Bank Lawyer's Blog

Bitcoin Rebuttal

My recent post on Bitcoin generated a correction from a state bank regulator, who sent me the following email (I've removed the name and link to protect the offended):

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Your premise seems to be that anonymity is one of the core useful features of cryptocurrency, but I think you've been misled by the popular press.

The supposed anonymity of Bitcoin is a primary feature only to a certain tin-foil-hat-wearing segment of the population. Bitcoin has never been anonymous, only pseudonymous, and the really smart computer science folks have been saying from the beginning that you will someday have all your bitcoin transactions revealed because of this. Most everyone else thinks the primary reasons Bitcoin is attractive are the essentially free cost of transactions, the nearly instantaneous nature of the clearing process, and the elimination of intermediaries. Personally, I think of Bitcoin as a proof of concept model for creating unique and unduplicatable pieces of computer code, an essential attribute for attaching value to an electronic file. That’s what has experts excited.

Cryptocurrencies have a market capitalization of something like $9 billion, of which Bitcoin is around $5 billion. That’s far less than the market capitalization of baseball trading cards, but it is essentially the same thing, a collectible “thing” for which there are buyers and sellers. It may go the way of a collectible from a few years ago, Pet Rocks. When we (government) are constantly asked about Bitcoin by consumers, bitcoin dealers and the media, we have to respond. Our release on the subject served as a model for the later CSBS release. We believe it is appropriate to warn the public that cryptocurrency is like a risky and speculative commodity at this point, especially because it is not subject to financial regulation as so many seem to believe. You apparently believe we should stay silent and let fools be fools (and let the media and others call us names for staying silent).

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I stand corrected on the anonymous versus the pseudonymous.

In my defense, I did not state, nor mean to imply, that state regulators should remain silent on the dangers of Bitcoin investing. However, in light my history on this blog, making the assumption that I was directing snark toward the regulators was understandable. Rest assured, when I intend it, it will be less-than-subtle.

In the course of the followup conversations with my correspondent, however, they directed my attention to a recent interview in The Washington Post with Silicon Valley legend Marc Andreessen, who's a believer in Bitcoin and who's put his money where his mouth is. Although I've not had a chance to do more than skim it, my correspondent pointed out the following telling statements concerning my comments about the lack of anonymity:

Anybody who thinks Bitcoin makes it easier to do transactions that aren't tracked by the government is 100 percent wrong. The transactions all happen in public view. Anybody can look at the entire ledger and verify who owns what. So if you're a law enforcement agency or an intelligence agency, this is a much easier way to track the flow of money than cash. So I think actually law enforcement and intelligence agencies are going to wind up being pro-Bitcoin, and libertarians are going to wind up being anti-Bitcoin.

I guess the tin-foil-hat wearers are going to continue to shy away from Bitcoin. On the other hand, if a visionary like Andreessen is right, bankers would be foolish to ignore it. Whether they should do that with alacrity or with due deliberation is a subject upon which reasonable people can disagree.

Bitcoin Wet Blankets

I may be wrong about this, as I have been wrong about many things (for example, that Senator Liz Warren is actually a 1/32nd member of the Wheredafugahwe Tribe). However, I'm getting the distinct impression that bank regulators are taking a dim view of Bitcoin. Maybe the fact that so may state banking regulators have issued "consumer warnings" about Bitcoin is tainting my enthusiasm for a currency based upon software code, high-speed "mining," and a fictional Japanese creator, which, in the world of combined currency/commodity/underwear/breath mint, is usually a surefire recipe for success.

The latest wet blanket was tossed by the State of Maryland, whose Division of Financial Regulation and Office of the Attorney General Securities Division "warned" consumers about the high risks of buying and selling the virtual currency.

“Virtual currencies, including Bitcoin, involve inherent risks that residents need to consider prior to deciding to transact with or invest in these currencies,” said Mark Kaufman, Commissioner of Financial Regulation. “The entities that accept and transmit, or exchange virtual currencies for U.S. dollars are subject to federal law, and may be subject to state law, including the requirement to be licensed as a money transmitter. While we are examining these issues with our colleagues in other states and at the federal level, it is important to be clear that currently, Maryland does not regulate virtual currencies.”

“As with any other financial transaction or investment, consumers should understand and check out both the venture and the people they’re doing business with before dealing with virtual currencies,” said Attorney General Douglas F. Gansler. “For now, there is little to no regulation and no safety net for consumers or investors who lose their money dabbling in virtual currency such as Bitcoin.”

As the linked press release points out, the warning was developed by the Conference iof State Bank Supervisors, and represents, I think, a general consensus among state banking supervisors that consumers need to be warned that all that glitters is not gold. Or even pewter, for that matter.

I have friends, people I very much respect, who are intrigued by and, in some cases, advocates for, Bitcoin. I'm not there yet, not merely because it's cutting edge and I'm a reactionary tool of entrenched capitalists and imperialists who want to thwart any innovation that might threaten their hegemony over the manna from heaven that fuels the lifeblood of the masses. That goes without saying, although I just did. No, I'm not there yet because the regulatory environment as it now stands appears to be at odds with one of the primary reasons that Bitcoin is attractive: anonymity.

