Consumer Protection in the Bitcoin Era
A look at four financial technology startups reveals major trends in the industry. Mobile applications, digital currencies, small data and alternative lending are all heating up.May 12
Fidor Bank AG is the first bank to integrate the real-time global settlement protocol provided by Ripple Labs.May 5
Bitcoin ATM provider Robocoin is touting its ATMs as bank branches after launching an online banking platform, Robocoin Bank.May 1
Rep. Jared Polis, D-Colo., has launched a hilarious stunt to urge federal regulators to ban U.S. dollars, following a more serious plea by Sen. Joe Manchin, D-W.Va., to prohibit Bitcoin.March 6
A common trope about Bitcoin is that it is "unregulated." That half-truth stirs doubts about the digital financial future. But Bitcoin is like digital cash yes, it is unregulated in itself, but it is fully regulated in its important uses. Consumer protection will be different in the Bitcoin era, though, and with the Conference of State Bank Supervisors' Emerging Payments Task Force meeting in Chicago on Friday, regulators should be aware that the thoughtful and deft will have a role in shaping the future. Others will not.
The short-term prognosis for consumer protection is fairly clear: Bitcoin-based financial services are regulated just as non-Bitcoin services are. Special regulation of this new payment technology would violate technological neutrality. But that does not mean Bitcoin businesses should get a free pass. Under existing legislation and common duties, they owe consumers care when they handle valuable digital assets. Government agencies around the world are nesting Bitcoin into existing legal and regulatory regimes with decent success.
On the longer horizon, consumer protections will change so that the public can enjoy the benefits of Bitcoin while minimizing the risks. To see how, let's look at the entire field of consumer protection and how it works, then look at how Bitcoin-based services may change things.
Consumer protection is not only the small collection of laws and agencies that fall into the "consumer protection" category. It's a wide array of social systems that help ordinary people get what they want out of commercial interactions. Our consumer protection systems produce more intense oversight as commercial relations become more complicated and consequential.
Start with the very simplest transaction. Nearly all consumer protection is produced by direct consumer oversight. A person purchasing a bottle of water at a music festival knows when the transaction has concluded successfully. In billions of financial transactions every day, direct observation of the exchange and the product provides the bulk of the consumer protection that people need.
When the successful results of transactions aren't going to be immediately obvious, reputation and trust provide another layer of consumer protection. Businesses seek a good reputation hoping to win repeat business, and they do this by providing suitably high-quality goods and honest services. When they don't, consumers can undercut businesses' reputations more effectively than ever thanks to Internet-based services (think Yelp).
Where oversight and trust have failed, there is after-the-fact law enforcement. If one of the parties fails to deliver, if there is embezzlement, or if a transaction was induced by fraud, civil and criminal law step in to make consumers whole and to punish wrongdoers. Of course, these mechanisms have their greatest influence upstream, as a deterrent. They threaten high costs to businesses that do wrong by consumers, making honest, high-quality service the path of least resistance.
If the threat of penalties after the fact is insufficient, then formal consumer protection regulation may be called for. It can take many forms: registration, bonding, command over products and prices, and even ongoing oversight of business operations. Government regulation provides sophisticated commercial oversight assuming consumers cannot or will not oversee things for themselves.
At least two developments in the Bitcoin world may undercut that assumption. They suggest how consumer protection may differ in the future.
One is cryptographic proof of reserves. In the wake of losses suffered at the hands of early Bitcoin businesses, some of the newer, more responsible companies are delivering public audits of their assets. The process is complicated, but Bitcoin's cryptography-based public ledger allows an organization to prove control of Bitcoin assets without revealing private information about customers or account holders.
Multisignature transactions are a second innovation that may remake consumer protection. "Multisig" allows any combination of consumer and business entities to exercise control over a Bitcoin-based asset. Consumers can have greater control over their "programmable" money even while it is held by a financial services provider.
These innovations, and others to come, will tend to make consumer oversight of Bitcoin businesses easier and government oversight a less important part of the mix. Consumers will be better positioned to do their own monitoring and, in the best case, to enjoy cryptographic proof that they are being properly served.
Another current suggests that regulators should anticipate this trend and get ahead of it by treading lightly. Bitcoin is a worldwide protocol: Service providers anywhere can reach customers everywhere. Governments that don't provide confidence-building consumer protection that is cost-effective will push Bitcoin businesses to the jurisdictions that do.
By strengthening direct consumer oversight, Bitcoin may shift consumer protection somewhat from the world of law and regulation to the more dynamic world of reputation and trust. And in the best cases, Bitcoin businesses will prove the fulfillment of their services cryptographically. It's easy to overstate, but a fascinating subject for the Conference of State Bank Supervisors to consider as it examines digital currency at the payments task force hearing (and at its supervisory forum) this week: consumer protection provided by math rather than law.
Jim Harper is the global policy counsel at the Bitcoin Foundation.