State Consumer Protection Bills Spawned by Crypto Drama

Cryptocurrency markets are characterized by sagging asset values and a drumbeat of scandals involving crypto banks, investment firms, and exchanges, resulting in a river of state legislation defining, licensing, and regulating digital assets.

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There are more than 60 legislative proposals addressing some of the issues associated with the love-hate relationship between the United States and blockchain technology, virtual currencies, and nonfungible tokens—certificates of ownership for one-of-a-kind digital assets—that have been submitted across state capitals in 25 states. In many of the proposed measures, tax incentives and legal structures that would pull these assets into broader commercial and tax codes would be designed to nurture the business climate for these assets. There are, however, an increasing number of bills that are seeking to regulate businesses that invest, trade, or manage digital assets as well.

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According to legislative analysts, states, specifically New Jersey, New York, and California, are undergoing a transition from a focus on business development to a focus on consumer protection, which is indicative of this shift.

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“There is a mix of legislation that encourages the use of cryptocurrencies and digital assets, while there are also bills that protect citizens from fraud, according to Heather Morton, a policy analyst at the National Conference of State Legislatures. The majority of the bills I have seen are still focused on encouraging rather than protecting, but I have noticed that there are more protection-type bills that have been introduced lately."

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There is wide skepticism among lawmakers regarding digital currencies during the 2022 legislative cycle, according to Ryan Maness, a tax analyst with the political consulting firm MultiState. In half a dozen states, tax credit bills for bitcoin mining have been debated in the legislature. It has been agreed that Colorado and Utah will accept cryptocurrencies as payment for taxes and fees in both states. There is a good chance the legislative cycle of 2023 will be marked by the roughly 66% drop in the price of Bitcoin since its peak, as well as the bankruptcies of BlockFi, Celsius Network LLC, and most glaringly FTX, the digital asset exchange, and lender.

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According to Maness, lawmakers' eagerness will be affected by all the bad press. “Will this move them in the direction of consumer protection, or will they continue to encourage the industry?”

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While handicapping a state legislative session during the early weeks of the session is difficult, Maness said some of the licensing and consumer protection measures have a reasonable chance of having their bills enacted, particularly in the northeastern states. Several bills that would protect crypto mining in state legislatures controlled by Republicans are also likely to catch fire this year. Bitcoin remains a long shot when it comes to bills with a distinct libertarian slant-including a measure in Arizona stating that Bitcoin is legal tender.

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Jersey’s Proposed Model

Bills moving quickly through the state Legislature suggest that New Jersey will enact one of the most comprehensive regulatory regimes in the nation.

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Digital Asset and Blockchain Technology Act, A2371/S1756, creates an expansive licensing process for businesses that accept, store, trade, lend, or issue digital assets. As part of the legislation, brokers, exchanges, and investment firms would also be required to keep and disclose records, and the state would have new enforcement powers.

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According to Christopher Gerold, who was chief of the New Jersey Bureau of Securities between 2017 and 2021, the bill would transfer primary authority for regulation from the Department of Banking and Insurance to the Bureau of Securities. Gerold filed 23 enforcement actions against crypto and decentralized finance companies between 2017 and 2021 as chief of the securities bureau.

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“This bill acknowledges the growing awkwardness of fitting rapidly evolving cryptocurrency businesses into the antiquated money transmission framework by allocating regulatory oversight of cryptocurrency to the bureau since the bill acknowledges that cryptocurrencies are becoming increasingly complex. “This law is common in almost every state, and it was originally enacted for the purpose of regulating check cashers and payment services,” Gerold, who now works for Lowenstein Sandler LLP in the New York metro area, said.

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As a result of the Assembly's vote on this bill in October, the bill passed by a vote of 72-1. In its meeting on Jan. 19, the Senate Budget and Appropriations Committee unanimously supported the bill.

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The state is also in the process of enacting A3288/S3142, which would foster awareness of decentralized digital technologies and recommend strategies for integrating them into governmental and commercial functions. It was unanimously approved last October by the Assembly.

