This is the second-part of a two-part series. For the first past, see “Thoughts on Regulating Bitcoin (Part 1)”
Financial Regulation vs Financial Enforcement
Currently, countries are a plethora of laws and legal codes which dictate that citizens in America and many other countires must report any amount of income, including interest from bank balances, while filing taxes in numerous forms to the federal government. The era of digital banking has opened new avenues for tax evasion and new methods for tracing money. The Panama Papers garnered significant media attention, an event which implicated celebrities and other wealthy billionaires using off-shore tax havens to conceal wealth. The headlines were especially timely as the FATCA, a new American tax law initially implemented in 2010 and finalizing around 2019, is making such actions increasingly more difficult by forcing foreign banks to report on American citizens whose accounts meet certain criteria.
However, monitoring and enforcing taxes on every individual’s everyday transactions is an impossible task, so another common and more effective regulatory method is through business and companies. Using businesses like Paypal to harvest user identification, file taxes and detect money laundering is a simpler way to it. Strict anti-money laundering laws are also enacted which require companies that handle transactions, such as banks and businesses, to monitor transactions to detect money laundering and other crimes and co-operate with law enforcement to prevent these acts. The most notable of these are the Bank Secrecy Act of 1970 (BSA) and the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (aka USA PATRIOT Act). Corporations such as Paypal have been fined millions of dollars for failing to “adequately screen and prevent transactions”. Because of these regulations necessitating strict scanning and automated detection systems, Paypal accounts are often frozen indefinitely because of triggering fraud and money-laundering safeguards. Lengthy processing and detection systems tend to make potentially simple transactions troublesome.
Because individual bitcoins are highly liquid assets, one of the only ways that global governments can feasibly hope to regulate cryptocurrency transactions is by requiring businesses to comply with consumer banking regulation. For example, a cryptocurrency exchange in Estonia was shut down and the owner charged for failing to comply and release sensitive information about his users. Coin exchanges are required to implement anti-money laundering algorithms put in place to detect suspicious transactions. These centralized platforms enforce plenty of security – is the user truly who they say they are? If these platforms do not initially harvest a user’s identification, the exchange usually then flags vast amounts of transactions as potentially fraudulent and demands ID from the owner in order to release the funds.
Regulating Bitcoin like currency is not nearly a catch-all solution, however. Bitcoin is much different than other forms of currencies, and has a great possibility for more independence. To start a cryptocurrency exchange, one doesn’t need to go through a bank or a processing service like Paypal. Instead a developer can create entirely independent applications which accept and process Bitcoin transactions to escape regulations of law. In fact, entire black markets started by independent developers run secretly on the darknet and process thousands of transactions daily. These underground black markets are testimony to the ability to escape regulation and government controls using the cryptocurrency. Alternatively, directories like localbitcoins.com also support transactions through local traders on independent terms and not the terms of tech companies, which also provide an alternative method of avoiding regulated exchanges.
The same issue manifests when treating Bitcoin as property. Writing laws which require owners to declare capital gains in Bitcoin is good in theory, but individuals seeking to avoid taxation through Bitcoin will likely not file their Bitcoin taxes willingly. And unlike physical property like a yacht, or even other assets like stocks and bonds, it is far harder for IRS agents to discover Bitcoin in an individual’s possession. The initial problem of enforcement persists.
Bitcoin as Digital Information
The last frontier is treating Bitcoin simply as information. As long as the internet is (relatively) free, it seems Bitcoin has a capacity to inherently avoid regulation. What might be the biggest threat to Bitcoin then are threats to the greater internet and digital information environment as a whole. As global governments increase draconian surveillance measures, such as the domestic surveillance programs deployed by the NSA, online communications are now always heavily monitored. New propositions are being pushed forward by agencies such as the FBI to implement mandatory backdoors into digital products to give law enforcement access to private information when they demand it. Other three letter agencies, such as the NSA, can also only hope for such access, for by weakening standard security, new attack vectors will appear within products the NSA have been trying to hack for years.
Recently the FCC won a landmark lawsuit for net neutrality, but the issue is far from resolved. The Trans-Pacific Partnership Agreement is another threat to general freedom of data transmission on the internet. The EU is drafting ideas of forcing certain sites on the internet to accept government issued ID for EU citizens. The Ross Ulbricht case has set precedents for web hosts, making warrantless searches of servers seemingly acceptable, ultimately nullifying the Fourth Amendment in regards to digital environments. Mandatory data retention laws will also negatively affect freedom in digital environments. Finally, laws that seek to undermine cryptography, if put in place, will ultimately nullify privacy on the internet. If that sounds ridiculous, remember that exporting cryptographic technology from the U.S was heavily restricted for many years, as cryptography was classified as an Auxiliary Military Equipment on the U.S. Munitions List. Louis Freeh, Director of the FBI in 1997 said “Uncrackable encryption will allow drug lords, spies, terrorists and even violent gangs to communicate about their crimes and their conspiracies with impunity.”
Cryptography, being what protects your information, is the fundamental basis of privacy and security on the inherently unsecure channels of the internet. By controlling the flow of data, enacting increased state laws over privacy on internet channels and finally, by requesting backdoors in faultless cryptography, governments and corporations could effectively control the internet. At this point, Bitcoin would be as easy to regulate as foreign banks under the new FATCA, as not only the globe but the entire internet as well would become a regulated frontier, controlled by the current regime in power.
The more control that is enacted on the internet, the more difficult it will be to have independent and free Bitcoin transactions. Just like governments can regulate national currencies by regulating banks, the traditional channel through which international money transfers occur, so too could Bitcoin be regulated by controlling the internet, the fundamental channel which facilitates both the transfer and very existence of cryptocurrencies. In an entirely controlled and regulated internet, every individual’s cryptocurrency transactions could be monitored, as nothing could enter the Bitcoin network privately.
The current state of the internet is still quite free. Even with massive data surveillance enacted by agencies like the NSA, cryptography and software which utilizes encryption, such as TOR, is quite secure and for the most part still beyond the reaches of mass surveillance. While other sectors of finances become more regulated through more severe and universal laws, the internet and Bitcoin may become a haven for those seeking security, privacy and independence. Regulating Bitcoin is a nearly infeasible task, for as long as the internet is secure and private, assets like Bitcoin might remain private and secure too for citizens seeking to use them.