UPDATE 2-New York regulator issues final virtual currency rules

By Karen Freifeld and Gertrude Chavez-Dreyfuss

NEW YORK, June 3 New York state issued on Wednesday extensive new rules for companies that operate in virtual currencies such as bitcoin but did little to accommodate complaints that overly tight regulation could hamper the nascent industry.

The new rules, the first by a state, create comprehensive guidelines for regulating digital currency firms, according to the state's Department of Financial Services, which developed the regulations.

It means that digital currency companies operating in New York state that hold customer funds and exchange virtual currencies for dollars or other currencies are required to apply for what is known as a state "BitLicense."

"There is a basic bargain that when a financial company is entrusted with safeguarding customer funds and receives a license from the state to do so, it accepts the need for heightened regulatory scrutiny to help ensure that a consumer's money does not just disappear into a black hole," Benjamin Lawsky, superintendent of the New York state regulator, said in a speech Wednesday at the BITS Emerging Payments Forum in Washington.

The "BitLicense" rules include consumer protection, anti-money laundering and cybersecurity protections.

The regulations come as digital currencies have drawn criticism for attracting drug dealers and other criminal elements, while failing to safeguarding consumer funds.

Last year, bitcoin exchange Mt. Gox collapsed after it claimed to have lost $500 million worth of customer bitcoins after being hacked.

Overall, industry participants said New York's new rules are still problematic but nonetheless an improvement over the original proposals laid out in July and revised in December.

Digital currency companies are required to obtain prior approval for material changes to their products or business models, such as wallet firms offering exchange services. They would also need approval for new controlling investors.

But they would not need approval from the state for every round of venture capital funding or standard software updates.

"We have no interest in micro-managing minor app updates. We're not Apple," said Lawsky.

Companies that want both a BitLicense and a money transmitter license can work with the state regulator to have a "one-stop" application submission to cover the requirements for both.

Jerry Brito, executive director of non-profit research group Coin Center, called the final regulations "far from perfect," specifically citing what he said were vague state-level anti-money laundering obligations that go beyond federal regulations.

He said the group was working with other states "to ensure they do not repeat the mistakes made here."

The rules do not apply to software developers, individual users, customer loyalty programs, gift cards, currency miners, or merchants accepting bitcoin as payment.

Lawsky, meanwhile, has come under fire from the bitcoin community for issuing the rules shortly after announcing he was leaving the agency to set up a consulting company that will advise companies on financial matters that could possibly include digital currencies.

The most prominent virtual currency now is bitcoin, often used as an investment or to pay for goods and services online.

Bitcoin prices have been steady of late, at $225.77 on the BitStamp platform on Wednesday. The price rose as high as $1,123 in December 2013.

"I think (the rules) are going to increase the costs to entry for businesses," said New York attorney Reuben Grinberg, who specializes in virtual currency. "But I think it's going to give consumers greater peace of mind and will end up promoting investment in this area much more so than it hurts." (Reporting by Gertrude Chavez-Dreyfuss and Karen Freifeld; Editing by Chizu Nomiyama and Steve Orlofsky)