On November 14, 2013, the New York State Department of Financial Services (NYDFS) announced plans to hold a hearing to better understand virtual currencies, how they work and whether to create a special licensing scheme dubbed ‘BitLicense.’ Although this hearing is mainly about getting acquainted with the Bitcoin system, fear of further regulation might drive innovation abroad.

Background

Bitcoin is a virtual currency, which is exchanged over the Internet through peer-to-peer network. Its zero transaction fee attracts online and brick-and-mortar shops that save on credit cards fees and Bitcoin’s utter lack of governmental or institutional oversight and ability to preserve anonymity appeals to those seeking to keep Big Brother out of their wallets. And, like gold, Bitcoin cannot be manipulated by the interest rate policies of any government, and has thus gained popularity as a safe haven asset. Bitcoin has slowly become an accepted medium of exchange online garnering renewed interests from investors and retailers, including Ebay and Baidu, “China’s google.”

But Bitcoin’s anonymous dimension has also been exploited to facilitate criminal activities, which has had governmental agencies concerned. In the backdrop of greater governmental scrutiny, over the last couple of months, the FBI shutdown an online black marketplace, Silk Road, which extensively accepted Bitcoins. Then a Bitcoin wallet provider, Inputs.io, was hacked with $1.6 million stolen. And finally, a scam Chinese bitcoin exchange vanished after taking $4.1 million worth of bitcoins.

Current Regulation

So far, the only Bitcoin entities being regulated are the exchange platforms that allow customers to trade their dollars for bitcoins. They must register with FinCEN, one of the US Treasury executive agency, and take on anti-money laundering, recordkeeping, and reporting responsibilities. On top of that, US banks, whose business model is threatened by the transaction fee savings the new currency offers, are making it very hard on bitcoin startups to operate by refusing to maintain deposit accounts in bitcoins. Tighter regulations will be discussed at hearings both at the federal and state level.

As Forbes’Kashmir Hill summarized,

“Bitcoin has two dates with policymakers [this] week. On Monday, it gets scrutinized for safety and security issues by the Senate’s Homeland Security Committee. On Tuesday, its implications for finance and banking go before the Senate Banking Committee.”

Too Late (And Impossible) To Stop

Bitcoin is here to stay. It is a true international currency. Like the Internet, it transcends territorial boundaries. And, because it is not operated by any single entity – it is an open-source project – and exists “only in the distributed peer-to-peer network created by its users,” shutting it down is an exercise in futility. Even more important, Bitcoin has already been legitimized by US courts (a Texas judge ruled that Bitcoin could be considered a formal currency), as mentioned, FinCen already regulates Bitcoin exchange platforms, the German government formally recognized Bitcoin, and reputable Internet companies already accept Bitcoin in their normal course of business, including Baidu, Reddit, WordPress, and Shopify.

Baby Steps

In fact, no one at Capitol Hill or at the NYDFS is seriously considering shutting Bitcoin down. Rather, upcoming hearings will center on helping legislators and regulator understand the Bitcoin system and consider whether to regulate it.

Coming up in New York is a preliminary “fact-finding” hearing. As Mr. Lawsky for NYDFS noted “regulators would be remiss if they turned a blind eye to virtual currencies. We have a responsibility to take a hard look at these issues.” Mr. Lawsky continued,

“To be clear, NYDFS has not made a determination at this point about the necessary regulatory guidelines for virtual currencies. Our Department is currently engaged in a broad-based inquiry on virtual currency.

It is reassuring that regulators are resisting the impulse of calling for rash actions, which is never a good idea and tends to stifle innovation. Still, with the sheer number of US regulatory bodies taking a stab at regulating Bitcoin, digital currency startups are likely to avoid the United States, at least until legal clarity emerges. “The way the regulatory dance works in the US, I think you will see more innovation elsewhere ” opined Peter Vessenes, founder of Seattle-based CoinLab and chairman of the Bitcoin Foundation.

Hospitable United Kingdom

In contrast to US regulators’ proactive stance, their Europeans counterparts have taken a wait-and-see approach and in some instances outright endorsed a no regulation stance.

In the UK, Coinfloor, a bitcoin exchange, received approval in the form of a formal letter green-lighting their bitcoin exchange operation. That same company refuses US customers because of the legal uncertainty here. Mark Lamb, Coinfloor’s founder, said “legally it is not safe to open up to US customers in the beginning.” And, Coinapult, a Mobile Bitcoin payment company, relocated to Panama to avoid the “murky, unpredictable, and onerous” regulatory environment in the U.S.

The looming US regulation has also swayed the Bitcoin Foundation, a non-profit organization serving as the currency’s unofficial custodian, to look outside the US for a headquarter. This move towards Europe underscores how important a climate of legal certainty is to startups. It also offers a glimpse as to how the startups of the future might avoid restrictive regulations by simply joining more hospitable jurisdiction.

Photo Credit: zcopley via photopin cc.