Category Archives: Regulation

Bitcoin and government regulation

Governments are starting to regulate Bitcoin and other cryptocurrencies. Is this good or bad? Why? Norbert Michel and I wrote a Heritage Backgrounder piece on Bitcoin and other cryptocurrencies, Bits and Pieces: The Digital World of Bitcoin Currency. We discuss the main aspects of Bitcoin without getting into technical details. We also discuss some of the possibilities for the future and indicate ways that the government can adapt to stay out of the way.
We don’t really take a stand on whether Bitcoin itself will succeed; time will tell that.
We do point out ways that the growth of Bitcoin and other cryptocurrencies could be throttled by government regulation and laws and suggest ways to avoid that outcome.

Bitcoin, Regulation and Bitcoin’s Future

Is regulation the likely downfall of Bitcoin? Last week at the conference for the Association of Private Enterprise Education, a session included speakers with differing points of view about Bitcoin’s future. One speaker pretty clearly suggested that regulation would be the downfall of Bitcoin. Is that plausible?

I interpret regulation as being the setting of rules by administrative agencies which are not courts as commonly understood. The “not courts as commonly understood” here is somewhat convoluted, but many administrative agencies in the United States have branches which resolve disputes in some ways similar to resolution by the judges.

With this definition, contract law and other rules applied by courts are not regulation, even though they are very important. Most importantly, there have been few if any court cases alleging fraud in the Bitcoin community. While not rampant, there have been serious frauds. In addition, criminal law is not regulation. For example, theft – taking something of value from a rightful owner — is a crime in most (all?) countries. While there are well known instances of theft – summarized at Wikipedia – nothing much seems to have been done about bringing the thieves to justice.

It is quite likely that fraud and thefts will be pursued more seriously than in the past. Bitcoins are worth far more than in the recent past. 400 bitcoins are worth $20 at $.05 per bitcoin and $200,000 at $500 per bitcoin.

If someone steals 400 bitcoins when they are $.05 apiece, there is not much point in doing anything about it. Of course, there’s not much monetary gain from stealing them either. On the other hand, when bitcoin are worth $500, stealing 400 bitcoins is no small thing. Similarly, someone defrauded of $20 is not likely to do much about it other than learn from the mistake. $200,000 is quite another matter.

It’s hard to imagine that bitcoins will not be subject to much more legal oversight than in the past. This is not the same as regulation.

Examples of regulation include the application of specific laws before starting an exchange for digital currencies compared to laws which apply to any other exchange, for example for collectors’ postage stamps.

Financial regulations have their own nuances. Before starting a bank in the United States, the backers must show they have the skill and assets to successfully operate a bank. They also must show that there is enough demand for banking services to support existing banks and the new bank. This is far different than opening a new grocery store. Still, this arrangement is better than the situation in many other countries, in which there is no effective way to start a new bank.

No doubt there will be attempts to regulate bitcoins along the lines of other financial enterprises. It remains to be seen how effective that regulation will be. For example, if New York state requires a license before someone starts an exchange for digital currency, the only thing affected is the probability that an exchange will start in New York state. It will be zero. If the United States government requires a license before starting an exchange, the only thing affected is the probability that an exchange will start in the United States. It will be zero, although it is not particularly high anyway.

It strikes me as implausible that regulation will stifle digital currencies in a serious way. It is too easy to get around the regulations. For example, Satoshi Dice is said to block U.S. addresses. Even if they are blocked, it is not hard to use Tor to have an address apparently outside the United States.

Bitcoins probably have the greatest immediate potential in countries such as Argentina, which has serious inflation. Inflation generates revenue from the government at the expense of money holders. Bitcoin is an attractive alternative to Argentinian pesos. While U.S. dollars are attractive also, holding them is illegal and U.S. dollars are harder to conceal than bitcoins. Argentina has dollar-sniffing dogs, but a bitcoin has no smell or other physical presence besides a sequence of numbers and letters.

In short, bitcoins are a way to get around regulations. While that may sound nefarious or evil to some, it doesn’t to me. More to the point, it strikes me as a positive for bitcoin’s continued use.

 

The drumbeat for regulation of bitcoin after Mt. Gox’s failure has begun, with an op-ed in the Wall Street Journal by Ezra Galston claiming that

In the near term, the bitcoin community must embrace external regulation to ensure that credible vendors may participate in payment processing. A “BitLicense,” proposed by the New York State Department of Financial Services, is a good start, but transmitter laws that differ by state may leave payment processors just as hesitant.

This is reminiscent of the call by Ben Lawsky for “smart” regulation by New York State. He takes it for granted that U.S. citizens would be better off dealing with a U.S. exchange – Lawsky hopes in New York state – instead of using an exchange in a foreign country.

Mt. Gox and similar exchanges are a remarkable development. At Mt. Gox, a customer could transmit an order to the exchange to trade bitcoins for currencies or currencies for bitcoins. The order could be submitted 24/7 and it could be executed 24/7. Mt. Gox did not limit trading by hour of the day or day of the week. No broker received a payment when the order was submitted; the trade was submitted online by the owner of bitcoins or currency.

I have found no evidence in Mt. Gox’s trade data of any lull in trading at any regular hours or any regular days of the week. To some extent, this probably is true because many holders of bitcoins are hackers (in the good sense) and they famously keep irregular hours. It also probably is true because Mt. Gox’s customers were located in many different time zones. Indeed, my purchase of a bitcoin might be a purchase from someone living on the other side of the planet.

None of this is true of regulated exchanges in the United States. Hours are limited. Orders are submitted through a firm that is a member of the exchange and a payment is made to the member for submitting the order. Some trades cannot occur without human intervention because of exchange rules. At least for American citizens, it is no small thing to open an account at established exchanges in other parts of the world. (We have the U.S. government to thank for that.)

Regulation to make bitcoin exchanges more similar to U.S. exchanges will not make trading better from customers’ point of view.