Internet Lawyer Blog
Creating a digital currency involves complying with a complex framework of state and federal regulations, including, but not limited to, the securities laws, anti-money laundering (“AML”) rules, and financial licensing requirements. Here’s an overview of the key legal considerations:
1. Federal Regulations for Creating a Digital Currency
For your information, several federal agencies oversee different aspects of digital currencies, depending on their structure and use.
a. Financial Crimes Enforcement Network (“FinCEN”) – AML Compliance
– FinCEN, part of the U.S. Treasury, regulates businesses that engage in money transmission which often applies to digital currencies.
What are the key requirements?
– Register as a Money Services Business (“MSB”) with FinCEN.
– Implement Know Your Customer (“KYC”) and Anti-Money Laundering (“AML”) policies.
– Report suspicious transactions and comply with the Bank Secrecy Act (“BSA”).
– Who this applies to: If your digital currency allows for transactions or exchanges, you may be classified as an MSB.
– Exception: Purely decentralized cryptocurrencies (e.g., Bitcoin) not controlled by a central entity may not require MSB registration.
b. Securities and Exchange Commission (“SEC”) – Securities Law Compliance
– The SEC regulates digital assets that qualify as securities under the Howey Test which determines if an asset is an investment contract.
– If your digital currency functions as an investment, you may need to register as a security or qualify for an exemption.
– SEC enforcement actions have targeted Initial Coin Offerings (“ICOs”) that resemble unregistered securities offerings.
– Who this applies to: (1) If you’re issuing tokens that promise returns or profits based on the efforts of others, your digital currency could be a security; and (2) Stablecoins and utility tokens may be exempt if they do not meet the Howey Test.
c. Commodity Futures Trading Commission (“CFTC”) – Commodity Laws
– The CFTC classifies Bitcoin, Ethereum, and other digital assets as commodities under the Commodity Exchange Act (“CEA”).
– If your digital currency involves derivatives, futures, or leveraged trading, it may fall under CFTC regulations.
– Who this applies to: If your project offers futures contracts, margin trading, or derivatives on a digital currency.
d. Internal Revenue Service (“IRS”) – Taxation of Digital Currencies
– The IRS treats digital currencies as property, meaning they are subject to capital gains taxes when bought, sold, or exchanged.
– Requirements: (1) maintain detailed records of transactions, purchases, and sales; and (2) report taxable events on Form 8949 and Schedule D.
e. Office of the Comptroller of the Currency (“OCC”) – Banking Regulations
– If you plan to create a digital currency that operates as a banking product, such as a stablecoin backed by fiat currency, you may need a national banking charter or approval from the OCC.
– Example: The OCC has granted special banking charters to crypto-focused financial institutions like Anchorage and Paxos.
f. Federal Reserve – Stablecoins and Central Bank Digital Currencies (“CBDCs”)
– The Federal Reserve has increased scrutiny over stablecoins and their potential impact on monetary policy.
– If your digital currency is pegged to the U.S. dollar or a basket of assets, you may need to comply with banking laws and reserves requirements.
2. State Regulations for Digital Currencies
Each U.S. state has its own approach to cryptocurrency regulation. In fact, some states have strict licensing requirements, while others are more crypto-friendly.
a. State Money Transmitter Laws
– Many states require a money transmitter license (“MTL”) for businesses that issue or exchange digital currency.
New York – BitLicense:
– One of the most stringent state regulations.
– Companies dealing with digital assets in New York must obtain a BitLicense from the New York Department of Financial Services (“NYDFS”).
Wyoming – Crypto-Friendly Approach:
– Wyoming has passed crypto-friendly laws, including a charter for special-purpose depository institutions (“SPDIs”) that allows crypto businesses to operate under banking-like regulations.
California & Texas – Emerging Regulations:
– California is developing a regulatory framework but has not yet implemented a full crypto licensing system.
– Texas has pro-business cryptocurrency laws but still requires compliance with money transmission rules.
3. Other Key Legal Considerations
a. Smart Contracts and Code Audits
– If your digital currency operates on a blockchain with smart contracts, ensure they are audited for security vulnerabilities to avoid hacking risks and legal liability.
b. Privacy Coins and Compliance Risks
– Privacy-focused cryptocurrencies (e.g., Monero, Zcash) face greater regulatory scrutiny due to their anonymity features, which could violate AML laws.
c. Consumer Protection Laws
– The Federal Trade Commission (“FTC”) enforces consumer protection laws related to fraud, misrepresentation, and unfair business practices in cryptocurrency projects.
4. Steps to Legally Launch a Digital Currency
If you plan to create a digital currency while complying with U.S. laws, follow these steps:
Step 1: Determine Your Digital Currency Type
– Is it a payment token, utility token, stablecoin, or security token?
– Will it be centralized or decentralized?
Step 2: Register with FinCEN (if necessary)
– If your project involves money transmission, register as an MSB and comply with AML rules.
Step 3: Ensure SEC Compliance
– Conduct a Howey Test analysis to determine if your token is a security.
– Register with the SEC, if necessary, or seek an exemption under Reg D or Reg A+.
Step 4: Obtain Necessary State Licenses
– If applicable, apply for money transmitter licenses (i.e., MTLs) in states requiring them.
– If operating in the State of New York, then obtain a BitLicense.
Step 5: Set Up Corporate and Tax Compliance
– Establish a corporate entity (e.g., LLC, C-Corp) for liability protection.
– Comply with the IRS tax reporting rules for cryptocurrency transactions.
Step 6: Implement Strong Security Measures
– Conduct a smart contract audit.
– Implement AML and KYC protocols to prevent illegal activity.
Step 7: Seek Legal Counsel
– Hire an attorney specializing in cryptocurrency and financial regulations to ensure full compliance.
Conclusion
In short, creating a digital currency requires navigating complex federal and state regulations as outlined in this article. Depending on how your currency is structured (payment token, security token, or stablecoin), you may need SEC registration, FinCEN compliance, and state licensing. If you’re serious about launching a legally compliant digital currency, it’s highly recommended to work with a cryptocurrency and digital currency attorney who understands the rules and regulations.