Can Bitcoin go mainstream?

Why governments should embrace Bitcoin - and vice versa

Coming soon to an ATM near you. Image credit: iStock by Getty

Few developments in the financial services world have caused as much confusion and concern than the advent of the virtual currency, Bitcoin. First, Bitcoin was hailed as the new gold – the perfect hedge against runaway monetary policy and inevitable hyperinflation – because it isn’t tied to any particular country’s currency, like the dollar. Then it became an alternative currency for illicit activity online – transactions are anonymous and no one’s “in charge,” making it ideal for money launderers, drug traffickers and their ilk.

Bitcoin is on the brink of becoming mainstream. But its viability depends on the next move by both regulators and Bitcoin advocates.
In truth, both characterizations miss the point of the power and benefits of Bitcoin. Despite some highly publicized recent setbacks, such as the crash of the Bitcoin “exchange” Mt. Gox, Bitcoin has the potential to be a true economic good. Its decentralized structure makes it more resilient, and in theory, its lower transaction costs can provide “unbanked” individuals in America and in the developing world with a valuable financial lifeline. These benefits are what give Bitcoin its appeal and staying power.

Since its invention in 2009, there have been more than 36 million transactions using Bitcoin, and almost 50,000 vendors accept it – including, Tesla, and Virgin Galactic.  According to the Bitcoin Investment Trust, the leading vehicle for sophisticated investors to gain exposure to Bitcoin, the value of current Bitcoins in circulation is more than $6 billion.

Bitcoin ATMs (machines that take your dollars and spit out Bitcoins) have been installed in locations from Vancouver, Canada to an office building in the U.S. Congress.  In fact, Rep. Jared Polis (D-CO) was the first person to use the Bitcoin ATM on Capitol Hill to exchange a $10 bill for .02 Bitcoin.  In New York, the state’s top financial regulator, Ben Lawsky, has established a new financial services license for Bitcoin companies – a Bitlicense.

Bitcoin is, in fact, on the brink of becoming mainstream. But what will determine whether Bitcoin becomes truly viable or remains a could-have-been depends on the next move by both regulators and Bitcoin’s advocates.

More than $6 billion in Bitcoins are now in circulation, and more than 50,000 vendors now accept this virtual currency.
Technically speaking, Bitcoin is a payments infrastructure that uses a decentralized network and public key cryptography to safely and efficiently transfer funds. In other words, Bitcoin is a payments system, a potential competitor to or collaborator with existing debit card and credit card providers, like PayPal, Mastercard or Visa. The difference is that instead of dollars or euros, the medium of currency is the Bitcoin. To use Bitcoin’s payment system, you convert your dollars or yen or Euros into Bitcoins, which are then transferred from your Bitcoin “wallet” to any vendor or person who accepts them, using the decentralized network. The person receiving your Bitcoins can keep them in their wallet or convert them back into whatever currency they prefer.

The process of “mining” – creating – Bitcoins isn’t easy. Mining requires state-of-the-art supercomputers to solve complex equations and it serves multiple functions.  It helps to limit the total number of Bitcoins in circulation, which contributes to its value; and it is the process that verifies the accuracy of Bitcoin transactions.  Effectively the payments infrastructure is paid for with newly-mined Bitcoins.

But while Bitcoin may have value and a ready set of users, what it doesn’t yet have is stability and public trust.

For Bitcoin to become mainstream, it needs stability and oversight.
For one thing, Bitcoin currency has been extremely volatile – rising quickly since it was founded and taking sharp dips on negative news events.  That’s a problem for a payments system or a currency. If we are trying to pay for a pizza using Bitcoins, merchants need confidence that they’re getting $15 worth of Bitcoins when they do their books at the end of the day or week. It is impossible to transact business with wild swings in value and merchants are not in the business of taking on currency risk.

The Bitcoin infrastructure also currently lacks the kind of oversight that only regulation can offer. From account custody and segregation, settlement systems, accounting and auditing procedures, to regulatory oversight – all require federal or state blessings and approvals.  But these steps are also needed to promote public confidence in the integrity of the system.

For Bitcoin to truly succeed, the Bitcoin world has to meet the policy world head on to achieve the following goals:

  •  Educate and ensure that Bitcoin is accurately defined in the public consciousness for what it is – an innovation in financial intermediation;
  • Help tailor regulations to enhance Bitcoin’s development, not inhibit it; and
  • Use government oversight as a way to bolster its credibility for consumers, businesses, and the financial system as a whole.
Regulators and the financial services establishment are cautiously embracing Bitcoin – a hopeful development.
Government oversight may actually be the best way to provide Bitcoin with the public credibility it needs.  Regulation can come with tough and expensive requirements; but it also comes with a government seal of approval.  Banks advertise themselves with the tag line “Member FDIC” in part because it signals that government has signed off on the safety of your savings account.

In fact, two recent developments signal that regulators and the financial services establishment are already cautiously embracing Bitcoin – a hopeful sign that deserves encouragement.

First, investors unveiled one of the first “bitcoin swaps” – bringing the virtual currency into the complex financial world of derivatives but also bringing it some much-needed stability. A well-functioning derivatives market will allow merchants to benefit from the payments system without taking the risks associated with its volatility.

Second, the Internal Revenue Service (IRS) provided guidance regarding the tax treatment of Bitcoin as property, NOT money, when it comes to tax day on April 15. Whether or not the IRS’s position is correct, clear federal tax rules will allow merchants and legitimate users of Bitcoin to transact with confidence and eventually use the system for retail customers.

These developments represent basic financial services infrastructure and rules that we take for granted. But they’re critical for making a system work efficiently. And before it can go fully mainstream, Bitcoin needs to have these and other basic infrastructure and rules fleshed out.

It is no surprise that many inside and outside of government look at Bitcoin with an arched eyebrow.  And frankly, there are real issues for policy makers and regulators to tackle. But rather than seeing Bitcoin as a threat, policymakers should instead seek to regulate this new currency and bring it into the mainstream.  Similarly, believers in this new technology should consider treating the interest of regulators not as a threat, but rather as an opportunity to build in clear rules for Bitcoin and promote public confidence in the integrity of the system.  That confidence can allow Bitcoin to fulfill its promise.

Israel “Izzy” Klein is a Principal at the Podesta Group and formerly a senior staffer for leading Senate and House members; and Tim Karpoff is a partner at Jenner & Block and formerly Director of the Treasury Department’s Office of Financial Institutions Policy and Counsel to CFTC Chairman Gary Gensler.