New York is the most recent to join the fray in state-led efforts to regulate the virtual currency markets. On April 17, 2018, New York Attorney General Eric T. Schneiderman announced the launch of the Virtual Markets Integrity Initiative, a “fact-finding inquiry into the policies and practices of platforms used by consumers to trade virtual or ‘crypto’ currencies like bitcoin and ether.” The Investor Protection Bureau of the Office of the Attorney General sent a questionnaire to 13 major virtual currency trading platforms, requesting information on their operations, internal controls and safeguards to protect customer assets.

The stated goal of the Initiative is “to increase transparency and accountability as it relates to the platforms retail investors rely on to trade virtual currency, and better inform enforcement agencies, investors, and consumers.”

These trading platforms, or exchanges, match buyers and sellers of virtual currencies. The Attorney General’s release describes these platforms as “a key point of entry into the virtual currency market for professional and retail investors alike. They serve as repositories for sensitive personal information and customers of vast sums of virtual and government-issued (or ‘fiat’) currency.” As an example, bitFlyer Inc., which is based in Japan with a US subsidiary, states on its website that it is the largest bitcoin exchange in the world by volume, with $100 billion in transactions year-to-date and one million users.

The Attorney General’s release refers to reports of “theft of vast sums of virtual currency from customer accounts, sudden and poorly explained trading outages, possible market manipulation, and difficulties when withdrawing funds from accounts.” The release further asserts that virtual currency trading platforms “lack the basic market protections of traditional platforms” and that “the extent of disclosures to customers about trading rules, internal controls and other basic practices varies from platform-to-platform, making it difficult or impossible for prospective users to evaluate the actual risks of trading on a particular platform.”

The transmittal letter accompanying the questionnaire expands on the Attorney General’s concern. Noting that “virtual currencies have captured the imagination of millions of people worldwide” and that they represent “a technological advance, a medium of exchange, and an investment opportunity all at once,” the Attorney General stated that virtual currency “is also a highly speculative sector, featuring significant volatility, instability, and risk” and “has attracted fraudsters, manipulators, and thieves.” The Attorney General noted that his office’s role is “separate from, but complementary to, that of New York State’s Department of Financial Services.”

The questionnaire asks the platforms to disclose information relating to six topics: (1) ownership and control, (2) basic operation and fees, (3) trading policies and procedures, (4) outages and other suspensions of trading, (5) internal controls, and (6) privacy and money laundering. Of interest to the Attorney General are the platforms’ approach to combating suspicious trading, policies on the operation of bots, limitations on the use of and access to non-public trading information, and safeguards in place to protect customer funds from theft, fraud and other risks. The Attorney General is also focused on the effectiveness of geographic restrictions, stating: “We are aware that certain trading platforms have formal rules barring access in New York and may not have a license to engage in virtual currency business activity in New York. Among other topics, we are asking platforms to describe their measures for restricting trading from prohibited jurisdictions.”

Responses are due May 1. The Attorney General’s office plans to analyze the responses, compare them across platforms, and ultimately present what it learned to the public.

The following virtual currency trading platforms received questionnaires:

• Coinbase, Inc.
• Gemini Trust Company
• bitFlyer USA, Inc.
• iFinex Inc. (Bitfinex)
• Bitstamp USA Inc.
• Payward, Inc. (Kraken)
• Bittrex, Inc.
• Circle Internet Financial Ltd. (Poloniex LLC)
• Binance Ltd.
• Elite Way Developments LLP (Tidex.com)
• Gate Technology Inc. (Gate.io)
• itBit Trust Co.
• Huobi Global Ltd. (Huobi.Pro)

The New York Attorney General is one of many regulators who have taken steps to join the patchwork quilt of state and federal regulators seeking to assert jurisdiction over virtual currencies and blockchain technology, which, ironically, were developed specifically to avoid the need for government involvement. Multiple divisions of the Securities and Exchange Commission have cryptocurrencies and initial coin offerings as one of their priorities for 2018. The Commodity Futures Trading Commission is seeking to regulate virtual currencies as commodities and recently prevailed in court on that theory. The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) published a letter in March indicating its belief that anti-money-laundering statutes apply to developers and exchanges involved in the sale of ICO-derived tokens. And, in 2014, the Internal Revenue Service issued a notice stating that for federal tax purposes, virtual currency is treated as property, the sale of which can generate gain or loss for tax purposes.

In addition to New York, other states are also focusing on the securities aspects of virtual currencies and initial coin offerings. On April 10, 2018, the Texas State Securities Board released a report from a four-week investigation of securities offerings tied to virtual currencies stating that it had found “widespread fraud.” And on March 27, 2018, the Secretary of the Commonwealth of Massachusetts issued consent orders in connection with a “cryptocurrency sweep,” blocking five initial coin offerings on the grounds that they constituted unregistered securities offerings in violation of state law.

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