Bitcoin Seen Facing Big Hurdles As Supporters Seek Wide Adoption

Bitcoin could be a long way from gaining wide acceptance as a viable medium of exchange in the U.S. marketplace, despite so far enjoying growing popularity among consumers and a warm reception in Washington, industry analysts told Bloomberg BNA.

Such “virtual currency,” while promising, presents significant risks to businesses, including fluctuation issues, security concerns and regulatory uncertainties, analysts said.

“More and more companies are beginning to look at Bitcoins, but most are not at the point where they’re ready to use them,” said Jeff Neuburger co-head of the technology, media and communications group at Proskauer Rose LLP. “Until the big issues are worked out, I think the companies that use Bitcoins will be a fringe, rather than mainstream, community.”

U.S. Seeing `Grassroots’ Trend.

Virtual currency is digital money without government backing that can be circulated over the Internet. The growth of Bitcoin in particular has drawn attention from Congress, federal agencies, and venture capitalists.

“In the United States, we’re seeing a grassroots phenomenon, where consumers are being allowed to use Bitcoins to pay for everything from pizza to drinks at the local bar,” said Marco Santori, an attorney at Nesenoff & Miltenberg, LLP and regulatory affairs committee chairman for the Bitcoin Foundation, a Seattle-based non-profit organization that promotes the currency.

Santori, who works in New York, said the foundation expects to see increased Bitcoin adoption in coming years. Among other positive developments, federal policymakers appear to be warming up to the currency, and its value has skyrocketed, he said.

On Nov. 27, the price of Bitcoin reached a new peak, surpassing $1,000 on the Tokyo-based Mt. Gox online exchange, a leading platform for trading the currency.

Companies such as Atlanta-based BitPay, Inc. are part of an emerging Bitcoin services industry that is pinning its hopes on the continued success of the currency.

“Now that it’s getting more popular with consumers, more and more businesses are putting it on their priority list,” Tony Gallippi, BitPay’s co-founder and chief executive officer, told Bloomberg BNA.

Bitpay’s mission, according to the company’s website, is to make Bitcoin “every merchant’s favorite form of payment.” More than 12,000 merchants around the world—mostly small and medium-sized businesses—have already signed on as clients, according to Gallippi.

Stronger Response Seen Overseas.

Bitcoin is gaining even more traction in places such as China, where the demand is greater and the regulatory environment is more appealing to the new industry, according to Santori. He noted, for example, that Bitcoins are now being accepted by Baidu, Inc., China’s leading Internet search provider.

The first U.S. congressional hearing on the issue, convened Nov. 18 by Senate Homeland Security and Governmental Affairs Committee Chairman Tom Carper (D-Del.), indicated that the federal government is so far taking an open-minded approach toward Bitcoin, despite concerns that it has become a popular tool for black market activities (223 DER A-14, 11/19/13).

“Legitimate financial institutions, including virtual currency providers, do not go into business with the aim of laundering money on behalf of criminals,” Jennifer Shasky Calvery, director of the Treasury Department’s Financial Crimes Enforcement Network (FinCEN), said in prepared testimony. “Virtual currencies are a financial service, and virtual currency administrators and exchangers are financial institutions.”

A similar hearing was held the following day by the Senate Banking, Housing, and Urban Affairs Committee.

“The hearings were a milestone for the Bitcoin community,” Jerry Brito, a senior research fellow at George Mason University, told Bloomberg BNA. “The question going into the hearings was: Will Bitcoin be outright banned or seen as a legitimate technology? The community has crossed that threshold.”

According to Brito, one of Bitcoin’s most attractive features is that it allows direct, person-to-person transactions over the Internet, without the need for a third-party intermediary. “It’s cheaper, faster, and censorship-resistant,” he said.

Security, Other Risks Cited.

A key risk, however, is that Bitcoins are essentially computer files that can be stolen by hackers, Neuburger said.

In addition, the value of the currency has tended to fluctuate widely, according to National Retail Federation Senior Vice President and General Counsel Mallory Duncan.

“It’s not at all clear that Bitcoin is ready for prime time,” Duncan told Bloomberg BNA. “A merchant wants to know that money he takes into his store today is going to be worth roughly that amount tomorrow.”

