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How Do We Regulate Bitcoin and Other Cryptocurrencies?

The digital currency market is changing so fast that any misstep could be huge.

A couple of months ago, in a congressional primary in Southern California, voters were treated to a truly unusual argument. Brian Forde, a former Obama White House aide, received almost $200,000 in donations in the form of cryptocurrencies. One of his opponents, Dave Min, a former enforcement lawyer at the Securities and Exchange Commission, savaged him for relying on “bitcoin speculators that oppose cracking down on drug deals and human trafficking.” 

In a flash, the race pulled political campaigning into uncharted -- and bizarre -- territory. Min painted Forde as a candidate sidling up to an industry that almost no one really understands. Forde countered that his familiarity with bitcoin placed him on the cutting edge of new and exciting developments. The voters ultimately decided not to embrace either claim, and went with another Democrat, Katie Porter. But there was a sense that the contest signaled the beginning of a role for the new digital currencies that will reach all through the American political system.  

Bitcoin, the most familiar cryptocurrency, was created by Satoshi Nakamoto, who might -- or might not -- be a real-life person. Cryptocurrencies exist only as bits in an electronic ledger, and they have only the value that those trading them agree on. Transactions are made through the internet, they’re encrypted (hence the “crypto” part of the name) and they’re not issued by any government.  

The mystery of this new form of money is part of its allure. So, too, for many players, is the fact it has been, so far, largely free of government regulation. Bitcoin has been irresistible to get-rich-quick speculators, some of whom made enormous amounts of money in 2017 as the currency’s value almost quadrupled. It has become the stuff of television drama, with characters secretly passing billions to each other on flash drives. 

All of this has made cryptocurrencies irresistible to crooks. In early June, hackers burrowed into a South Korean cryptomarket -- which, after all, is just an online accounting system -- and stole some bitcoin, pushing the currency’s value down 10 percent over a single weekend. Since digital currencies are only worth what people are willing to pay for them, their value has fluctuated wildly. In just the first six months of 2018, bitcoin’s value fell two-thirds from its record high of $20,000 a share in December.  

Even without the presence of hackers, cryptocurrencies would have a shady reputation. In their earliest days, online drug dealers used them to transfer their proceeds without leaving an easy trail for investigators to follow. That came to an end when the feds busted the multimillion dollar Silk Road drug market, created by a kingpin who called himself the Dread Pirate Roberts after a character in the 1987 movie The Princess Bride.  

Cryptocurrencies pride themselves on standing apart from government, but that hasn’t stopped some states and localities from trying to crack down, at least on illicit dealings that range from drug smuggling to bribery to fraud. The Chinese government has banned the use of cryptocurrencies to fund startup companies. But in the U.S., the federal government has stayed away from regulation, in part because it’s not clear even to regulators exactly what these digital currencies are and who would be responsible for regulating them. Are they a security, like a bond, and thus under the jurisdiction of the Securities and Exchange Commission? Or are they a commodity, like gold, to be regulated by the Commodity Futures Trading Commission? 

The debate over regulation isn’t just about protecting citizens. It’s also about maneuvering for position in what states see as an emerging market with lots of potential economic growth. Most states are sitting back right now to figure out where this is going. Others are jumping in, trying to gain an advantage either by protecting taxpayers or encouraging investment.

Washington state, for example, has been wary about cryptocash flooding in to make tech deals. To protect investors from fraud, the state requires cryptocurrency exchanges to create a cash reserve, equal to the volume of transactions, so there’s real backup for the deals. New York state, determined to retain its place as the nation’s financial hub, has fostered the creation of a fully licensed digital currency exchange.  

Wyoming, on the other hand, has made a play for the Wild West side of the business. Hoping that a free market would help boost jobs, the legislature exempted cryptocurrencies from the state’s financial and securities regulations, as long as the currencies weren’t being sold as investments. The state effectively decided that the new money was neither a commodity nor a security.  

We’ve been here before: big battles throughout the nation’s history among bankers, federal regulators and entrepreneurs who want the freedom to go their own way. This time, the feds are on the sidelines and states are jockeying for advantage in a global marketplace that none of them can control and few of them fully grasp. The pace of change is so fast that any state advantage could be gone in a heartbeat, and the damage from any misstep could be huge. 


Donald F. Kettl is professor emeritus and former dean of the University of Maryland School of Public Policy. He is the co-author with William D. Eggers of Bridgebuilders: How Government Can Transcend Boundaries to Solve Big Problems.
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