California is Now the Last State With Digital Assets Regulations
California has recently taken a significant step towards regulating digital assets, joining New York and Louisiana as the third state in the U.S. to implement a virtual currency-specific regulatory licensing framework. The California Digital Financial Assets Law (DFAL) and Senate Bill 401, signed by Governor Gavin Newsom on October 13, 2023, are set to become effective on July 1, 2025. These regulations establish stringent license requirements, compliance obligations, and guidelines for stable coin approvals.
Key Provisions of the DFAL
- Definition of Digital Financial Assets: The law defines digital financial assets as digital representations of value used as a medium of exchange, unit of account, or store of value, excluding legal tender. Notably, reward points, online gaming values, and securities registered or exempt from registration with the U.S. Securities and Exchange Commission (SEC) are not considered digital financial assets under DFAL.
- License Requirements: Businesses engaging in digital financial asset activities with California residents must obtain a license from the California Department of Financial Protection and Innovation (DFPI). The licensing process is detailed and includes enhanced requirements such as maintaining internal controls, related policies, and insurance obligations.
- Compliance and Customer Protections: Licensees are subject to numerous compliance requirements, including maintaining sufficient digital financial assets to satisfy customers’ entitlements. The law imposes specific control requirements to protect customers’ assets from being treated as the property of the covered person or subject to their creditors.
- Exchange Listing Requirements: Before listing or offering a digital financial asset, exchanges must conduct comprehensive risk assessments and adhere to various policies and procedures, including evaluating the likelihood of a digital financial asset being deemed a security by federal or California regulators.
- Recordkeeping and Reporting: Extensive recordkeeping requirements are set forth, with a mandate to maintain records for five years. Licensees must also submit annual reports detailing various aspects of their digital financial asset business activities.
- Stablecoin Regulations: The DFAL includes specific provisions for stablecoins, requiring issuers to maintain eligible securities on a one-to-one basis with outstanding stablecoins and requiring DFPI approval for stablecoins to be exchanged, transferred, or stored in California.
- Enforcement Powers: The DFPI has been granted robust enforcement authority to act against entities violating the DFAL. This includes the power to bring enforcement proceedings against entities engaged or about to engage in digital financial asset business activities without proper licensing.
- Penalties for Non-Compliance: Civil penalties of up to $100,000 per day can be charged for unlicensed activities, and material violations of the DFAL by licensees or covered persons can result in penalties of up to $20,000 per day.
- Impact on Gaming Publishers: The DFAL’s scope extends to digital representations of value used within online games, potentially requiring licensure for game publishers that issue in-game tokens that can be exchanged for digital assets or fiat.
The enactment of DFAL represents a significant move towards a regulated digital asset market in California. Its comprehensive framework sets a precedent for other states, potentially influencing future legislation in the digital asset space. Entities operating in this sector in California need to start preparing for compliance with the new law, ensuring they understand and meet all the requirements before the law takes effect in July 2025.