As the Internet’s favourite digital currency gains widespread acceptance and a upcoming US securities listing, its challenges are mounting. How will the cryptocurrency survive its coming of age party?

bitcoins Bitcoins coming of age party

This past Friday Bitcoin hit a major milestone: a Bitcoin based gambling site was purchased for a hefty sum. Unlike most takeovers, it wasn’t paid for in cash, stock options or other commonly used methods of payment in the corporate world — it was paid for in Bitcoins.

SatoshiDice was purchased by an anonymous party for 126,315 BTC, which is approximately $11.5 million given current BTC-to-dollar exchange rates. When dividends are included into the payout shareholders received, it amounted to a payout of approximately 175%.

SatoshiDice was listed on a Romanian exchange for Bitcoin-based companies called the MPEx. Considering the lack of regulatory burden placed on SatoshiDice and other companies listed on the exchange, the sheer profit margins from such a deal are enormous. While other publicly listed companies the world over have to spend huge overhead to access the capital found on a public listing, SatoshiDice was saved the army of lawyers and accountants usually required to make a company IPO-worthy.

Weeks before the  SatoshiDice deal was announced, Bitcoin met another major milestone. The Winklevoss twins, made famous by their role as angel investors in Facebook, announced that they were in the process of creating a Bitcoin-based exchange traded fund. Exchange- Traded Funds, or ETFs, are investment vehicles that can be bought and sold like stocks which track an index of companies or the value of a commodity. When the index or commodity its tracking goes up so does the value of the ETF, and vice versa. The Winklevoss twins ETF would track the value of Bitcoin, going up and down based on the value of the currency.

But as a digital currency comes into the limelight and has a coming of age party, there are issues that need to be addressed by regulators and stakeholders within the Bitcoin community. Fraud and money laundering both run rampant within the digital currency sector, and as the swift demise of LibertyReserve shows regulators with swoop in with extreme prejudice.

It won’t be another Liberty Reserve

The most obvious stigma that faces digital currencies like Bitcoin is that they are underworld havens of crooks and gangsters. In the case of Liberty Reserve, that was largely the case.

Liberty Reserve allowed people to send Liberty Dollars or Liberty Euros to one another with all the anonymity of a name, email address and birth date. In order to cash out Liberty currency to physical currency one would have to go through an intermediary — much like one would have to go through a Bitcoin exchanger in order to convert BTC to dollars.

Bitcoin and Liberty Reserve had to main differences: Liberty Reserve didn’t have a guiding force to keep the value of its currency in check; nothing could have stopped Arthur Budovsky (its founder) from printing as much Liberty Reserve currency for his own use. Bitcoin, in contrast, has an algorithmic ceiling to how much currency can be generated  at one time and how many CPU cycles it takes to create a single Bitcoin.

The other difference between Bitcoin and Liberty Reserve is that Liberty Reserve had a head office, a central node. This made it possible to shutdown the service, while the same can’t be said about Bitcoin since its only a white paper and an algorithm. While there are a fair amount of illicit goods paid for through Bitcoin (see: Silk Road), Bitcoin can’t be shut down since it doesn’t have a head office like Liberty Reserve. Exchanges can be shut down, but if one goes down a new one will arise in its place somewhere offshore.

Given the obvious interest from regulators in Bitcoin, one would think that a public listing of a Bitcoin-based equity would not be a possibility. While it would be a stretch to say that Bitcoin has an ally or an evangelist in Washington, one of the key figures in Washington’s regulatory apparatus seems to be not outright opposed to the idea.

Bitcoin on the market

In early May, reports said that the US Commodities Futures and Trading Commission was studying if Bitcoin fell under their purview. The CFTC’s mandate is to regulate the derivatives market, meaning the trade of derivatives on exchanges, commonly oil and metals, fall under its mandate. Should a Bitcoin based derivative be listed, as the Winklevoss twins propose, it would fall under the mandate of the Securities and Exchange Commission as well as the CFTC (since its technically a derivative) by its nature.

