Law raising red flags on crypto exchanges now targeted for repeal

One New York lawmaker wants to undo a big part of the state’s regulation of cryptocurrency exchanges. Yet that very regulation may have raised a red flag about some of the world’s largest—and most controversial—bitcoin exchanges three years ago.

Assemblyman Ron Kim, a Democrat from Queens, introduced bill A9899 that he touts as replacing the state’s “BitLicense” rules that were put in place three years ago. It’s not the first time such a proposal has been bandied about the legislature. Last month, Sen. Jesse Hamilton and Sen. David Carlucci, Democrats from Brooklyn and Rockland County respectively, also discussed changing regulations. But now a bill is in committee, where it faces the long, arduous journey through horse-trading nightmare that is the New York legislature.

To get a BitLicense issued by the New York State Department of Financial Services (NYSDFS), companies have to do agree to a list of rules, such as be bonded in New York and maintain records for 10 years, keep retained earnings in U.S. dollars or government bonds.

While A9899 is winding its way through Albany right now, it may take more than a year to end up on the governor’s desk to be signed or vetoed, provided it passes both chambers. And although it would get rid of the license and its related fees, it keeps in place many of the same regulations.

Only half a dozen companies have received BitLicenses, including Coinbase, Circle, and Paxos’s itBit. But many more crypto exchanges felt the rules were too onerous and chose to leave New York in what was dubbed “The Great Bitcoin Exodus” by the type of people who name such things.

Getting a BitLicense isn’t just about forking over tens of thousands of dollars to New York State bureaucrats and attorneys. It also requires significant investment in security, anti-money laundering (AML) and “know your customer” (KYC) procedures, biennial reviews of the company’s financial conditions, quarterly financial reports, audits using generally accepted accounting principals (GAAP), and fingerprinting and FBI background checks on employees and management.

In other words, the sort of stuff expected of institutions and exchanges in the rest of the financial world.

Poloniex was one of the first to leave New York rather than comply with Albany’s regulations. But it was recently purchased by Circle, the first company to receive a BitLicense.

Others that bailed from the Empire State include Kraken, BitMEX, and Bitfinex. In hindsight, that makes rules regarding BitLicense particularly interesting. All three of these exchanges have something to do with tether, the controversial cryptocurrency that is supposedly backed by U.S. dollars and priced at roughly one tether for each dollar.

Tether was created by the same people who run Bitfinex, the world’s largest bitcoin marketplace that sees about one-third of all bitcoin trades. In April 2017, Bitfinex and Tether lost their banking relationship with Wells Fargo. In subsequent months, the outstanding supply of the tether token went from $50 million worth to $2.2 billion. Proponents of tether insist that its growth was entirely due to organic demand as the prices of cryptocurrencies began to skyrocket. However, an anonymous research paper on behalf of an outfit called 1000x Group argued that the opposite was the case—that tether issuances were driving the market.

What is known is tether issuances came to a grinding halt once they established a banking relationship with Netherlands-based ING Bank in early February. Coincidentally—or perhaps not—the price of bitcoin slid at the same time no new tether were entering the marketplace. [Update: $300 million in new tether were issued just after the story was filed.]

It hasn’t been smooth sailing for Bitfinex/Tether. On December 6, 2017, the Commodity Futures Trading Commission paid a visit to their offices with subpoenas. And while Tether promised audited financial statements to prove they have enough U.S. dollars in the bank to back each tether, such documents have yet to happen. Tether and Bitfinex cut ties (or had them severed) by its auditor, Freidman LLP, in January.

Yet to the folks at BitMEX research arm, everything is hunky-dory when it comes to tether. They’ve issued several reports insisting tether isn’t a scam. This week, they reiterated their claim that Tether was using Puerto Rico’s Noble Bank to store its U.S. dollars.

Modern Consensus reached out to a spokesperson for Bitfinex and Tether asking whether the BitMEX report was true. The response we received was, “I don’t comment on speculation regarding commercial counterparties.”

And while it’s still impossible to trade tether for U.S. dollars directly on Bitfinex, one can do so on Kraken. On Tuesday, for example, some $1.5 million worth of tether was traded for the greenbacks. That may seem small relative to all outstanding tether but it’s the largest exchange for that pair.

Once again, Modern Consensus contacted Bitfinex and Tether, asking if any change to current regulations would mean a return to New York. We have yet to receive a response.

But if regulations remain—even if the actual license and fees go away—one can assume the answer.