New York lawmakers bite hard on Bitcoin: why that's good for investors

As two days of hearings on the future of digital currencies – think Bitcoin – wrapped up Wednesday in the New York State Legislature, fans of the cyber-cash were getting both bad and good news.

Supporters who are drawn to Bitcoin because it largely functions outside governmental control may have been dismayed at the attempt to corral the currency inside state guidelines for the handling of money.

But, at the same time, say experts, the simple act of enacting regulations bestows the legitimacy the digital currency needs to become widely used.

“Most of the folks in this market who are not anti-establishment or fringe elements understand what’s necessary for this market to grow,” says Kevin McIntyre, an economics professor at McDaniel College in Westminster, Md., who specializes in the study of virtual currency. “And for virtual currency to have a future, some level of oversight – and the cache and legitimacy that come with that – is necessary.”

At the moment, says Professor McIntyre, “there is this wild unchecked market out there” in the online world of transactions using Bitcoin, noting that “the potential for abuse is too large to be ignored.” This includes the use of Bitcoin and other virtual currencies – through transactions that that are largely anonymous – for terrorism and money laundering.

New York is the logical state to take the lead in such regulation, he adds, as it is the financial capital of the country.

The hearings were held the same week that the top executive of a New York City-based Bitcoin company and a Florida Bitcoin exchanger were arrested and charged with conspiring to commit money laundering by selling more than $1 million in Bitcoins to users of Silk Road, a black market website, the Associated Press reported.

Federal prosecutors in New York said Charlie Shrem, CEO of BitInstant and vice chairman of a foundation that promotes the Bitcoin currency system, personally bought drugs on Silk Road and was aware it was a website that let users buy illegal drugs anonymously, the AP reported.

States such as California, Virginia, and Texas have taken actions to prevent the unlicensed transmission of money,  while several others have granted licenses to Bitcoin companies, points out attorney Barrie VanBrackle, co-chair of the Consumer Financial Services practice at national law firm Manatt, Phelps & Phillips. 

“New York is the first state to be taking a systematic approach to provide clear expectations on devising a regulatory structure to work for both consumer protection and preventing the use and abuse of the financial system for money laundering,” she says via e-mail. [Editor's note: The original version of this paragraph used an incorrect pronoun in referring to Ms. VanBrackle.]

The hearings pursued basic questions, says Ben Mazzotta, a postdoctoral research fellow at the Institute for Business in the Global Context at Tufts University and co-author of a research study, the Cost of Cash in the United States.

They were an effort by regulators to learn the fundamentals of the Bitcoin ecosystem, he says: “Who uses Bitcoin today, for what, when, where and how? What are the legitimate ends of Bitcoin financial services? Does anybody need Bitcoins for something you can't already do in dollars or euros? Are the only people that need that kind of privacy, by definition, people with something to hide? And is there any way that Bitcoin's system of ownership and transactions can be made compatible with a stable and legal financial system?”

The New York Legislature’s hearings were focused in particular on defining virtual currency, he says, adding, “These hearings have to do with what constitutes a bank, and whether Bitcoin exchanges and Bitcoin financial services have to play by the same rules as banks today. Understandably there are different rules for banks from most other businesses in the economy.”

Meaningful action from these hearings will depend on the answers to important questions, says James Jalil, a partner at the New York law firm Thompson Hine who specializes in Bitcoin matters.

“Can regulations be crafted which satisfy both the protection of New York people and businesses from fraud and abuse while at the same time encouraging, or at least not stifling, innovation and creative business and financial practices?” he says via e-mail.

Achieving that balance in a technology that is rapidly evolving can be difficult, he says. Still, he notes, “laws and regulations that are decades old and were adopted long before the electronic, digital age cannot always be applied easily, effectively and efficiently to new ways of thinking about currency and financial transactions.”

It makes all the sense in the world to review existing laws and regulations with a new perspective and in light of cutting edge innovation and technology, says Mr. Jalil.  “If nothing else, these hearings will perform a useful function,” he says, “in asking both the regulators and the users of Bitcoin technology to understand the needs and perspectives of the other.”

Early Bitcoin investor Cameron Winklevoss, who testified at the hearings, expressed confidence that regulation of virtual currency is not incompatible with further growth of the crypto currency world.

“I’m just glad we’re doing this because I think that New York has the ability to set the tone, not only for the state, and the US, but being a financial center of the world, I think a lot of people are going to sort of have eyes on New York and watch what New York does,” Mr. Winklevoss said.

“So I think there is a huge opportunity to set the right tone,” he continued. “The Bitcoin idea is freedom, it’s very American. It challenges the duopolistic forces, and that’s very healthy. I think this is what we should all be striving for.”