Regulating Bitcoin Legitimizes a Treacherous Business

Regulating Bitcoin Legitimizes a Treacherous Business

At a time when “cyber security” has become an oxymoron, why is our government joining with Wall Street to greenlight Bitcoin? The virtual currency, rocked by serial scandals and failures since its invention in 2008, has taken on new life as financial officials roll out regulations to govern the cyber cash and banks invest in its future.

By requiring bitcoin exchanges to register and granting them legal status, the government is signaling to users and backers what may prove an unrealistic promise of transparency and security. These are the same financial officials, after all, who have struggled historically to oversee savings and loans -- shifting to virtual currencies is like jumping from Beatrix Potter to James Joyce in one semester. At the least, regulators need to affix flashing red warning lights to every Bitcoin undertaking: consumers beware.

Related: Proposed Bitcoin Rules Threaten Emerging Digital Currencies

In 2013, the Financial Crimes Enforcement Network, a branch of the Treasury Department, ruled that virtual currencies must register with the US government and adopt steps to combat money laundering. Soon, the New York State Department of Financial Services will issue a broad bitcoin regulatory framework. Meanwhile the department has granted a trust company charter to itBit, a first.

ItBit, an exchange located in New York and Singapore, played its hand well. The company earlier this year raised $25 million from venture groups and also added some high-profile financial types to its board, including former FDIC Chair Sheila Bair and former Senator Bill Bradley. Both the financing and pumped-up board are doubtless comforting to the deep-pocket investors itBit targets.

They should require comforting, given the following Bitcoin data points:

1)      Its inventor, Satoshi Nakamoto has so far refused to reveal him/herself. That name was on a paper posted just seven years ago describing the design behind Bitcoin; it is assumed to be an alias. The revelation, and the software underpinnings released a year later, was sent to a “cryptography” email list, i.e., one designed to convey secret messages.  

2)      Bitcoin valuation and creation depends on mathematical algorithms (yes, those same bad boys behind high frequency trading and the flash-crash) that few understand.

Related: Why States Want a Bite of Bitcoin and Other Virtual Currencies

3)      According to an article in MIT Technology Review, academics are spotting “flaws” in Nakamoto’s math, which could allow cheats. Game theorists have shown that greedy types with sizeable positions could exploit the rules underpinning the mining of Bitcoins to gain unfair advantage.   

4)      The Bitcoin infrastructure has proved vulnerable to hacking. Exchanges Bitstamp and Mt. Gox have suffered thefts through hacking, forcing the latter out of business after losing $474 million to thieves.   

5)      Among the most enthusiastic users of Bitcoin have been drug dealers and other miscreants online. They assume anonymity and untraceable payments, the advantages of a virtual currency.

6)      Promoters of Bitcoin come from a ragged intersection of Wall Street and the Occupy version: an odd assortment of crypto-anarchists, venture capitalists, conspiracy theorists, bankers, and coders who love secrecy and trust no one. Rand Paul has begun accepting campaign contributions in Bitcoin. Just saying.

7)      Ian Miers, a doctoral candidate at Johns Hopkins, maintains that Bitcoin payments are actually not anonymous. There is a public record (using no names) of every transaction ever conducted, one of the advantages according to some. He says the entity behind logged entries can be exposed. Conspiracy types whisper that the U.S. government is already tracking Bitcoin transactions.

Related: Federal Agents Busted for Stealing Bitcoins, Extorting Silk Road Founder

8)   The price of Bitcoins hit a high of $1,150 in November 2013; by January of this year, after a day in which the price fell by 27 percent, the virtual currency had collapsed by more than 80 percent. Two such crashes had already occurred – in 2011 and 2013. The price today is $241. Even one of its biggest promoters agrees: “High-risk commodity” isn’t a completely incorrect definition of bitcoin right now.”

9)   And yet, not only are regulators lending Bitcoin legitimacy, Wall Street heavyweights have virtually guaranteed it. The New York Stock Exchange announced earlier this year it would back Coinbase, a platform for trading digital currency. More persuasively, Goldman Sachs recently participated in a $50 million fundraising by Circle Internet Financial Ltd., which provides storage and other services to bitcoin users. This investment followed a bullish report from Goldman’s research department in which analysts describe crypto currency as “part of a technology "megatrend" that could change the fundamental mechanics of transactions.”

Most recently, the NASDAQ announced this week that it will run a pilot project using the blockchain technology behind Bitcoin to trade stocks. The advantage, according to the firm, is the instantaneous   transfer of assets between individuals, without the use of intermediaries.

Related: Rand Paul’s Website Accepts Bitcoin Donations

This is the secret sauce – verifiable, instant money transfers. Cash moving as fluidly around the globe as emails. Settlements on stock trades in real time, instead of three days later. The GS report notes, “The large public companies that will benefit will be merchants who will reap savings on payment costs. Firms who might lose out are traditional money-transfer firms like Western Union, Moneygram and Xoom.” Because of lower costs, consumer-to-consumer and remittance payments are likely to adopt bitcoin, capturing “20 percent of the current $30bn consumer-to-consumer market from incumbents over the next 10 years,” according to the report.  

It will not be a smooth process. One of the firms GS touts as a leader in the space – Ripple Labs –was just hit with $700,000 in fines for failing to register as a money services business, a warning shot across the bow of the fledgling industry.

It will also challenge regulators. Former Ireland regulator Peter Oakes notes that governments around the world have focused on preventing money laundering and blocking bitcoin’s use for funneling cash to terrorists. He worries that “consumers will be lulled into a false sense of security that these AML/CTF driven regulations somehow equate to greater consumer protection.”

He is quite right. The government would do well to caution consumers that the technology is unproven and risky, and that regulators may struggle to keep up. Benjamin Lawsky, New York’s Superintendent of Financial Services said it best earlier this year, “It’s generally a difficult proposition for financial regulators to forecast technological trends. It’s not something we do particularly well.” 

Amen to that.

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