Crypto 1.0’s Original Regulator Is Preparing For Web3

Perhaps no regulator in the world has been at the forefront of the cryptocurrency industry than the New York Department of Financial Services (NYDFS). From holding its first virtual currency hearings in 2013 to the creation of the famed “BitLicense” in 2014, which was the first bespoke piece of regulation focused on crypto in the country, the NYDFS has played an outside role in the development of crypto across the world.

As we are preparing to enter a new stage of industry development due to the advent of Web3, increased regulatory pressure as a result of the LUNA/UST collapse, and more institutional money coming into the space I reached out to NYDFS Superintendent Adrienne Harris to get her thoughts on how the NYDFS has grown and adapted to changes in crypto. She also shed some interesting insights on how the agency is scaling up and building out its expertise to track everything from stablecoins to NFTs.

I spoke to Harris on the sidelines of Chainalysis’ Links conference in New York City on May 19.

Forbes: To start off, could you give me a quick rundown of what you spoke about on stage?

Adrienne Harris: We covered a wide range of things. We talked a lot about the DFS and what we do, regulating about 80 foreign banks—17 of the 30 G-SIBs (global systemically important banks)—in addition to state-chartered banks and insurance companies. It really is a preeminent global financial regulator just by virtue of being here in New York, and we have such a broad purview of the financial services space, from student lending all the way up to the largest and most important financial institutions in the world. We obviously talked quite a bit about crypto, including our internal transformation initiative around our licensing with the BitLicense and the limited purpose trust charter. We call that transformation initiative VOLT for “vision, operations, leadership and technology.”

We’re working very hard to maintain DFS’s role as the preeminent digital asset regulator. As you know, DFS was the first to regulate the sector, and we continue to improve and do new things, like our blockchain analytics guidance. We’re soon to put out some stablecoin guidance that we’ve been working on for a while. So, in terms of vision: maintaining that status as the preeminent regulator and cementing New York’s place as the financial capital.

In terms of operations, my goal is to have operational excellence in everything we do across the board and, certainly, with respect to crypto. That means making sure we have standardized processes when we think about licenses, bringing the application times down. To that end, we talked about the new assessment authority that we’ve got, but really, we’re making sure we’ve got process improvements in place to be efficient and effective and maintain the regulatory rigor that the space requires.

As for leadership, we’ve already brought 15 new people into the virtual currency unit this year, and we’re looking to probably 3x the size of the staff this year and continue to grow it from there. Pete Marton, whom we brought in, is a great example. He is an amazing thought leader and a well-known person in the space. Now having the assessment authority (they can charge operational fees to companies they regulate) we’ll have the resources we need to continue to grow the staff at the pace we need to grow it and all the tools at our disposal, whether it’s guidance, FAQs or regulations, to continue to make sure we’re leading the space in terms of thinking about developments.

The last thing is technology. We’re obviously using blockchain analytics in-house as part of our role as a regulator to do transaction monitoring. As I mentioned, we also issue guidance to encourage the marketplace to use blockchain analytics for its own compliance purposes. So, VOLT is how we think about all the things we’re doing in the virtual currency area.

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Forbes: There were a lot of concerns surrounding the Russia-Ukraine war and illicit crypto transactions potentially taking place. How did you approach that challenge? What did you do to assuage fears or perhaps track this illicit activity?

Harris: We were able to act very quickly, within a day and a half of the war’s start, to issue guidance to all our regulated entities—not just virtual currency companies—to make clear our expectations that they would be in compliance with sanctions requirements and be engaged in transaction monitoring. Thanks to Governor Hochul, we were able to expedite procurement of the blockchain analytics tools that I was just talking about so we could use those as our tools internally to do transaction monitoring and other things. We also have daily engagements with our companies to make sure they’re staying abreast of illicit finance generally, but also as it relates to the war. There’s not a day that goes by that the team isn’t talking with OFAC, FinCEN, the FBI and other law enforcement agencies. That coordination has been wonderful. Given our role as a global regulator, I’m very glad that we were able to act so quickly.

Forbes: The other big story today is the downward trajectory in the market. We’ve observed the bearish trend for the past several months, but we saw a dramatic shift recently with the TerraUSD collapse. How did DFS respond to that? Looking ahead, how does that impact the work that your team is doing?

Harris: With respect to stablecoins, we have a robust framework where we require collateral reserve of cash or cash equivalents on a one-to-one basis with on-chain tokens. We also require third-party attestations to the reserving and a series of internal and independent audits of the company. So, a lot of stuff the PWG (Presidential Working Group) laid out and recommended earlier this year is the stuff that we do. In addition to the blanket regulatory requirements that we have for the licensing process, we also have individual supervisory agreements with every one of our licensees. That allows us to tailor our supervision and to tailor exams to the idiosyncratic risks that different business models and product offerings pose. It’s a great tool over and above the blanket regulatory requirements, which are already quite rigorous.

