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Growing Bitcoin Regulations and Its Constituencies

By District of Columbia Bar

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By Elijah Alper, WilmerHale

Several federal and state regulators have now begun creating regulations governing Bitcoin and other virtual currency. This year alone, regulatory guidance or proposed rules have been issued by FinCEN, the IRS, the Consumer Financial Protection Bureau (CFPB), along with several states, including New York, Texas, and Maryland.  Last month, a Commodities Futures Trading Association (CFTC) commissioner urged his agency and others to create a regulatory framework for virtual currency.

Reaction from the Bitcoin community has been mixed. Some Bitcoin supporters have welcomed, or at least accepted, greater federal and state involvement, while others have criticized both the specific rules and the rulemaking process. It would be a mistake to place all Bitcoin advocates in one of these two categories. There are actually multiple Bitcoin “constituencies,” and understanding these groups helps explain why effective regulation will be such a challenge.

Supporters of Bitcoin (or other virtual currency) generally fall into one of these categories:

Technologists:  Technologists are attracted to the newest technological advances, and they see Bitcoin as the next “Internet.” Technologists focus on Bitcoin’s underlying blockchain technology that allows for trusted, de-centralized, and quausi-anonymous payments. Their interest is more in the ideas and technological possibilities behind Bitcoin rather than any business opportunity. 

Humanitarians:  Humanitarians believe that Bitcoin can assist developing economies.  Humanitarians see Bitcoin as providing a reasonably stable form of value in countries that restrict foreign currencies but have rampant inflation. They also praise Bitcoin’s ability to effect inexpensive international payments.

Investors:  Investors view Bitcoin as the next dot-com boom. They believe that the right startup companies can make millions or billions of dollars by building the “killer app” for Bitcoin or otherwise bringing Bitcoin to widespread use. 

Libertarians:  Libertarians are excited about Bitcoin’s potential as an alternative to the heavily regulated traditional banking and currency systems. Libertarians believe that a payment or currency system does not require the current level of government interference, and that Bitcoin, if successful, could prove their case. Some members of this group believe that governments should not control the financial system and that any regulation of Bitcoin is per se illegitimate.

Criminals:  Bitcoin is attractive to some financial criminals. Bitcoin payments are irreversible, quasi-anonymous, and operate largely outside of traditional U.S. financial institutions and these institutions’ transaction monitoring systems.

In general, investors support regulation because they favor certainty over regulatory risk, while Libertarians (and certainly Criminals) oppose regulation. This does not mean, however, that every sensible regulatory proposal is “good” for virtual currency in the long run. Bitcoin is unlikely to gain widespread adoption if the public views Bitcoin transactions as a haven for criminals or as an anti-government device, nor will Bitcoin reach its potential unless Investors are confident enough to place large sums of money behind the most promising startups.

At the same time, Bitcoin is also unlikely to succeed if even the best-intentioned regulations drive the Technologists, many of whom are also Libertarians, away from Bitcoin to the next promising technological invention. Careless regulation may also eliminate many of the advantages Bitcoin promises to the developing world by making Bitcoin too expensive to use in a compliant manner. 

The challenge for regulators is to make rules comprehensive enough to make Bitcoin less attractive to criminals and more attractive to investors, while also leaving enough flexibility for the Technologists to innovate and for the Humanitarians to use Bitcoin for good causes. 

Meeting this challenge will be difficult, and it requires federal and state authorities to be extra careful when deciding what rules will govern virtual currency. More regulation is probably essential for Bitcoin’s continued growth, but unwise regulation might stop existing growth entirely and shift Technologists and other first movers to another innovation.

This material does not represent legal advice as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments.