This afternoon the Senate Committee on Homeland Security will hold a hearing on virtual currencies, followed by a Banking Committee hearing Nov. 19. Judging from the witness lists, lawmakers will hear the usual warnings about how Bitcoin and other digital monies facilitate money laundering, online underground drug bazaars, Internet gambling and worse.
Representatives of the Bitcoin community, meanwhile, will make the case that heavy-handed regulation would drive innovative businesses out of the U.S. "The U.S. jurisdiction has to do a lot to make themselves appealing," Jon Matonis, the executive director of the Bitcoin Foundation (and a former BankThink columnist), told me last week. "They're definitely not appealing right now."
The industry is already feeling a "chilling effect," he said, in the form of "the unwillingness of American banks to do any business with Bitcoin-related companies in the U.S." The banks are "unwilling to cause themselves any more scrutiny. They're way overstaffed on compliance attorneys as it is. How can you have innovation in banking when 30% of the staff is attorneys?"
Longtime readers may roll their eyes, having heard similar arguments about the danger of losing business to more-lax jurisdictions in so many other contexts (e.g. derivatives, bank capital). But I would take a different tack. I'd argue that Bitcoin, for all its baggage, should be allowed to flourish because it's good for banks, good for merchants, good for America and good for humanity.
Before you scoff, hear me out. Here are five reasons Washington should refrain from putting any further screws on Bitcoin:
Bitcoin Raises the Bar for Banks
As my colleague Kevin Wack recently reported, last year the country's largest banks torpedoed a plan to speed up payments on the automated clearing house network. The Federal Reserve Board, he noted, now has doubts about the banking industry's ability to implement a faster payments system on its own and may try to force change. Here is where Bitcoin could provide some healthy competition, by demonstrating to U.S. consumers what is possible with money in the Internet age and making them clamor for something similar from their banks.
A transaction on the Bitcoin network takes 20 minutes, on average, to be confirmed. Then it is done: Control of the bitcoins (lowercase "b" when referring to the currency or unit of account) has been transferred and recorded in a public ledger known as the blockchain. No reversals. In that light, it's pitiful that Nacha, the bank-owned association that sets rules for the ACH system, couldn't garner enough votes among its members to pass a proposal for same-day settlement.
Shakil Khan, one of the earliest investors in the music service Spotify and an investor in Bitcoin-related businesses, put it well in a "fireside chat" with yours truly at a conference this summer:
Why is it in 2013 I can send you an email, a voicemail, or text message, but if someone says 'you owe me $10 for my pizza last week' and I try to send it, the bank wants to charge me $27? You might get it next week but it isn't guaranteed. We have a banking system that's slower than it's ever been.
Granted, cashing out bitcoins for dollars or other national currencies is a huge hassle. But that says more about the cumbersome nature of the legacy financial system than about the Bitcoin network, which debuted in 2008 and is available to anyone with an Internet connection. Moving your money in and out of Bitcoin is like visiting both sides of the Berlin Wall during the Cold War, or going from black-and-white Kansas to Technicolor Oz and back. The more people experience that contrast, the more they'll expect from mainstream financial providers and if the banks fail to deliver, the more political cover the Fed will have to push them.
Bitcoin Is a Low-Cost Alternative for Merchants
It is also true that while light years ahead of ACH and Western Union, that 20-minute wait for Bitcoin confirmations is awkward for in-store retail purchases. Depending on the size of the purchase, a merchant who accepts Bitcoin may be taking a risk if he lets the customer walk out before the transaction is confirmed. But arguably he's already taking that risk if he accepts credit cards, since from a merchant's point of view the transaction isn't really done until the funds are placed in his account which could be two or three days later in the card world.
In other ways, Bitcoin can be a compelling alternative (or supplement) to Visa, MasterCard or PayPal for merchants, particularly independent online merchants. For starters, there are no acceptance fees (Bitcoin has an optional transaction fee for senders, typically the equivalent of a few pennies, to expedite payments). And merchants who are put off by the notoriously volatile exchange rate between bitcoins on dollars don't have to take the currency risk. They can elect to hire a processor like BitPay, Coinbase or BIPS, which will take immediate possession of the bitcoins on a merchant's behalf and remit the equivalent in dollars or euros. The fee for this service is around 1%, which still beats 2% to 3% for credit card payments. So merchants can reap the benefit of Bitcoin without having to worry about the price of bitcoin at least, as long as those processors are around.
