On November 20, 2023, the California Department of Financial Protection and Innovation (DFPI) issued an invitation for comments on proposed application-related rulemaking under the Digital Financial Assets Law (DFAL). This move comes after Governor Gavin Newsom signed Assembly Bill 39 and Senate Bill 401, which together create the DFAL. The DFAL and Senate Bill 401, signed into law by Governor Gavin Newsom on October 13, 2023, are set to regulate virtual currency activities within California, effective July 1, 2025.

The DFAL outlines specific definitions, license requirements, compliance obligations, and stablecoin approvals, among other guidelines. It prohibits any person from engaging in digital financial asset business activity with or on behalf of a resident unless they meet certain criteria and obtain a license from the DFPI, are exempt from licensure, or are awaiting approval of a license application submitted on or before July 1, 2025. The DFAL does not apply to 17 categories of persons, e.g., banks, certain trust companies, credit unions, persons who use or obtain a digital financial asset as payment solely for the person’s behalf or for personal, family, household, or academic purposes, and persons whose digital financial asset business activity with California residents does not exceed $50,000 per annum.

Licensees will be subject to various compliance requirements under the DFAL, including customer protections (e.g., licensees with control over digital financial assets for more than one person must maintain an amount of each type of digital financial asset sufficient to satisfy the aggregate entitlements of the respective individuals), exchange listing requirements, transaction recordkeeping, annual reporting, ad hoc reporting, M&A approval, disclosure requirements, and the establishment of policies and procedures.

The DFAL also has specific implications for stablecoins, prohibiting a covered person from exchanging, transferring, or storing stablecoin where the issuer of such stablecoin is not a bank, trust company, or national association authorized under federal law to engage in a trust banking business or licensed under the DFAL. The DFAL mandates certain obligations for stablecoin users, such as the requirement for an issuer to possess eligible securities in a one-to-one ratio with its circulating stablecoin. In addition, before a stablecoin can be traded, moved, or held in California or by Californians, it must first receive approval from the DFPI’s commissioner. The State Senate bill supplements the DFAL by setting limits and disclosure requirements for operators of digital financial asset kiosks.

The DFPI is considering rules to facilitate the DFAL licensure process and seeks public comment on topics related to the DFAL license application, licensure requirements, and stablecoin approval. The invitation for comments is an opportunity for stakeholders to propose specific rule language and provide an estimate of the potential economic impact on businesses and individuals affected by the language.

The DFPI has outlined several topics for discussion. These include the license application form and related fees, surety bond and trust accounts, capital requirements, and the stablecoin approval process, including the risks potentially impacting the redeemability of stablecoins. The DFPI is also seeking input on the future rulemaking actions related to the administration of the DFAL.

Interested parties are invited to submit comments by January 12, 2024, by email or by mail. Additionally, the DFPI is planning to host a Virtual Informal Listening Session on January 8, 2024, to discuss feedback on this invitation for comments. If interested in attending the Virtual Informal Listening Session, stakeholders must email regulations@dfpi.ca.gov.

This invitation for comments is a significant step towards California’s development of a regulatory framework for digital financial assets and provides an opportunity for stakeholders to contribute to the shaping of regulations that will govern the future of digital financial assets in California.