What is Bitcoin? Regulating Bitcoin Legitimizes It As a New Currency

Bitcoin users should celebrate the government attention they're getting. U.S. officials froze an account tied to the largest bitcoin exchange for not registering with the Treasury Department's Financial Crimes Enforcement Network, or FinCen. This could legitimize bitcoin as a valid currency.

The Wall Street Journal reports that Tokyo-based Mt. Gox exchange, which handles 80% of bitcoin trading, failed to comply with rules as a money-transferer like Western Union. FinCen evaluated bitcoins as decentralized virtual currencies and found that anyone exchanging bitcoins qualifies as a money-transmitter under the Banking Security Act. 

The anonymity factor has been the undoing of bitcoin's idealism. The currency has been plagued by reports of nefarious transactions involving illegal drugs and gambling as is to be expected by any unregulated resource. This complicates its legitimacy. The volatile price fluctuations and lack of resources in the cases of fraud other than filing private lawsuits add further risk for bitcoin users.

It was only a matter of time before the government took notice given these factors. The IRS has been supposedly developing a bitcoin unit to evaluate how to tax transactions in virtual currencies just as it developed a framework for bartering. If bitcoins are traded for cash that cash is counted as income. As more online merchants also adopt bitcoins they are likely to see new regulations on sales tax.

The irony is inescapable, yet expected. Bitcoin was developed in 2008 as a "peer-to-peer electronic cash system" specifically meant to be outside the controls of governments. Bitcoin transactions were intended to live online and occur between computers and smartphones through exchange servers. Bitcoin bypasses financial institutions altogether.

Bitcoin users should only celebrate this recent flurry of government activity. Wired.com's Dan Kaminsky provides an excellent breakdown of how bitcoin functions like any other unregulated network, but that bitcoin should welcome analysis of how to improve the network through regulation instead of arguing against it altogether:

"It’s not merely that bitcoin must interact with the messy real world, and absorb its faults and foibles. Currencies do not naturally maintain fairly stable valuations ... The supply shocks, the hoarding, the speculation — all admit the possibility that bitcoin just might not scale to all the uses that people have for teleporting, difficult-to-regulate currency."

This may seem like sacrilege to bitcoin purists but if bitcoin remained unregulated it is also unlikely to gain mass adoption. The euro was a failed experiment in a new currency system but bitcoin can avoid being another. Warren Buffet has mirrored bitcoin founder Satoshi Nakamoto's view that modern financial instruments have "destroyed the purchasing power of investors in many countries" and bitcoin is currently poised to fill this need.

Bitcoin requires regulation and protections for its user to become a truly revolutionary new currency system. It can remain unregulated if it so chooses, but it risks becoming a 4chan over Reddit. Instead of fighting against the government intrusion Bitcoin has the opportunity to work with the government and bring a new financial system to the masses.

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