Also, Bitcoin does not allow chargebacks. That theoretically provides less protection for consumers, but on the flip side, it means more protection for merchants. Sometimes consumers can be fraudulent and merchants are defrauded. Unquestionably, fraud protection is part of the value for consumers of using a network payment card like Visa or MasterCard. But protection from chargeback risk and consumer fraud is one of the advantages for a merchant of physical cash or digital cash like Bitcoin.
A merchant that only takes cash or Bitcoin, or charges extra to accept payment by credit or debit card, may drive away some business, but that should be the merchant's choice. A consumer who wants the protection (or the loyalty rewards) of cards may find no merchants in certain categories willing to accept his preferred payment method, or may have to pay more for the certainty at some merchants. But that should be the consumer's choice. The situation I am describing here, in which parties with differing preferences negotiate to reach mutually agreeable outcomes, is called a "market."
Bitcoin Helps Protect Privacy
Much has been written about the anonymous, or pseudonymous, nature of Bitcoin (whose mysterious creator went by a pseudonym Satoshi Nakamoto). While the block chain ledger details every single transaction for all to see, each party is identified only by a Bitcoin address, a cryptographic string of numbers. It's up to users whether to identify themselves publicly as the owner of a particular address. And you can generate as many addresses as you want.
It's easy to see where the laundering concerns come in. I've previously argued (here, here, here and here) that user-defined anonymity is a virtue, not a vice, and I stand by that. But for the sake of argument let's say we agree with Benjamin Lawsky, superintendent of the New York Department of Financial Services, that it's important "to make sure records are being created" so there won't be "terrorists, narco-traffickers engaging in actions that prosecutors someday could never find out about." (That quote, from an interview he did with Bloomberg News, reminds me of the character in Dave Eggers' dystopian novel The Circle who says "all that happens must be known.")
Well, the blockchain itself is, as I said, a record permanent, transparent and continuously updated as transactions are added. And most if not all of the online exchanges where bitcoins are sold for dollars are now following anti-money laundering and know-your-customer requirements. That means getting identification and keeping records on customers, and reporting suspicious activities or large transactions to the government. The result is that the authorities have a pretty good ability to trace a Bitcoin transaction to a real person.
Hence, Bitcoin is "a terrible, terrible tool for breaking the law," said Constance Choi, the general counsel for Payward, the parent company of Kraken, a virtual currency exchange platform.
At the same time, she noted, Bitcoin allows innocent users to securely transact online without transmitting personally identifiable information. If The New York Times were to accept Bitcoin, people could buy a 25 cent article on the web without having to worry about having their name and credit card number stolen.
Choi, who made her remarks during a panel discussion I moderated at SourceMedia's ATM Debit & Prepaid Forum in Las Vegas last month, is a veteran of the Electronic Frontier Foundation, the privacy rights and civil liberties group. She was clearly concerned that the financial privacy provided by Bitcoin is at risk:
It's incredibly important that as we're building the rules around this platform, around these technologies and these payment rails, that we don't say, 'ok let's just conveniently create a back door for the government and all this transaction history and it'll solve all our AML problems.'
There's a reason why we don't do that. We could create a totalitarian government where murders are not possible, but we accept a few murders in exchange for the ability to have liberty and to walk around with our freedoms. So there's a tradeoff there. There's a moral balance that we put between the risk of illicit activity and freedoms that we actually stand for. So it's really important that as these regulations are crafted that we do not trade our financial privacy rights. Right now that's where the battle's happening. [over] whether we ensure that before such information can actually be gleaned by the government, there has to be some sort of lawful process.
If you're unfamiliar with the term "back door," read up on what the National Security Agency's been up to. Ultimately, the discussion of anonymity in virtual currencies should be part of the broader national debate about surveillance of Americans' communications the debate our constitutional law professor President claims to welcome. Bitcoin by itself won't restore online privacy, let alone the Fourth Amendment. But if used properly, in combination with other technologies like email encryption and the anonymizing Tor browser, it can help, along with protest and tough investigative journalism. Speaking of which
Bitcoin Helps Protect Free Speech
Three years ago, under extralegal pressure from U.S. politicians, Visa, MasterCard and PayPal stopped processing donations to Wikileaks, nearly dooming the organization. Set aside whatever you may think about Wikileaks or Julian Assange. Just take a step back and consider this: Lawmakers strong-armed financial institutions into cutting off payments to a publisher that embarrassed the government.
