A Red Flag for Bitcoin



By Mark Norton: [email protected] 7/22/2014

In the late 1900s, just as the car was starting to appear on the streets of the nation, legislators took on the responsibility of regulating these threats to life and property. A common form of the law mandated that vehicles must be preceded by someone waving a red flag to warn pedestrians of the danger approaching. Pennsylvania took it a step further:

Legislators unanimously passed a bill through both houses of the state legislature, which would require all motorists piloting their “horseless carriages”, upon chance encounters with cattle or livestock to (1) immediately stop the vehicle, (2) “immediately and as rapidly as possible… disassemble the automobile,” and (3) “conceal the various components out of sight, behind nearby bushes” until equestrian or livestock is sufficiently pacified.[1]Wikipedia

For several months, Ben Lawsky of the New York Department of Financial Services (NYDFS) has been talking with the Bitcoin community and working up a set of requirements for a proposed license for Bitcoin businesses, labeled a BitLicense. Some in the Bitcoin community had been hopeful that Lawsky was earnestly working on sensible rules for the road that might be uncomfortable for the community, but which would also provide legitimacy to Bitcoin and coherence to how Bitcoin businesses could operate.

When the proposed rules for the license were posted for comment earlier this week, it was discovered that Lawsky, by interacting with the community may have been doing little more than scoping out the field so that the final rules would be broad enough to touch on every aspect of Bitcoin. The rules have broad reporting requirements that mean that practically every business handling Bitcoin would have to collect substantial records on every customer they have, regardless of location world-wide, on the off-chance that that person might happen to be in New York. The rules also hamstring Bitcoin financial service businesses with strict reserve and denomination requirements essentially limiting any Bitcoin bank to storing their customers’ funds, but forbidding them to loan those Bitcoins out essentially preventing these banks to operate as banks.

Curiously, the one type of business explicitly exempted from needing a BitLicense, are banks already licensed to do business in New York. If any of these institutions wanted to start Bitcoin banking, they would still have to abide by the existing (flawed) regulatory system, but not the more stringent rules placed on upstart, Bitcoin only, businesses.

It may well be that Lawsky is trying to do his best to write sensible rules for Bitcoin. He is a tough regulator who has brought a few of the (non-American) big banks to account for their misdeeds leading to the Great Recession. We applaud him for that, and wish he would do more. It also means that Lawsky is a hammer, and to a hammer, every problem looks like. Further, though Lawsky has talked to some in the Bitcoin community, he spends much more time with established economists, government lawyers, and high-ranking officials in the financial services industry, all of whom are doubtless telling him that Bitcoin is something that we really need to watch out for.

It is nearly inconceivable that Lawsky doesn’t see the wide-ranging implications of these rules. They’ll make it nearly impossible to bootstrap a Bitcoin business, require innovations to be checked with the state, impose massive oversight and retention rules, and make a criminal of Satoshi Nakamoto if he doesn’t come forward to register. Further, because New York is the financial hub of the world, it means that these rules could be enforced far beyond the borders of New York. Cryptocoins News reports that the mining pool BTC Guild located in Nevada has a shutdown plan in place in the event that anything like this license in its current iteration is approved. The demands of the license are too heavy to apply and operating without one is just too risky for the owner.

The real danger, though, is that most regulators around the world have been taking a wait-and-see approach to how the US or other governments would respond to the cryptocurrency. After the European Central Bank issued a warning about Bitcoin late last year, central banks around the world started issuing similar warnings. If the BitLicense is implemented, then we can expect any number of world regulatory agencies to use it as their template for how to respond. This would, in essence, create two Bitcoin economies, one for the wealthy who deal with businesses able to skirt the rule or rich enough to comply, and a Bitcoin black market. A worst case scenario is that the license would make Bitcoin illegal for all not rich enough to use it.

Regulation of the intersection between Bitcoin and fiat is unavoidable and probably even necessary. Lawsky’s NSA-like ‘collect it all’ attitude is not the right approach, though. Bitcoin is a new technology, and though it has some inherent risks, it needs room to breathe. The governor of Pennsylvania in 1894 sensibly vetoed the bill requiring people to disassemble their cars until the cows calmed down. Lawsky should wise up and recognize that change is coming and do what he can to help it progress smoothly and for the benefit of everyone rather than heeding the whispers of those most threatened by the change.