Regulation is stunting the growth of digital currency businesses that pose a long-term competitive threat to banks.
The latest to get caught in the regulatory thickets is TradeHill, a Bitcoin exchange that has suspended trading until it can get licensed as a money transmitter. Its reasons for retreating echo the concerns of Facebook Inc., which has been pursuing money transmitter’s licenses to legitimize the social network’s Facebook Credits.
That TradeHill, which shut down its service and returned its clients' funds on Feb. 13, and others like it would run into regulatory challenges was almost a given. Bitcoin, a digital currency with no central issuing authority, is touted by its users and admirers as being outside the control of any government.
Though Bitcoins can't be stored in traditional bank accounts, the exchanges that trade them for dollars and euros depend on numerous payments providers, which ultimately are attached to bank accounts, for funding.
Had TradeHill been found culpable of operating a money services business without a license, it would have had no chance of returning to business of any kind, experts say.
"It was smart and proactive on their part, and they heeded the legal advice they received, which said to them, 'If you want to continue operating in the U.S. jurisdiction, you have to become a licensed [money services business],' " says Jon Matonis, a payments industry veteran and creator of the blog The Monetary Future.
In a letter to customers TradeHill said it shuttered as a result of mounting regulatory pressure, the closing of multiple bank accounts associated with its business, and other factors. (TradeHill did not respond to repeated requests for an interview.)
It was one of the largest services that people use to exchange government-issued money for Bitcoins. There are approximately a dozen such exchanges worldwide. The largest one, Mt.Gox, is based in Japan.
Mt.Gox does not have a money transmitter's license either, so it may soon encounter similar problems. The Financial Crimes Enforcement Network said last year that money service businesses with no physical locations in the U.S. are now subject the same regulations as domestic providers if they transact in this country electronically.
Mt.Gox, in an email, said it is pursuing appropriate licensing in its home country as well as the U.S., the U.K., and Australia.
"There is [no] exact E.T.A. on when we are going to get these licenses but we are … actively working on this and speaking to the correct authorities," a Mt.Gox representative wrote.
TradeHill's sudden closure is certain to have a ripple effect on the Bitcoin economy. About 200,000 Bitcoins, worth more than $1 million, change hands each day.
BitInstant, a New York company that helps move funds into the exchanges, said about half of the $50,000 it handles each day was transacted over TradeHill.
"It was our biggest revenue stream, and when they told us it was closing down, I was very scared," says Charlie Shrem, chief executive officer of BitInstant.
Since the shutdown, business has rerouted to Mt. Gox and other exchanges, Shrem says.
Not pursuing the appropriate licensing would also have risked allowing customer funds to be seized by the authorities, says Carol van Cleef, a partner at the law firm of Patton Boggs LLP, in Washington.
"For small, entrepreneurial companies, the time and day is over [when] you can start a payments business and try to grow it to the point where you can then afford to get compliant," van Cleef says.