If Wikileaks can be censored this way, it can happen to another publication or media organization someone in a position of power doesn't like be it Playboy or High Times or Guns & Ammo or Fox News or MSNBC or your trusty American Banker.
But Wikileaks continued to accept donations via Bitcoin. That's the benefit of having a decentralized system, where payments are validated by "mining" computers scattered around the globe. There's no company with nervous shareholders for the demagogues to bully, no single point of failure. For someone who values freedom of speech, it's nice to know something like that exists.
WordPress similarly touted the benefits of a payment system without a central authority when it announced this year that it would accept bitcoins as payment for blogging software add-ons:
PayPal alone blocks access from over 60 countries, and many credit card companies have similar restrictions. Some are blocked for political reasons, some because of higher fraud rates, and some for other financial reasons. Whatever the reason, we don't think an individual blogger from Haiti, Ethiopia, or Kenya should have diminished access to the blogosphere because of payment issues they can't control. Our goal is to enable people, not block them.
Bitcoin Is Neutral
As a decentralized system, Bitcoin is neutral. It doesn't care who its users are, or where they are. That may terrify AML compliance officers. And it seems contrary to the trend in financial services, where politicians and regulators increasingly expect banks and payment processors to act as society's surrogate police in the war on drugs, the war on terror, against fraudulent merchants, against payday lenders and even against gun makers.
But neutrality has clear human benefits. Consider Mohammed Rafigh, an Iranian pianist and composer, who sells his music online for bitcoins. It's perfectly legal for someone in the United States to buy them, since the sanctions against Iran specifically exempt "information and informational materials." But as a practical matter, paying him would be difficult without Bitcoin. PayPal doesn't service Iran.
I bought the album, and found it wasn't to my taste. It sounds like the kind of music you'd hear in the background while getting a microdermabrasion facial treatment with aromatherapy candles burning. But heaven knows there's a market for that sort of thing.
Bitcoiners are worried now because there's talk of aspiring government contractors creating "whitelists" of known identities associated with Bitcoin addresses and/or "blacklists" of coins tainted by association with illicit transactions. The concern is that this would hurt not only privacy but the fungibility of the currency. As Justus Ranvier wrote on his "Bitcoinism" blog:
Do you currently care about the complete history of every physical currency note you carry in your wallet? What if stores would suddenly reject your cash because two years ago someone you never even met used in the commission of a crime? How willing would you be to accept dollar bills if you were suddenly responsible for the actions of every other person who had ever touched them?
I'd add that if you can taint a coin sent to a blackmailer or a drug dealer, you can taint one sent to an investigative news organization or to a political dissident blogger living under dictatorship. I hope the lawmakers realize that the government has more than enough surveillance tools at its disposal and should be content to have the exchanges verifying customers and keeping records.
I ought to disclose that I own three bitcoins and change. I am under no illusions that I'm going to get rich off them, and whenever people ask me if they should "invest" in bitcoins, I tell them not to put in any more money than they can afford to lose in Vegas. I have no idea what they'll be worth tomorrow, or a year from now.
Nor do I especially care. The volatility is a nuisance for dabblers like me and a risk for businesses. Stabilization would be welcome but as long as the exchange rate is greater than zero, the Bitcoin protocol is extremely useful, as I hope I've demonstrated.
Journalists with limited imaginations and jaded hearts like to mock the cultish devotion Bitcoiners have to their currency. But I find it quite endearing. The energy and enthusiasm of the Bitcoin community is one more thing the technology has going for it. No one will ever write Google Wallet-themed erotica, or organize a PayPal Meetup, or start a podcast called Let's Talk MasterCard!
And, if Bitcoin can make the "crippling sanctions" against Iran the sanctions that our Nobel Laureate president brags about marginally less crippling for a musician trying to make some bread, then Satoshi Nakamoto has done something good for humanity.
Marc Hochstein is the executive editor of American Banker. The views expressed are his own.