On Tuesday the State of California sent a letter to the Bitcoin Foundation, saying that the Foundation might be in violation of California’s law against running an unregistered money transmission business. The letter isn’t important in the grand scheme of things—it’s clear that the Bitcoin Foundation isn’t transmitting money—but it does raise the obvious question of how governments will try to regulate the use of Bitcoin.
Obviously, regulating Bitcoin itself is different from regulating specific companies that happen to use Bitcoin. As an example, Mt. Gox, the best-known Bitcoin exchange, is a Japanese company that does business in the U.S. (among other places). Mt. Gox is subject to Japanese laws regarding corporations generally as well as its specific business, and to the extent it does business in the U.S. it is subject to U.S. law. For example, FinCEN (the part of the U.S. Dept. of Treasury that enforces laws relating to money laundering) has insisted that Mt. Gox report financial transactions in the same way that other institutions would. It seems like common sense to apply these laws evenhandedly to Bitcoin and non-Bitcoin transactors. Exactly how to fairly apply business laws and regulations to companies that use Bitcoin is an interesting question; but whether governments should enforce these laws against individual companies that use Bitcoin should be an easy question.
The most interesting questions arise when a government wants to regulate the overall Bitcoin system. Contrary to some punditry, there is no simple argument that Bitcoin is unregulable. As I explained in my previous post on governance in Bitcoin, the rules of Bitcoin can change and have changed, and there is an emerging though informal governance structure for Bitcoin, which coincides with the governance of the open-source Bitcoin reference software by the software’s lead developers.
The people who govern Bitcoin are an obvious point of leverage for regulators. In principle, a regulator might try to compel the developers who govern the Bitcoin software to deploy certain rule changes, by compelling them to push software changes that implement the modified rules.
But there are limits to the power of this regulatory approach, due to the limited power of the developers who govern the Bitcoin reference software. The developers can push any software change they want, but they cannot force users to adopt the modified software. If the developers make a change that the community of users rejects, then the community can fork the software: they can create their own version that does not incorporate the unwanted changes, and they can switch to using the new version. In effect, this kind of fork amounts to the community firing the administrators of the software and appointing new ones.
Importantly, this kind of decision would be made by a consensus of the community, with each member’s influence ultimately determined by their importance in the Bitcoin economy, in the sense that a fork will succeed if it is is followed by a large enough fraction of the mining and transaction activity of Bitcoin.
Because of this, the leverage of a regulator will depend on how centralized the Bitcoin economy becomes. If a lot of mining activity is controlled by a few entities, or if a lot of transactions are mediated by a few exchanges, then those few miners and exchanges will be points of leverage for a regulator who wants to change the rules. On the other hand, if activity is more dispersed, then regulators will have more trouble nudging the system in the direction they want.
Just like the Internet itself, which was once thought (by some) to be unregulable but is now influenced strongly by various governments, Bitcoin will turn out to be more regulable than its initial advocates thought. Also like the Internet, Bitcoin will flummox some of the less savvy people in government, leading to some series-of-tubes moments. Bitcoin, like the Internet, is a new kind of thing, and governments will find new ways to influence it.