform law does not guarantee that the law will remain uniform as each state may tailor the language of the model law to meet the unique needs of their specific state. The Uniform Commercial Code is evidence of this phenomenon. There may also be a situation where competing uniform laws develop. In that case, the CFPB would get to choose between them and possibly rest their decision based on a political agenda that may not be particularly aligned with a given state.
So, is there a better alternative that meets the Congressional goals of Section 803? Part II of Reforming Money Transmission Laws for Digital Asset Businesses will discuss a potential solution and why it’s important for the digital asset ecosystem.
Disclaimer: The author is the co-founder of an Ethereum-based startup.