The New York State Department of Financial Services held its first of two public hearings yesterday to discuss the regulation of Bitcoin. The discussion comes at a turbulent time for the cryptocurrency, and the stakes are high for both investors betting on Bitcoin-based ventures and authorities seeking to prevent criminal operators from exploiting the privacy afforded by virtual currencies.
With the arrest this Sunday of Charlie Shrem—a high-profile Bitcoin advocate who is heavily invested in the cryptocurrency (sources tell me he recently bought a plane with his crypto-bling)—New York prosecutors seemed to prove that they have both the will and the means to police illegal activities among the ranks of the Bitcoin elite. In this case, it didn't require a new regulatory framework. Shrem was charged under well-established anti-money laundering laws pertaining to any business that operates as a money transmitter.
Despite the recent charges, and despite the significantly larger trophy brought in by federal prosecutors last month when they arrested Ross Ulbricht for allegedly running the online drug bazaar Silk Road, New York officials are looking to expand their powers with new regulations specifically pertaining to Bitcoin and its ilk.
“Right now, the regulation of virtual currency industry is akin to a virtual Wild West," said Benjamin Lawsky, New York State's superintendent of financial services, at yesterday's hearing. "That lack of regulation, however, is simply not tenable for the long term. And I think it’s going to change." It was Lawsky who called for the hearings late last year after doling out subpoenas to a list of important Bitcoin players in New York.
When asked by Lawsky what kind of action the committee should take to weed out the bad actors in the cryptocurrency community, the witnesses made a resounding appeal for restraint, explaining that recent prosecutions were evidence enough that the system is working. “In response to how to stop Silk Road type situations from happening in the future, you’re asking how can we control this. And it appears to have been controlled,” said Jeremy Liew, of Lightspeed Venture Partners.
Others tried to convince the committee that the Bitcoin community, as a whole, has organically evolved into an age of financial compliance. The credentials of the panelists, including Cameron and Tyler Winklevoss, who have filed with the U.S. Securities and Exchange Commission to open a Bitcoin trust and who own a hefty portion of all the Bitcoins in circulation, would seem to support this argument. In the last year, well-known venture capitalists have stepped into the cryptocurrency spotlight, replacing high-roller early adopters, such as Shrem, with a more entrenched breed of financial investors.
It was Fred Wilson, a managing partner at Union Square Ventures, who drove this point home. “The vice phase is in the rear view mirror," he said.
While seemingly open to some new form of regulation, the panelists asked the committee to keep in mind that many important Bitcoin companies are emerging from garages and basements and will not immediately have the resources they need to comply.
“I think it’s important to recognize that many of these new companies are two, three, four person companies," Wilson said. "It’s very difficult for them to do what JP Morgan Chase does. I think when they grow up they should be expected to do exactly what JP Morgan Chase does, but I think there should be some kind of on-ramp.”
He introduced an idea for a safe harbor that would allow new companies to identify themselves, inform regulators that they were operating, but then be given a certain amount of time to fall into compliance.
Lawsky showed some sympathy for this perspective and he was seemingly loathe to asphyxiate the growth of a new, promising technology. But as a representative of law enforcement, he made his priorities very clear.
“If the choice for regulators is permitting money laundering on the one hand or permitting innovation on the other, we’re always going to choose squelching money laundering," he said. "It’s not worth it to society to allow money laundering and all the things it facilitates to persist, in order to permit a thousand flowers to bloom on the innovation side.”
As one might expect, coming from a panelist of technology investors, an idea for a technical fix was floated. In my mind, it was also the most controversial point made at the hearings so far. Wilson, the VC, suggested putting "the compliance into the code." He described a world in which compliance with anti-money laundering laws was automated directly by the Bitcoin code—or, more likely, by the services being built on top of it. You could do this, he explained, by enabling communication between Bitcoin accounts and other social media services, such as Facebook, that we already routinely use to authenticate identities.
When opening a bank account, he said, "I have to fill out five separate pieces of paper. I have to file an AML form. I have to file an account opening form. I have to file a W9—all this stuff, right?" Instead, he suggested he could just go to a bank's website and authenticate with his Facebook account. "They would have gotten most of that information directly from Facebook and they could have on-boarded me instantly."
Regardless of how these companies choose to comply, they will do so in their own best interest, said Liew, who did what he could to play down the appeal of Bitcoin as a pseudo-anonymous (as opposed to perfectly anonymous) currency. If his remarks are any indication of the future, then this aspect of Bitcoin (which has inspired some to call it "cash with wings") will likely erode in a wash of funding. Bitcoin has always been about money. But now it's about big money. And the real way to cash in, according to this new wave of entrepreneurs and investors, is not by appealing to segments of the community that place a premium on privacy.
“It turns out that the market of radical libertarians is not very big. The market of criminals is not very big," said Liew. "But when you're offering radically reduced transaction costs. And when you're offering the ability for programmable money that can put a lot of additional functionality on money, then you're talking about a market size of everybody in the world."