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The Last Straw for Bitcoin

"Digital currencies are just a financial service and those who deal in them are [financial institutions]," Jennifer Shasky Calvery, the director of the Financial Crimes Enforcement Network, told American Banker in an interview last week.

The significance of this sentence, as it relates to Bitcoin — the upstart decentralized virtual currency designed to remove financial institutions from electronic payments — is huge. It can only be fully appreciated by understanding the digital currency and payment system's history and the legal framework of the Bank Secrecy Act.

Satoshi Nakamoto, the pseudonymous creator(s) of bitcoin, introduced it to the world with "Bitcoin: A Peer-to-Peer Electronic Cash System," a white paper posted on the Internet in 2009. Nakamoto described the problem that Bitcoin was intended to solve in the first sentence: "Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments."

Yet those dealing in bitcoins are now themselves considered financial institutions. To survive, these businesses will have to do more than "de-anonymize" their operations. They will also have to cope with the loss of Bitcoin's most fundamental characteristic: irrevocability. 

It is hard to have a serious conversation about Bitcoin without discussing anonymity. While anonymity is not an inherent characteristic of Bitcoin, the two have become nearly synonymous in the public imagination. Since law enforcement depends on the ability to track financial transactions, the anonymous nature of certain Bitcoin transactions has always been a difficult sell in some quarters. The BSA, the United States' primary anti-money laundering bulwark, requires financial institutions to establish AML programs, collect information from their customers, and file reports about large, unusual, or suspicious transactions. To the extent that financial institutions are not involved in transactions, the paper trail related to such transactions becomes harder for law enforcement to follow. To plug the holes in the BSA's coverage, the law's definition of "financial institutions" has expanded to include several types of businesses such as "money service businesses," including money transmitters.

In March, Fincen issued guidance confirming that certain virtual currency participants were money transmitters—and, as a result, MSBs and financial institutions—and therefore subject to the BSA. After the guidance and the federal government's actions against Mt. Gox (the largest bitcoin exchange) and Liberty Reserve (a centralized international issuer of its own virtual currency), the message being sent to the Bitcoin community is clear: anonymity is dead. 

Bitcoin was conceived as a payment system with transactions that are computationally impractical to reverse. Indeed, unlike anonymity, the finality of Bitcoin transactions is hardwired in the protocol. However, it appears that this will need to change. In its findings against Liberty Reserve, Fincen recently opined that "[t]he fact that the transactions are irrevocable, meaning that they cannot be reversed or refunded in the event of fraud, makes it a highly desirable system for criminal use and a highly problematic one for any legitimate payment functions."

Unlike anonymity, the finality of payments does not appear to fall squarely within Fincen's regulatory authority. However, Fincen's comments may foreshadow regulatory action by the Consumer Financial Protection Bureau or the Federal Trade Commission, the two federal agencies most likely to take issue with irrevocable payments.  Even if a fix to the bitcoin protocol were devised to allow for reversible transactions, the loss of irrevocability could be fatal for bitcoin as it would result in increased transaction costs and slower remittances.

One question is whether the United States' posture will drive innovation into more lightly-regulated jurisdictions. FinTRAC, Fincen's Canadian counterpart, has recently indicated that certain Bitcoin transactions and business models will not require MSB registration in Canada. However, Stuart Hoegner, a Toronto attorney with clients in the Bitcoin field, says that, just like the United States, other regulations may still apply to bitcoin businesses. "The Department of Finance might also change the AML regulations, either on its own initiative or in response to pressure from the Financial Action Task Force or its members. The FinTRAC rules could change quickly," Hoegner told me.

The BSA is only one part of the U.S. financial regulatory landscape that Bitcoin businesses must navigate if they are to survive. Many Bitcoin entrepreneurs will also be subject to a variety of state money transmission regulatory schemes. Other federal regulators (such as the Commodity Futures Trading Commission) are also likely to weigh in.

If Bitcoin is to survive, it will have to do so as a transparent and (likely) expensive payment system operated by a bunch of financial institutions. 

Ryan Straus is a financial services attorney at Graham & Dunn PC in Seattle.


(10) Comments



Comments (10)
Proper anonymity will be guaranteed by the successors of Bitcoin. Such is Monero. Transactions are untracable and unlinkable in Monero.

While the FinCen guidance will be obsoleted by legislative action eventually, until then the U.S. is going to decline in importance in the financial world, as value increasingly flows into the new technology.
Posted by akohn | Sunday, September 07 2014 at 2:43PM ET

I wasn't taking a moral position, i was merely commenting on how I think bitcoiners tend to be ridiculously naive in thinking the powerful governments of the world can't easily mess with the bitcoin market and its value. You don't need to be able to bruteforce the crypto technology to be able to drive it underground make a unusual to legit businesses and kill 95% of its market cap.
Posted by JamesH11 | Thursday, June 06 2013 at 6:40PM ET
It is wishful thinking of established actors that Bitcoin will have to take on all their burdens and become as slow and expensive as they are. Yes, people dealing with other people's money have to comply with rules of financial services, but this does not extend to those dealing with their own money, selling own products, and this is the core of Bitcoin. Being your own bank, at least for payment processing and cash - and more to come.
Posted by methinks | Thursday, June 06 2013 at 1:50PM ET

Your avid cheerleading for cross-country violations of someone's basic rights is depressing. I'm sure you'd be singing a different tune if you were on the receiving end of a badly-enforced Patriot Act seizure of your assets. You know, the kind that doesn't require a warrant and only the "suspicion" of wrong-doing.

