Crypto Rule Push in California Sees Momentum After FTX Debacle

An effort to regulate cryptocurrency in California will show up again this year after Gov. Gavin Newsom (D) vetoed a similar bill in September amid concerns that measure could conflict with other state efforts.

The collapse of FTX and other turmoil in the cryptocurrency market last year have created a new sense of urgency about building safeguards around crypto.

“The misguided, unethical, and likely illegal business practices of FTX have done severe damage to the credibility of an entire industry,” said Charles Belle, executive director of the Blockchain Advocacy Coalition, a California-focused group that’s pushed for pro-blockchain policy. “The industry needs regulatory clarity now more than ever.”

But separate, ongoing regulatory work by the Newsom administration could complicate any legislation.

“There’s no slacking in effort here,” said Russ Heimerich, deputy secretary of communications for the California Business, Consumer Services and Housing Agency, which oversees the Department of Financial Protection and Innovation. “The DFPI is working very hard to protect consumers and to lay that foundation for meaningful and thoughtful recommendations.”

The Newsom administration wants to make sure that any new crypto regulations are implemented deliberately, with some thought to potential federal standards. A key point may be how much new legislation will be able to accommodate the work DFPI is already doing.

A separate, and perhaps more immediate, problem is the state budget deficit. Newsom cited the cost of greater crypto regulation in his veto message last year, when the state was more flush with cash. Lawmakers are being cautioned now not to overreach with costly legislative proposals as the state faces a projected $22.5 billion budget deficit.

Another Attempt

Assemblymember Timothy Grayson (D), who chairs the Banking and Finance Committee, will reintroduce regulatory language under AB 39, which he filed earlier this month with a brief description. He’ll add details later.

Grayson is changing the measure from last year’s version to assuage some concerns of the industry. Many of the planned components, which he shared in an interview, will be the same as AB 2269 that Newsom vetoed.

Beginning in 2025, the bill says companies in the digital financial asset space would need to be licensed with the DFPI. Licensees would have to provide disclosures to consumers on a schedule of fees, consumer complaint processes, and other information. Based on its risks, licensees would also have to maintain a surety bond or trust account, as well as capital, as a form of insurance.

Though this year’s measure will propose some lighter requirements, crypto exchanges would still have to meet certain consumer protection standards, such as disclosing conflicts of interest or mitigating risks. One difference is that they would be allowed to self-certify. AB 39 also would create a new pathway for those with New York cryptocurrency licenses to be more quickly approved in California. New York was the first state to set up a regulatory platform for digital currency.

“It’s a whole lot easier,” said Grayson. “We’re trying to show that we’re willing to work. This is not about banning. This is about responsible innovation.”

Other planned changes, however, strengthen some regulations and may not be as favorable to the industry.

A prohibition on “stablecoins” not backed by reserve assets was a sticking point for the industry last year. In the new bill, that would become permanent instead of expiring in 2028, as last year’s bill called for. Consumer protections also would go into effect one year earlier, in 2024, and there would be more emphasis on requiring live customer service over the phone, said Grayson.

Cryptocurrency organizations are asking for more flexibility, instead of a blanket approach, to all licensees. Regulations and licensing requirements should be tailored to the risk of certain products or activities, they said.

“Digital assets are innovative and dynamic. As such, legislation should define them based on their underlying activities or use cases,” said Scott Talbott, senior vice president of government affairs for the Electronic Transactions Association. “This approach will allow legislation to encourage innovation and protect consumers.”

Grayson said he’s open for further discussion, adding that it’s early in the legislative session.

Laying Groundwork

Heimerich said the Newsom administration is watching for federal regulations as the DFPI conducts its work.

There likely will be revisited efforts on cryptocurrency regulation at the federal level, though a divided Congress and fallout from the FTX scandal makes further regulation uncertain.

On the state level, DFPI has been laying groundwork. It gathered input from stakeholders for a set of “consumer protection principles,” according to a December report. It’s implementing a crypto-specific consumer complaint process and putting together a voluntary market monitoring inquiry process. Timeframes on those efforts are still to be determined, said a spokesperson.

Crypto-related guidance will also be issued by the department to state-licensed banks and credit unions in March, according to the report.

“It’s not like we’re taking a very leisurely, slow approach to this,” said Heimerich when asked whether turmoil in the crypto market necessitates more urgency. “We are working pretty hard right now to work with consumer groups, to work with stakeholders to set that foundation. We can work fast, but also be deliberative.”

Consumer advocates say regulations are needed now. “Real people are getting hurt,” said Robert Herrell, executive director of the Consumer Federation of California. “If there’s anything we learned over the past year and a half, it’s that the longer you wait to get a proper licensing and regulatory regime in place, the more people get hurt.”

Supporters of Grayson’s bill will have to grapple with the cost of setting up a regulatory framework given the state’s budget deficit. Newsom said last year such a regime could cost “tens of millions of dollars.”

Grayson said that not protecting consumers in the cryptocurrency market is even more costly. “I’m really optimistic overall, especially working with the administration, because I know and I’m confident that the governor and I, that we actually share very similar goals,” he said.

There’s More

Grayson’s bill won’t be the only measure this year in California dealing with digital assets. Assemblymember Laurie Davies (R) introduced AB 76, which would simply add blockchain technology transactions tothe crime of money laundering. She had cited the FTX scandal in a press release announcing her bill.

While not as ambitious as launching a regulatory framework, Davies’ bill would close a loophole and would be just as important in protecting Californians, said Michael Fern, who helped create the bill and is part of the Conference of California Bar Associations.

“Sometimes that’s the best way to change law is not take huge bills that are really complicated and hundreds of pages long, but instead find the simple fix,” he said.