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On Friday, Attorney General Letitia James proposed a bill that would grant the New York Department of Financial Services increased regulatory powers over digital assets. If passed, the bill would require exchanges to compensate customers who fall victim to fraud.

"We're proposing commonsense measures to protect investors and end the fraud and dysfunction that have become the hallmarks of cryptocurrency," James said.

The crypto industry is facing a significant hurdle with the introduction of a new bill in New York, which directly contradicts some of the core practices of crypto companies. These firms often provide a range of services such as trading platforms, custody solutions, and brokerage services under a unified model, which could be deemed an illegal conflict of interests under the proposed legislation. Furthermore, the bill seeks to restrict marketplaces from holding customer funds in custody, adding further complexity to the regulatory landscape for crypto businesses.

In the past few months, New York Attorney General Letitia James has been actively targeting crypto companies such as Celsius, KuCoin, and Nexo. She has argued that certain crypto tokens should be classified as commodities or securities, despite the ambiguous legal framework surrounding the matter. James has also taken to Twitter to announce that the proposed bill would grant her additional enforcement powers in this regard. With a lack of federal oversight on crypto, New York has taken on a leading role in regulating the industry in the US. Other states, such as California and Illinois, have attempted to follow suit but have yet to establish concrete regulations.

James' tweet highlighted that the proposed legislation aims to impose comprehensive disclosure requirements on a broad spectrum of stakeholders, ranging from crypto issuers and exchange platforms to digital asset influencers. The disclosure would include information regarding potential risks and conflicts of interest for investors. Additionally, crypto companies would be prohibited from borrowing or lending their customers' assets.

"The bill would grant the Attorney General jurisdiction to enforce any violation of the law, issue subpoenas, impose civil penalties of $10,000 per violation per individual or $100,000 per violation per firm, collect restitution, damages, and penalties, and shut down businesses engaging in fraud and illegality," a press statement from Friday said.

The New York Department of Financial Services (NYDFS) currently regulates the state's crypto activities and oversees the "BitLicense" program, which has been a topic of controversy. However, the fact that several members of the state's legislature have expressed support for James' bill implies that the NYDFS may not possess adequate authority to effectively govern the crypto sector.

“I applaud New York State Attorney General Letitia James for the timely introduction of this legislation to protect New Yorkers from financial harm by establishing a comprehensive regulatory framework for the opaque cryptocurrency market,” State Senator Kevin Parker said in a press statement, while Steve Otis, state lawmaker representing Westchester County, called the legislation "groundbreaking."

“The lack of transparency plaguing the crypto industry causes immense harm to countless investors, especially low-income New Yorkers and people of color who carry a disproportionate share of the losses,” New York City Comptroller Brad Lander said.

An NYDFS spokesperson told CoinDesk in a statement that the regulator was currently the "only prudential regulator" that has crypto-specific authority in the U.S., and "it is DFS’s priority to ensure that consumers and markets are protected and New York continues to be the global financial center."

"Recent DFS guidance has made clear expectations around the use of blockchain analytics technology, U.S. dollar-backed stablecoin issuance, banks engaging in virtual asset activity, and consumer protections in light of insolvencies," the spokesperson said. "Earlier this year, the Department was the first regulator to address Binance, ordering Paxos to cease minting Paxos-issued BUSD, ameliorating risks before consumers were harmed. The Department also reached a $100 million settlement with Coinbase after an investigation found that the platform was vulnerable to serious criminal conduct, such as money laundering, suspected child sexual abuse material-related activity, and potential narcotics trafficking."

In March, James filed a lawsuit against KuCoin, alleging that certain tokens, including ether (ETH), should be considered securities that require registration with her office. Similarly, in a separate case against CoinEx, she made analogous claims regarding the LUNA token, which was linked to the now-defunct stablecoin terraUSD.

Earlier this week, Alex Mashinsky, who is the founder of Celsius, refuted allegations made by James that he had provided false information to investors regarding the crypto lender before it declared bankruptcy in the previous year. Mashinsky argued that James had selectively chosen statements made to investors to support her claim.

James' proposed legislation aims to formalize the New York State Department of Financial Services (NYDFS) as the regulatory body responsible for licensing and supervising cryptocurrency brokers, marketplaces, investment advisors, and issuers before they commence operations within the state.

Andrew Hinkes, a partner at the law firm K&L Gates, expressed his belief via Twitter that the bill is doomed to fail due to a fundamental misunderstanding of the nature of cryptocurrencies. Hinkes argued that the provisions of the bill would not be applicable to decentralized organizations, and that the market does not currently offer the necessary auditing or insurance options proposed by James.

In order for the bill to take effect as state law, it is still necessary for it to be approved by the state legislators.

Earlier on Friday, both The Wall Street Journal and Bloomberg had published reports about the bill.