<nettime> Stephen Foley: Bitcoin needs to learn from past e-currency

["Patrice Riemens" <patrice@xs4all.nl>]

Original to:
http://www.ft.com/intl/cms/s/2/6d51117e-5806-11e3-a2ed-00144feabdc0.html#axzz2m82EZsOg


Bitcoin needs to learn from past e-currency failures
By Stephen Foley

A pile of Bitcoin slugs sit in a box ready to be minted by Software
engineer Mike Caldwell in his shop in Sandy, Utah on April 26 2013©Getty

Before Bitcoin, there was e-gold. In 1999, the Financial Times called it
"the only electronic currency that has achieved critical mass on the web".

As it kept growing through the next decade, users ultimately opened more
than 4m accounts, with more than $60m in deposits, backed by almost 4
metric tonnes of precious metal, and millions of dollars of transactions
on a typical day.

And then it all stopped.

The founder of e-gold, an oncologist and economic history buff in Florida
called Douglas Jackson, had hoped his gold-backed electronic currency
would become a new base money to rival flawed fiat currencies.

Instead, it became a tool for hackers and drug dealers. The FBI and Secret
Service raided his offices in December 2005, and he wound up spending
three years on probation, including six months under house arrest, after
pleading guilty to running an unlicensed money transmitter business and
aiding money laundering.

Mr Jackson has spent months tracking down former e-gold customers in order
to return cash from their accounts, even calling up parish priests to
chase down relatives of deceased customers. Under the eye of a
court-appointed administrator, users are often getting back far more than
they put in, since the gold price has soared over the past decade.

And as he has wound down e-gold and consulted for a 2.0 version, he has
watched with some irritation as a new generation of entrepreneurs
evangelised Bitcoin, Ripple, Litecoin and other innovations.

Despite being one of the pioneers of alternative currencies, Mr Jackson
has rarely spoken publicly since his conviction and never before on
Bitcoin. In an email interview with the Financial Times he had a blunt
answer to whether he thought any of the virtual currencies since e-gold
hold particular promise: "No."

The story of e-gold provides a cautionary tale and a slew of lessons for
virtual currency entrepreneurs, as they wrestle with how to operate
legally amid a thicket of financial regulations and regulators.

The fatal flaw that doomed e-gold, Mr Jackson says, is that it would sign
up new users without checking their identities.

"It had things backwards. Permissions would be restricted or revoked
reactively in the event unusual activity was detected. It was great at
finding bad guys after they did something."

The US Treasury has been warning Bitcoin businesses since March that they
must comply with "know your customer" (KYC) laws that require stringent
identity checks, monitoring of accounts and reporting of suspicious
activity. They must also register as money transmitters with most of the
50 US states.

The difficulty and expense of meeting those obligations has led to several
Bitcoin US exchanges and brokers shutting down, including Tradehill and
Bitinstant. Regulators in New York and California are among those to have
subpoenaed early Bitcoin companies for investigations into the currency.

"It appears many digital-currency firms may have underestimated their
regulatory obligations, the anti-money laundering risks presented by their
business models and the degree of law-enforcement concern surrounding
those risks," Adam Shapiro, consultant at Promontory, wrote in a recent
client note.

The rules have also made banks and other companies wary about dealing with
Bitcoin companies. Jaron Lukasiewicz, whose Bitcoin derivatives trading
platform Coinsetter is due to launch around New Year, took many months to
find a bank willing to take his firm as a customer, but he is optimistic
that entrepreneurs have absorbed the lessons of e-gold and the
pronouncements of regulators.

"It appears many digital-currency firms may have underestimated their
regulatory obligations, the anti-money laundering risks presented by their
business models and the degree of law-enforcement concern surrounding
those risks".
        - Adam Shapiro, consultant at Promontory

"The entrepreneurs have moved. Bitcoin companies are taking steps towards
compliance and introducing KYC," Mr Lukasiewicz said.

Bitcoin, whose price topped $1,000 for the first time this week, differs
from e-gold in that it does not rely on a single company to manage the
system. Transactions are recorded instead on a peer-to-peer network of
computers.

Mr Jackson believes that currencies and payments systems with central
management authorities are more likely to succeed, since regulators and
customers demand protections against hacking, fraud and errors.

And this, he argues, is the biggest lesson from e-gold: the superior value
of an asset-backed currency. His company has begun paying out what will be
more than $20m of claims, after liquidating vaults full of gold that
backed the currency, something that will not be happening for users of
today's virtual currencies, should anything go wrong.

"Suppose that someone has 1 Bitcoin in their wallet, which they regard as
having the equivalent value of $500 or $900 or, give it another day or
two, $20,000, and then suppose that some circumstance emerged that
effectively prevented it from ever circulating again," Mr Jackson says.

"Who, after six years of non-circulation, would pay that $500 or $20,000
or even so much as a nickel?"


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