Bitcoin Is Here to Stay and Will Transform Payment Systems

Since the digital currency known as Bitcoin came on the scene in 2009, much has been written about it, both good and bad.  However, it seems clear that Bitcoin's underlying “protocol” has the potential to transform the global payments system. Entrepreneurs are flocking to the Bitcoin protocol. Private equity and venture capital, most notably in Silicon Valley, have also begun to make substantial investments in the technology. The technology for "crypto-currencies" like Bitcoin may hold particular promise for opening up the financial system to the masses of individuals in the world’s poorest countries, the majority of whom do not have access to bank accounts. The technology also has implications far beyond the financial system and could have fundamental impact on voting, legal contracts and real estate transactions, to name just a few. A debate is raging over whether Bitcoin should be regulated, and, if so, how far regulation should go, to minimize any dangers while not suppressing innovation as Bitcoin develops out of its “infancy.” Several events have galvanized those in favor of more robust regulation. In October 2013, the FBI arrested Ross Ulbricht, a.k.a. “Dred Pirate Roberts,” who is alleged to have been the mastermind behind Silk Road, a website that was devoted to selling illegal drugs and other illicit items and services. The sole medium of exchange on Silk Road: Bitcoin. In January 2014, Charlie Shrem, a well-known member of the Bitcoin community and the CEO of BitInstant, one of the best-known and largest Bitcoin exchanges at the time, was arrested on money-laundering charges. Then, Mt. Gox, a Tokyo-based digital currency exchange, collapsed, and the loss of millions of dollars of customer Bitcoins spread through the news like wildfire. Taken together, these events have caused many fraud prevention professionals working in law enforcement, regulatory agencies, compliance departments and other institutions where digital currencies could conceivably be an issue to eye Bitcoin and other “alternative” currencies with a healthy dose of skepticism. In spite of these events, Bitcoin has been gaining support commercially among merchants and retailers. The Sacramento Kings of the National Basketball Association, the Chicago Sun-Times and Overstock.com, among others, now accept Bitcoins as a method of payment. Thousands of small businesses scattered across the U.S., with notable concentrations in San Francisco and New York, also are accepting Bitcoins. Because Bitcoin is a disruptive technology, there were no real applicable regulatory or enforcement mechanisms in place when Bitcoin came into existence in 2009. The nature of the Bitcoin protocol is such that regulations already in existence, in most cases, could not be easily adapted. The exchange, transmission, trade, securitization and commoditization of Bitcoins all have regulatory implications. Regulators are rightly concerned about such issues as consumer protection, anti-money laundering/countering the financing of terrorism, fraud prevention and other important issues.  However, because of Bitcoin’s disruptive nature, the application of existing regulations often places Bitcoin in a regulatory “gray zone.” In March 2013, the U.S. Financial Crimes Enforcement Network, known as FinCEN, issued guidance that characterized Bitcoin exchanges in such a way that they must register with FinCEN and follow the Bank Secrecy Act’s (BSA) anti-money laundering (AML) regulations. Exchanges also must develop bank-level AML and Know Your Customer compliance standards for their businesses. In July 2014, the New York Department of Financial Services (NYDFS) issued proposed regulations regarding “virtual currencies.” The proposal has entered a 45-day comment period. The proposal would require companies involved in virtual currency business activities to have in place policies and procedures designed to mitigate the risks of money laundering, funding terrorists, fraud and cyber attacks. At the same time, the regulations seek to impose privacy and information security safeguards on companies operating in this environment. As the country’s leading financial center, New York has taken the lead in proposing regulations that seek to balance the need for anti-money laundering, fraud prevention and consumer protection safeguards against the desire to promote innovation within the nascent digital currency industry. Though it is unclear whether the proposed regulations achieve these ends, it might be argued that these regulations are preferable to a regulatory vacuum that leaves industry insiders and investors with more questions than answers. However, the danger of overregulation is that it could drive away legitimate industry actors and the innovation that would follow. Absent investment and innovation in the industry, the technology is largely left in the hands of those who wish to exploit it for nefarious purposes. Only time will tell. KEY TAKEAWAYS 1)  Digital currency technology is here to stay, and overregulation could stifle investment and innovation in the industry, leaving the technology in the hands of those who wish to exploit it for nefarious purposes. 2)   Bitcoin technology is still in its infancy, and venture capital and private equity elements are beginning to show real interest in the technology’s exciting potential to transform certain business practices across a wide range industries. 3)  Regulatory agencies have only recently begun to take notice of the potential issues that this disruptive technology presents.