When regulating digital currencies, motivation matters
As attention and money focus on Bitcoin and other digital currencies, would-be regulators are among the crowd of onlookers. Early signals reveal divergent approaches: facilitation (a la the New York State Department of Financial Services’ Bitlicense) and restriction (a la Senate Bill 1241). If digital currencies are going to do the most good for society, regulators should be sensitive to the importance of their decisions between the two approaches.
Facilitation means regulating in order to make digital currency activity (development, exchange, or use) safer and fairer. Facilitation does sometimes restrict — but it does so with the overall goal of either supporting digital currency activity, or making it less prone to the unsavory stuff that might come with a completely unregulated activity of any kind. For example, the Bitlicense forbids unlicensed entities from engaging in “virtual currency business activities” (like controlling or administering virtual currencies, or storing them on behalf of others) and it in that sense restricts; the idea, though, is not to hamper such activity per se, nor is it to eliminate societal harm that is perceived to be native to certain (again, perceived) aspects of digital currency activity. The idea is to protect consumers and businesses from the risks of fly-by-night operations and to make it harder for dishonest players to do their thing.
So just as a city might have no problem with (or even might want to encourage) football tournaments at the local stadium, while still recognizing that safety regulations or vending licenses can protect participants and spectators, jurisdictions can be indifferent to (or supportive of) digital currencies while imposing regulations on related activities. Players might be required to wear certain padding, or spectators might be required to sit a certain distance away from the field of play. Similarly, digital currency exchanges are, under the Bitlicense, required to provide evidence of competence and trustworthiness before they can do business in New York.
Restriction is motivated by different concerns. S 1241 — officially, a bill “to improve the prohibitions on money laundering, and for other purposes” — is, on its face, a response to the social harms of money laundering and terrorism. The fear motivating S 1241 is that Bitcoin and other digital currencies have been, are being, or could easily be used to launder money related to criminal enterprises. The legislative response, so far, is to bring virtual currencies into the regulatory fold with money technologies that are similarly suspected of being useful to criminals (for example, prepaid cards and certain physical checks).
Extending the football analogy, if a city believes that watching or playing football brings out aggression and causes off-field violence in teens, it might engage in restrictive regulation of football. The city might decide to limit spectator ticket sales to patrons over the age of 20. The motivation is to stem negative externalities of the sport, rather than to make the sport itself safer. Similarly, S 1241 is meant to curtail criminal activity that is fundamentally independent of (or not native to) digital currencies.
Why do motivations matter? Or, if both restrictive and facilitative regulation can, in the end, mean that certain digital currency activities or uses are squeezed, why should we care whether a regulation falls into one category or the other? One reason is that legislative intent matters for judicial interpretation. In an emerging area of law, judges who are otherwise at a loss for guidance when interpreting statutes will look to the purpose of the law, or the goals that the legislature hoped to achieve by making the law. When trying to decide how a law applies to a particular set of facts, a judge who finds a restrictive motivation will get the message that the legislature prioritized stamping out a certain bad. Stopping terrorism by curtailing money laundering seemed more important to the legislature than the impact of limiting digital currency activity, a judge may determine, and interpret the statute accordingly. The law’s impact on the regulated digital currency activity can expand. (This might not be a bad thing. But it’s a risk to be aware of. Judges stepping into uncharted waters can, quite understandably, end up compounding the negative effects of regulation).
Next, motivations matter because they make a difference to public perception of the activity. Digital currencies (and the blockchain technologies that often underlie them) are new, complicated and mysterious. They promise tremendous social benefit, but that benefit will be harder to realize if regulation feeds our fear or heightens the apprehension that often comes with mystery. This is because the success of digital currencies relies on network effects; critical mass is required to unlock much of the value in digital currencies. The more use, the more value society will see. And that means that when we decrease the size of the network through regulation (or through the message restrictive regulation sends), the benefit that society forgoes is compounded into the future. One Bitcoin user scared off by regulation today might miss out on some utility today. But her absence from the network also means that others who would have benefited from her presence themselves forego utility today and into the future.
To make matters worse, because digital currencies are mysterious and sometimes scary, we lose more from restrictive regulation than we do simply from such regulation’s direct limitations. When regulators act restrictively, their demonstration of fear snowballs: by associating digital currencies with money laundering, crime and terrorism, some members of the public may come to believe that digital currencies are best avoided. Those scared off miss out, and society as a whole realizes less value over time.
Regulators must be aware that, particularly in the realm of new law related to new technology, their public-facing motivations matter.
