For the past three years, the rickety state-based money transmission framework conceived of by Congress in 1992 has had an increasingly acute affect on the state of innovation—real innovation—in the financial sector. Its most recent victim: Apple Pay, a system deliberately stunted in its functionality so as to avoid any involvement with money transmission laws. Talking about the myriad problems caused by these laws can only do some much, unfortunately. It's time for policy makers to take action.
They'll tell you that without Congress, they can't. But they can.
Regulatory action typically requires legislative authority, but we live in a country where the only authority legislators grant anymore is the authority to serve more expensive wine instead of less expensive wine at their fundraising dinners. Fortunately, there's a workaround: regulations.
Unlike statutes, regulations are written by agencies, not lawmakers. They have the force of law, but they're more flexible. And as luck would have it, many money transmission statutes grant a huge amount of discretion—arguably an unconstitutional amount—to the agencies. In California, for example, Financial Code § 2032(b) reads, "An applicant for a license under this division shall do so in a form and in a medium prescribed by the commissioner by order or regulation" (emphasis added). The next sub-section, § 2032(c), continues "The commissioner may waive any of the information required under subdivision (b) or permit an applicant to submit other information instead of the required information." Just to drive the point home, § 2039(a) also states, "The commissioner may by order or regulation grant exemptions from this section in cases where the commissioner finds that the requirements of this section are not necessary or may be duplicative." In other words, the Commissioner of the Department of Business Oversight and her deputy can do whatever they damn well please. Western Union, MoneyGram and American Express wouldn't have it any other way.
The fact that money transmission laws exist in so many states means that those states already have the ability to issue regulations interpreting their laws. Rather than act as protectionist stooges, those state regulators could actually choose to take their jobs seriously and protect the public from the increasing risks posed by virtual currency, and to allow innovation in the field to actually take place again, whether in the form of Bitcoin or otherwise (and I would certainly prefer otherwise). In other words, each state's financial regulator should adopt new regulations as a temporary measure, until federal legislation catches up, which could take decades at Congress's current pace. The main goal of these regulations would be to establish a virtual insurance pool for money transmitters, in lieu of an actual one, for which there is presently no legal authority. Surety bonds and wildly different tangible net worth requirements would go into the dustbin where they belong, because they don't work. (See MF Global, Peregrine, Bernie Madoff, etc.)
Here's how it would work. In lieu of an applicant's surety bond and completely arbitrary net worth requirements, the financial agencies of each state would accept a pro-rated, nationally standardized monetary contribution into a virtual insurance pool, and simultaneously choose to recognize as valid in their own states the money transmission licenses of other states. The insurance pool would be "virtual" because the contribution would be payable only to the money transmitter's home state, but counted on a ledger for the pool spanning all of the participating states nationwide. For example, NewCo Payments headquartered in California would contribute a baseline of $1,000 to the pool as a new money transmitter (holding $0.00 of deposits at the outset) up to the sum of [$1,000 divided by the contribution rate]. By their new regulations, all of the other state regulators would recognize the validity of that contribution. Virtual currency operators would be required to contribute double or triple the rate per dollar of deposits held to offset the risk posed by their operations, but no company would be required to contribute more funds due to operations across state lines within the United States. That being said, companies transmitting funds internationally would be required to make a higher starting contribution. A hypothetical contribution rate might be $0.01 per dollar of consumer deposits held for the first million dollars, and $0.001 per dollar thereafter. Presently used money transmission surety bonds cost about $0.03 for every dollar of the bond—but with none of the benefit of an insurance pool, where other participants' contributions can help drive down the cost.
In the unlikely event that NewCo failed, consumers would make claims in their respecive states, and those state regulators would inform California, NewCo's home state, of the total losses. Then, unlike the situation with a surety bond, all of the states could reimburse the claimed losses of depositors nationwide from the larger virtual insurance pool, instead of from a limited surety bond in each state. If the fund started to run dry, contribution rates could go up. If the fund was flush, contribution rates could go down.
This is effectively how FDIC insurance works already for banks, except that the FDIC has the benefit of being a centralized federal agency. Here, there would be no center agency necessary—just a network of Memoranda of Understanding between the various state regulators (or the Council of State Bank Supervisors, CSBS, to coordinate them all). The CSBS is already quite fond of MOUs to share information, even with the federal government.
This model would correctly presume that money transmission in the modern world crosses state lines. It would account for the additional risk posed by the holding of more and more consumer funds. It would account for the additional risk posed by Bitcoin. And by incorporating effective reciprocity, it would drastically reduce the insane regulatory burden posed by 47 redundant state laws. The virtual pool would allow funds to flow to various states, without getting into political hot button issues around which federal agency (FDIC? CFPB? IRS?) should hold onto the pool itself. In the event of a money transmission failure, the state agencies would simply reimburse each other based on the pool's holdings.
In short, there's no reason why this can't be done. Regulations are doable. Insurance pools are doable. Double-entry accounting is doable. The states need to get moving and do it already before more money gets lost.