The New York Department of Financial Services (NYDFS) released a proposal today to regulate bitcoins and other forms of virtual currency, making New York the first state to draft up regulatory legislation for virtual currencies.

The NYDFS is proposing to issue “BitLicenses,” certificates allowing holders to transact in virtual currencies in New York State. The license will be required for almost any company conducting business in bitcoin, but not merchants who simply accept the cryptocurrency as payment.

Jim Jalil, senior partner at Thompson Hine LLP and the firm’s cybercurrency chair, said, “[The proposal is] very broad, but I think from a consumer protection aspect it’s very much in line. It’s important to note that Superintendent Lawsky noted that they wanted to regulate virtual currency ‘without stifling beneficial innovation.’ For a government to come out and say that they won’t stifle innovation and work with bitcoin community is a very positive step.”

The Consumer Finance Protection Bureau (CFPB) released a statement to Bank Innovation regarding the NYDFS proposal:

The CFPB is working to identify and understand potential consumer protection concerns raised by these emerging technologies and to determine what steps may be necessary to protect consumers. We will continue to carefully monitor the development of digital currencies as they relate to the consumer financial marketplace.

The Government Accountability Office suggested that the CFPB should be more involved in bitcoin regulation.

The biggest shift is that bitcoin users will no longer be able to conduct transactions anonymously. The proposal says that “companies must provide clear and concise disclosures to consumers” and provide names and addresses for customers. The draft writes that this is to combat a number of issues, including the fact that virtual currency transactions are irreversible and bitcoin’s notorious price volatility, among others.

This is a departure from bitcoin philosophy, which dictates that transactions should be completely anonymous and made the virtual currency appealing to users. However, with the Silk Road incident and Mt. Gox bankruptcy last year, the NYDFS looks to not only protect the consumer but also prevent illicit activity occurring through virtual currency.

In addition, Bitcoin companies must have a compliance officer on staff, who will work directly with the NYDFS. The NYDFS will also be conducting audits to prevent money laundering, so companies will need to keep strict records.

Companies will be required to hold on to assets equal to 100% of the amount being held for consumers and have a bond with the New York State, which will range in value to be determined by the NYDFS. If this sounds familiar, it’s because financial institutions deal with similar compliance regulations. Jalil thinks that this shows the NYDFS is “viewing bitcoin more as a currency equivalent” than the IRS did when it decided to tax bitcoin as a property (Jalil noted that the IRS didn’t say that bitcoin was property).

“I think it’s meant to level the playing field between banks and bitcoin dealers,” Jalil said. “The bitcoin community will want to make sure the regulations make sense and [are] not overly zealous.”

The proposal further legitimizes bitcoin as a tool for transactions, though there are some costs, both philosophical and monetary.

One of the distinct advantages bitcoin has over fiat currencies is that transaction fees are minimal, so companies can cut costs. But the NYDFS regulations may mean companies will need to spend more on compliance, which could lead to fees for transactions. Anonymity is also a prized aspect of cryptocurrency to many bitcoin users. It seems the N.Y. State regulation will get rid of the anonymity bitcoin users cherish.

How will news of this regulation go over? Our guess is, not well.