The battle to regulate the Bitcoin market

This article originally appeared on the FXcompared Blog "The transatlantic battle to regulate the Bitcoin market"

The UK and the US are now taking very different paths in their proposed regulation of the Bitcoin market and this could have a major impact on the development of bitcoin globally. In March 2015, against a backdrop of uncertain regulation in the US, the UK took a significant step to establish itself as the global hub for Bitcoin trading. The UK Treasury announced it would begin regulating digital currencies by applying anti-money laundering ordinances to digital exchanges. Published at the same time as finance minister George Osborne’s annual budget statement, a report from the Treasury stated that the measures would both prevent criminal use of digital currencies and encourage innovation.

Furthermore, the UK Treasury announced that it would begin a new research initiative in conjunction with the Digital Catapult tech accelerator and the Turing Institute that will inject £10 million GBP ($14.85 million USD) into digital currency technology research. Beyond the Treasury, the Office for Science of the British government also released a report that depicted a bright future for financial tech, calling for increased innovation in digital currencies and blockchain technology, as well as mobile payments. The UK Treasury also plans to work with the British Standards Association to draft consumer protection regulations, another sign that Bitcoin and other crypto-currencies may soon be better integrated into the mainstream economy.

In the March 18th response to the call for evidence on digital currencies, the UK Treasury outlined how digital currencies like Bitcoin have the potential to lower transaction costs and increase security. The development of decentralized digital payment systems could mean that domestic and international payments would not only become cheaper and faster, since they don’t rely on financial institutions as intermediaries, but also more secure, since digital currency transactions don’t link back to consumers’ bank accounts.

The UK Digital Currency Association (UKDCA), a non-profit advocacy group that promotes the development and adoption of digital currency technology, heralded the government’s response as a significant step in the right direction, stating that the UK is now poised to become the “most attractive place in the world to establish a digital currency business.” The group was less enthusiastic about the more onerous regulations proposed last year by the New York Department of Financial Services, however, claiming that the proposed restrictions would effectively bar New York residents from engaging with overseas virtual currency businesses, and that they set an “unfortunate precedent” for the development of further regulations in the US.

In July 2014, Benjamin Lawsky, the New York State Superintendent of Financial Services, first proposed a set of rules to regulate digital currencies aimed at protecting consumers, preventing money laundering, and increasing cyber security. The initial proposal was strict, requiring all firms conducting transactions in digital currencies to obtain a BitLicense. The proposed regulations provoked the ire of the digital currency community, who, like the UKDCA, decried the restrictions as overly burdensome and complained that they would stifle innovation. In response, Lawsky and his team presented a revised proposal in December 2014 that required only institutional buyers and sellers to obtain a BitLicense (and not software developers, miners, personal investors, or retailers accepting digital currencies). Moreover, the amended proposal gave digital currency startups two years to become fully compliant with the licensing law.

Around the same time that Lawsky and his team released their amended BitLicense proposal, a bill was proposed in the US House of Representatives calling for a five year moratorium on the regulation of Bitcoin. HR 5777 also called for Bitcoin to be classified as a traditional foreign currency, rather than property, as it’s currently classified by the IRS. The purpose of the proposed moratorium is to assess and evaluate the potential economic benefits of digital currencies like Bitcoin before rushing to regulate. Representative Steve Stockman from Texas proposed the bill in an effort to preempt what he viewed as unnecessary regulation on the part of New York State that might discourage companies and individuals who might otherwise work to ensure the success of digital currency technology. It remains to be seen whether or not the bill will be passed.

Policy disagreements notwithstanding, the first regulated Bitcoin exchanges opened in the US in early 2015. In late January, Coinbase, a company that offers digital wallets and other services to bitcoin users, opened a new exchange that has regulatory approval in half of the US states, including New York and California. Just a week before the opening of its exchange, which is called Lunar, Coinbase announced the completion of a $106 million USD round of funding from several investors, including former Citigroup CEO Vikram Pandit, BBVA, and the New York Stock Exchange. And the NYSE isn’t the only major US exchange making a bet on Bitcoin: recently, Nasdaq announced that it will be partnering with the New York-based Bitcoin startup Noble Markets to create a new digital currency marketplace focused on enabling companies and institutions to trade bitcoins.

The US is expected to clarify its regulatory approach to Bitcoin and other crypto-currencies in the coming months. With digital currency advocates and traditional financial institutions alike praising the UK’s foresight and embracing innovation, the US risks falling behind if it chooses not to adopt a more encouraging approach to digital currency regulation.