Licensing and Regulation of Digital Assets

Summary

A slide presentation titled Licensing and Regulation of Digital Assets, prepared by the Washington State Department of Financial Institutions for the Senate FIEDT Committee and dated December 1, 2020. The securities section, presented by the Director of Securities, outlines when an offer or sale of a security is unlawful, the Howey test from SEC v. W.J. Howey Co., 328 U.S. 293 (1946), initial coin offerings and SEC guidance including SEC Release No. 34- 81207. The virtual currency section, presented by the Director of Consumer Services, covers the department's interim guidance of 12/8/2014, statutory definitions of virtual currency and money transmission, SSB 5031 and Chapter 208-690 WAC. It also gives examples of regulated and unregulated business models. A final section addresses crypto asset custody, including a Wyoming bank charter and SB 5107 on trust institutions.

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Senate FIEDT Committee
Licensing and Regulation of Digital Assets
December 1, 2020




    Washington State Department of Financial Institutions
           “Leading the way in consumer protection and financial services regulation .”
  Securities and Initial Coin Offerings
       Bill Beatty, Director of Securities


It is unlawful to offer or sell a security unless:
• The security is registered or exempt;
• The persons selling the security are
    licensed or exempt; and
• There is full disclosure of all material facts
    to all offerees and purchasers.



Washington State Department of Financial Institutions
        “Leading the way in consumer protection and financial services regulation .”
          What is a “security”?

•     Stocks
•     Bonds
•     Notes
•     Mutual Funds
•     Investment Contract




    Washington State Department of Financial Institutions
           “Leading the way in consumer protection and financial services regulation .”
      Investment Contract

Howey test:
• Investment of money,
• In a common enterprise,
• With a reasonable expectation of profits to
  be derived from the efforts of others.

  SEC v. W.J. Howey Co.,328 U.S. 293 (1946)


Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
          Howey continued

• Substance over form. Applies to any
  contract, transaction or scheme even if not
  a typical security.
• Focus not only the instrument itself, but
  also on the manner in which it is offered
  and sold.




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
 Initial Coin Offerings (ICOs)

• Tokens or coins are sold to develop
  networks on which digital assets will
  operate.
• Purchasers are told that once the network
  is built, the enterprise will be more
  valuable and they can sell their coins or
  tokens at a profit.



Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
      Regulatory Guidance

• The DAO Report, SEC Release No. 34-
  81207, July 25, 2017
• Digital Asset Transactions: When Howey
  Met Gary (Plastic). Speech by William
  Hinman, SEC Director of Corporation
  Finance, June 14, 2018
• Framework for “investment Contract”
  Analysis of Digital Assets, SEC Staff, April
  3, 2019
Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
       Virtual Currency Regulation
Cindy Fazio, Director of Consumer Services

Interim Guidance – 12/8/2014
  • Defined virtual currency
  • Required licensure for exchange or wallet
    holding services
  • Set minimum tangible net worth for custodial
    wallet holders
  • Required a third party security audit for
    custodial wallet holders




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
    Interim Guidance, Continued


• Required licensees transmitting virtual
  currency to hold virtual currency of the
  same type and value as that held by the
  licensee but obligated to consumers.




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
                       Definition

"Virtual currency" means a digital
representation of value used as a medium of
exchange, a unit of account, or a store of
value, but does not have legal tender status
as recognized by the United States
government.




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
                       Definition

"Money transmission" means receiving
money or its equivalent value (equivalent
value includes virtual currency) to transmit,
deliver, or instruct to be delivered to another
location, inside or outside the United States,
by any means including but not limited to by
wire, facsimile, or electronic transfer.



Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
   History of CS Regulation
SSB 5031 Uniform Money Services --Virtual
Currency—Online Currency Exchangers
(Mullet)
Chapter 30, Laws of 2017, Effective 7/23/17

  • Followed the guidance

  • Added consumer disclosures


Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
   History of CS Regulation

Amendment to the Rules –
Chapter 208-690 WAC



Effective 8/1/18




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
  Business Model Examples

Bitcoin ATM – consumer inserts cash into
kiosk and receives a paper wallet which is
the value of the bitcoin purchased OR vice
versa

3rd party money transmitter – consumer A
gives licensee fiat or virtual currency for
transmittal to consumer B.

Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
  Business Model Examples
Service provider to merchants – consumers
purchase goods and services with bitcoin.
Licensee exchanges bitcoin for fiat and
remits fiat to merchant.

Wallet provider with control stores virtual
currency for consumer. Control - Licensee
has access to value and controls its
movement.

Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
                Not Regulated
Users – persons who use virtual currency for
their own use

Wallet provider that stores virtual currency
but does not have access to the value or
unilateral power to execute a transaction
  • Multi-sig wallet models




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
                Not Regulated
Data storage or security services not
otherwise engaged in virtual currency
business activity on behalf of other persons

Providers of software or protocols governing
the transfer of the digital representation of
value
   • Software or hardware provider helping
     miners mine bitcoins

Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
                Not Regulated

Verification of ownership or authenticity
through a virtual distributed ledger system
when the virtual currency is not used as a
medium of exchange
   • Registration of documents, property, etc.
     without use of notaries




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
         Crypto Asset Custody
              Roberta Hollinshead


• Crypto Asset Custody – Emerging issue
  and regulatory response

• Wyoming Special Purpose Depository
  Institution – New Commercial Bank
  Charter




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”
   Crypto Asset Custody, Continued



Trust Charter for Crypto Asset Custody

SB 5107 Addressing Trust Institutions (Das)
Chapter 389, Laws of 2019




Washington State Department of Financial Institutions
       “Leading the way in consumer protection and financial services regulation .”


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