New York State Regulator Promises Tough Bitcoin Rules

New York’s top financial regulator told Bitcoin entrepreneurs he’ll prevent their companies from abetting money laundering even at the risk stamping out innovation in the embryonic virtual-currency industry.

As he convened two days of hearings yesterday on the regulation of Bitcoin and other virtual currencies, Benjamin Lawsky, the state’s superintendent of financial services, said New York will be the first to propose rules for the new technology’s oversight. The hearings began a day after a Bitcoin promoter was indicted on money-laundering charges.

Bitcoin entrepreneurs at the hearing -- including Cameron and Tyler Winklevoss, early backers of Facebook Inc. -- said overzealous regulators could stifle the fledgling technology’s promise to reduce costs and fraud in the existing payments system dominated by companies such as Visa Inc. (V) and JPMorgan Chase & Co. (JPM) Today’s hearing will begin with testimony from law enforcement officials.

“If the choice for regulators is to permit money laundering on the one hand, or to permit innovation on the other, we are always going to choose squelching the money laundering first,” Lawsky said at the hearing.

Lawsky convened the hearings a day after federal prosecutors indicted a prominent figure among Bitcoin entrepreneurs, Charlie Shrem, for alleged money laundering linked to Silk Road, a Bitcoin-driven website allegedly used buying for drugs and other illicit goods. Shrem, the chief executive officer of exchange company BitInstant, yesterday resigned from the board of the Bitcoin Foundation, a group promoting the currency, the organization said in a blog post.

Debating Investors

In a two-hour session, Lawsky and his staff debated with a group of investors in virtual currency companies over the potential for the technology to cut costs and reduce fraud in the payments system. Law enforcement officials including Cyrus Vance Jr., the New York district attorney, lead off today’s testimony.

Bitcoin, a software protocol for issuing and moving money across the Internet, has gained traction with merchants selling everything from Sacramento Kings basketball tickets to kitchen mixers on Overstock.com. Venture capitalists see it as an alternative to the global payment system currently dominated by companies including Visa, Western Union (WU) and large banks.

The price of Bitcoin rose 3.6 percent yesterday to $844.88 at 5:30 p.m. New York time, according to the CoinDesk Bitcoin Price Index.

Federal regulators in March said Bitcoin-related businesses can be handled as state-licensed money transmitters, triggering a race by some states to assess their own rules. Only New York has publicly contemplated creating rules specifically for virtual currency companies -- what Lawsky has called a “BitLicense.”

Skeptical Reception

The idea got a skeptical reception from industry participants at the hearing, who argued to Lawsky that regulation could stifle innovation.

“It is difficult to determine the problems the BitLicense idea is meant to solve, or how well it would solve them,” Marco Santori, chairman of the regulatory affairs committee of the Bitcoin Foundation, said in written testimony for the hearing.

The Winklevoss brothers, who are seeking regulatory approval for a Bitcoin exchange-traded fund, pointed out that federal regulators have said their legal tools are enough.

“We agree,” they said in a joint statement. “We also believe the same is true of state law.”

‘Right Kind’

Fred Wilson, managing partner of Union Square Ventures, a New York venture capital firm, said at the hearing that existing rules on money laundering and consumer protection “are probably the right kind of regulations.”

“We should not regulate how the system itself operates,” Wilson said.

At the same time, Wilson also suggested that New York might adopt a simplified rule in which companies notify the regulator they are operating, and are in a legal “safe harbor” for a certain period of time.

Lawsky’s general counsel, Daniel Alter, countered that “simply knowing somebody is operating” isn’t enough for regulators. “It would be great for any industry if you could simply open the doors,” Alter said.

Jeremy Liew, a partner with Menlo Park, California-based Lightspeed Ventures, argued that the current system has so far worked well to stop illicit use of Bitcoin, and that new rules could push startups away.

‘Pushed Offshore’

“If that same company can be started in the U.K. or Germany, maybe that innovation just gets pushed offshore,” Liew said.

Lawsky, speaking near the rebuilt World Trade Center in New York, said that regulators have to focus on how to prevent money laundering that can play a role in crimes like the terror attacks of Sept. 11, 2001, not simply investigating after the fact. “The first job is to get rid of money laundering,” he said.

One option for New York would be to apply regulations that existing companies, such as Western Union Co. or MoneyGram International Inc. (MGI), fall under, said Barry Silbert, chief executive of SecondMarket Inc., which runs a Bitcoin investment fund.

“Expanding the existing money transmitter rules is a good first step that does not preclude others,” Silbert said.

In an interview after the hearing, Lawsky said the complexity of the emerging virtual currency business suggests his department needs to do more than extend current rules.

“It’s feeling more like little tweaks around the edges are not enough,” Lawsky said.

Goals Welcomed

Lawsky at times sympathized with the goals of the investors at the hearing, complaining that it could take “days” to pay his credit card from a bank account. And he criticized fees immigrants pay to send money home, and welcomed the chance to use Bitcoin to reduce the costs.

“That’s a huge thing, for the country and New Yorkers,” Lawsky said.

Israel Klein, a principal at the Podesta Group, a Washington-based public affairs firm, said the Shrem arrest threatens to undo what progress the nascent industry has made in convincing regulators of Bitcoin’s promise.

“The Bitcoin ecosystem of companies and investors has to engage to allay real concerns and avoid being pigeonholed by policy makers,” Klein said.

Bitcoin was introduced in 2008 by a programmer or group of programmers under the name Satoshi Nakamoto. It has no central issuing authority, and uses a public ledger to verify encrypted transactions.

To contact the reporter on this story: Carter Dougherty in Washington at cdougherty6@bloomberg.net

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