Why Regulators Should Embrace Bitcoin

Governments are increasing their scrutiny of the decentralized digital currency and payments system Bitcoin. The Senate Homeland Security and Government Affairs Committee recently initiated an inquiry into Bitcoin and other digital currencies, and the New York Department of Financial Services last week subpoenaed two-dozen Bitcoin-related businesses. The media often portray these developments as a "crackdown"—but this is incorrect.

Most regulators are only pursuing the facts—though perhaps more aggressively than is warranted, as with New York's subpoenas—which is an admission that they don't fully understand the nascent technology. Despite the inevitable tension between regulators and their targets, it's refreshing when policymakers seek to understand a new industry before regulating it.

It's not uncommon for pundits to advocate government taking steps to "regulate Bitcoin" the same way government might regulate banks. Others contend "Bitcoin cannot be regulated" because of its decentralized and distributed peer-to-peer design. In a sense, both statements are true, and policymakers must understand how this new technology limits their power to regulate.

Bitcoin is an Internet protocol undergirding a global peer-to-peer payments network, much like SMTP is the protocol undergirding e-mail. Like the email protocol, Bitcoin is open-source software controlled by no individual or corporation and run independently on thousands of computers around the world. Short of blocking Internet access, it's nearly impossible to regulate either Bitcoin or email.

That said, while it's impractical to regulate email, it would not be difficult for a government to regulate email services like Gmail or Outlook.com. That is, one can regulate particular email servers, but not the email protocol. Similarly, government may regulate companies and persons operating services over the Bitcoin network—like those subpoenaed by New York—but government cannot control the Bitcoin network itself.

Even if government controlled popular commercial email providers, users could still communicate over email by maintaining their own servers. The same logic applies to Bitcoin. Regulating commercial services that operate on the Bitcoin network won't prevent connections and transactions within the Bitcoin network independent of these services.

Regulators should not see this as a challenge to their authority, but simply as a fact—a consequence of decentralized peer-to-peer technology. Here's the takeaway: Rather than attempting the impossible feat of regulating the Bitcoin protocol or aggressively targeting the start-ups that want nothing more than to comply with the law, policymakers and law enforcement should work with the Bitcoin community to realize the potential benefits of censorship-resistant money—and to develop tools and techniques to address the technology's potential misuse.

Bitcoin's censorship-resistance is a feature, not a bug. Even though it could be abused, it's important to remember that it can also be used for good. For example, the popular blogging platform WordPress announced last year that it would accept payments in Bitcoin to provide bloggers around the world with access to premium services even if their governments disapproved.

"PayPal alone blocks access from over 60 countries, and many credit card companies have similar restrictions," WordPress said in its announcement, adding, "Some are blocked for political reasons, some because of higher fraud rates, and some for other financial reasons. Whatever the reason, we don't think an individual blogger from Haiti, Ethiopia, or Kenya should have diminished access to the blogosphere because of payment issues they can't control."

Bitcoin also allows oppressed individuals to transact even when governments regulate traditional payments processors, and that's a good thing. Consider an NGO that wants to fund human rights groups fighting for gay rights in Russia. Without a facility like Bitcoin, it might be impossible to electronically transfer money for good causes.

Naturally, this technology could be put to nefarious uses, like human trafficking. This is why law enforcement must develop new techniques to investigate crime to account for the fact that Bitcoin cannot be controlled as easily as traditional payments systems. Another immutable aspect of Bitcoin's design—that all transactions are publicly viewable—should help. Many in the Bitcoin community, including the subpoenaed start-ups, will undoubtedly be happy to assist law enforcement pursue terrorists and child pornographers who might use the network. They can only help, however, if they aren't driven out of business by regulatory overreaction.

This is why it is crucial that policymakers educate themselves about Bitcoin. By acting too hastily, they could forgo the many benefits of this innovative technology, while ceding the space to the criminals they want to control.

— Jerry Brito is a senior research fellow with the Mercatus Center at George Mason University, director of its Technology Policy Program, and coauthor, with Andrea Castillo, of the newly released "Bitcoin: A Primer for Policymakers."