Why bitcoin and its digital cousins are under increasing scrutiny

Cryptocurrencies are under the microscope as never before. Financial regulators in the US are concerned about the emergence of bitcoin and its digital cousins as speculative investments and have hinted that much tougher regulation is in the pipeline.

Last week, the Securities and Exchange Commission (SEC), which regulates the New York financial markets, issued an alert, saying it was “cautioning market participants that offers and sales of digital assets by ‘virtual’ organisations are subject to the requirements of the federal securities laws”.

The message was that selling coins issued by a digital currency provider and selling shares on the stock exchange amount to pretty much the same level of risk. This sent tremors through the digital currency industry.

The Bank of England, the UK’s main financial regulator, reckons that digital currencies remain very different from standard currencies such as sterling and the dollar because they “act as money only to a limited extent and only for relatively few people”. A spokeswoman for the Bank said it was monitoring developments.

At the same time, the consumer watchdog, the Financial Conduct Authority, is considering the impact of digital currencies, and plans to report on its findings later this year.

The nub of the problems the authorities are considering is that digital currencies are behaving more like an investment than simply a way to pay. Supercharged increases in the value of bitcoin and ethereum, the two largest digital currencies, have recently driven the total value of cryptocurrencies to more than $100bn.

Certainly, they are becoming more acceptable as money: consumers can buy a Dell computer with bitcoin and gift card businesses in the US accept bitcoin, which can then be used at big retailers such as Walmart, Amazon and Nike.

In the UK, Theatre Tickets Direct has recently started accepting bitcoin to buy tickets for London West End shows, along with the online craft beer supermarket Honest Brew.

Peach Aviation, a low-cost Japanese airline, last month became Japan’s first airline to allow customers to pay directly for tickets using bitcoin.

While some people are now being paid in bitcoin, others buy them from exchanges or directly via websites like eBay, from people who have “mined” the coins.

Bitcoin was invented in 2009 when an anonymous software developer issued the first of a limited number of coins based on the novel concept of a digital ledger or blockchain in which transactions made are recorded chronologically and publicly. Buyers and sellers remain anonymous, but the transactions are transparent and transferred at virtually no cost, unlike the transactions processed by stockbrokers and banks, which levy large fees.

The cryptocurrency quickly became popular among among tech businesses that needed to transfer large amounts of funds overseas, who saw the benefit of a cheap alternative to the major banks. Unsurprisingly, it also found ready users in the criminal class, for the purposes of buying and selling drugs online and money laundering.

But this year, bitcoin and ethereum have been behaving less like currencies and more like popular stocks that rise and fall according to market sentiment. Bitcoin’s value has trebled in a year and doubled in the past six months, to $2,648 last week, despite a 20% crash in its value in May and a slump from a peak of almost $2,900 to below $2,000 in the last two weeks.

Some analysts have speculated that the currency’s value could reach $6,000 before the end of the year, making it behave more like a get-rich-quick speculative bubble, more akin to the “tulipmania” that scarred 17th-century Holland.

On Tuesday the blockchain supporting bitcoin is splitting in two, as members of the bitcoin community unhappy with the digital currency’s direction set up an alternative called Bitcoin Cash. However, Bitcoin Cash will likely only be worth a fraction of bitcoin. The original digital currency is trading at around $2,778.39, but future values for Bitcoin Cash are just $288.35, or 0.103 of a bitcoin.

Last week the Russian national Alexander Vinnik, who allegedly defrauded early adopters of millions of pounds’ worth of bitcoins, including funds obtained from the hack of failed bitcoin exchange Mt Gox, was arrested in Greece.

Vinnik was described by the US Department of Justice as the operator of BTC-e, an exchange used to trade bitcoin since 2011, which was allegedly used to launder more than $4bn for people involved in crimes ranging from computer hacking to drug trafficking. Greek police claimed that the 38-year-old was an “an internationally sought ‘mastermind’ of a crime organisation”.

US authorities also linked him to the failure of Mt Gox, the Japan-based bitcoin exchange that collapsed in 2014 after being hacked. Vinnik “obtained” funds from the hack and laundered them through BTC-e and Tradehill, another San Francisco-based exchange he owned, according to court documents. Vinnik has copycats, who, it is widely speculated, also operate in Russia.

The Russian authorities have become increasingly concerned about the potential for digital currencies to be used for illicit means, but remain undecided about whether it is a currency or a financial asset. Elvira Nabiullina, governor of the Russian central bank, has said it should be regulated as a digital asset. “We don’t consider that bitcoin can be considered as a virtual currency,” she told CNBC.

But the country’s deputy finance minister, Alexey Moiseev, recently said the authorities hoped to recognise bitcoin and other cryptocurrencies as a legal financial instrument next year in an attempt to tackle Vinnik-style money laundering.

The SEC is also under pressure from speculators to recognise bitcoin as a mainstream investment vehicle. The speculators lobbying for change include the Winklevoss twins, Cameron and Tyler, who won a $65m payout after they accused Mark Zuckerberg of stealing their social media idea as the basis for Facebook.

The brothers have since become involved in several cryptocurrency businesses and lobbied the SEC for clearance to launch a fund built to track the digital currency. Bitcoin, they reckon, is “better than gold”. Their lobbying effort has lasted three years so far, but in March was rejected again, triggering another tumble in the volatile price of the currency. But they haven’t given up, and it might not be long before clearance is achieved. A welter of regulation is likely to follow in its wake.