Does Bitcoin Bite?

Katie Coulson

On January 22, 2015, the Winklevoss brothers announced that they were creating a new exchange for the virtual currency, Bitcoin. They hope that, unlike other Bitcoin exchanges, this one will be fully compliant with all applicable regulatory laws. While their efforts at compliance may curb some of the illegal activity surrounding Bitcoin, ultimately, it will be insufficient. Instead, Bitcoin should be regulated on a more micro-level in order to protect the average Bitcoin users.

According to the guidelines issued by the Financial Crime Enforcement Network (FinCEN), Bitcoin exchanges must comply with all regulations that apply to Money Services Businesses. However, these regulations only apply to the exchanges—that is, the businesses where users can turn their government-backed money into Bitcoin. While regulating these exchanges is helpful in theory, in practice, many of the exchanges have few incentives to comply. Most are hosted internationally and are run by people who retain a large degree of anonymity. Plus, many exchanges do not charge significant transaction fees and make fairly little money. So, many exchanges would cease to exist if complying with regulations would cause them to incur significant fees.

Also, importantly, many exchanges are run by people who are antagonistic toward any government regulation. These Bitcoin champions believe strongly in Bitcoin’s success in large part because it is free of government interaction, anonymous, and does not require any third party like a bank, or in this case a regulator[1]. So, even to the extent that a particular exchange could comply with regulations, many would not out of principle. And, most small exchanges could refuse to comply with impunity. Law enforcement does not have the resources to devote to indicting every single Bitcoin exchange, and even if they had the time, many of the relevant people live internationally and are particularly adept at hiding their identities. So, overall, any Bitcoin exchange that doesn’t want to comply with regulations likely won’t.

So, Bitcoin transactions should be regulated at a more micro level in order to protect everyday Bitcoin users.

In the past, such regulation was less necessary—most Bitcoin users had a strong understanding of the way Bitcoin worked, and the associated risks. However, as evidenced by the Winklevosses’ recent interest, Bitcoin has grown in popularity, especially among young people. As it grows in popularity, more users may invest in Bitcoin, or choose to accept Bitcoin as payment at their small businesses, without really understanding the hazards that it can entail. For example, many new users hope to use Bitcoin to make everyday purchases at restaurants and clothing stores, and many such stores want to accept Bitcoin as payment. However, either party may not know how to handle return policies—would the return be paid back in the equivalent amount of Bitcoins, or dollars? Who would benefit from any fluctuation in price? Without standardization across businesses, neither party can plan accordingly.

Additionally, without micro-level regulation, Bitcoins could be used to anonymously purchase particularly sensitive products, like guns or prescription drugs, without any oversight. For example, until recently, a website called the Silk Road offered a variety of illegal products for sale and used Bitcoins in its transactions. Because the website operated through a secret and untraceable portion of the internet called the “deep web,” law enforcement had to undergo extensive investigation in order to shut it down. Such investigation would not be possible on a large scale, and in the future, sites similar to the Silk Road could spring up and take years to successfully eliminate. Because these sites operate in Bitcoins, there are no credit card transactions or bank statements to track cash flow, as there would be for other businesses trafficking in illegal goods. So, regulations should require record keeping of Bitcoin transactions—then, businesses that do a large volume of Bitcoin sales without proper tracking could be singled out by any investigations.

Overall, as Bitcoin becomes more popular, the government should ensure that users are well protected.


[1] Satoshi Nakomoto, Bitcoin: A Peer-to-Peer Electronic Cash System, available at https://bitcoin.org/bitcoin.pdf