Regulatory Action on Bitcoin should not be knee-jerk reactions

Within the past week, two Bitcoin exchanges shut their doors.  Japan-based Mt. Gox, a large Bitcoin trading platform, has filed for bankruptcy protection.  It says hackers have stolen 850,000 Bitcoins from its system, with a reported value of around half a billion dollars.  Flexcoin, based in Canada, though much smaller, also cited theft by hackers of its 896 Bitcoins.

Questions of accountability rise to the fore, but the Bitcoin industry is not regulated.   While this has prompted calls for regulatory actions, regulators should exercise caution and carefully consider the possible regulatory actions and potential consequences, instead of any knee-jerk reactions.

United States Federal Reserve Chief, Janet Yellen, has said her department does not have the authority to supervise or regulate Bitcoin, and that there is no intersection at all between Bitcoin and banks.    Contrast that with Japan’s response, which is proposing to impose taxes on Bitcoin transactions and gains, similar to commodities.   Such measures would not recognize Bitcoin as a currency, but will serve to bring Bitcoin from the periphery into the mainstream and regulatory radar.

There have been divergent views as to why and how Bitcoin ought to be regulated.  Regulators should seek to apply a consistent regulatory approach to Bitcoin, as different standards could result in confusion or regulatory arbitrage.   A key regulatory concern expressed so far is on Bitcoin’s anonymity and potential use for money laundering and terrorist financing, but just a handful of countries have banned Bitcoin outright.  In March 2013, the United States Treasury Financial Crimes Enforcement Network (FINCEN) issued a guidance note that virtual currency is not considered a “currency” under the Banking Secrecy Act and its users, dealers or administrators are not subject to FINCEN regulations relating to “money services businesses”.   Yet, in certain European jurisdictions, Bitcoin operators are regarded as a payment service that may potentially be licensed.

Without clear regulatory guidance, different markets and investors develop different ideas.   In the last year or so, Bitcoin has significantly expanded in popularity and gained traction within the tech community.  Bitcoin value started on its up as more people and merchants began to accept Bitcoin as payment for products or services, although its value is not backed by any tangible assets.   Bitcoin is created by “Satoshi Nakamato” in 2007 as a peer-to-peer digital currency.   Bitcoin mining is complex computer technology that very few truly understand.

Interest in the virtual currency may be largely speculative.  There are many Bitcoin exchanges that quote Bitcoin rates against most international currencies, and investors may enter into short sales, options or other instruments designed for profit on price movements.  From its first published exchange rate of US$1 to 1,309.03 Bitcoins (or BTC) in 2009, its value reached US$30 per Bitcoin in February 2013.    Bitcoin price has been incredibly volatile and may be inconsistent from one exchange to another.

It is also remarkable that the recent events are not the first failures of Bitcoin operators.  On the websites of a number of Bitcoin exchanges, there are specific warnings on the risks of investment and Bitcoin storage.    Therefore, one argument is caveat emptor – whoever deals in it should know and bear the risks.  There may then be no reason for regulators to get involved, at the expense of taxpayers’ money.

An inappropriate regulatory approach without fully appreciating the implications may end up supporting the Bitcoin market when it was not intended.  On November 17, 2013, Bitcoin was traded at US$503.10 on Mt. Gox.   When a United States Senate hearing held on November 18, 2013 acknowledged the potential benefits of Bitcoin, its price was driven above US$1,000.

Unfortunately, regulators will need to take action especially as Bitcoin spills onto the main street.    Physical Bitcoin ATMs are being established in some cities.   In the same week Mt. Gox collapsed, Asia Nexgen Bitcoin Exchange (ANXBTC) established the first physical store in Hong Kong, including an ATM that would facilitate purchase of Bitcoins using hard cash.  The ANXBTC team was handing out Bitcoin vouchers to pedestrians, promoting the virtual currency to “men on the street” and retail investors.

Regulators need to address vulnerabilities that result from the regulatory vacuum within which Bitcoin is operating, but should also be careful not to become a contributor to the phenomena, or set any unintended precedent. Besides Bitcoin, there is a significant number of other “crypto-currencies” or “Altcoins”, such as Litecoin, Namecoin, Peercoin, Dogecoin, Feathercoin, Terracoin, just naming a few.    Regulators need to take action before the network of virtual currencies risk becoming “too big to fail”.

A global and holistic approach is necessary.  Let this not be a missed opportunity to properly regulate digital currencies.