Is The Best Way To Kill Bitcoin To Make It Legit?

When the government attempts to regulate and tax Bitcoin transactions, it may keep users from ever converting the virtual currency into fiat money. Will a discrete Bitcoin economy flourish, or will it veer toward the mainstream and become just another flimsy virtual currency?

This week, a Texas judge may have initiated the beginning of the end of Bitcoin--by ruling it a legitimate currency under the protection of the U.S. government.

The ruling came out of a case in which the Securities and Exchange Commission has charged Trendon Shavers with running a Bitcoin Ponzi scheme--but since Bitcoins aren’t real-life securities (i.e., backed by the U.S. government), the SEC can’t sue him.

Bullshit, says the judge:

"It is clear that Bitcoin can be used as money. It can be used to purchase goods or services, and as Shavers stated, used to pay for individual living expenses. ... Therefore, Bitcoin is a currency or form of money, and investors wishing to invest in [Shavers’ company] provided an investment of money."

That puts Bitcoin firmly on the road to government-respected currency--which means the G-men will probably attempt to regulate it. What happens if they do?

What made Bitcoin attractive was its independent value decoupled from governmental regulation. But as Bloomberg’s Timothy Lavin points out, this case (which the SEC is now citing in its press release warning investors of possible future Ponzi schemes in “virtual currencies”) is just the latest in a string of U.S. government agencies that are taking notice of Bitcoin’s use. Especially, say, its use in capital gains that may or may not be honestly reported to the IRS. The more agencies take notice, the less easily you’ll actually be able to get away with using it. Though with almost no way to track the flow of Bitcoins or who is purchasing the currency, regulators would need to nail people only when they convert back to fiat currency. It’s possible that would keep an all-Bitcoin economy somewhat isolated from the larger markets.

See, the thing about transferring money -- the thing that makes it expensive and cumbersome and oh-so-20th-century -- is that it comes with these annoying rules. Companies that move money have to register themselves and apply for licenses. They have to comply with money-transmitter laws. And the Patriot Act. And the Bank Secrecy Act. And international anti-money-laundering norms. And, if they're overseas, the profoundly complicated and meddlesome Foreign Account Tax Compliance Act. And then there's the taxes.

Of course, the government also wants in on all those fun little activities that Bitcoin’s purchase anonymity is useful for, like drugs and the widespread gambling sites that operate outside the U.S. to avoid the SEC hammer. Of course, as Lavin points out, there are people working to decry the assumption that Bitcoin is even anonymous at all, as purchase patterns and behaviors in activity bottlenecks like exchangers and wallet systems provide enough data to narrow down buyer identity.

Doesn’t this sound familiar? Legalize, regulate, and neuter black market prices? Unlike drugs, however, Bitcoin isn’t a physical product. It can neither be physically seized (sources theorize that the DEA’s Bitcoin seizure back in June was acquired in a sting/honeypot operation) nor destroyed.

But if it is “legalized” and regulated, it could finally be used for real-world point of sale transactions beyond open source projects. POS purchases means folks wouldn’t have to exchange for fiat currency, reducing hassle and transaction fees and delay. But it would also defeat the purpose of a virtual currency. Whatever the outcome of this trial, Bitcoin’s position in the gray market will be as precarious as ever.

[Image: Flickr user Zach Copley]