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In a move that has upset many in the bitcoin community, New York has become the first state to issue guidelines for the regulation of the trade and storage of bitcoins and other virtual currencies. With New York City being the hub of the nation’s financial network, state regulators introduced the new rules in an attempt to introduce safeguards to cryptocurrencies — which have received scrutiny recently as several states have moved to remove restrictions on virtual currency use or to clarify existing virtual currency laws.

The proposal introduced Thursday by the New York State Department of Financial Services would establish a mandatory “BitLicense” for any company involved with the buying, selling, mining or trading of cryptocurrencies. Licensed firms would be required to learn the names of all cryptocurrency customers they accrue; maintain a reserve of cryptocurrency funds equal to 100 percent of all deposits — similar to cushioning requirements for banks; carry bonds to protect their customers from theft or collapse; and submit to security audits.

“We have sought to strike an appropriate balance that helps protect consumers and root out illegal activity — without stifling beneficial innovation,” said Benjamin Lawsky, New York’s Superintendent of Financial Services. “Setting up common sense rules of the road is vital to the long-term future of the virtual currency industry, as well as the safety and soundness of customer assets.”

These requirements are meant to safeguard cryptocurrency transactions from incidents like the collapse of Mt.Gox. The bitcoin market is still recovering from the fallout of Mt.Gox, which saw 850,000 bitcoins lostdue to alleged hacking attacks earlier this year. So far, only 200,000 bitcoins have been recovered.

The licensing requirement is also meant to create a “paper trail” to assist in attempts to combat the use of cryptocurrencies in money laundering and in illicit merchandise trafficking. Merchants and consumers that utilize cryptocurrencies solely for buying and selling goods and services, however, would be exempt from the license requirement.

Critics of the new proposal point to the notion that the large compliance cost — in particular, the establishment of an investment “cushion” — would stifle the growth of small or mid-sized bitcoin companies, making it difficult for these companies to invest their earnings freely. Such rules would benefit highly capitalized bitcoin players, shifting control of the bitcoin market from individual miners and investors to Wall Street firms and major capitalists, such as Cameron and Tyler Winklevoss — twin brothers who sought to create the bitcoin instant payment exchange BitInstant and, at one point, claimed to own 1 percent of all the bitcoins available on the market at the time.

The fact that bitcoin processors would be required to disclose to the state of New York the names of their customers, however, threatens to undermine the single-largest selling point for the use of cryptocurrencies: anonymity. Many who subscribe to the idea of cryptocurrencies do so because they have an inherent distrust of government involvement in commerce and hope to be able to use money not attached to a centralized bank or to a national regulatory network. New York state’s attempt to turn bitcoins into a safe investment vehicle may ultimately push away the original supporters of virtual currency.

Others, such as Bryce Weiner, director of Cryptoeconomy Engineering for the Blockchain Technology Group, argue that the disclosure of the names of cryptocurrency customers, along with metadata analysis, would lead to the compromising of cryptocurrency customers’ privacy.

“The combination of that published metadata analysis and the proposed regulations would lead to effectively ending the privacy of cryptocurrencies and regulate the creation of any new currencies developed in the US, which would not only cost American jobs as development firms move to more welcoming countries, it would ultimately stifle innovation and protect bitcoin from competition,” Weiner wrote to Business Insider.

New York’s licensing requirements also reinforce the notion that cryptocurrencies are to be seen as a commodity with an established cash value — similar to stocks —  and not legal tender. The Coinage Act of 1965 defines legal tender as “United States coins and currency,” effectively establishing the federal government’s sole authority to control and regulate the nation’s monetary supply. The IRS’s March clarification establishing virtual currency as property subject to capital gain gave the states justification to establish property management rules for its use.

New York state’s proposed legislation may, however, be in violation of federal law. As securities in the U.S. are exclusively regulated by the federal government, the proposed controls may prove to be an overreach, if challenged in court. However, as the federal government has yet to establish the legal status of cryptocurrencies and is unlikely to do so in the near future, the states are moving to make sense of the ambiguity.

Last month, California dropped its ban on all virtual currencies, including cryptocurrencies and loyalty points. Prior to this, the use of “community currencies” — as they were known in California — was discouraged and was not recognized in state courts. The Texas Department of Banking in March took the official stance that cryptocurrency transactions are not — in a technical sense — “currency” transactions, but property transactions, as cryptocurrency is not money, per federal regulations.

The Bitcoin Foundation, an organization that works to promote the virtual currency, argues that new and separate rules may not be the best way to promote security within the cryptocurrency. Instead, bitcoin operators should be included in existing securities regulations. This would lend both credibility and fairness in dealing with virtual currencies as investment and trading vehicles.

The proposal will enter a 45-day public comment period, starting July 23. After the end of the review period, a final set of rules will be drafted before the Department of Financial Services votes to approve the rule change. This vote is expected in September or October.