New York banking regulators are expected to release new rules this week governing Bitcoins and other virtual currencies.
Many think virtual currencies--sometimes called crypto-currencies--will soon revolutionize financial services, but until now they have been largely unregulated.
New York State is about step into this regulatory void. Within days, the Department of Financial Services will issue far-reaching rules focusing on three things: consumer protection, cyber security, and anti-money laundry rules.
In many ways, virtual currencies are just like old fashioned money that can purchase furniture, books, beer, and any number of things.
But Jon Johnson, chairman of the internet retailer Overstock.com, says currencies like Bitcoin are better than money. He explains it with an anecdote from a visit with his hairstylist.
"She asked me, tell me about Bitcoin," Johnson told a public hearing earlier this year.
"And I noticed the previous patron had paid with a credit card and she said I would love to have something that didn't have interchange fees where I wasn't giving three percent of every haircut to the credit card companies."
Johnson and Overstock were early adapters to Bitcoin because anyone online can cutout middlemen making transactions cheaper.
Bitcoin Companies Need Regulation
Gil Lauria, a financial technology analyst with Wedbush Securities, says banks and investment firms blossomed under oversight by the Federal Reserve and the Securities and Exchange Commission.
"It's very difficult for a Bitcoin companies to function right now because they don't have a natural regulator," he says.
There are some federal laws that Bitcoin companies have to obey so as to not launder money or fund terrorism, but Lauria says the rules are not clear enough.
"There's processes to make sure you know what the customers is doing, and then there's processes of reporting things that look suspicious. The regulation of all that" he says, "Bitcoin businesses don't necessarily have."
Bitcoin Is More Than Money
But some in the industry worry that New York could go too far and create anti-money laundering rules that define and limit Bitcoin before we really know what it can do.
"That's just it, we have no idea. The power of the Bitcoin protocol is enormous," says Marco Santori, a lawyer specializing in financial transactions.
On the surface, Bitcoin is a currency, but underneath, it is a secure system for electronically transferring things of value from person to person. That could be money, but it might also be the deed to a house or a copyright--anything users would not want counterfeited.
Santori says it is shortsighted to regulate Bitcoin as if it were money when in twenty years it could be so much more.
"Had the federal government come down and started regulating the predecessor to the internet and said 'look this is a very powerful tool for terrorist's communication we should require licensing for anyone using this tool.' It's unlikely we would now have amazon.com."
Most in the industry agree that rules dealing with consumer protection and cybersecurity would be welcome. Currently there is no single authority that could help consumers recover lost funds if a Bitcoin company goes under.
Nor are there rules that require third party security audits that could prevent the theft of what is essentially bits and bytes on a computer somewhere.