WASHINGTON Lawmakers dove headlong into the growing debate over virtual currencies like Bitcoin this week, with back-to-back hearings in the Senate.
The Homeland Security and Government Affairs Committee and two subcommittees of the Banking Committee separately examined the role of virtual currencies in the financial system and the opportunities for criminal activity with a host of government officials and industry experts on Monday and Tuesday.
Below are four key insights from the marathon investigation into where the virtual currency market is headed and what it means for banks, consumers and those looking to exploit the system.
It's tough to balance innovation against the potential for abuse
Panelists and lawmakers at both hearings expressed interest in finding ways to foster, or at least not hinder, technological innovation, while at the same time working to expose use of virtual currencies in criminal activity.
"I think the great challenge for the regulators is to encourage innovation wherever we can, and put smart regulation in place that tries to deal with risks, very real risks about which we need to be concerned, but minimizes the burden on innovation," said Jennifer Shasky Calvery, director of the Financial Crimes Enforcement Network.
Still, how to go about reaching that balance in practice remains a big question.
"In the early 1990s, when the Internet was in its infancy, Congress took a wait-and-see attitude to let the Internet develop," said Anthony Gallippi, co-founder and chief executive of BitPay, a Bitcoin merchant payment processor. "So where would social media and other free applications of the Internet be today if in the 1990s we required licenses for the Internet and we taxed Internet access as if it was a telecom?"
But others, including Sarah Hughes, a university scholar and fellow in commercial law at Indiana University, cautioned against such a hands-off approach.
"Don't buy the Wild West argument. Just because something is new, doesn't mean it should not be regulated on the same basis as the types of activity with which it competes," she said.
Patrick Murck, general counsel for the Bitcoin Foundation, warned that it's not just regulators but the financial industry itself that may be hindering the progress of virtual currencies, perhaps out of an overabundance of caution.
"It's from the ability of businesses in the space to get bank accounts and to be integrated into the banking system. There is currently a chill in the banking system and in the banking industry that is preventing businesses from getting just simple checking [accounts]," he said. "There are stories that if you have the word Bitcoin anywhere in your name or your documentations, your application will be immediately placed in the circular file, as it will."
At the same time, the threat of virtual currencies to aid criminal activity was clearly on the minds of lawmakers, and remains a key focus for the government particularly after crackdowns on the Silk Road, an online black market for illegal drugs, and Liberty Reserve, a Costa Rican payment and virtual currency network, earlier this year.
"Our experience over the last several years has showed us that there's reasons for our vigilance, and there is good reason for us to remain vigilant. Liberty Reserve was the largest money laundering case ever brought by the Department of Justice. And that is an important fact," said Mythili Raman, acting assistant attorney general for the criminal division at the Department of Justice. "And it reminds us that there is good reason for us to remain watchful and we intend to do that."
The hearing also included a clarification of sorts from Sen. Chuck Schumer, D-N.Y., who said his earlier criticism of Silk Road was not an attack on Bitcoin itself.
"I do not want to shut down or stamp out Bitcoin," he said. "New York sits in many ways at the nexus of all the issues being discussed today, as financial capital, the potential for the creation of a new payment platform and the rise of alternative currencies could have profound and exciting implications for the way we conduct financial transactions."
U.S. overregulation could push the industry overseas
A key offshoot of concerns about stifling innovation was the worry that overly tough rules could simply push virtual currency activity offshore.
"We have to strike the right balance, since we're talking about here no governmental entity, we're talking about here the anonymity that is allowed to take place, the ability to set up these exchanges with little oversight," said Sen. Mark Warner, D-Va. "Too much regulatory burden, [and] we could simply chase these exchanges offshore and still leave Americans unprotected."
Calvery argued that all countries are invested in rooting out money laundering, terrorist-group funding and other criminal enterprises, suggesting that those using Bitcoin for illegal activity could soon run out of places to hide.
"If this virtual currency payment system about which we're talking today is going to survive and be a real player, a significant player in the financial system, regulation both at home and abroad is going to catch up. Because it has to," she said.
But others argued that the world could take a while to catch up, leaving plenty of time for regulatory arbitrage. It was only this year that Fincen and the intergovernmental Financial Action Task Force each released guidance on the issue, noted Ernie Allen, president and chief executive of the International Centre for Missing and Exploited Children.
"My sense is that most of the world is not applying money transmitter laws, is not applying any laundering principles," he said. "So I think the question of how we get from here to there regarding an area that there's not great knowledge and understanding about, is really the issue."
Meanwhile, others continued to press the case that legitimate businesses could also move offshore to look for better opportunities.
"The danger is real hardworking entrepreneurs who are looking to comply just don't find a regulatory environment here that is amenable here" said Jerry Brito, a senior research fellow at the Mercatus Center. "That's something we don't want to allow to stretch for too much of a period of time."
Will digital currencies harm consumers?
Lawmakers also questioned panelists about the extent to which consumers are protected using digital currencies and whether more safeguards are needed.
Virtual currency is still a relatively new concept, and even its supporters acknowledged it's not yet completely safe for consumers.
"When you look at Bitcoin, especially, we haven't even released version 0.9 [of the software] yet so we're not on version 1.0. It's very much still an experimental currency and it should be considered a high-risk environment for consumers and investors at the moment," said Murck, noting that those concerns are evolving over time as companies build services around the currency.
The hearings this week also come in the wake of several high-profile reports of bitcoin thefts from online wallet providers, which essentially amount to bank robberies. There are currently very few protections for those who do business in bitcoins and no reversibility for transactions issues to be weighed against the lower processing costs and the ability to clear payments with lightning speed.
"Today, if you want to use electronic payments, you're probably going to be using a credit card or something like PayPal. And that comes with fees sometimes high fees. And those fees are important because they provide things like insurance. If you have your identity stolen or something that you received is not what you ordered, you can always have that charge reversed," said Brito. "Decentralized digital currencies are like cash, in that there's nothing to reverse. But that also means that there are very little fees. So, this now presents a new choice for consumers. They can choose 'insured but more expensive' or 'not insured but less expensive.'"
Laws on the books may be enough, at least for now.
Sen. Tom Carper, D-Del., chairman of the Homeland Security committee, pressed DOJ and Fincen representatives on Monday about whether new laws or rules were needed to better address criminal concerns over Bitcoin and its competitors, but government officials said that the statutes on the books appear to be enough for the time being.
"I think as far as criminal statutes, we feel confident that the statutes that we have available to us our money laundering statutes, our money transmitter statutes are broad enough to encompass the activity that we've been talking about," said Raman, adding that the Justice Department continues to support updates to certain provisions related to money laundering.
Calvery added that the current regulatory environment "has the flexibility in it to change as the landscape changes."
"So in other words, if some part of the industry were to ultimately be defined to come under the SEC or the CFTC anti-money-laundering regulations also apply to those areas of the industry," she said.