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In 2009, a computer programmer created a new kind of money, a digital currency called bitcoin. It lets a user store bitcoins on a computer or phone and send them anywhere in the world with only minimal fees.
At first there was little interest outside of computer science circles, and bitcoins were worth very little. But acceptance has grown over time, and with greater interest, the value of a bitcoin has increased as well. Venture capital firms are now funding new startups focused on bitcoin and the underlying blockchain technology that records transactions.
In eight years, the price of a bitcoin, once worth a small fraction of a penny, has grown to nearly $1,200, around the same price as an ounce of gold.
There are now $19 billion worth of bitcoin in circulation, but amid this growing worldwide acceptance, the Hawaii DCCA’s Department of Financial Institutions issued a regulatory advisory earlier this month that has effectively shut down access to bitcoin for Hawaii businesses and individual users.
In deciding to regulate a bitcoin exchange as a money transmitter, the DCCA followed only the state of Wyoming in imposing a restriction that forces bitcoin exchanges out of the market.
Perhaps they didn’t understand the implications of that decision. Bitcoin has always confounded regulators, not just because it is a complicated and unique technology, but because it has so much in common with many other financial concepts and assets, most of which are highly regulated. It’s easy to see how bitcoin exchanges are similar to money transmitters such as Western Union. Both let a person send something of value to someone else. But there are differences as well.
For one thing, a money transmitter transmits money. Is bitcoin money? Bitcoin users often call it a digital currency as a shorthand, but it is not a currency, legally speaking under U.S. law. It’s not backed by the full faith and credit of any government, nor is it considered legal tender in any country.
Bitcoin also has a lot in common with collectible assets such as a baseball cards, in that many people buy bitcoin and hold it, speculating that it will continue to grow in value over time. Its value stems from the interest of users, much like other collectibles. Collectors think that baseball cards and Beany Babies are valuable, but that doesn’t make them currency. A bitcoin in this way can be thought of as a collectable math problem.
Others think it should be considered as a commodity, and some regulators have explored that possibility. Presented with a proposal for a bitcoin-based swap, the Commodities Futures Trading Commission has considered whether it should be regulated that way.
While it is a well-established asset, it’s legal classification is still murky and open to interpretation depending on how it is used.
The recent ruling targeted Coinbase, which is among the largest bitcoin exchanges, backed by more than $100 million in venture capital financing. A bitcoin exchange lets a person or company buy and sell bitcoin, or send bitcoin as a payment to another bitcoin account. It also lets a business process bitcoin payments so a customer can pay in bitcoin, while the business gets cash deposited in their bank account. Exchanges are central to bitcoin; the technology is virtually useless without these providers.
When the DCCA classified Coinbase as a money transmitter, it triggered a requirement that the company keep double collateralization for every transaction. That’s a requirement that makes sense for a money transmitter.
When you walk into a Western Union to send money to another person in a faraway place and hand them $100, they now have $100 in assets, but you have an expectation that on the other end of that transaction there is another $100 waiting to give to the recipient. Requiring that the transmitter has money on the other end makes sense, and because those transactions happen quickly, Western Union can turn around and use your $100 to cover some other transaction almost immediately.
But that requirement is a deal-breaker for a bitcoin exchange, because so many users are buying bitcoin as an investment. If you give Coinbase $1,200 for a bitcoin, they need to spend that $1,200 to buy that bitcoin for you. With these new rules, they would also be required to keep $1,200 in cash or securities as a secondary collateral.
For every new customer from Hawaii, they would have to sock away more money in low performing assets, while also providing those customers with the bitcoins they purchased. And as the price of bitcoin fluctuates, the collateral requirement would fluctuate as well. An exchange that honored Hawaii’s money transmitter rules would lose money on every transaction.
But the requirement is also unnecessary for a bitcoin exchange because unlike a money transmitter, there is no need to keep physical assets in two different locations. When you transmit bitcoins, it takes a few minutes for the transaction to be completed, and then the very same bitcoins show up on the other end. They aren’t transferring dollars after all, just bitcoin.
When the DCCA’s advisory was sent to Coinbase, the reaction was swift. Coinbase has given Hawaii customers 30 days to move their bitcoins and close their accounts. While the advisory was only sent to Coinbase, we can expect the same reaction from every other exchange.
Hawaii companies that may want to accept bitcoin payments are left with no options. And customers who have purchased bitcoins in the past are left in uncertain territory. We either sell our bitcoins now, which for many users may trigger a capital gains tax, or hold them in offline accounts with no expectation that we will ever be able to sell them.
In most states, regulators have taken a careful “wait and see” approach with bitcoin exchanges, just as they have with other new technology companies. AirBnb is used to rent thousands of entire homes throughout the islands, but state and county regulators and lawmakers do not intervene, even as neighbors complain and the state misses out on Transient Accommodations Tax from those rentals. Uber drivers are providing transportation in exchange for compensation, subject to Public Utilities Commission rules and licensure for taxicabs, but Uber drivers continue to operate in Hawaii without permits or penalties. It is far less clear that the money transmitter law applies to bitcoin exchanges, but the DCCA has moved ahead with this ruling, oblivious to the consequences.
The money transmitter law already has a broad set of exclusions. You can transfer money through the mail, but delivery services are excluded. You can transfer money through a bank but banks are excluded. You can transfer money with gift cards, but those are excluded as well.
A bitcoin exchange is a new kind of company that should be specifically included or excluded in this law, but instead of waiting for the legislature to clarify the law, they’ve begun enforcing their interpretation of the rules in a way that will freeze bitcoin assets in Hawaii and prevent companies from using this new technology.
In the Legislature, there is no bill in the current session which could bring our laws up to speed. Rep. Chris Lee has proposed a Blockchain Technology and Digital Currency Working Group which would begin discussions of how the state should proceed. This is a good first step, but if we wait for that group to be formed and then craft legislation based on their reports, we could well see the DCCA freeze on bitcoin transactions last for two years or more before the law is updated.
A two-year freeze on bitcoin in Hawaii, an asset which few people in the state own, may not impact many people. But we need to recognize the chilling effect this can have on startups in this state.
More than $1 billion has been invested in bitcoin-related startups, but any company that wants to pursue an idea like this in Hawaii is out of luck. While the state gives lip service to the idea that we foster high-tech companies in Hawaii, a careless or hostile regulatory environment for new technology tells entrepreneurs and investors that doing business in Hawaii comes with unnecessary hassles and risks.
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