Due process isn't about lawyers getting paid, its basic rights that shouldn't be trampled just because a company with big pockets can use government as their enforcement service.

But I'm sure its all lost on you, with your 401k, the job, blindly nodding along with the rest as your currency is actively debased to the tune of $85 billion a month. And even if you aren't an American, there's plenty of financial chicanery going on globally that means you're being impacted - but you choose to turn a blind eye.

Good luck with that - because the system that is exploiting you relies on your willful ignorance, which you demonstrate in spades.
Posted by TraderTimm | Thursday, June 06 2013 at 12:53PM ET
It's cute the bitcoiners think the bitcoin technology is immune from government interference. We'll see. If hollywood can get countries like New Zealand to dance for it (megaupload) you can only imagine what the western financial order is capable of if properly motivated.
Posted by JamesH11 | Thursday, June 06 2013 at 1:33AM ET
The author's reasoning is deeply flawed. First, the United States doesn't rule the entire globe, even if they do spend more than the top 13 countries combined. Second, every node in the bitcoin network would have to agree to any rule change - and it is highly unlikely that ANYONE would agree to revoke irreversible payments.

You might as well ask the entire network to spend their bitcoins on a popsicle-stick skyscraper. That's how flawed the idea is. Not one node will do it, which blows your entire article out of the water.

It bothers me when people who seem like they're reasonably educated and can utilize logical thinking can't seem to piece together the concepts that Bitcoin represents.

Was it a deadline? Some hasty typing before lunch? An unwillingness to know the subject? We may never know - but what we DO know is that the author shouldn't be trusted to write on complex subjects, as he has fully embarrassed himself and the site his article is published on.

Do your homework next time, and don't be so intellectually lazy. Your remaining readers thank you.
Posted by TraderTimm | Wednesday, June 05 2013 at 6:13PM ET
This author clearly has no idea what he is talking about. He needs to stop spewing garbage from his keyboard and actually take the time to research the weak points of BTC before he writes an article on a subject he knows nothing about. BTC does have weak points, but none of them were expressed in this article.

They will only be taxed if they want to be. They won't report it and there is NO way to track it. The transactions will appear on the blockchain, but if you have no name attached to the wallet you are effectively anonymous. You don't consider wordpress a legit business, or reddit?

Openuris, BTC is nothing like napster, megaupload or LR. All of those systems had central points of failure. A server to take down or and people to arrest. BTC does not have any of those. It is decentralized network. As long as a single copy of the blockchain exists BTC will exist. No government has a prayer of regulating BTC unless the community allows them the power to do so.

I hope they do allow for it to be encompassed into regulation. It will bring to the masses more quickly. Once you can buy a loaf of bread at the grocery store with BTC, fiat currency will be truly dead and the banking system along with it.
Posted by Anon098 | Wednesday, June 05 2013 at 3:42PM ET
I think anonymity is going to be the downfall and not irrevocability, at least the first test it must somehow pass. And yes, I absolutely think they are going to hit a wall more so like napster, megaupload, and other supposedly infallible P2P operations, than what liberty reserve recently experienced.

Another is going to be coming to terms with rapid valuation changes and the capital gain and loss liabilities that would come with that. Until it gains some stability, I don't think many legitimate businesses are going to take it seriously. This will perpetuate it being considered an off the books currency as it often is now.
Posted by openuris | Wednesday, June 05 2013 at 2:36PM ET
'If bitcoin is to survive', what does that mean exactly?

Are you threatening bitcoin, then?

You took 10 years to take down LR on trumped up charges, you think you can take bitcoin down because it's irrevocable? Shouldn't that also mean you should start banning USD cash and physical interactions between people in all currencies because they include transactions that are irrevocable?

Most countries think Bitcoin is a commodity, you think they're just going to change their mind at the whim of the fincen?

Whoever's had bitcoin these last three years and seen their value skyrocket, will americans not get taxed on those USD gains because it was just a currency exchange?

Streisand effect bla bla bla
Posted by joao mush | Wednesday, June 05 2013 at 2:07PM ET
America is the new North Korea - good luck with trying to control the world via already irrelevant legal mechanisms.
I'm not an American, so apologies if I choose to ignore your laws and continue to live my life in the free world.
Posted by gleetree | Wednesday, June 05 2013 at 12:56PM ET
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