Whether or Not Bitcoin Needs it, Regulators are Going to Regulate

UPDATE: The full video of today’s Senate Committee on Homeland Security and Governmental Affairs hearing can be viewed here.

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As the Senate’s Committee on Homeland Security and Governmental Affairs begins its hearing on virtual currencies today, one question stands out: do we need one?

One commenter on bitcointalk.org said: “Waste of time. A decentralized currency doesn’t need that.”

The whole point of bitcoin, after all, is that it was designed to usurp central control. Like the Internet itself, it routes itself around regulation. And yet, bitcoin advocates including Jeremy Allaire, founder of merchant payment services firm Circle Internet Financial, are gathered in a room in Washington, DC, to try and help regulators understand it. Why?

“It is very short-sighted for community members to think that bitcoin can be anything but a niche tool by eschewing policy makers and government,” Allaire told CoinDesk. He should know – some $2m of the $9m that Circle raised will likely be spent on achieving regulatory compliance.

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“Whether one wants it, or thinks the currency needs it, or not, the fact is that the Senate will hold hearings, and regulators will regulate,” agreed Jerry Brito, a senior research fellow at the Mercatus Center at George Mason University and director of its Technology Policy Program, who also testifies today.

“Bitcoin can’t be controlled very easily by governments, if at all, but the development of its infrastructure by entrepreneurs and innovators can certainly be hampered by bad law and regulation,” Brito said. “So if it’s going to happen anyway, what’s the harm in being there to present a rational and reasonable perspective?”

These hearings are generally fact-finding expeditions to brief senators on the details of a topic, and to prepare them for potential legislative measures further down the line. But most people CoinDesk spoke to didn’t think there would be many decisions made on the back of this hearing. Instead, lawmakers are simply trying to understand how the whole thing operates.

“It’s an opportunity for Congress to learn about the issue, to learn what the agencies are doing, to learn what the private sector is doing, and to chime in with what it thinks is the right approach,” Brito said. “I doubt we will see any virtual currency-specific legislation anytime soon.”

In fact, that may be the industry speakers’ purpose at this hearing; to soothe senators, and avoid knee-jerk reactions like this one, in which Senator Chuck Schumer blasted the “surrogate currency”, by linking it directly to Silk Road.

Increased understanding

Even Senator Tom Carper, who is chairing the hearing, admits that lawmakers need a better understanding of virtual currencies.

“Virtual currencies, perhaps most notably bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of many of us,” he will say today. “Indeed, based on conversations my staff and I have had with dozens of individuals both inside and outside of government, it is clear that the knowledge and expectation gaps are wide.”

Bitcoin Foundation general counsel Patrick Murck isn’t alone in thinking that there’s enough regulation already. In his testimony today, he will argue that the Foundation saw the introduction of FinCEN’s guidance on virtual currencies in March as a signal that “existing regulation covers most of the business activity taking place in the bitcoin ecosystem”.

Today, he will say:

“Bitcoin’s differing characteristics potentially make it a different asset class than what existing regulation recognizes. But it fits well within the legal and regulatory regimes that bar frauds like the Ponzi scheme at issue in that case.”

There are those who are more concerned about bitcoin’s use for criminal activity. In his opening statement, Carper highlights concerns about the anonymity of virtual currencies, which can make it hard for law enforcers to track criminals, and will reveal that the individual who sent ricin to President Obama was a Silk Road vendor.

“Whether it is bitcoin or any of the other virtual currencies, the federal government and society as a whole need to come together to figure out how to effectively deal with it,” he will say, adding that “a few bad apples” shouldn’t be allowed to spoil the whole bunch.

Ernie Allen, the president and CEO of the International Centre for Missing and Exploited Children, will also testify today. He is halfway through an investigation of virtual currency and criminal economies targeted for release in February, says that he is already seeing cases of bitcoin use in child porn rings.

Both bitcoin and Tor are being used for this purpose, he says. While the market was small compared to the use of bitcoin for drugs and other illegal goods, he points out that those accepting digital currencies for child porn were often the producers of the content. He lists several sites in his testimony, owned by an operator arrested in August (Freedom Hosting), which he said accepted bitcoin.

