The bitcoin community was reeling over the weekend, after it was revealed that California’s state financial regulator had issued a cease and desist order against the Bitcoin Foundation.
The cease and desist order was dated May 30, one and a half weeks after the Bitcoin 2013 conference in San Jose. The letter said that the Bitcoin Foundation may be a money transmission business (MTB), and threatened it with fines and jail time.
Jon Matonis, who is a board member at the Foundation, revealed the letter in his Forbes column over the weekend.
The letter threatens the Foundation with penalties of $1000 for each violation of Financial Code 2030, or $1000 per day under Financial Code 2151. Anyone violating Financial Code 2152 could also incur jail time, it said, before throwing a slew of other regulations at the Foundation.
The letter, signed by Paul Clayton, senior counsel at the Department of Financial Institutions (California’s financial regulator), gave the Foundation 20 days to respond, although it was only received last week. The Foundation is drafting its response with legal firm Perkins Coie this week.
The California action was served against a nonprofit Foundation, however, which Matonis argues in his column has no money transmission operation at all. So, why send it?
“It appears that the California DFI is on a bit of a fishing expedition and is also sending a warning to companies in the bitcoin economy,” said Patrick Murck, general counsel for the Foundation, adding that he knew other companies had also received letters.
“I know at least one other company has, and I have hints that others have as well,” he said.
Peter Vessenes, head of the Bitcoin Foundation, went further. “The state of California is blanket C&D-ing all Bitcoin businesses,” he claimed, on Y Combinator’s Hacker News site.
The language in the letter (which didn’t directly accuse the Foundation, but suggested it ‘might be’ an MTB), indicated that the letter might be a fishing expedition said Murck. The use of cease and desist letters is an easy way to cast the net, he argued. “It’s less resource- and time-consuming to send out cease and desist ‘warning letters’ and demand a factual response than to build an evidentiary basis for action independently.”
The DFI’s mandate is consumer protection, mused Murck, arguing that the DFI doesn’t want to see too much innovation among financial startups, because it favours established players, who are a known quantity. “These barriers are there for a reason. They want to prevent two-man shops working out of a garage handling customer funds. They would rather there not be that many startups,” he said.
Others put it more succinctly. “Their goal here is to remind people that they’re in charge,” said one well-connected member of the California bitcoin community – not affiliated with the Bitcoin Foundation – who had intimate knowledge of state regulations.
It would be difficult for financial startups to fight back against this publicly, because of the way the DFI operates, said the source, who wished to remain anonymous.
“We’re terrified,” he said, describing industry relations with the DFI. The regulatory is notoriously arbitrary when dealing with license applications in the state, he added. When it rejects a license application, it will not provide guidance for resubmission, the source pointed out, which creates a culture of fear among financial technology startups.
“None of these startups can speak up on the record because they’re afraid of adverse reactions from the DFI,” he said.
He was already considering moving offices to Austin, to try and escape what he saw as regulatory pressures from the DFI.
But this isn’t just a Californian problem. “Texas is pretty strict as well,” said Murck. “You should also bear in mind that States like New York and Texas have publicly stated that merely conducting a single transaction with a consumer residing in those States creates a sufficient nexus between a company and that State to give them jurisdiction on issues of money transmission,” he said.
“Presumably, California and other States would argue similarly,” he warned. “This is not just an issue for California businesses, it’s an issue for any business that takes on a single California resident as a customer.”
Other states have been aggressive in tackling financial technology startups. Virginia hit Tangible Cryptography with a complaint over its FastCash4Bitcoins service early last month, causing it to shut down operations. Even other payment technologies have been targeted; Matonis points to a spat between Illinois regulators and financial payments firms including NetSpend.
This ‘spray and pray’ approach to regulating businesses could dampen the prospects for bitcoin-based businesses in the long run, warned Murck. “I have talked with companies here, some of whom have spent the money to be compliant, and some who have given up on the idea,” he said.
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