US regulations are hampering Bitcoin’s growth

If the United States does not foster a reasonable regulatory environment for Bitcoin, the country might soon lose its head start in what could be the next great technological revolution. That’s the message policymakers should hear today and tomorrow when the US Senate holds hearings on the virtual currency.

While Bitcoin is an international phenomenon, the United States has been central to its growth to date. Bitcoin’s lead developer, Gavin Andresen, is an American based in the United States, as is the Bitcoin Foundation that employs him. The most innovative startups building out Bitcoin’s infrastructure are also US-based. These include the merchant services provider Bitpay in Atlanta, backed by PayPal founder and early Facebook investor Peter Thiel, and the consumer-friendly wallet service Coinbase in Silicon Valley, backed by early Twitter funders Union Square Ventures.

But Bitcoin’s center of gravity is beginning to shift. Earlier this year, China became the first country to overtake the United States in downloads of the Bitcoin client software, and since China’s dominant search engine, Baidu, began accepting Bitcoins for services, demand has skyrocketed. BTC China, the main exchange there, recently became the largest in the world, accounting for 35% of all Bitcoin trades.

Even more important than losing market share, the United States may also be losing mindshare. The Bitcoin Foundation is reportedly considering moving its headquarters overseas, and citing regulatory concerns, startups are beginning to avoid the United States.

For example, Coinfloor, a newly launched Bitcoin exchange in London has gone so far as to bar American customers. Mark Lamb, its founder, told the Financial Times:

Legally it is not safe to open up to US customers in the beginning … partly because of regulation, we think there is a larger market in the UK and in Europe and then in Asia.

More visibly, the world’s first Bitcoin ATM went into service last month to much media fanfare – not in Silicon Valley or New York City – but in Vancouver, British Columbia. As Jordan Kelley, CEO of the company that manufactured the ATM, explained to Wired, “The regulations right now in the United States are a pretty decent barrier to entry for any operator.”

The regulations in question include federal anti-money laundering and terrorist financing rules, as well as the cumbersome state-by-state licensing of money transmitters. Federal rules require that money transmitters register with the Treasury Department’s Financial Crimes Enforcement Network (Fincen), implement anti-money-laundering programs, keep records of their customers, and report suspicious transactions and other data. In March, Fincen issued guidance that these rules apply to virtual currency businesses. State regulations are more onerous since virtual currency startups may have to complete a laborious licensing process in each of 48 states and the District of Columbia before they can even open for business.

Indeed, it’s not just Bitcoin businesses, but all money transmitters that are being hampered by stricter regulation. Shares of Western Union, the largest money transmitter in the United States, plummeted 12% last month after it reported in its third-quarter earnings call that it expects higher compliance-related expenses in 2014, because it is “subject to increasingly strict legal and regulatory requirements”.

In contrast to the US’s regulate-first-and-ask-questions-later approach toward Bitcoin, other countries are taking a more deliberate wait-and-see path. The UK’s Financial Conduct Authority told Coinfloor that it has no plans to regulate Bitcoin exchanges, allowing it to launch unencumbered. And Fincen’s Canadian counterpart, Fintrac, has similarly assured various Bitcoin businesses that they are not subject to money transmitter regulations.

Going a step further, the Canada Revenue Agency, earlier this month issued a statement clarifying the tax treatment of Bitcoin. In the United States no such statement is forthcoming from the Internal Revenue Service even though the Government Accountability Office recommended that the agency issue one.

Law enforcement and regulators in the United States certainly have an interest in ensuring that criminals don’t take advantage of the latest technology, but it is foolhardy to meet that goal by hampering all uses of the technology, including legitimate ones.

Pursuing an aggressive regulatory path on Bitcoin could mean ceding the US’s head start in what could be a disruptive industry to countries like China, Canada and the UK, all of which seem to be taking a more laissez faire approach. Not only could regulators forfeit Bitcoin’s potential economic benefits, but if Bitcoin startups begin to make their home overseas, law enforcement might lose the visibility into transactions they seek.

That’s why the path best forward, which confronts risks while ensuring that the United States can reap Bitcoin’s potential, is to allow the Bitcoin network and its surrounding infrastructure develop in the United States by ensuring that entrepreneurs can easily comply with existing regulation.