Bitcoin Regulation Is Coming – Here's What To Expect

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We're on the verge of a defining moment in the drama-filled life of Bitcoin.

In light of all the troubling issues that have plagued the digital currency over the past year or so, some think Bitcoin regulation would help limit its use for illicit purposes while adding an air of legitimacy.

But others warn that too much Bitcoin regulation too soon could discourage startups and snuff out innovation.

What is not in question is that some level of Bitcoin regulation is very much on the radar of government, both in the United States as well as overseas.

Governments that fear and dislike the decentralized nature of Bitcoin have already taken drastic steps against the digital currency.

In China, it's been almost impossible to exchange yuan for Bitcoin since December, though it is still legal to trade it. In January, Canada ruled that Bitcoin "is not legal tender." And just this month, both Russia and Indonesia have banned Bitcoin outright, citing its use for illegal activities.

The United States, somewhat surprisingly, has so far taken a more measured approach to Bitcoin regulation. Top regulators at both the federal and state level do want to create safeguards, but haven't made any rash moves because even they recognize the powerful economic potential of the digital currency.

"Our objective is to provide appropriate guardrails to protect consumers and root out money laundering - without stifling beneficial innovation," Benjamin Lawsky, superintendent of New York's Department of Financial Services, said at a recent Washington conference on digital currencies.

That's much easier said than done, because writing Bitcoin regulations is in many ways new territory. Just as the Internet and e-commerce has posed many new challenges to lawmakers and regulators, so does digital currency.

While some Bitcoin regulation is clearly needed, a bunch of poorly conceived, ham-fisted rules would only make matters worse.

Here's where things stand now...

Bitcoin Regulation: There's No Way to Avoid It

Bitcoin's problems are fairly well known, because that's the one aspect of Bitcoin the mainstream media seems to understand.

There is the long association with Silk Road, a website where illicit drugs could be purchased with Bitcoin. Last month, one of the leaders of the Bitcoin Foundation was arrested for his involvement with Silk Road.

Bitcoin has earned its bad reputation because of a feature that makes it attractive to criminals - and alarms government authorities.

Although Bitcoin transactions are publicly recorded, no identifying information is attached to them, affording a degree of anonymity otherwise found only with cash. But unlike cash, digital currency can be transferred in large amounts nearly instantaneously anywhere in the world.

Lawsky, who conducted two hearings on Bitcoin regulation last month, voiced more practical concerns in his speech. He said people may not realize that the virtual transactions are irreversible and that the keys to their Bitcoin wallets require a certain amount of vigilance.

Properly done, Bitcoin regulation would help mitigate these issues.

For example, Lawsky has proposed issuing "BitLicenses" to businesses that want to use Bitcoins. That would help increase the trust between both the customer and the company.

"We've found in other areas of the financial world that strong, clear, concise disclosures are critical to earning the long-term trust and confidence of consumers," said Lawsky. "And virtual currency is no exception."

But at the same time, Bitcoin proponents are worried that regulators, no matter how well-intentioned, will get it wrong.

How Bitcoin Regulation Could Go Wrong

Bruce Fenton, the managing director of Internet-based investment provider Atlantic Financial, a 20-year veteran of Wall Street and a member of the Bitcoin Financial Association, thinks it's far more likely regulators will damage the fledging Bitcoin economy.

Fenton drew upon his own experiences in the financial industry - which is heavily regulated - in describing the harm that Bitcoin regulation could cause.

"What innovations have we seen in the banking or financial sector in the last 30 years? Almost nothing," Fenton told CoinDesk. "Nobody ever decides to start a bank out of their garage, there is no Google, PayPal or YouTube-like innovation that's come out of banking or finance, because it's so scary to people they don't even bother to try to begin with."

Fenton said he was most concerned about Bitcoin regulation that would place onerous record-keeping and approval burdens on businesses.

Still, even Fenton sees the need for some Bitcoin regulation.

"I understand regulators want to regulate. If they must do something in this space, there's a lot of productive things they could do," he said.

Fenton suggested regulators focus more on the consumer protection aspects of Bitcoin regulation, specifically rules that would guard against fraud, theft, and hacking.

The good news is that what Fenton is saying isn't much different than what Lawsky is saying. Of course, it's up to regulators like Lawsky to get the balance right.

For his part, Lawsky is optimistic that proper Bitcoin regulation could make the United States a center for Bitcoin business innovation.

"If we get those rules right, perhaps we can make New York and the United States a magnet for legitimate, well-regarded exchanges and other virtual currency firms," Lawsky said.

What's your take? Will Bitcoin regulation succeed in legitimizing the digital currency? Tell us on Twitter @moneymorning or Facebook.

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