Fincen's New Regulations Are Choking Bitcoin Entrepreneurs
More than a decade ago, regulators nearly suffocated PayPal. Now it looks like they’re trying to squelch another disruptive, innovative payments system.
At least three exchanges in the U.S. that traded the digital currency Bitcoin have shut down, apparently as a result of guidance issued last month by the Financial Crimes Enforcement Network. That agency has emerged as the top threat, at least in in the United States, to the decentralized Bitcoin network – moreso than the widely reported price volatility and hacker attacks.
"They've been the single biggest factor for stomping out currency competition," says Bradley Jansen, a former assistant to Rep. Ron Paul and director of the Center for Financial Privacy and Human Rights. Speaking recently on The Daily Bitcoin podcast with Adam Levine, Jansen expressed surprise at how little focus bitcoin business leaders are putting on Fincen, especially considering how regulators thwarted earlier emerging payment systems like PayPal and e-gold. PayPal obviously survived and prospered – but only after selling itself to eBay and agreeing to put restrictions on its service. E-gold was not so fortunate.
"Fincen was able to stop currency competition with technical innovations in the 90s even before their expanded powers under the U.S. Patriot Act. And, what we've got now is a Fincen on steroids without clear restrictions from Congress," Jansen says.
The guidance requires certain intermediaries that handle virtual currency to register with Fincen as money services businesses, which entails recordkeeping and reporting responsibilities. And it says some of those businesses may additionally be money transmitters, which would mean fingerprinting of directors and officers and compliance with a patchwork of state licensing requirements.
Jansen postulates that the recent Fincen virtual currency guidance was issued ex post facto as a way to set the stage for potential prosecutions in the future.
"It's a failure of Congress to do its job. We knew that these guidelines and these prosecutions were in the works even last Congress. Ron Paul was the chairman of the House subcommittee that had jurisdiction over Fincen and he never had a single hearing on this."
In a recent speech, Fincen Director Jennifer Shasky Calvery said the new guidance aims "to protect [digitial currency] systems from abuse and to aid law enforcement in ensuring that they are getting the leads and information they need to prosecute the criminal actors." She reiterated that the guidance does not apply to everyday users who pay or accept bitcoin for goods and services.
But by saddling startups with compliance requirements, and making them unattractive clients for regulated banks that despair of serving MSBs, Fincen is choking these businesses that facilitate conversion of bitcoins into dollars. Fewer exchanges and more red tape will make it harder for merchants or consumers (who, after all, must still pay the bills with dollars) to take advantage of the Bitcoin payment system’s speed, privacy and competitive costs.
On March 20 – just two days after the guidance from Fincen came out – the bitcoin exchanger bitme.com suspended operations indefinitely. Bitme was a relatively small operation, but it was widely suspected among bitcoin users in online forums that this closure resulted from difficulties related to potential regulatory compliance.
BTC Buy, another bitcoin exchange site, suspended services and closed permanently in early April, specifically citing the legal uncertainty brought up by the Fincen guidance.
Most recently, the largest bitcoin exchange to halt trading was Bitfloor, run by Roman Shtylman, who blamed "circumstances outside of our control." His New York operation had average daily trading volume of about $300,000 (depending on the exchange rate), with U.S. dollar deposits and withdrawals running through a Capital One bank account – which the bank unilaterally closed. "I had very little time to act between receiving the account closure letter and the account being closed," Shtylman told PaymentsSource.
In this case, the regulatory guidance may have had an indirect effect. Bitfloor was registered with Fincen as an MSB but was not licensed as a state money transmitter. Shtylman surmised that Capital One had judged his business to be "not worth the risk."
Across the Atlantic and presumably unrelated to Fincen, Poland-based Bitcoin-24 suspended trading after the government there froze its bank account. It reportedly did so because a bank in Germany complained of compromised accounts transferring stolen money without identification to Bitcoin-24. Also, U.K.-based TransferWise, a foreign currency intermediary, ceased transfers to any bitcoin exchanges at the request of its banking partners. TransferWise had mostly been servicing customers in the U.K., Poland, and Spain.
It will be interesting to watch how Fincen intends to treat one-way, fixed-rate brokers that either buy or sell bitcoin at a fixed price. Since a two-way exchange market is not involved it could be seen as merely a typical commodity purchase or sale.
Tangible Cryptography LLC, which registered as an MSB this month, operates FastCash4Bitcoins for selling bitcoins and Bitcoins Direct for private off-exchange purchases. The two businesses function independently of each other and neither is technically an exchange. Bitcoins Direct is frequently closed to new clients and its cash deposit feature was recently cancelled.
The fact that bitcoin survives at all with so many powerful forces lined up against it is a testament to its resiliency and tenacity. Now, in addition to the vicious press coverage and persistent denial of service attacks on exchanges, the emerging cryptographic money has to contend with onerous and targeted regulation.
With respect to bitcoin and financial regulation, Jansen warns: "I think the lesson from the 90s was that you either become what Fincen wants you to be or you're not going to be."
Not in the U.S., that is. But jurisdictional competition will kick in and overseas exchanges will gain market share and liquidity. They just may not have U.S. customers.
Jon Matonis is an e-money researcher and crypto economist focused on expanding the circulation of nonpolitical digital currencies. His career has included senior posts at Sumitomo Bank, Visa, VeriSign, and Hushmail. Currently, he serves on the board of the Bitcoin Foundation. Follow him on Twitter @jonmatonis.