California’s pioneering digital financial assets law: A new era in crypto compliance

California's pioneering digital financial assets law: A new era in crypto compliance

Until now, cryptocurrency companies in California have operated without a license, but this is set to change with the introduction of the Digital Financial Assets Law (DFAL), signed into law by Governor Newsom in October.

This places California as the third state, following New York and Louisiana, to implement a licensing regime for cryptocurrency activities. The DFAL stands out as perhaps the most stringent virtual currency licensing law yet, encompassing a broad spectrum of provisions including licensure, disclosures, customer protections, stablecoins, exchange-specific sections, and robust enforcement powers. It also interestingly extends to gaming publishers under certain conditions.

The DFAL’s impact on the cryptocurrency sector is expected to be significant. RegTech company Alessa has created an in-depth guide for the new law, its requirements, and the broader implications for the digital assets industry.

Overview of DFAL The DFAL’s reach is extensive, covering any individual or entity involved in “digital financial assets business activity” with California residents. To engage in such activities, unless exempted, one must obtain a license from the California Department of Financial Protection and Innovation (DFPI) and adhere to various prudential requirements, recordkeeping rules, and disclosure obligations. Issuing a digital asset alone does not necessitate licensure unless it’s redeemable for legal tender, bank credit, or another digital asset.

California’s law is largely in line with New York’s BitLicense regulation, with some notable additions specific to digital assets.

Understanding the definitions in the DFAL is crucial. They range from defining an applicant, a covered person, digital financial assets, to digital financial asset business activities. The latter includes a broad range of activities, from exchanging and transferring digital financial assets to holding electronic precious metals on behalf of another.

Significantly, the DFAL exempts several categories from its requirements, including banks, certain credit unions, trust companies, payment processors, registered broker-dealers, entities regulated by the Commodity Futures Trading Commission (CFTC), and more. There’s also a public interest exemption allowing the DFPI discretion in applying the law.

License Requirement Starting July 1, 2025, covered entities must have a license or have submitted a licensing application. The requirements are extensive, from customer asset security to anti-money laundering, anti-fraud, information security, and general compliance programs. There are also specific insurance obligations.

Capital, Reserve, and Disclosure Requirements Licensees face strict capital and reserve requirements, including maintaining a surety bond or trust account and liquid capital based on risk assessments. Customer disclosures before engaging in any digital financial asset activity are mandated, covering a range of topics from fees to transaction revocability.

Exchange-Specific Obligations Covered exchanges are subject to listing requirements, disclosures, and best execution requirements, akin to those imposed on broker-dealers under securities laws. There’s also a safe harbor provision for exchanges that fail to achieve best execution, provided they have appropriate policies in place.

Stablecoin and Gaming Publishers The DFAL also touches on stablecoins, requiring licensing or exemptions for issuers. It also extends to gaming publishers, particularly if their in-game tokens are exchangeable for digital assets or legal tender.

Enforcement and Future Developments The DFPI is empowered to enforce the DFAL rigorously. Governor Newsom has acknowledged ambiguities in the legislation, with further clarifications expected from the DFPI. With the law’s full effect from 2025, companies should start preparing for compliance now.

The evolving nature of the digital assets industry necessitates dynamic compliance programs. Alessa’s integrated AML platform provides solutions to align with these regulations. For more information on Alessa’s capabilities and to explore their compliance software ROI calculator, interested parties can contact their representatives.

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