As a recent article that discussed the first licensed Bitcoin ATM made clear, the regulators don't want Bitcoin users to remain anonymous.

But there's one way the bitcoin ATM is not like a bank: To buy or sell bitcoins there, a person will have to set up an account, create a PIN, enter a phone number, scan a government-issued ID, have their photo taken and do four palm scans. That's a list of requirements that is likely to put privacy advocates on edge.

"I will not be first in line at this machine," said Lee Colleton, a privacy and ethics enthusiast and member of the Seattle Privacy Coalition.

Colleton said banks and governments have been looking for ways to get people to convert their anonymous cash into cryptocurrency for decades so it can be monitored and tracked. But most people have been reluctant to convert entirely to such a monitored system.

"That’s why they’re seeking out a system like bitcoin," Colleton said. It feels anonymous, like cash. It feels like using a Walkman instead of Spotify — no one knows what you're listening to, where you are, who you are or when you're listening. But if you have to hand over your palm print, ID, face and phone number to access your money, he said, you're actually giving up more information than you would to a bank.

"What they don’t realize is that they’re doing the work of the banks, playing into their hands," he said.

"Doing the work of banks." I'm sure Mr. Colleton spit up a little in his mou8th when he uttered that phrase.

I'm not as much of a privacy advocate as is Mr. Colleton. However, I recognize that many of the people initially attracted to Bitcon were enamored of its use to quickly settle transactions in a manner that protected privacy. If using a Bitcoin ATM means you're palm-printed, strip-searched, and probed by aliens, that's going to take the icing off the cake for many.

There are many other pros and cons for Bitcoin and other virtual currency concepts. We'll be weighing them all as we see where this brave new world created by Satoshi Nakamoto.

The Next New Thing: Paying For Pot With Bitcoin

When we discussed why Colorado bankers are having a tough time providing banking services to pot growers and sellers, we noted the obvious impediment: it's illegal under federal law. Until that inconvenient roadblock fact is worked out with the federal government, the fact that growing and selling pot in a regulated fashion under state law is legal in Colorado doesn't make banking Mary Jane-associated businesses any less problematic.

Recently, The Wall Street Journal (paid subscription required) noted that virtual currency companies (like those dealing in bitcoin) are, likewise, finding that there's no room in the bank vault for their cold, hard "something-like-cash-but-a-lot cooler."

Lenders are leery of dealing with virtual-currency companies because of concerns that the businesses could run afoul of anti-money-laundering laws or be involved in illegal activities, banking executives say. Regulators and central bankers around the world have raised similar concerns in recent months.

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"This is definitely causing a bottleneck in the industry," he said in an interview. "The ability of companies to get bank accounts is necessary so that they can take the next step in building out the core bitcoin infrastructure."

Apparently, some businesses are attempting to disguise their connection to bitcoin by eliminating any variation of the words "bit" and "coin" from their business names. How that would help a business avoid the fact that federal law requires banks to "know their customer" and, therefore, the bank is going to know the business is virtual currency related, is beyond me.

As long as the federal and state banking regulators classify the business as a "money transmitter," the business brings with it all the heightened regulatory scrutiny and accompanying risk that comes from banking any other type of money services business. While some banks will take on that burden, many more of them will not. The article states that Wells Fargo and Bank of America publicly make noises that they're willing to do the extra due diligence required, but that Chase flatly refuses to get involved with such businesses. An owner of one virtual currency business who was interviewed for the article claims that he was rejected by 30 US banks because of regulatory scrutiny issues and that he finally found a bank in Germany (perhaps the same one that bankrolled "Sprockets").

The federal bank regulators gave their usual clear and concise guidance on the matter.

"Banks make their own decisions on which customers to accept, but areas like virtual currency that present heightened risk require heightened risk-management and controls," said a spokesman for the Office of the Comptroller of the Currency, which regulates banks.

And, of course, those risk-management practices and controls will never, ever be "heightened" to a sufficient level to satisfy regulatory "concerns," will they? You don't need to be a reader of tea leaves to get the OCC's drift. It's another case of "We can't tell you not to bank them, but if you do, prepare for a world where bank examiners arrive at your office and spend all day sitting there, not saying a word, just staring at you like those kids in 'Village of the Damned.' You can still go about your business if you wish, but sooner or later your head might spontaneously combust."

At least one bank, from an area of the country that should be no surprise to anyone, is willing to bank the virtual currency crowd.

Silicon Valley Bank, a Santa Clara, Calif., lender with $23.7 billion in assets, is one of the few institutions providing banking services to bitcoin companies. The bank has established a separate due-diligence process to vet such ventures and is being "extraordinarily selective," said Chief Operations Officer Bruce Wallace.

Mr. Wallace said providing services to bitcoin companies fits with the bank's business model to support innovative companies and "market disrupters." But he added, "I can definitely understand how some other financial institutions, where this is not a core part of their business, would question the point of taking any risk at all."

The lesson is that if you want to jump into banking a business that will heighten your risk, virtual currency is the land of opportunity. If you're not anxious to cope with the additional risk, then stick to something more traditional, at least until virtual currency becomes more traditional, which, in the current environment, may be only a few years down the road.