zorroYesterday was a seminal day in the maturation of the bitcoin ecosystem, as the world’s largest exchange, Mt. Gox, announced it would now require user verification – via approved photo identification – for all accounts seeking to deposit or withdraw fiat currencies (aka, government-backed currency). This is a direct response to two recent government actions against virtual currency operators accused of violating anti-money laundering regulations. It was also absolutely necessary if bitcoin were to become the legitimate, global alternative currency that many suggest it can be.

Earlier this month, the Department of Homeland Security-FinCEN ceased the accounts of Mt. Gox’s US subsidiary Mutum Sigillum LLC for failure to properly register as a Money Service Business (MSB). While jolting to the ecosystem at the time, it was, in fact, a reiteration that bitcoin is legal, but not above the law. Earlier this week, authorities brought charges against the men behind Liberty Reserve, alleging that the virtual currency and exchange aided in laundering more than $6 billion.

The government has a long history of taking similar action against virtual currency ecosystems and operators that skirt traditional financial regulations. But this is a major reason why no virtual currency has achieved ubiquity.

As FinCEN director Jennifer Shasky Calvery said in an interview with American Banker:

Digital currencies are just a financial service and those who deal in them are a financial institution. Any financial institution and any financial service could potentially pose an AML [anti-money laundering] threat. It depends on whether folks have the controls in place to deal with those money laundering threats and that they are meeting their AML reporting obligations … Undersecretary [David] Cohen was pretty outspoken yesterday in saying that exchange providers that comply with the law have nothing to fear from Treasury.

Many people have flocked to bitcoin and other virtual currencies for their perceived anonymity, but this is largely a fallacy and more importantly not their most valuable characteristic. Rather, the value of a universal virtual currency would be its transcendence of borders. Unlike fiat currencies and the traditional federal banking system, virtual currency transactions don’t incur wire transfer fees and currency conversion fees when crossing international borders. As technological progress continues to shrink the world, this property will be a bigger driver of commerce than anonymity could ever hope to be.

Further, anonymity within the bitcoin ecosystem is largely misunderstood. As others have pointed out, it’s the anonymity of ownership that is under threat, not the anonymity of use. In other words, Mt. Gox’s change in policy made it more difficult to obtain and hold bitcoin anonymously, but not any more difficult to use bitcoin you already hold without authorities knowing what you did with it. Further, it brought bitcoin on par with fiat currency (aka, cash) and the traditional banking system in terms of anti-money laundering properties, but did not make it any more stringent.

For those intent on using bitcoin for illicit purposes there are still ways to gain anonymity, as there have always been for cash. For example, if a criminal organization held $1 million in cash, it could use that money to buy goods and services then turn around and “fence” them for new, clean cash. The same option exists with bitcoin. In fact there are subtly named services like Bitlaundry, Bitcoinlaundry, and Bitmix set up expressly to “launder” dirty bitcoins, or mix it with other legitimately-gotten currency to prevent it being traced. It’s not legal, but it’s never stopped anyone before.

Further, cryptographers at John Hopkins University are creating a system called Zerocoin that would be an Inception-like alternative currency to the bitcoin alternative currency. By exchanging bitcoin for anonymous Zerocoin tokens, and vice versa, true anonymity would be enabled – for as long as financial regulators turn a blind eye to the method.

The big challenge in today’s slightly less anonymous – or at least more onerous – bitcoin ecosystem is in “cashing out” or redeeming bitcoin for fiat currency (or the reverse). But if bitcoin becomes a true global alternative currency, accepted everywhere and with trillions of dollars worth of daily liquidity, this may never be necessary. People could conceivably live their entire lives in bitcoin, as they now do in the euro, despite the fact that the currency did not exist 20 years ago.

Despite the occasional speculative spike and fall, the total value of the bitcoin ecosystem has grown steadily over the last year reaching approximately $1.5 billion today. Legitimate businesses like Expensify, Automatic (WordPress), the Internet Archive, Reddit, Namecheap, and many others have begun supporting the currency. As both trends continue, there is a real opportunity to create something truly revolutionary. Further, scale should conceivably normalize much of the wild fluctuations in the value of bitcoin, making it more welcoming to mainstream consumers and businesses.

Mt. Gox’s policy change made life only slightly more difficult for users of Silk Road and other underground marketplaces, but the convenience of these users shouldn’t be the focus of the bitcoin economy. Rather, the focus should be on achieving sufficient scale and ubiquity that one might conceivably give up fiat currencies entirely and transact solely in digital ones and zeroes. Given this, it would be wise for users to embrace the recent scrutiny and view it as a natural step in the maturation of this promising, but still nascent virtual currency economy.