On February 7, 2018, the New York Department of Financial Services (NYDFS) published guidance to remind virtual currency (VC) companies licensed by New York State of their responsibilities. Addressed from NYDFS superintendent Maria T. Vullo to "All Virtual Currency Business Entities Licensed under 23 NYCRR Part 200 or Chartered as Limited Purpose Trust Companies under the New York Banking Law," the document stresses that:
"1) VC Entities are required to implement measures designed to effectively detect, prevent, and respond to fraud, attempted fraud, and similar wrongdoing; and
2) Market manipulation is a form of wrongdoing about which VC Entities must be especially vigilant, given that such manipulation presents serious risks both to consumers and to the safety and soundness of financial services institutions."
Interestingly, the department's guidance was published just one day after the CFTC testified before the Senate Banking Committee. As virtual currency regulation is an evolving – and still ambiguous – space, it is vital for the CFTC and the NYDFS to determine which government entity has jurisdiction over the relevant businesses.
The NYDFS guidance explicitly notes that fraud and market manipulation can be attempted by external actors (i.e., customers) or internal actors (i.e., employees). "For example, a customer or coordinated group of customers might misuse a VC Entity's exchange service in an attempt to wrongfully manipulate the price of a virtual currency," Vullo writes. "Or, an employee of a VC Entity might wrongfully act on insider information regarding that VC Entity's plans to expand (or curtail) its services with respect to a particular virtual currency."
This is obviously an allusion to allegations of insider trading, which may have occurred when Coinbase debuted bitcoin cash (BCH) on its platform in December 2017. It's not immediately apparent whether the NYDFS is investigating or pursuing action against any potential wrongdoing in the matter.
Encouraging "diligent evaluation of the particular risks" faced by individual virtual currency businesses, the NYDFS establishes minimum measures for detection, prevention, and response to malicious activity. This includes investigation of suspected or actual wrongdoing.
The superintendent calls on companies to implement a written policy that:
"1. Identifies and assesses the full range of fraud-related and similar risk areas, including, as applicable, market manipulation;
2. Provides effective procedures and controls to protect against identified risks;
3. Allocates responsibility for monitoring risks; and
4. Provides for periodic evaluation and revision of the procedures, controls and monitoring mechanisms in order to ensure continuing effectiveness, including continuing compliance with all applicable laws and regulations."
Immediately after discovering wronging, a virtual currency business must submit a report to the NYDFS with the following information:
"i. A statement of the actions taken or proposed to be taken with respect to such developments, and
ii. A statement of changes, if any, in the VC entity's operations that have been put in place or are planned in order to avoid repetition of similar events."
The NYDFS expects additional information within 48 hours of the original report and demands that virtual currency businesses maintain records of each incident.
Through its regulation of bitcoin futures, the CFTC appears to also be taking spot markets (and potential market manipulation) under its purview. However, state regulators like the NYDFS have taken it upon themselves to create reporting and compliance standards that might also assist in the development of healthy cryptocurrency markets.
For now, there might be too many cooks in the kitchen, but the regulatory attention to virtual currency should act as a boon to consumer confidence and investor protection efforts.