Bitcoin may be a $1.2 billion marketplace, but the virtual currency still operates in a legal gray area: Companies that accept Bitcoin as payment--including reddit, Wordpress, and Mega--aren't breaking the law, but they aren't exactly complying with it either. That's because there are no laws governing Bitcoin--yet.

On Monday, New York's top bank regulator announced it was launching a probe into Bitcoin. The New York Department of Financial Services subpoenaed 22 Bitcoin merchants, including the Winklevoss Capital Fund, a Bitcoin ETF led by the Facebook-famous Winklevoss brothers. The subpoenas were met, somewhat ironically, with open arms. Why? 

"In the Bitcoin world, we love regulation," Cameron Winklevoss, the founder of Winklevoss Capital Fund said recently. "I don't want to facilitate bad uses of money as much as anybody else." 

Clamoring for More Regulation

As the use of Bitcoin grows, the companies that stand to profit off its legitimization have recognized that regulation--usually the dirtiest of words among entrepreneurs--might actually be the most effective route to the long-term success of their businesses.

Which makes sense, especially for the entrepreneurs and VC firms behind new Bitcoin start-ups. As one redditor points out:

There is certainly some "legitimacy" to be gained, in the short run, by getting bitcoin under the full complement of federal and state alphabet soup agencies. The boost to the comfortability with crypto-currencies as an asset class; one watered-down enough to be palatable to retirees and institutional investors alike, could propel adoption to new heights not yet seen.

The only problem is that Bitcoin--which is a largely decentrilized, anonymous currency--operates completely outside the realm of traditional payment systems. That, in turn, means no specific government agency would be in charge of overseeing it. 

So despite several desperate pleas from Bitcoin upstarts to regulated, various government authorities that regulate the currency have declined to take any significant action. 

Put another way: it all boils down to typical political bureaucracy.

The Hot Potato

In March, FinCEN, a division of the Treasury, issued guidelines on dealing with virtual currencies, but declined to cite Bitcoin specifically. The Department of Justice shut down the private currency exchange system Liberty Reserve in May, but made no attempt to create a framework for acceptable Bitcoin transactions. A month later, the head of the Commodities Futures and Exchange Commission said the agency was researching whether or not Bitcoin would fall under their purview, but have no made announcements since. In July, the Securities and Exchange Commission charged a Texas man with running a Bitcoin Ponzi scheme, and issued an investor alert about the risks of virtual currencies, including Bitcoin. But they, too, have not chosen to pursue any sort of formal regulation. Perhaps the most promising development was when, in June, the Federal Reserve announced it was studying the potential risks of Bitcoin. 

Earlier this week, Senators Tom Carper (D-Del.) and ranking member Tom Coburn (R-Okla.), sent letters to several of these agenices, urging them to review Bitcoin as a regulated currency. But their comments didn't offer any specific guidance on where to start.

"As with all emerging technologies, the federal government must make sure that potential threats and risks are dealt with swiftly," the senators wrote in a letter obtained by Politico. "However, we must also ensure that rash or uninformed actions don't stifle a potentially valuable technology."

Why It's Tricky

If the government could ever find a way to officially regulate Bitcoin, it would need to involve the collaboration of many of the agencies mentioned above--a notoriously difficult process in the nation's capital. So far, the various agenices' baby steps towards addressing Bitcoin's proliferation are laudable, but ultimately pretty useless in setting up a regulatory framework. 

That regulation may come one day, but perhaps an even bigger issue is what official regulation might do to Bitcoin. Right now, the Bitcoin entrepreneurs clamoring for more regulation seem to think that regulation would make their businesses more legitimate, and therefore attract more Bitcoin users (or more aptly, customers). But there's a flip-side to this argument, particularly for the long-term prospects of the currency. 

If the government does get its act together and legitimize Bitcoin as a currency, it will inevitably compromise some of the currency's core features--e.g. its anonymity, cost (exchanging Bitcoins are virtually free), and general ease of use. In other words, regulation will almost certainly come with unintended consequences. And ultimately, the Bitcoin entrepreneurs pushing for more regulation may find themselves victims of their own success.  As Timothy Lavin at Bloomberg writes

The closer Bitcoin gets to being an accepted currency, the less useful it will be as a method of exchange. And the less useful it is as a method of exchange, the harder it is to see why it has any value at all.

Published on: Aug 13, 2013