RegTech Intelligence 
It is known that regulators are continually playing catch-up with technological innovation in financial services, whether it’s HFT trading, being addressed in MiFID II, or internet banking in the new Bank Account Directive.
Bitcoin, however, is an entirely new kettle of fish.
For a start it’s a currency that comes bundled with its own payment infrastructure. Secondly, its non-central distribution means there is no means of governing its liquidity. Thirdly, like cash, it’s largely anonymous.
This causes problems for regulators. In Europe, the ECB released a report (here) in 2012, in which it grudgingly admits Bitcoin “do[es] indeed fall within central banks’ responsibility”. The report did not, however, provide any ideas about how it should be regulated, nor whether it was necessarily worth doing so.
The current Bitcoin transaction volumes don’t merit too much regulatory scrutiny, unlikely as they are to impact consumers or financial stability in a meaningful way. But that could change. As the ECB (circumspectly) notes, as soon as someone loses their pension, blame will be placed on the regulators.
This leaves Bitcoin in somewhat of a grey area. Because Bitcoin and other virtual currency systems have many commonalities with more traditional payment systems, they do logically fall under existing supervisory regimes. But due to its relatively small user base, the case can be made that Bitcoin is not worth the trouble. The challenge for regulators is to design or amend existing rule-sets in a way that can be effective and enforceable in these new environments.
Bitcoin’s unique selling point is its anonymity and opaqueness which put it squarely in the sights of regulatory efforts to Know Your Customer. Anti-Money Laundering, bribery, wire transfer and organised crime rules all have the potential to have a huge impact on the way Bitcoin can be used.
The U.S has gone ahead and started the process, with FinCEN director Jennifer Shasky recently having said that “a little regulation may boost Bitcoin’s Main Street cred.” New FinCEN guidance (here) requires Bitcoin exchanges (which exchange Bitcoins for conventional currencies) and large-scale Bitcoin ‘miners’ (in short, encryption breaking servers that generate new Bitcoins) to register as Money Services Businesses (MSBs) and comply with anti-money laundering regulations.
The problem is that these rules are a square peg in a round hole and it is unclear, as yet, whether or not they are enforceable in practice. There is still a huge amount of legal and definitional uncertainty. For example, due to its distribution model it is not clear who ’issues’ Bitcoin, nor is it clear whether it even truly fits the definition of ‘currency’ as currently defined. In short, to make legally watertight rules regulating Bitcoin or other virtual currencies will take a lot of work.
What we have here is a chicken-and-egg problem: What will come first? Will we have to wait for end investors to lose money before regulators intervene? Or has the financial crisis taught us that regulation has to come first?