Bitcoins

The bitcoin ecosystem got a late Christmas present from the US Department of Treasury, Financial Crimes Enforcement Network (FinCEN) on Friday. As first reported by CoinText, FinCEN provided much-needed clarification on its previous guidance, making it clear that under most circumstances bitcoin miners do not need to register as Money Services Businesses (MSB) under the Bank Secrecy Act. This eliminates a series of potentially costly and onerous requirements for a critical segment of the bitcoin ecosystem.

Since the dawn of virtual currencies, market participants of all sizes and shapes have faced a degree of uncertainty around their standing in the eye of the law. Exchanges, wallet platforms, payment processors, merchants, miners, and traders have all been forced to question their registration obligations. Any company classified as an MSB must pay a registration fee and post a surety bond in every state in which it wishes to operate, as well as establish an anti-money laundering program. Collectively, these requirements can amount to a multi-million dollar cost of doing business. Few bitcoin operations have raised enough outside capital or generated enough liquid profit to pay such expenses.

In the US, there has been little to no legislation passed to clarify these questions around registration requirements. The closest thing to legislation has been “guidance” issued by agencies like FinCEN and seemingly arbitrary enforcement actions by the Department of Homeland Security. This is problematic, given that FinCEN sent the first of a series of cautionary letters in July 2011 to bitcoin companies and market participants it viewed as being non-compliant with MSB regulations.

In March of this year, FinCEN issued preliminary guidance indicating that merely spending or exchanging mined bitcoins did not in and of itself make a miner a MSB. But there remained unanswered questions about whether organizing a mining operation as a for-profit corporation or raising money from investors would push that company over an invisible line.

In May, it became abundantly clear that exchanges were subject to MSB registration requirements, when the Department of Homeland Security seized the US accounts of Tokyo-based Mt. Gox, which was then the world’s largest bitcoin exchange, for failure to register its operations appropriately. But this action brought little clarity to individual, pooled miners, or hosted mining operations.

FinCEN divides virtual currency market participants into three categories: exchangers, meaning those who exchange a virtual currency for real or other virtual currencies; administrators, meaning those who issue new virtual currency – which does not apply in bitcoin’s case; and users, meaning those who obtain virtual currencies to purchase goods and services on their own behalf.

One unfortunate consequence of the ambiguity around bitcoin miners’ regulatory requirements is that many of these individuals and organizations have been denied bank accounts or had their existing accounts frozen. Absent these banking relationships, many miners have had to cease operations while others have had trouble raising money from investors.

Some of the confusion around the classification of miners stems from statements made by George Mason University senior research fellow and adjunct professor Jerry Brito in July at a bitcoin conference. Brito indicated that FinCEN had informed him in personal letters that miners would be required to register as MSBs.

Friday’s FinCEN clarification makes it clear that this is not the case, provided that such operations are using the bitcoin for their own purposes, and not transmitting currency or selling currency-related services. In its letter to Atlantic City Bitcoin, FinCEN wrote:

To the extent that a user mines Bitcoin and uses the Bitcoin solely for the user’s own purposes and not for the benefit of another, the user is not an MSB under FinCEN’s regulations, because these activities involve neither “acceptance” nor “transmission” of the convertible virtual currency and are not the transmission of funds within the meaning of the Rule. This is the case whether the user mining and using the Bitcoin is an individual or a corporation, and whether the user is purchasing goods or services for the user’s own use, paying debts previously incurred in the ordinary course of business, or (in the case of a corporate user) making distributions to shareholders.

This ruling is a positive step for the bitcoin ecosystem as a whole and for miners in particular. Miners play a critical role in verifying bitcoin transactions and maintaining bitcoin’s global general ledger known as the blockchain. One important result of this activity is that new bitcoins are created and distributed as a reward to those miners most efficient at verifying new “blocks” of transactions. The creation of new bitcoins is essential to increasing market liquidity.

If miners were obligated to register as MSBs, it would be near-impossible for them to operate profitably based on today’s compensation structure, thus jeopardizing the whole ecosystem. In the past, conspiracy theorists have predicted that regulators, whom they perceived as fearful of bitcoin’s threat to the current economic system, would seek to destroy the crypto-currency by eliminating the economic incentive to mine it and provide related services. FinCEN’s latest guidance clarification suggests that these fears are likely unfounded.

Bitcoin regulation remains a work in progress in the US, but every bit of clarification, like every day the virtual currency market continues to operate, is one step toward long-term sustainability.