Bitcoin to Congress: Back Off

Bitcoin’s representatives are appearing before Congress this week for a first-ever series of hearings into the crypto-currency. And they’ve got a message for the array of D.C. lawmakers and regulators looking to tame Bitcoin: If the government’s attempts to oversee the digital currency are too harsh or intrusive, Bitcoin users easily could go offshore or underground — and then no one in Washington will be able to control what they do.

"Incautious behavior on the part of governments and law enforcement could make the Bitcoin environment harder to work with," Bitcoin Foundation General Counsel Patrick Murck said in testimony prepared for Monday’s Senate Homeland Security and Governmental Affairs Committee hearing — the first of two hearings on virtual currencies this week.

Lawmakers are looking into what, if anything, to do about Bitcoin as its role in legal finance grows and yet remains ill-defined. Bitcoin’s steep, volatile rise to over $500 on Sunday is attracting high-profile investors, while at the same time the Bitcoin system is still plagued with theft and fraud, and it remains the payment method of choice for shoppers on internet black markets. Federal and state regulators have put out some guidelines for digital currencies, but a consolidated government approach is not yet clear.

While Washington has assembled its alphabet soup of federal agencies into several different task forces to contemplate Bitcoin, New York’s top financial regulator, Benjamin Lawsky, has been sending out subpoenas. New York’s Department of Financial Services sent them to 22 Bitcoin businesses in August requesting information about their activities to see if they were complying with existing regulations and whether more rules were needed.

Now, Lawksy’s looking into issuing a "BitLicense" for digital currency businesses, which would require them to comply with further regulation. The Department of Financial Services hasn’t made any final decisions, he said Thursday, but would look into to the idea of a license at yet another public hearing "in coming months."

"If virtual currencies remain a virtual Wild West for narcotraffickers and other criminals, that would not only threaten our country’s national security, but also the very existence of the virtual currency industry as a legitimate business enterprise," he said in a statement when he first announced the inquiry in August.

Murck, the Bitcoin Foundation’s envoy for Monday’s hearing in Washington, said Lawsky’s statements are "irresponsible" and his actions show an "early antipathy to Bitcoin" that could push the fledgling industry overseas to seek more hospitable regulatory environments.

Murck further warned that law enforcement shouldn’t abuse Bitcoin’s open ledger, where all transactions are recorded. The ledger is part of the original Bitcoin system created almost five years ago by someone (or several people) going by the name "Satoshi Nakamoto," whose real identity is still unknown. The collectively-kept ledger records when Bitcoins change hands, in order to keep someone from spending the same coin twice, and also when new Bitcoins are created or "mined," by using computers to solve complex mathematical problems.

Sarah Meiklejohn, a PhD student at the University of California San Diego, recently demonstrated that the communal ledger or "block chain" could be used to trace suspect transactions. That means authorities can use the block chain to track down alleged criminal activity, if they can compel companies that facilitate Bitcoin transactions to give them information about their customers. But if the government goes too far and uses the ledger "for excessive or illegitimate surveillance of private financial activity," Murck said users may take further steps to hide their activity and protect their privacy by employing "mixing services, which are intended to obscure the source of their users’ bitcoins."

Representatives from the Justice Department and the International Centre for Missing & Exploited Children also said the possibility of Bitcoin companies moving offshore would make it harder for U.S. authorities to find and prosecute illegal activity.

Digital currency transactions still represent a very small part of the overall economy, but it’s becoming an increasingly popular place for criminals, according to Ernie Allen, President and CEO of the International Centre for Missing and Exploited Children.

"While much of the evidence is still anecdotal, there is consensus that commercial child pornography, sexual exploitation, sex trafficking and other criminal enterprises are increasingly moving to a new unregulated, unbanked digital economy," Allen said in testimony prepared for Monday.

It’s hard to know how much of the Bitcoin economy is made up of the (shudder-inducing) criminal activity Allen refers to and how much is legal, but the answer could affect the viability of U.S.-based Bitcoin companies. If the U.S. government continues on the path to crack down on internet black markets and make digital currencies more transparent, it’s not clear whether users will flock to the ostensibly safer environment or stick to the already popular exchanges in less-regulated countries.