Commentary: Bitcoin needs ‘Goldilocks’ regulation

Bitcoin, a new form of private money, is designed to remove the government’s ability to create inflation by printing money. Bitcoin was designed to nurture a new unregulated monetary system without the involvement of governments, banks or other regulated financial institutions.

Ironically, bitcoin and other cryptocurrencies are unlikely to gain mainstream status without the right mix of government regulation and oversight. Too much regulation and cryptocurrencies will succumb to compliance costs. Too little regulation and the cryptocurrency market will fail to achieve the integrity it needs to attract mainstream institutions and investors.

The supply of bitcoin is tightly controlled by open source software to ensure that the cryptocurrency’s value can never be debased. The blockchain distributed ledger technology, which makes bitcoin and other cryptocurrencies possible, underpins a transnational payment system that needs neither banks nor governments to operate.

The integrity of the blockchain payment system depends on the actions of independent “miners” who compete to solve the next blockchain cryptologic puzzle. The solution to the puzzle creates a permanent record of bitcoin transactions, and the winning “miner” earns bitcoin as a reward.

Unfortunately, the blockchain is not tamper-proof. A single “miner” with too much computing power can manipulate the timing of transactions on the blockchain and potentially counterfeit the cryptocurrency. This risk is greater than initially believed, and no government monitors the computing power of individual mining firms to ensure the integrity of the blockchain payment mechanism.

While the blockchain records payments of cryptocurrency between two virtual wallets, bitcoin and other cryptocurrencies must have additional functionality to be viable substitutes for national currencies. For example, cryptocurrencies must be easily and safely exchanged for national currencies.

At present, more than 50 cryptocurrency exchanges around the globe facilitate the exchange of cryptocurrency for national currency. These exchanges are private, unregulated intermediaries that match customer purchase and sales orders for cryptocurrency-national currency pairs.

Cryptocurrency exchanges provide a critical service. But even though the integrity of these exchanges are critical for the long-term viability of cryptocurrencies, the bitcoin blockchain technology does not protect investors against theft or fraud when their cryptocurrency balances and transactions are entrusted with these intermediaries.

To use a cryptocurrency exchange, a currency owner must transfer virtual currency to the exchange, or provide the exchange with national currency to purchase cryptocurrency. Either way, the customer’s cryptocurrency is held in the exchange’s virtual wallet. Unlike regulated exchanges, there is no law or regulation requiring that the balances of customers be segregated from exchange balances. If the exchange goes bankrupt from fraud or mismanagement, or the exchange’s virtual wallet gets hacked, customer cryptocurrency balances can be lost. Unlike U.S.-regulated securities firms, there is no Securities Investor Protection Corp. insurance to protect customers.

In the short time cryptocurrency exchanges have existed, they have been hacked repeatedly and several have experienced bankruptcy. Other risks include “flash crashes,” the potential for front-running (where insiders enrich themselves through their knowledge of a pending transaction), the unknown impacts of algorithmic trading, and other information asymmetries that may disadvantage mainstream investors trading on cryptocurrency exchanges.

The anonymity of cryptocurrency transactions also creates risk. Cryptocurrencies are traded between virtual wallets that contain no identifying information about their human owner. The anonymity of cryptocurrency transactions attracts those who profit from illegal activities including criminals, terrorists and tax evaders.

One recent study estimates that nearly 24 million bitcoin market participants and nearly half of all bitcoin transactions can be linked to illegal activities.

The link between cryptocurrency and criminal activity is a major problem for regulated financial institutions. These institutions are subject to anti-money-laundering laws that expose the institutions to fines and other sanctions should they accept funds linked to illegal activity. Currently, the risk of processing funds related to illicit activities limits the participation of mainstream financial institutions in cryptocurrency markets.

Reader Comments ...

Next Up in Opinion

POINT OF VIEW: Everyone should want to help greyhounds

At a time when we can’t seem to agree on anything, there is still an issue that unites Democrats and Republicans: protecting dogs. Community leaders across the state support Amendment 13, a humane proposal to phase out greyhound racing. As a state, we have a proud tradition of leading on animal welfare issues. Our first anti-cruelty law was adopted...
Opinion: A great moment in black history

In 2006, Leonard Pitts wrote this column based on an interview with Ron Stallworth, who, 12 years later, is the subject of Spike Lee’s latest film, “BlacKkKlansman.” In 1979, Stallworth was an intelligence officer with the Colorado Springs police department. He infiltrated the Ku Klux Klan, a hate group, and even developed a relationship...

Childrens Place should have hedged its bet Childrens Place at HomeSafe made a bad decision for the victims of child abuse and domestic violence it will serve when it purchased a minimal-width property on a potentially hazardous lake, on a busy highway, knowing it was not zoned for their operation. (“Residents near Wellington support HomeSafe...
Opinion: Markets know better than bureaucrats what society needs

Governments, seemingly eager to supply their critics with ammunition, constantly validate historian Robert Conquest: The behavior of any bureaucratic organization can best be understood by assuming that it is controlled by a secret cabal of its enemies. Consider North Carolina’s intervention in the medical-devices market. Born in India, Dr. Gajendra...
Opinion: Trump’s failure to condemn bigots of alt-right tars presidency

WASHINGTON — How can a president as successful as Donald Trump be so unpopular? Fueled by his historic tax reform and an unprecedented regulatory rollback, the economy grew by 4.1 percent in the second quarter. The unemployment rate is just 3.9 percent — near the lowest it has been in nearly two decades — and the New York Times reports...
More Stories