From its website, the CFTC’s mandate is “to protect market users and the public from fraud, manipulation, abusive practices and systemic risk related to derivatives that are subject to the Commodity Exchange Act, and to foster open, competitive, and financially sound markets.”

Speaking to the Financial Times, Bart Chilton, one of the CFTC’s commissioners, said, “[Bitcoin is] not monopoly money we’re talking about here – real people can have real risk in these instruments, and we need to ensure that we protect markets and consumers, even in what at first blush appear to be ‘out there’ transactions.”

Chilton expanded upon his comments in an interview with VR-Zone via email.

“Regulators would be irresponsible not to look into this cyber-currency to ensure its traded in a fair manner devoid of fraud or manipulation,” he said. “There are a lot of risks that need to be considered by various regulators.  For one, you’re gambling on something that is not only virtual, but almost totally speculative and not regulated by anyone.”

The CFTC would go after exchanges with a physical presence in the United States, requiring them to undergo audits to ensure that they are not manipulating the market. They would also likely leverage favours and clout with their worldwide counterparts to go after offshore exchanges.

Because exchanges are considered “money transmitters”, US money anti money laundering agency the Financial Crimes Enforcement Network (FinCEN) could go after exchanges under anti money laundering laws should they face non compliance. This spring, the most famous of Bitcoin exchanges, Mt. Gox, had its U.S. bank account shut down because it was accused of not complying with FinCEN guidelines.

But for some, the very idea of involving the banks is antithetical to the libertarianish off-the-grid MO of Bitcoin. As Wired documents its recent piece “Why the Only Real Way to Buy Bitcoins Is on the Streets,” a growing trend within the Bitcoin movement is in-person trading for not only cash but also things like gold, silver or merchandise. The vibe the article presents is that a complex regulatory framework wouldn’t mix with the Bitcoin outlook on the world, an impression that the Bitcoin Foundation seems to give off as well.

It won’t be regulated, for most people

It wouldn’t be much of a stretch to say that an organization that wants to “help people transact on their own terms” is one that would want to embrace regulation or even work with regulators in drafting the law.

Speaking to someone from the Bitcoin Foundation confirms this.

“The ‘regulating bitcoin’ narrative is flawed because it doesn’t take into account all the the nuances of reality,” said foundation spokesperson John Stahl.  “It instead plays into what people think of when they hear the word ‘regulation.’  ‘Bitcoin regulation’ sparks a visceral reaction from people based on what ‘regulation’ means in other areas of their lives.”

Stahl points out that as an education-oriented foundation, working with regulators will simply amount to education.

By presenting such an anti-regulation outlook In many ways the Bitcoin Foundation is missing out on an opportunity to proactively engage with regulators, and help write the laws that Bitcoin will fall under.

For most people, Bitcoin will offer a utopian escape grounded in libertarianish ideals from the confines of cash. Either a desire to get off the grid for privacy’s sake, or to simply provide a shield for illicit activities, Bitcoin provides a great venue.

In light of bailouts and a general feeling of mistrust in traditional investments, a growing number of people want an alternative investment vehicle. Bitcoin also provides a great venue for this. Its politically agnostic and not tied to other currencies. However, in order for it to be a serious investment vehicle it needs to be scrutinized by regulators.

While some regulators have have an in-depth existing knowledge of Bitcoin, and will approach it with a critical but fair eye, there are others that will approach it with uneducated paranoia.

This is where the Bitcoin Foundation should step in. Its one thing to try and proactively educate lawmakers, but the Foundation also needs to help write the laws through lobbying and the publishing of policy white papers. Its Bitcoin’s coming of age party now, and the digital currency has the potential to be a major disruptive force. In some circumstances its fine to approach Bitcoin with Randian-esque idealism, however stakeholders need to realize that Bitcoin isn’t immune from the regulators of the world and they should try and proactively embrace regulators and lawmakers to help write the future of Bitcoin.