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Navigating the Murky Waters of Bitcoin Regulation

Michael Hudson
1 October 2015

From a young age, we’re taught to conform to rules. From Mum’s simple instructions about table manners and sharing our toys, through to school regulations on conventional dress code and complying with our company’s employment policies. We’re raised to have a healthy respect for the parameters laid down by authoritative figures or institutions. Naturally this has its place in civilisation, ensuring we grow up as responsible adults, understanding that there are bounds to – and consequences for – our actions and attitudes. Without restrictions, society would run amok!

This is often the opinion of the central authorities when it comes to Bitcoin. Viewed as the unruly kid that refuses to follow directions. They’re quick to point out the tales of the fallen Mt. Gox or failed Mintpal to push their own agenda and use them as classic examples of the shortcomings of being an unregulated industry. The problem is - it’s not the full story. Not by a long shot.

Bitcoin is a decentralised digital currency. This means it’s free from the direct control and influence of any central authority. It’s for precisely this reason that it allows for inspirational and groundbreaking innovation. In fact, fintech has seen more innovation over the last 5 years - since the invention of Bitcoin - than it has in the last 20 years, and we’re only just getting started! Bitcoin was never designed to fit within the constraints of the customary financial market principles; it was developed to allow for permissionless financial and economic activity.

Attempting to regulate Bitcoin (as a network and technology) will stifle innovation, and is, quite frankly, unnecessary. You see, bitcoin is regulated and does operate within certain parameters – just not the parameters and regulations we’re accustomed to. Most definitely not those imposed by the financial jurisdiction.

Let me explain.

Bitcoin supply is finite. Its issuance is predictable. The transactions are irreversible. And the network is impermeable. These features - which simultaneously serve as benefits - are made possible by the fact that Bitcoin is ‘regulated’ by mathematical algorithms. Algorithms which eliminate the need for trust in a central body, and as such, negate the necessity for centralised regulation in the traditional sense of the word. This works. It enables and promotes the ongoing innovations built around the network.

What doesn’t work and where a lack of regulation presents a challenge - and perhaps even a threat - is for financial companies building commercial opportunities and services around Bitcoin, and more importantly, for the consumers who wish to engage them.

In the face of an unfettered industry these firms are operating in uncharted water, and in an effort to present some level of structure, adopt traditional custodial models. This practice leaves consumers vulnerable on two fronts. Firstly, they are effectively yielding full control of their bitcoins to these organisations and, therefore, fail to benefit from the truly decentralised nature of bitcoin and the blockchain (full personal control of finances). Secondly, they don’t have the advantage of the safety net that traditional financial services regulation would impose on these companies, providing a level of ‘insurance’ and recourse for any transgressions. This is a definitive grey area within the Bitcoin industry. And one which desperately needs regulatory clarity.

An established regulatory framework would allow these businesses to conform to traditional financial regulation levied in their respective jurisdictions, providing reassurance to consumers. This has a positive knock-on effect on mainstream adoption as consumers can trust that their bitcoin funds, despite being managed by a 3rd party, are secure, and that they ultimately dictate the level of control the company is given over their wealth.

Would a regulatory code of practice prevented the crashes of Mt. Gox and Mintpals? Highly unlikely. These companies didn’t fall as a result of a lack of regulation. They fell because they were ill-structured businesses participating in unscrupulous behaviour. But industry regulation could’ve helped mitigate or minimise the losses of the consumers, by providing them with protection, or even compensation, from these illegitimate, rogue companies - who just so happened to be associated with Bitcoin.

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