Thoughts on the Regulation of Bitcoin

As Bitcoin moves into the mainstream, the question of whether – and how – it should be regulated continues to loom large. It’s an issue that’s naturally divisive within parts of the community.

As a decentralised currency beyond the control of any country or organisation, Bitcoin has always held a certain appeal to those who hold certain ideologies or intend to subvert the system in some way. And it’s fair to say that neither radical libertarians wanting to stick it to the man nor criminal networks drawn (erroneously) to its anonymity tend to campaign for greater regulation.

But at the same time, regulation is for many in society inextricably bound up with legitimacy and, if handled correctly, could in fact provide important benefits that go far beyond simply clamping down on illegal activities like money laundering. The reason is simply that with regulation comes certainty – and with certainty, investors become more willing to part with the cash required to fund the development of Bitcoin businesses that will in turn make the ecosystem more user-friendly for the man on the street.

At least that’s the theory. Of course, the reality is that poorly crafted regulations, despite being imposed in order to prevent evil activities that may damage society, can also severely hamper innovation. Think of the torturous amount paperwork and delays involved in opening a bank account as they tick the boxes to ensure you’re not in fact Tony Soprano. Then add into the mix the fact that Bitcoin is a truly global technology and the likelihood is that entrepreneurs will vote with their feet to base businesses outside regions that place them at a competitive disadvantage and the issue becomes even more complex.

I watched the livestream of the first day of the New York Department of Financial Services Hearing into Virtual Currencies and I got a clear sense of the conflict that regulators face in a very complex debate that is increasingly being played out in public in different countries around the world. It’s too early to say which way popular opinion will go in the majority of countries but there’s a need for regulators (around the world) to really take on board that Bitcoin is far more than simply a gradual evolution of the existing financial system.

With the probable adoption of Bitcoin as a protocol on the internet and the emergence of programmable money, there are real risks if regulators fail to innovate their own processes in tandem. There’s a real tension here. It’s clear that forcing Bitcoin startups, most of whom have no more than a handful of employees, to comply with the same levels of regulation that apply to global multi-billion dollar banking behemoths is just not going to work. We’re talking about with technology startups here – they need to get into the marketplace as quickly as possible in order to see whether someone actually wants to buy what they’re selling and to iterate their business models accordingly. Technology startups cannot hang around for months on end for authorisations to roll in in the way that traditional financial services businesses could.

Fred Wilson gave short shrift to the Winklevoss suggestion that startups could perhaps hire specialist businesses to assist them in meeting any regulatory burden with the process, in much the same way that modern-day banks do. Doing this would simply reintroduce some of the cost that Bitcoin has removed straight back into the system. Fred is urging regulators to find a coding solution to help startups to meet any regulatory burden and to me, this just seems like an area with huge potential. If the regulators around the globe show leadership by building a system for this new world of financial services in which individuals can  log and prove their identity and status (in much the same way as people use the authorisation services of Facebook or Twitter to log into websites today, for example), we introduce even greater efficiencies into financial services and suddenly regulation gets a whole lot easier to achieve for small businesses.

There was plenty more discussed but I just want to wrap up with one final point. The hearings took place in the shadow of the two high profile arrests earlier in the week and so the tired comment about Bitcoin being used to facilitate illegal activities was raised once again. Those testifying at the hearing were in no doubt at all that this is increasingly an old story. As the ecosystem has grown, the composition of the community has changed significantly. Indeed Jeremy Liew testified that his personal research from around nine months ago had shown that Bitcoin was in fact only being used in around 0.5% of all transactions taking place on Silk Road at that time. As I’ve written about many times before, it remains an easy story for the media but entirely misleading.

Both the Bitcoin economy and the make-up of the community has developed hugely over the past couple of years and the reality is, I believe, far closer to Fred Wilson’s view that the Bitcoin ecosystem will have five distinct stages to its development:-

1. The Academic Stage: the emergence of the community
2. The Vice Stage: the use of Silk Road and reliance on anonymity
3. The Speculative Stage: where we currently are, with huge price volatility
4. The Transactional Stage: where merchants start to accept and the public start to use bitcoins generally
5. The Programmable Money Stage: where we build upon the protocol and the whole system really starts to fly

So, let’s hope that the regulators get this right. Call me a pessimist but my instinct is they won’t – at least at first. But as everyone involved in the tech world knows, sometimes the best way to learn is to fail fast and come back quicker, this time with improvements. Let’s see whether they can learn from the technology industries that they’re having to engage with and continually refine their processes at pace. It’s not going to be easy. But it is going to be important.

Watch this space.

photo credit: communitiesuk via cc