Regulatory developments surrounding digital assets, and the lack thereof, have become preeminent issues in the blockchain industry. California’s newly minted Digital Financial Assets Law (DFAL), signed into law by Governor Gavin Newsom, is set to take effect in July 2025. It makes a significant stride towards a regulated digital asset landscape for California, and potentially the rest of the country.

At the heart of the California DFAL is the mandate for providers engaged in “digital financial asset business activities” with California residents to adhere to a licensing regime. The activities referred to in the law include the exchange, transfer, custodianship, and issuance of digital financial assets. The law outlines certain exemptions, notably for banks, connectivity software providers, miners, and entities that transact less than $50,000 annually in digital financial assets. “Digital financial assets” are defined to mean digital representations of value that are used as a medium of exchange, unit of account or store of value, in each case, that are not legal tender.

The legislation empowers the Department of Financial Protection and Innovation (DFPI) with examination and enforcement authority over bitlicensees, similar to the oversight the DFPI presently enjoys over money transmitters. A pivotal reporting requirement is for licensees to report material changes to their virtual currency business activities within a 15-day window of making such changes.

A benefit of this reporting structure is that, unlike the New York framework, California’s law does not necessitate DFPI’s pre-approval for launching product changes. However, the law does not clearly define what constitutes a “material change”, and this does not prevent the DFPI from determining that a launched product should be pulled on other grounds. 

Moreover, entities intending to sell or exchange digital financial assets have to submit certifications regarding the appropriateness of offering each digital asset to the DFPI. Again, although the law doesn’t require pre-approval before listing a new digital asset, this certification requirement may in effect grant the DFPI a de facto right to review and potentially object to listings under its broad authority to curb unsafe or deceptive practices.

Mirroring the consumer-centric ethos of New York’s Bitlicense, the California law requires licensees to submit disclosures similar to those required in New York, such as disclosures covering applicable fees, availability of insurance coverage, irrevocability of transactions, and error resolution rights pertaining to the licensed services. Licensees must also ensure 1:1 control of digital financial assets being custodied for residents, ensuring a robust safeguard against consumer losses.

The legislation also echoes federal Electronic Funds Transfer Act (EFTA) provisions, designed to protect consumers in electronic fund transfers. For instance, it mandates at least a 14-day notice prior to altering fees or other significant terms and conditions, alongside a requirement for licensees to provide on its website a toll-free customer assistance number, which, in the case of California, must be operative 10 hours per day, Monday through Friday, excluding holidays.

Amid ongoing deliberations by federal regulators and courts on the applicability of existing consumer protection laws to digital assets, California’s stance symbolizes a progressive effort to argue the capability of states in offering these protections. It is clear that the states feel the urgency to fill this void in the face of the glaring lack of federal certainty on the topic.

Another noteworthy provision is a pathway for conditional license eligibility for entities who have been issued a Bitlicense under New York’s analogous virtual currency regulations prior to January 2023, but are experiencing certain DFPI delays with review of their application. This provision could streamline the licensing process for firms already operating in New York, potentially fostering a regulatory harmony between the two states.

California’s Digital Financial Assets Law marks a milestone in the evolving regulatory discussion surrounding the digital assets industry. While offering a structured licensing and enforcement framework, the legislation also accentuates the importance of consumer protection, a crucial aspect in fostering public trust and promoting broader adoption of digital financial technologies. Amidst uncertain federal legislative and regulatory waters, the dialogue between legislators, regulators, industry stakeholders, and the public will be instrumental in shaping a conducive environment for innovation while ensuring the integrity and safety of the digital asset ecosystem.