Why Regulate Bitcoin?

Okay, so Mt. Gox, once the largest Bitcoin exchange, has belly flopped and lots of people have lost lots of Bitcoins (apparently hundreds of millions of dollars worth).  Mt. Gox is in bankruptcy, but unsecured creditors like its erstwhile customers usually get the back of a hand in bankruptcy proceedings.  Last year, Bitcoin was celebrated for its independence from any national authority and the anonymity it supposedly provides.  This year, the losses from Mt. Gox have many crying for regulation.  Is that a good idea?

First, Bitcoin would have to change fundamentally for regulation to work.  Anonymity would have to go.  Regulators need to safeguard the market from thieves, manipulators, and all variety of fraudsters and other crooks.  That necessarily means they need to know who is behind transactions--potentially any transaction.  It is axiomatic among financial regulators that, in order to uncover shenanigans in the market, one follows the money.  And you have to be able to find out who is behind transactions in order to follow the money.  So, if you really want regulation, say goodbye to the anonymity of Bitcoin.

But an even more important question for the nation(s) that might consider regulating Bitcoin is why would regulation serve the public interest?  Bitcoin is economically trivial.  If all Bitcoins disappeared tomorrow, the world economy and all major national economies wouldn't even hiccup.  Setting up an effective regulatory regime would require not just one nation, but the participation of all economically significant nations because Bitcoin can be bought or sold worldwide.  The costs of establishing regulatory agencies, hiring personnel, buying equipment, leasing office space, and funding investigative and regulatory processes would, by all appearances, greatly outweigh the societal benefit. 

Another risk of regulating Bitcoin is that doing so would legitimize it.  Once a government begins to regulate a financial contract, it makes that contract more attractive to mainstream financial markets players.  That would mean the major banks, hedge funds and other big players would start trading all manner of Bitcoin contracts.  A derivatives market in Bitcoins would pop up, and with it all kinds of headaches about risk management, settlement and clearance, and so on.  All for something the world doesn't need. 

And sooner or later, some form of governmentally sponsored deposit insurance would probably be sought by Bitcoin enthusiasts.  If the big banks and hedge funds add their lobbying power, such insurance might make it through Congress.  But deposit insurance could easily, directly or indirectly, end up putting taxpayers on the line to cover Bitcoin losses like those suffered by Mt. Gox customers.  Which would be just peachy--another taxpayer funded bailout in the making.

The bottom line:  don't regulate Bitcoin.  There's nothing in it for national governments or taxpayers.  We don't need more financial risk for regulators, central banks and taxpayers to worry about.  If Bitcoin is truly worth anything, it will survive in the market.  And if it doesn't, good riddance.