Forbes: Now I want to talk about you. You’ve been in this role now for about eight months. What has it been like?

Harris: I have a long history in financial services, both in the public and private sectors, and I think that really informs the way I approach this role. I’m a firm believer that we can protect consumers, protect the market, ensure the safety and soundness of our regulated institutions—and still have New York be a good place to do business. In the crypto area in particular, the BitLicense and the limited purpose trust charter frameworks that we have are the most rigorous in the country, and yet, we only see increased demand for companies to be here and be licensed by DFS. I think that sort of philosophy really does inform the way I approach this role.

The other thing I would say is I’m very focused on “kitchen table” issues. Not just with respect to crypto, but more generally, as we think about the enforcement powers DFS has that are really incredible. We will obviously bring the big cases when we have large institutions that are breaking the law. We won’t hesitate to do that, and we’ve done it in my time. But I’m also very focused on those kitchen table issues where we had, for example, insurance companies violating mental health parity requirements. We had a life insurance company that wasn’t looking for beneficiaries and wasn’t paying out benefits when policyholders passed away. I think one thing that goes underappreciated about DFS is that we have the ability not to just bring penalties against companies when they break the rules, but we can also require remediation. We can also in some cases get restitution for consumers. That’s incredibly important to me. We have a number of tools that we can use in addition to enforcement, in addition to regulation, and we have a fantastic team that we’re growing all the time. That’s all been wonderful for me to experience in this role.

Forbes: I want to ask you about a few bigger trends I’m seeing in the world of finance, especially when they collide with crypto. For one, fintechs purport to be tech companies but many are financial firms at their core. Sometimes they also fall between the cracks or straddle the lines of regulators. Look at Robinhood Crypto or FTX beta-testing tokenized stocks. What challenges does that present to you? And how are you guys looking to respond?

Harris: As you noted, we do have broad authority. It’s my firm view that fintech should be regulated as it evolves, to your point, and takes on new dimensions, new products and new business delivery mechanisms. Regulators need to be innovating right along with them to make sure that consumers and markets are protected. One of the great things about being at a global regulator like DFS is that we do have a lot of tools to make sure we’re staying abreast of those developments, regulating appropriately—whether it’s through writing, guidance or enforcement actions where we need to step in. What I think about financial services—whether they are being delivered through a brick-and-mortar context, on one’s phone, if it’s embedded finance, if there’s AI involved—is that it’s important that we’re creating a financial system that’s equitable, transparent and resilient and that we are making sure that we’re protecting consumers and markets.

Forbes: How do data privacy and privacy law fall within this context of fairness, transparency and equitability? Also, I’m sure you’re seeing a lot of discussion about Web3 and its promise to break down some of these data silos that have dominated Web2. How does this discussion fall within your remit?

Harris: There are lots of existing frameworks. As we think about data privacy and financial services, financial regulation is evolving and will continue to evolve, and we need to make sure that it does, especially as we consider data that we didn’t traditionally think of as financial data but now very clearly is. It’s used by providers and consumers to make financial decisions, so the regulations have to evolve accordingly. We just brought on Kaitlin Asrow as the head of our research and innovation division. She came to us from the San Francisco Fed and the board, and her specialties are data, data privacy and Dodd-Frank 1033, among a number of other things. So, it’s something we care very much about, making sure that we’re staying abreast of developments there as we think about AI. Are there ways it can be used to build robust markets on behalf of consumers, but also guard against things like data privacy issues, discrimination and bias that often comes along with AI and other things? It’s something we spend a lot of time thinking about.

Forbes: Anything you’d like to share on NFTs?

Harris: One of the things we talked about on stage was how the digital assets sort of shapeshift. It’s true for NFTs (non-fungible tokens) as well. Is it a financial asset when it can be music, art and tickets? Certainly, it’s something we spent a lot of time on, and folks will hear more from us in the coming weeks and months on that.

Forbes: New York is the epicenter of financial services in the U.S., but a lot of the states are now really trying to become friendly domiciles for crypto, Wyoming in particular. Some other ones are laying out the red carpet for miners. How does that impact your work?

Harris: As I said in the beginning, I am a firm believer that we can have a rigorous regulatory framework and be a great place to do business. I think the facts really bear that out. Wyoming has done a lot of incredible work. They have about six companies, I think, that have taken advantage of the SPDI license versus our 33 licensees and many, many more in the queue. I think the good actors in the space are really attracted to the rigorous regulatory framework we have in New York. To that end, when we look at venture capital investment in crypto last year, 46% of it was in New York-based regulated companies. That’s two times the investment we saw in Silicon Valley and eight times the investment we saw in Miami. So, I think the good actors in the space want to be regulated. They value the clarity and the rigor that we bring in New York, and we just see continued increased demand for our regulations.

Forbes: Thank you for your time.