The fragile Bitcoin economy will change drastically as companies scramble to obtain the proper licensing in response to guidance from the Financial Crimes Enforcement Network (FinCEN), which categorizes administrators and exchangers of virtual currencies as money services businesses.

FinCEN issued the guidance because "the industry and banks who provide services and law enforcement that investigate cases sought some regulatory certainty about where virtual currencies fall," says Steve Hudak, a spokesman for FinCEN.

FinCEN defines an exchanger as "a person engaged as a business in the exchange of virtual currency for real currency, funds or other virtual currency." An administrator is defined by FinCEN as "a person engaged as a business in issuing (putting into circulation) a virtual currency and who has the authority to redeem (to withdraw from circulation) such virtual currency."

"Those who are intermediaries in the transfer of virtual currencies from one person to another person, or to another location, are money transmitters that must register with FinCEN as MSBs,” says Jennifer Shasky Calvery, director of FinCEN, in a March 19 speech. “Some virtual currency exchangers are already registered with FinCEN as [money services businesses], though not necessarily as money transmitters."

The document, titled Application of FinCEN's Regulations to Persons Administering, Exchanging or Using Virtual Currencies, does not single out any particular e-currency. However, companies that handle Bitcoin, an increasingly prominent digital alternative to cash, see the guidance as having clear consequences for them.

"In some ways [the guidance] legitimizes the currency and in some ways it destroys it," says Bob Egan, founder and managing director at The Sepharim Group, in a phone interview.

To many, Bitcoin's appeal has been its unregulated, anonymous, cash-like nature. Adding regulation eliminates many of these traits.

Some companies that handle Bitcoin, such as CoinLab Inc. and BitInstant LLC, are already registered with FinCEN as money services businesses. As a result of the new FinCEN guidance, many more may have to do the same.

"What they did here is clever," says Charlie Shrem, co-founder and CEO of BitInstant, in an email. "They said, not only is a Bitcoin business an MSB, it is also a MTB (Money Transmitter); 48 states require separate MTB licensing."

The federal government requires only registration, reporting and recordkeeping from MSBs. But as MTBs, Bitcoin companies will also have to comply with the separate licensing practices.

State licensing looks like the biggest hurdle facing most Bitcoin companies now.  Even mainstream payments providers such as Square Inc. have encountered pushback from state regulators over licensing.

Bitcoin "is a pretty fragile ecosystem and there's likely to be some pretty big fallout," says Egan.

Licensing is rarely available to new companies, says Shrem. "Many states only license 10 to 15 companies in the whole state," he says.  "Specific states will need to make their own statement about this, but FinCEN has handed them a free pass here on defining Bitcoin for them."

Even if new entrants can obtain the proper licensing, the cost of doing so could exceed $10 million per company, Shrem says.

"I've spent more money on legal fees than I'm proud of," Shrem says.

Since its founding, BitInstant has complied with Anti Money Laundering (AML) and Know Your Customer (KYC) rules, says Shrem. BitInstant registered with FinCen before its 2011 launch.

Many businesses which could be affected by future regulation and licensing rules will be unable to handle the costs, says Roman Shtylman, founder of Bitfloor, an exchange dealing in U.S. dollars. "Most business in the USD space can't even handle the regulations and costs."

"The whole idea [behind Bitcoin] was to create a freewheeling global economy without regulatory burden and operating costs," says Egan.

But that isn't going to happen anymore.

"The Treasury is acknowledging that virtual currencies exist and they're not going to go away," Egan says. "It's saying, 'we're acknowledging this is a global problem and because we haven't thought this all the way through let's do what we do with any other kind of money."

Shrem says the Bitcoin community should have seen this coming and anyone who continued to ignore the legal framework is at their own fault. FinCEN has been working to clarify the guidance for a year, says Shrem.

Bitcoin companies transmitting or exchanging the virtual currency for traditional currencies should register with FinCEN now, Hudak says. The IRS examines businesses on FinCEN's behalf, he says. Hudak refused to comment on the timeline for any consequences for noncompliance.

Failure to comply with state licensing could result in large fines and/or jail time.

"The fact that [FinCEN] issued it is already a sign that the critical mass on Bitcoin is there," says Juan Llanos, executive vice president of operations and compliance officer at Unidos Financial Services Inc., which handles remittances for the underbanked.

Earlier this month while speaking at a gathering for Bitcoin enthusiasts, Llanos predicted regulation would come in the next two years.

"They usually issue a notice of proposed rule-making, giving stakeholders a few months to send feedback, and then they issue the final rules and give a 12 to 19 month grace period," he says.

While Bitcoin companies may still have a couple of years before the new rules are enforced, Llanos says, "my concern is that the Department of Justice may be cooking an indictment behind closed doors as we speak."

FinCEN's actions in some ways mirror the Securities and Exchange Commission's approach to another new financial system, peer-to-peer lending, five years ago. In late 2008, Prosper Marketplace Inc., created by Chris Larsen, shut down for about six months to cooperate with regulators that declared it was offering  unregistered securities. Its rival Lending Club underwent a similar dormant period to cooperate with regulators.

Larsen, who has made a name for himself as a disruptor in the payments industry, is currently working on a virtual-currency project called OpenCoin Inc.

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