Are Regulators Holding Back Digital Currency?

WASHINGTON — Federal and state banking regulators are still struggling with how to come to grips with banks whose clients are heavily involved in digital currencies like bitcoin — and that may be curbing interest from many in the financial industry.

"This is a new area," said Margaret Liu, deputy general counsel of the Conference of State Bank Supervisors during a panel in January at the Brookings Institution. "It's going to take time for regulators to figure out the right way to encourage the good and manage out or mitigate the risks."

Digital currency firms have complained since 2013 that the Financial Crimes Enforcement Network's rules governing digital currency are too strict. And while some states like New York have announced clear standards, it's not always clear how other regulators see the relatively new technology.

Liu suggested that regulators are understandably wary given mistakes in the past.

The 2008 crisis "was about financial institutions taking too much risk," she said. "That is just in the rearview mirror for regulators."

But digital currency advocates argue that the rules are simply slowing down a safe industry.

"The regulators made some very strong pronouncement about bitcoin … being a financial crime risk," said Christine Duhaime, a Canadian lawyer specializing in anti-money-laundering matters. "There's no evidence really that this is the case so as a result, those laws to regulate bitcoin have kind of stalled."

"The second you overregulate without understanding the technology, you kill innovation and you kill investment in that technology."

Bitcoin companies are still having trouble opening bank accounts, according to some.

Bill Schafer, founder of a digital currency startup, spoke up during the conference in January: "I'm on my third bank. Tell me what can I do differently?"

Speaking to American Banker later, he said his troubles started when he registered his company, the bitcoin platform Epok, as a money-services business regulated by Fincen. Theoretically, that is supposed to make financial institutions more comfortable in doing business with them. But that wasn't how it turned out.

"I thought it was a badge of honor," Schafer said. But the reactions he encountered from compliance officers proved it otherwise. The MSB designation had the effect of a "scarlet letter," he said.

Banks are also wary of the potential risks faced by companies involved in the notoriously unsteady bitcoin market.

"If you can't manage it, you shouldn't be having it on your book," said P. Faisal Islam, the director of compliance at the payments platform Bolt.

But once banks have a better comprehension of the business, banks and bitcoin companies "have to find a symbiosis where one will understand the other," Islam said. "They should both complement each other."

Though many banks remain skittish about digital currency, they are also expressing a strong interest in harnessing the distributed ledger technology that undergirds bitcoin.

In September, 13 of the largest banks, including Bank of America, Bank of New York Mellon and Citigroup, joined a partnership with the startup R3CEV to develop commercial applications of the blockchain.

Other sections of the financial industry are taking note. Brad Peterson, the chief information officer for Nasdaq, argued at the panel that bitcoin technology could significantly speed up money flows.

Though stock buyers and sellers can now be matched within microseconds, he said, consummating the transaction entirely takes about three days, because of centralized database systems.

"It should be done instantly, and we can do that," Peterson said. Ledgers could also help public-company executives keep track of their shareholders in real time, he added.

For bitcoin companies, however, the potential competition might just be one of the factors behind banks' wariness.

"I can't tell if I'm getting kicked out because I'm a bitcoin company or if I'm getting kicked out because I'm a money-service business," Schafer said.