But such talk leaves Jon Matonis fuming. “I don’t even know why they’re invited,” said Matonis, the executive director of the Bitcoin Foundation, and a contributing editor to CoinDesk.

“There’s nobody who disagrees with the issue on that,” says Matonis of the child exploitation risk, arguing that the Bitcoin Foundation isn’t a law enforcement agency. But cryptocurrencies don’t have morals, he says, citing the old NRA adage: “guns don’t kill people – people do.”

The benefits for financial inclusion, for the unbanked, for personal financial privacy and individual control, far outweigh the negative uses of the currency, Matonis warns. “Society has to make a decision on accepting some of the negative to get the good.”

Controls

At the crux of this security hearing, then, is the same age-old argument that accompanies any enabling technology: should you regulate it because criminals can use it? Phil Zimmerman, the inventor of the PGP encryption protocol, faced the same issues when the US government made a case against him (and subsequently dropped it) in the nineties.

The new crop of enabling technologies faces the same questions, Matonis says. “Tor is there also. What do you think that the Tor project will say when asked the question ‘what can you do to track these transactions so that people don’t use Tor anonymously’? Will they come out with Tor Lite?” he laughs. “And what’s bitcoin going to do?”

But some are already proposing technological controls to accompany the legal measures already imposed at the exchange level in the form of AML and KYC. Today, in his testimony, Allen will discuss ‘clustering’, the act of analyzing patterns in bitcoin usage to identify perps, and he will explicitly discuss that in the hearing today.

Another idea is marked coins, which are bitcoin outputs tagged so that every subsequent output will also have a tag. They would enable a bitcoin client to tell a user that an output came from money that was ‘marked’ earlier, possibly because it was involved in criminal activity. But Mike Hearn’s discussion of this last week prompted uproar from the bitcoin community.

“I know that people at the Bitcoin Foundation wanted to get past the public hearings before we started talking about that, but it is the next big thing to tackle,” says Matonis of coin marking. But the majority in the community don’t approve of it, he says.

Brito isn’t sure that such a scheme would be workable, either technically or from a regulatory perspective. He said:

“It would be akin to taking out of circulation any dollar bill that has ever been used by a drug dealer. More importantly, how will it be decided what uses are clean and which are not?

And how do you get the massive buy-in you’d need from the bitcoin-using public. Color me skeptical.”

And then, of course, there’s the idea of tying bitcoin addresses to identities, as proposed by Coin Validation. The Foundation itself is unimpressed with the whole idea of making coins more identifiable.

“The Bitcoin Foundation does not support the use of money for identity tracking,” said spokesperson Jinyoung Englund this morning, hours before the Senate hearing started.

Tension and dissent

The most interesting part of this Senate hearing isn’t really what’s happening inside the room. There, the community is simply trying to get regulators up to speed on bitcoin to avoid them taking any rash measures.

Instead, it’s the tension and dissent in the larger bitcoin community that is perhaps most telling. On the one side, those trying to build large, ongoing businesses from bitcoin are doing their best to placate regulators by working with them to avoid commercial risk further down the line.

On the other side, we have a collection of users who point to the original ethos outlined in Satoshi’s white paper. This faction is vehemently anti-central control, and will aggressively defend any attempt to impose such control on the currency.

And then, you have people like Roger Ver, who sits somewhere in the middle. Ver, aka the “Bitcoin Jesus,” has been an ardent defender of Silk Road on libertarian grounds. But he is also an investor in around a dozen bitcoin companies, many of which must dance toe to toe with regulators to succeed.

“The approach I like the best is to comply with all the regulatory requirements, but point out every chance I get that the only reason I am complying is because these strangers, who I have never met, will hurt me if I don’t comply,” he says.

No matter what happens at these hearings, bitcoin will continue. The question is whether it continues unhindered in the US, or whether key tools like price discovery mechanisms move offshore, concludes Matonis.

“There are not many available options when it comes to altering gravity,” concluded Matonis. “It would be akin to changing the trajectory of an incoming asteroid.”

Featured image: Mesun Dogan / Shutterstock