The coming political battle over Bitcoin

Given that Bitcoin first broke into mainstream attention when Gawker explained how to use it to buy drugs, perhaps the surprise is that it took federal regulators this long to take action against it.

Julian Assange of Wikileaks, which might have benefited from dealing in Bitcoins. (Kirsty Wigglesworth / AP)

In the wake of the Gawker story two years ago, Sen. Chuck Schumer (D-N.Y.) described Bitcoin as an “online form of money laundering” and called for the authorities to shutter the Bitcoin-based drug market Silk Road. Yet until recently, the feds have taken a relatively hands-off posture. Agencies have issued guidelines and signaled that they are monitoring the situation, but none have taken active steps to force Bitcoin intermediaries to comply with federal regulations.

That hands-off stance may have started to change this week when the feds took action against Mt. Gox, the world’s leading Bitcoin exchange. Many people use Dwolla, a PayPal-like payment network, to send dollars to their Mt. Gox accounts. They then use those dollars to buy Bitcoins. On Tuesday, Dwolla announced that it had frozen Mt. Gox’s account at the request of federal investigators. It’s the first federal action against the currency.

CNet has confirmed that the asset seizure was initiated by Homeland Security Investigations, a division of Immigration and Customs Enforcement. Among other things, that agency has the power to enforce laws against money laundering and drug smuggling.

The government refused to say more about the ongoing investigation, so we don’t know if the feds have targeted Mt. Gox itself or one of its customers. But either way, the move isn’t very surprising.

For years, Bitcoin supporters have touted the currency’s potential to resist government surveillance and censorship. They point to the example of Wikileaks, the whistleblower Web site whose access to funds dried up after the federal government applied informal pressure to intermediaries such as PayPal to cut off payments. The Bitcoin network is fully decentralized, so there is no one with the ability to monitor the network and block illicit transactions. If Wikileaks had funded itself through the Bitcoin network, the government wouldn’t have had such an easy time freezing its funds.

That’s a feature for people concerned with press freedom, but it looks more like a bug for government officials charged with enforcing the nation’s drug, gambling, counter-terrorism, and money laundering laws. The government relies heavily on financial institutions to help them monitor their customers’ financial activities and flag or block potentially illegal transactions. The lack of intermediaries makes Bitcoin an attractive technology for those who want to evade government scrutiny. It was only a matter of time before authorities started to give the technology some unwelcome attention.

Jerry Brito, a scholar at the libertarian Mercatus Center at George Mason University, urges federal regulators to tread lightly. “Bitcoin has the potential to be a boon to the economy and a boon to merchants,” he argues. He believes it could “disrupt traditional payment networks that have not been innovative for a very long time,” reducing the costs of financial services.

Moreover, he says, “You can’t put the genie back into the bottle.” In his view, the federal government would have as much difficulty shutting down the Bitcoin network as major content companies have had shutting down peer-to-peer file sharing. A major crackdown would merely drive the network underground, where it would continue to be used for illicit transactions but would be off-limit to ordinary consumers.

Brito, a Bitcoin enthusiast, worries that the Bitcoin community will be caught flat-footed if this week’s enforcement action turns out to be the first step in a broader Bitcoin crackdown. “I hate to say it, but the Bitcoin community needs to start lobbying,” he says. “It needs to start educating policymakers, lobbyists and influencers about the pros of Bitcoin and the impossibility or the difficulty in getting rid of all the bad uses.”