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Another bill, A1975/S1267, would establish the Virtual Currency and Blockchain Regulation Act, aimed at providing certain incentives to virtual currency businesses that want to locate in New Jersey, in order to attract them to the state. Businesses involved in blockchain technology, including Bitcoin miners, would be exempt from sales tax on energy purchases and would be able to claim income tax credits for jobs that have been created in the state. Additionally, the bill would mandate the state to develop a blockchain-based system for accepting tax returns that would be used by the state. With a vote of 45-23, the measure was passed by the Assembly in October of this year.

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A385 / S3321 would require the state to create a "digital payment platform" to support cash-heavy businesses without access to traditional financial institutions, such as cannabis retailers. It would facilitate regulatory compliance and enable local municipalities to collect sales tax, according to the bill.

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Across the Hudson

Across the Hudson River, politicians in New York may expand the state's already robust BitLicense rules and the recent ban on Bitcoin mining enacted by the state, according to John Olsen, the organization's leadership for the state of New York.

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State crypto regulators were paved by the 2015 BitLicence rules that gave the Department of Financial Services authority to license, regulate, and discipline cryptocurrency businesses. In November, Governor Kathy Hochul (D) further irritated the industry by approving a two-year moratorium on new permits for fossil-fuel mining operations and proof-of-work authentication methods for blockchain transactions.

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Several bills are being sponsored by Rep. Clyde Vanel (D) to promote the industry and protect consumers. The legislator has already introduced A954, which would create a task force to investigate the impact of widespread cryptocurrency use on the state; A2599, which would create a task force to examine the possibility of issuing a state-issued cryptocurrency; and, A2532, which would allow state agencies to accept crypto as payments for taxes and fees.

His A944, which would bring virtual token fraud, illegal rug pulls, and private key fraud into the criminal code is also an investor protection measure he authored. While blockchain technology and cryptocurrency are growing, New York must “create the proper guardrails for investors.”

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A possible anti-fraud bill from Attorney General Letitia James (D), who recently called for more aggressive regulation of crypto, was mentioned by Vanel and Olsen as an example of such legislation.

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In her inaugural address, she said, "these risky products have caused too many seniors and working people to lose their pensions and hard-earned money."

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Golden State Outlook

The Californian government is another state that is acting with a new sense of urgency in order to regulate the digital asset companies that have emerged following the collapse of FTX. Governor Gavin Newsom (D) vetoed a bill in September that would have established licensing requirements for cryptocurrency firms in California. Lawmakers already have drafted a replacement bill addressing the governor’s concerns.

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A bill introduced by Assemblymember Timothy Grayson (D) would grant the Department of Financial Protection and Innovation authority to license, regulate, and discipline digital financial asset businesses beginning in 2025.

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In Grayson's opinion, it's evident that licensure is one of the logical next steps for this industry," he said. “Until we take this step, however, Californians will continue to be vulnerable to numerous and preventable financial scams that are prevalent in the state and can be prevented."

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Mining Protection Bills

There are a number of states that are taking a more friendly approach to the issue. A number of states have introduced laws to protect crypto mining, including Missouri, Mississippi, Montana, and Oklahoma.

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In accordance with these bills, small-scale Bitcoin mining would be permitted in residential areas and large-scale mining would be allowed in industrial areas. There are also proposed laws that would prohibit local units of government from imposing limits on mining through zoning or noise ordinances, and that would prohibit utilities from imposing discriminatory power rates on mining operators in order to reward them for their activities.

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SB 178, the legislation proposed by the state of Montana, takes this one step further. By enacting this law, the state and local governments would be prohibited from imposing any additional tax, withholding, assessment, or fee on digital assets when they are used as payment methods.

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The bills have drawn opposition from a wide range of groups worried about the potential loss of local control over mining facilities, which are frequently criticized for their outrageous levels of carbon emissions and noise pollution, among other things. There is an argument being made by the Montana Environmental Information Center that there shouldn't be a restriction on the rulemaking authority of the state Public Service Commission and local governments.

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Since China banned Bitcoin mining in 2021, a few states are considering tax incentives for commercial mining operations.