Regulating Bitcoin

History has shown that whenever the people have a means of obtaining items of currency out of the ground, governments will step in and not only demand a piece of the action, but will eventually shut it down. For instance, the US government eventually made the use gold as currency illegal, despite the gold rush that added so much to the country’s wealth. Bitcoin may be affected in the same way as governments become nervous of a currency being created that is beyond their control, regulation may be imposed to prevent Bitcoin mining.

Bitcoin was developed in 2008 as a “peer-to-peer electronic cash system” specifically meant to be outside the controls of governments. Bitcoin transactions were intended to live online and occur between computers and smartphones through exchange servers. 

With impressive value growth, the currency has quickly become a popular choice for traders and investors. Some have even suggested that the Bitcoin and other virtual currencies could be the saving grace for countries in dire economic straits. In March, the world’s first Bitcoin ATM was opened on Cyprus after banks had been closed for a week. The ATM allows customers to deposit “real money” into a Bitcoin ATM in exchange for bitcoins and vice versa – making the virtual currency, a very real option for those who didn’t have access to money during the Cypriot crisis.

Stateless and bankless, Bitcoins are not subject to regulation or fees, and therefore enjoy extreme volatility, according to its proponents. But according to regulators, this is exactly the problem. Because Bitcoin allows for identity free transactions, it is understandably of concern to law enforcement. The currency has been plagued by reports of nefarious transactions involving illegal drugs and gambling as is to be expected by any unregulated resource. This complicates its legitimacy. The volatile price fluctuations and lack of resources in the cases of fraud other than filing private lawsuits add further risk for bitcoin users.

The people who govern Bitcoin are an obvious point of leverage for regulators. In principle, a regulator might try to compel the developers who govern the Bitcoin software to deploy certain rule changes, by compelling them to push software changes that implement the modified rules. But there are limits to the power of this regulatory approach, due to the limited power of the developers who govern the Bitcoin reference software. The developers can push any software change they want, but they cannot force users to adopt the modified software. The leverage of a regulator will thus depend on how centralized the Bitcoin economy becomes. If a lot of mining activity is controlled by a few entities, or if a lot of transactions are mediated by a few exchanges, then those few miners and exchanges will be points of leverage for a regulator who wants to change the rules. On the other hand, if activity is more dispersed, then regulators will have more trouble nudging the system in the direction they want.

Bitcoin will turn out to be more regulated than its initial advocates thought, just like the internet which was once thought to be unregulated but is now influenced strongly by various governments. Bitcoin requires regulation and protections for its user to become a truly revolutionary new currency system.