Bitcoin and the Importance of Regulation Part 1

Over the next few days I will use my blog to add to the debate on Bitcoin and the importance of regulation. Given my more than 15 years' experience in financial services, regulation and compliance I am confident that I can make a significant contribution to the debate and the way forward for Bitcoin. This is the first part an article I have written on Bitcoin and the Importance of Regulation. In this post I focused on the recent failure of Mt. Gox and draws on comparison with the rapid failure of Continental Illinois National Bank and Trust in 1980s.

  

The shutting down of Mt. Gox, one of the largest Bitcoin exchanges, and the alleged disappearance of 744,408 bitcoins from the exchange — about $365-million have caused shock waves around the world in the virtual currency community.

The purpose of this post is to add to the debate on why Bitcoin and other virtual currencies should be regulated by providing clarity on Bitcoins and other virtual currencies and there links to the traditional financial system. In recent weeks there have been important announcements from Canada’s Federal Finance Minister Jim Flaherty that the government and regulators will explore developing regulations for Bitcoin and other virtual currencies. He noted in his 2014 Budget Speech that it is important to continually improve Canada’s regime to address emerging risks, including virtual currencies, such as Bitcoin, that threaten Canada’s international leadership in the fight against money laundering and terrorist financing. Benjamin Lawsky, superintendent of New York's Department of Financial Services also revealed new details of plans to govern virtual currency firms in the state in order to protect consumers and combat money laundering.

Why are these announcements from governments and regulators important? The reality is whether we like it or not Bitcoin and other virtual currencies are a form of medium of exchange that comes with their own dedicated retail payment systems. These two factors makes the technological innovation of Bitcoin and possible the transmission of risks relevant to a number of key areas of the global financial system.

It seem to me that Bitcoin firms are no different than airlines responsible for taking passengers from point A to point B. Airlines have enormous power in terms of pricing and the servicing of their aircrafts. Governments and regulators have a responsible to ensure that airlines don't abuse such powers. They want to know that consumers are treated fairly and that airlines act responsibly when it comes to servicing and maintenance of their aircrafts. The same can be said of telecommunication firms, oil and gas and you name it. My point here is in the case of Bitcoin as it gains greater public acceptance, the creators and providers’ power over consumers will likely increase and so does the risk for abuse. I share this view on the basis that Bitcoin is relatively sophisticated and complex form of currency. At recent Meet-up in Toronto, I met one lady who was seeking out information on how to acquire investments while admitting that she also which she knew more about money and finance. In my view, government and regulators as they do with banks and other financial institutions have a responsible to ensuring accountability and transparency of Bitcoin and other virtual currencies and their operators. They have to do this to safeguard the public interest.

Mt. Gox bankruptcy filing and the alleged theft of over 700,000 Bitcoins will be a defining moment in the evolution of Bitcoin. This is no different than the collapse of Continental Illinois National Bank and Trust in 1980s. Continental Illinois is a good example of how quickly problems revealed at a financial entity can turn to disaster for a financial entity once held in high regards by the public. Mt. Gox's experience is no different and just as Continental Illinois was a watershed event in banking regulation, the demise of Mt. Gox will play a key role in how regulations for Bitcoin emerges. Consumers backlash of Mt. Gox is no different than the run on Continental Illinois. The disorderly failure of Mt. Gox, a significant Bitcoin exchange, has highlighted important vulnerabilities in the Bitcoin system that regulation can help to address. Opaqueness and speculation is already a significant concerns and the failure of a key player will not ease those concerns but rather might ignite further concerns. In a nutshell the abuse of Bitcoin by criminals as in the case of Liberty Reserves/Silk Road and the rapid failure of Mt. Gox will be the key driving forces with how the regulations emerges. Regulation is required to mitigate and manage such risks and failure.

Sources:

Bradbury, Danny.  “Canada’s Finance Minister Prepares to Regulate Bitcoin.” February 13, 2014. http://www.coindesk.com/canadas-finance-minister-regulate-bitcoin/

Faggiano, Mark. “Tax Trouble May Burst The Bitcoin Bubble For Merchants.”February 24, 2014. http://www.forbes.com/sites/groupthink/2014/02/24/tax-trouble-may-burst-the-bitcoin-bubble-for-merchants/

Gomzin, Slava. “Bitcoin payments will face big challenges heading to brick-and-mortar (but it’ll get there)” January 26, 2014.  http://venturebeat.com/2014/01/26/bitcoin-payments-will-face-big-challenges-heading-to-brick-and-mortar-but-itll-get-there/

Greenwood, John “Canadian Mint ready to test its own digital money project.” September 19, 2013. http://business.financialpost.com/2013/09/19/canadian-mint-pushes-ahead-in-murky-world-of-crypto-currency-with-mintchip-project/

Knight, Sophie and Yamaguchi, Takaya “Japan says any bitcoin regulation should be international” February 27, 2014. http://www.reuters.com/article/2014/02/27/us-bitcoin-mtgox-idUSBREA1Q1YK20140227

Wagstaff, Jeremy. “Beyond Mt. Gox, bitcoin believers keep the faith, see more robust system.” February 26, 2014. http://www.reuters.com/article/2014/02/26/us-bitcoin-future-idUSBREA1P0OT20140226

“New York regulator moving ahead on bitcoin regulation.” February 11, 2014. Reuters. http://www.cnbc.com/id/101408527

Mark McKenzie is a leading Subject Matter Expert in financial services regulation and supervision as well as a professional motivational speaker, corporate trainer and youth mentor.  He can be contacted by email mastbmckenzie@gmail.com or by telephone 647-406-4622. Read my blog http://mastbmckenzie.blogspot.ca/ and always write me a comment and share. Follow me on Twitter @mackynacky. Connect with me on www.youtube.com, Google+, Facebook and Linkedin.