Similar concerns were raised by BITS, the technology division of the Financial Services Roundtable, in testimony provided to the Senate Banking Committee.

“Since its creation four years ago, the [Bitcoin] market has gone through several significant swings in value, including in 2011 when the value fell 90 percent from $30 to $3,” BITS President Paul Smocer said in prepared remarks. “Recently, its value took a steep dive again when the use of Bitcoins was associated with the alleged operations of the drug ring known as ‘Silk Road.’ While its value has bounced back, broad swings in value create significant risk to both holders of the currency and to merchants and others who accept the currency as payment.”

Smocer added that none of the digital currency operators or infrastructure providers are currently subject to the Gramm Leach Bliley Act’s cybersecurity and data breach notification requirements and other rules that are applied to regulated financial companies.

The volatility of Bitcoin reflects the immaturity of the market, according to Santori. “As the market matures, we’re going to see things even out significantly,” he told Bloomberg BNA.

Also, there are businesses within the emerging Bitcoin industry that are dedicated to addressing security issues, he said, adding that the currency, for now, is not for the “faint of heart.”

Regulators, Law Enforcers Watching.

Santori said the Bitcoin community has made a concerted effort in recent months to address concerns about virtual currencies, particularly in Washington, where the issue is coming under increased scrutiny.

Earlier this year, the Department of Justice announced an indictment against operators of Liberty Reserve, an enterprise charged with laundering more than $6 billion in proceeds for cybercriminals, Ponzi schemers, child pornographers and identity thieves, using a global digital currency exchange. Recently, the department took action against Silk Road, a website that was allegedly used to facilitate illicit drug transactions and money laundering through a Bitcoin payment mechanism.

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has been working collaboratively with government and industry partners to close gaps in U.S. regulations that might be exploited by criminals seeking to use virtual currencies for illicit activities, Calvery told Carper’s committee.

In March, FinCEN issued guidance that clarified compliance expectations for individuals involved in virtual currency transactions that are subject to agency rules. According to the guidance, administrators or exchangers of virtual currencies qualify as “money transmitters” and must register with FinCEN and institute recordkeeping, reporting and anti-money laundering program control measures, unless an exception applies. Those who use virtual currencies exclusively for common personal transactions, such as buying goods or services online, are not covered.

Feds: No Hill Action Needed.

Calvery and other government witnesses testifying before Carper’s panel said they believe they currently have the legal tools they need to address concerns related to virtual currencies, and they are not seeking congressional action on the issue at this time. In addition to Calvery, testimony was provided by officials from the Justice Department and the U.S. Secret Service.

Meanwhile, other federal agencies monitoring the growth of virtual currencies include the Securities and Exchange Commission, the Internal Revenue Service, the Federal Election Commission, and the Federal Reserve. States such as New York also are looking at the issue (159 DER A-17, 8/16/13).

In a Sept. 6 letter responding to a Carper inquiry, Federal Reserve Chairman Ben Bernanke said there are areas where virtual currencies may have long-term promise, “particularly if the innovations promote a faster, more secure payment efficient payment system.”

Although the Federal Reserve generally monitors developments in virtual currencies, it does not have authority to directly supervise or regulate virtual currencies, or the entities that issue them, Bernanke wrote. “In general, the Federal Reserve would only have authority to regulate a virtual currency product if it is issued by, or cleared or settled through, a banking organization that we supervise,” the letter said.

Bitcoin Community, Feds `Aligned.’

Santori said the Bitcoin Foundation and the federal government have generally “aligned” on the question of how the currency should be treated going forward.

“Both the foundation and federal agencies that have spoken on this subject have so far agreed that we don’t need any new regulations for Bitcoin businesses,” he said.

However, Santori said there is room for regulatory improvement at the state level. “There are currently onerous state-by-state licensing requirements that are difficult for most entrepreneurs to meet,” he said.

One solution might be for states to develop “reciprocity” agreements that would streamline the process, Santori said. Otherwise, if the states fail to address the issue on their own, there may ultimately be a need for a “nuclear option,” where Congress steps in and passes legislation with federal preemption, he said.