Alert November 26, 2013

Senate Holds Hearings on Virtual Currency

In the wake of a recent hearing before the Senate Committee on Homeland Security and Governmental Affairs regarding the threats and promises of virtual currency, the value of Bitcoin soared above the $700 mark—a record high for the nascent financial platform. The support offered in some testimony at the hearing suggests that there may be an optimistic face toward the future of digital currency. However, the Senate Banking Committee’s hearing on the same topic proved divisive and ill-focused, with regulators and industry specialists each touting Bitcoin’s potential to survive or fail in the coming months and years.

FinCEN reiterated its sentiment from the recent hearing that it is important for financial institutions to put controls in place to mitigate threats of abuse. These controls include FinCEN’s March 2013 guidance on virtual currencies (see April 2, 2013 Alert), which recommends that administrators and exchanges of virtual currency, including Bitcoin, must register with FinCEN, set-up anti-money laundering controls, and provide frequent reports to FinCEN. FinCEN additionally felt “lucky” that any misuse of digital currency can be tackled under existing flexible regulations, which their international counterparts are finding more difficult.

David Cotney, the Commissioner of the Massachusetts Division of Banks, looked at state-level participation in the regulation of Bitcoin. A cooperative venture among states, including an open dialogue among state regulators, was proposed as the goal of determining the appropriate level of government oversight of digital currency. The main difference in the ability to regulate the virtual currency space, as stated, was the fact that the state regulatory regime is about consumer protection, rather than investor protection. Its needs, however, remain virtually identical to the federal regulators, in that it seeks to make financial actors “Play by the rules through agencies like mine.”

Moving outside the scope of previous hearings, there was greater debate over how virtual currency should be defined. While FinCEN noted that a definition is outside its purview, it did recognize the fact that Bitcoins are “filtering through our financial system.” This, in turn, gives FinCEN the ability to regulate digital currency, since it falls into the broad-sweeping regulatory pool of “other value that substitutes for currency.” Pushback from Sen. Heidi Heitkamp on the need to categorize virtual currency focused on the ability of more than “just illegal, terrorist groups that have the ability to skirt the edges” of the law. However, FinCEN stated that, from its counter-terrorist, money-laundering perspective, defining digital currency is not as important, because they have similar regulations across different parts of the industry, whether it involves currency, securities, or commodities. FinCEN’s current unease with putting digital currency into a particular financial bucket is perhaps colored by the assumption that Bitcoin may not grow as many enthusiasts think it will. In fact, FinCEN admitted that it may be a “binary investment: either it will be the cell phone of twenty years ago, or it will fail completely.” BITS, the Technology Policy Division of the Financial Services Roundtable, demonstrated how complicated it will be to develop this “standard” definition. BITS delineated Bitcoin’s tripartite makeup as (1) a currency, (2) a depository system, (3) and a payment system. Whether or not a government body will want to demarcate these boundaries further, or to offer up a new definition that encompasses them all, remains to be seen.

As just witnessed, the industry, legal, and academic panelists seemed to offer, at times, divergent ideas about how best to incorporate Bitcoin into the U.S. financial landscape. BITS observed that digital currencies are subject to significant market unreliability without any government backing or funding. The spike in Bitcoin values the previous day adequately evidenced this claim. BITS pressed for more regulatory protections, especially consumer protections, because there are none currently existing outside March 2013 FinCEN guidance. The unstable market for virtual currency strongly correlates to Bitcoin’s uncertain acceptability, legitimacy, and usage, BITS acknowledged.

Much like BITS, Ms. Sarah Jane Hughes of Maurer School of Law also underscored the need for users of virtual currency to have the same protections that other consumers currently receive under the Gramm-Leach-Bliley Act and the Right to Financial Privacy Act of 1978, for example. Hughes’ enthusiastic support for virtual currency was coupled with the feeling that any new regulatory regimes, though, need to be crafted with “great care and … great flexibility” so as not to make investors “get cold feet.” An “open set of rules,” then, was what Hughes advocated. Additionally,  she was careful to recognize that “[i]f we do regulate, then we do legitimize.” Yet,  Hughes believed that amounts to “a risk worth taking,” and a greater structure around Bitcoin would lend itself to both more clarity and growth in the space.

A unique perspective on these issues was provided by BitPay, Inc., which is considered “pretty old” in the Bitcoin space (founded May 2011). BitPay promoted a “wait and see approach,” analogous to the government’s method of dealing with the advent of the Internet in the early 1990s. As a way to combat illicit use of digital currency, BitPay did not encourage greater law enforcement of criminal activities. Rather, its approach was to separate legitimate from illegitimate uses of Bitcoin by having a “know your users” policy. The “bad guys” will, BitPay alleged, figure out how to conduct illegal activities on their own, without the services of companies like BitPay. A counter to this argument, however, was raised by BITS, which queried whether BitPay’s controls and mitigations are an industry-wide standard or are merely an exception to the rule.

This hearing reflected general agreement that Bitcoin does have the potential to positively influence the U.S. financial system and ease money transfers internationally. Nonetheless, virtual currency’s future impact is confronted by lack of consensus even among industry, legal, and academic supporters of how to control its entry into the U.S. financial landscape.