The Executive Order aims to strengthen consumer protection and cultivate innovation in digital assets and related financial products and services.

By Christopher D. Frey, Scott D. Joiner, Barrie VanBrackle, Katherine A. Sawyer, and Scott Kanchuger*

On May 4, 2022, California Governor Gavin Newsom issued an Executive Order (California Order) calling upon California state agencies to develop stronger regulatory and enforcement mechanisms for blockchain technology, cryptoassets, and related financial products and services. Recognizing the historical costs of reactive government regulation for new technologies, the California Order seeks to draw upon the benefits of early engagement by public institutions to “manage emerging risks and opportunities, with the twin goals of strengthening consumer financial protection and cultivating responsible innovation.”

The California Order is the first of its kind in any state and follows President Biden’s March 2022 Executive Order on Digital Assets, which calls for greater federal regulation and enforcement activity over digital assets and related technologies. The California Order aims to create a “transparent and consistent business environment for companies operating in blockchain … that harmonizes federal and California laws” and “balances the benefits and risks to consumers.” Governor Newsom ordered California state agencies to “work with, and concurrently to, the federal government” to “establish a comprehensive, thoughtful, and harmonized regulatory and business environment for crypto assets.”

Notably, the California Order empowers the state’s Department of Financial Protection and Innovation (DFPI) to take the lead in developing California’s regulatory approach and enforcement actions for cryptoassets and related financial products and services. DFPI, an agency similar in structure to the Consumer Financial Protection Bureau, was created in 2020 under the California Consumer Financial Protection Law (CCFPL) to bolster the state’s consumer financial protections. In its 2021 annual report, DFPI stated that a top category of complaints it received concerned cryptocurrency products. The California Order calls for DFPI to develop regulations that ensure that California remains “the premiere global location for responsible crypto assets companies” while also “increasing the reach of DFPI’s consumer protection efforts.”

Expanding DFPI’s Regulatory Mandate

The California Order instructs DFPI to develop a “comprehensive regulatory approach” to cryptoassets that is “harmonized with the direction of federal regulations,” to include:

  1. engaging with federal agencies to promote a common approach that increases the reach of DFPI’s consumer protection efforts and reduces unnecessary burdens on companies seeking to operate nationwide; and
  2. developing guidance and regulatory clarity and supervision of private entities offering cryptoasset-related financial products and services in California.

In line with increasing the reach of DFPI protection efforts, the California Order also instructs DFPI to protect consumers of digital assets and related financial products and services by:

  1. initiating enforcement actions under the CCFPL and other relevant consumer financial protection laws;
  2. enhancing its collection and review of consumer complaints relating to cryptoasset financial products and services;
  3. working with cryptoasset-related companies to remedy these complaints; and
  4. consulting with appropriate law enforcement agencies regarding criminal activity in the cryptoasset and virtual currency space.

Increased Regulation and Enforcement

Increased regulation and enforcement in California appears inevitable, especially in light of the California Order and the increased scrutiny at both the federal and state level over consumer protection involving financial products. Thus far, DFPI has taken a relatively hands-off approach and has yet to provide anything beyond highly caveated guidance for entities offering financial products and services related to cryptoassets. The result is a regulatory gray zone, with the agency taking care to leave room for future regulation and enforcement. As underscored by certain of DFPI’s recent opinions, companies operating in California must be attentive to the necessity of compliance and potential enforcement actions under the California Money Transmission Act (MTA).

Under the MTA, a person shall not engage in the business of money transmission in California, or advertise, solicit, or hold itself out as providing money transmission in the state, unless the person is licensed or exempt from licensure or is an agent of a person licensed or exempt from licensure. The MTA defines “money transmission” as any of the following:

  • Selling or issuing payment instruments
  • Selling or issuing stored value
  • Receiving money for transmission

In opinions issued on February 22 and March 23 of this year, DFPI found that companies operating what it termed “closed loop” digital currency marketplaces were not subject to the MTA, consistent with the closed-loop exemptions under the applicable federal regulations. However, also consistent with federal regulations, DFPI stressed that companies offering crypto-wallets may fall under the MTA regime.[1] For instance, in the March 23 opinion, DFPI reasoned that sales between the company and a customer of crypto products do not meet the definition of money transmission, in part because the transactions are “closed loop,” meaning that the value of funds can be used only for goods or services in transactions involving a defined merchant or location (or set of locations), such as a specific retailer or retail chain, a college campus, or a subway system. Significantly, however, both opinions stressed that DFPI’s decision “is subject to change,” and that “any time” it “may decide this activity (i.e., closed-loop access) is subject to regulatory supervision.” Further, both opinions stated that companies offering digital wallets may be required to register as money transmitters under the MTA. Although the February 22 opinion set forth that companies holding fiat currency meet the definition of “stored value” (i.e., a category of money transmission that would ordinarily require registration), because the wallets are offered only to facilitate the trading of digital currency (under the circumstances presented), DFPI did not require the company to be licensed under the MTA (in that it is inferred that the offering of wallets is merely incidental to the company’s underlying business activities); again, such conclusion is consistent with federal exemptions for money transmitters as well.

Next Steps

The California Order reflects the state’s intent to pursue early engagement and harmonization with stakeholders and the federal government on digital assets. Notably, the California Order does not purport to tackle specific technical issues or to fundamentally change the current digital asset regulatory landscape. However, it may accelerate the rate at which the state inserts itself into regulating the space, particularly as it collects and analyzes complaint data for California consumers. Other states may also soon follow suit, which raises the potential for inconsistent regulation and enforcement nationally. As the regulatory landscape for digital assets, crypto products, services, and related technologies continues to evolve, stakeholders should remain vigilant and attuned to the rapidly developing regulatory environment in order to minimize the risk of potential licensing requirements and enforcement actions and the business disruptions that may follow.

*Admitted only to practice in New York


[1] The opinions also highlighted the fact that the entities seeking guidance were subject to federal regulation under the Bank Secrecy Act for similar activity, including registration as a money services business with the Financial Crimes Enforcement Network.