Bitcoin: Currency of the Future or a Regulatory Nightmare?

Bitcoin is a potential nightmare for security policymakers who are already struggling to keep pace with the problems posed by the Internet age.

By Samuel Doo
November 18, 2013

Imagine an unregulated currency that can be accessed from any digital device anywhere in the world and transferred in minutes, at no cost and completely anonymously. In essence, that is what the much-hyped Bitcoin is about. But while it may be a libertarian's dream, the Bitcoin is a potential nightmare for security policymakers who are already struggling to keep pace with the problems posed by the Internet age. Unlike traditional currency, which is backed by a central bank, the Bitcoin is digital currency that exists through an open-source, P2P network. The Bitcoin’s uniqueness lies in the fact that it is both a currency and a commodity, and the users within the network serve as both consumers and suppliers of the currency.

While many legitimate online retailers accept Bitcoins as a form of payment, Bitcoins are also used by underground sites like the Silk Road for the sale of illegal narcotics and firearms. A recent FBI report examined how the Bitcoin's features make it an appealing apparatus for illicit actors. While all Bitcoin transactions are recorded in a digital ledger, the records do not include information on the geographic locations of transfers. In addition, the parties involved often employ pseudonyms. Bitcoin users can also create as many addresses as they want, which further obscures the person behind the transaction. Finally, as Bitcoins are fully decentralized, one cannot target a central location for investigative purposes. Terrorist networks and transnational organized crime groups depend heavily on hiding their financial assets; these assets are often difficult to pinpoint but they still tend to be hidden in places that governments can target, such as offshore accounts and merchant banks. If left unaddressed, the Bitcoin network could potentially evolve into a robust and full-fledged financial system for the global black market.

The sheer ease with which the Bitcoin network facilitates money transfers is worth noting. Paypal charges roughly three percent and a 30 cent fee per transaction, while bank wire transfers charge about three and a half percent and take three to five days to clear. In contrast to those rates, Bitcoin transfers are free, place no limit on the transfer amount, and occur within minutes. Most significantly, Bitcoins would thrive in regions that lack the institutions necessary to meet international financial regulatory standards. For example, many Middle Eastern and African countries rely on informal financial networks such as the Hawala. As these regions are fertile recruiting grounds for terrorists and other illicit actors, the prospect of an unchecked Bitcoin network could greatly enhance the operational capacity of illicit actors, especially when one considers the ubiquity of mobile phone networks.

So what can policymakers do to address this novel issue? One option is to completely criminalize the use of Bitcoins. Governments could pass strict laws and sanctions for banks and businesses that engage in Bitcoin transactions. Bitcoins hold value because they can be converted into traditional money; since this policy would render them inconvertible, their inherent value would be lost. Another approach would be to devote more resources into cyber-initiatives to better infiltrate and track Bitcoin transactions. While these two policy prescriptions are fairly uncomplicated and require little political will, pursuing either of them would negate the potential benefits that Bitcoins could provide. If properly regulated, the government and private sector would benefit from a highly efficient and flexible means of transferring capital across the globe.

Bitcoins could be an incredibly useful asset for international development initiatives. Poorer countries often suffer from high inflation, rendering their currencies useless. Bitcoins could remedy this issue since they are not tied to an unstable regime’s central bank. As previously mentioned, poorer countries often lack the institutions necessary to provide a traditional credit network. One of the challenges for NGOs and development agencies engaged in microfinance is that microfinance tends to involve small financial transactions relative to constant transaction fees. Because Bitcoins can be transferred interest-free, they may prove an efficient tool for alleviating poverty and fostering regional security in poor regions of the world.

That said, the Bitcoin does come with considerable risks. As a purely digital currency, it is vulnerable to hard drive crashes and data corruption, which is problematic given the prevalence of hacking. Moreover, like many novel technology startups, the value of the Bitcoin has been prone to drastic fluctuations given its relatively new and polarizing status among investors. Finally, the decentralized nature can be a curse, since there is no overarching authority to guarantee a minimum valuation. If users were to engage in a mass currency dump, the Bitcoin’s valuation would plummet, hurting those with large investments.

All things considered, policymakers should focus on bolstering user confidence in the Bitcoin. Governments could provide secure backup servers. They could also purchase and hold a certain amount of the coins to provide informal backing and ensure that their value is maintained at a certain level. However, governments must refrain from implementing excessively restrictive standards and tax or interest rates on transactions, as this would dissuade potential users and negate the efficiency inherent in the Bitcoin. Finally, policymakers may have to concede that the Bitcoin poses too many risks for widespread use. If that is the case, they should seek to limit the scope of Bitcoin usage to small businesses and international development projects. Following these guidelines will help to bring about a balanced regulatory framework for this new and intriguing technology.

Samuel Doo is a first-year M.A. candidate in the Security Policies Studies program at the Elliott School of International Affairs. He previously earned his B.A. in Political Science at the University of Michigan.

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