Ringing the Bell for Bitcoin Regulators and Compliance Officers

A Little Bit of Money

Thought Experiments on Cross-Border Payments - Of Couriers, Bankers, and Bitcoiners

Series 9: Ringing the Bell for Bitcoin Regulators and Compliance Officers

Remember Setting Up Your First Email Box?

The Internet itself faced fierce criticism when it was introduced more than 20 years ago. Back then, some early adopters abused its possibilities, getting a notoriously bad name for business opportunities in relation to utilization of the World Wide Web. There’s a funny parallel to photography and film – both were once mocked as obscure arts. History does tend to repeat itself. In banking terms, anything that is subject to trashy reports by mainstream media goes on the compliance officer’s list for review. It falls under “reputational risk.” Today, most banks and many regulators (luckily not all) put Bitcoin on the top of that list, which is like making a mountain out of a molehill, when you consider the facts.

The Condemned Live Longer

By design, Bitcoin addresses, which function as references, have no names or other customer data attached to them. The payment protocol does not require identification and verification of participants. Bitcoins are sent from one address to a recipient’s address, much like conventional emails. No intermediary is required for P2P-transactions when using digital cash. The work of Satoshi is seminal in this respect. Bitcoin raises the question of banks´ right to exist. No wonder that the technology is condemned to failure by many compliance officers of financial intermediaries, just like emails once were ridiculed when the world first heard about them back in the day.

The Bitcoin Address – A String Using Alphanumeric Characters

There is no central oversight body. Confidentiality is achieved through pseudonyms – no legal identity is associated. As a result, Bitcoins are digitally traded between users with a high degree of anonymity. However, financial intermediaries are held liable for systematically linking Bitcoin transactions to users. That is why Payment Service Providers and Bitcoin exchanges have to identify their customer`s digital cash accounts. This verification process is called Know Your Customer, KYC.

Fine Feathers Make Fine Birds

So how does Bitcoin actually look like? On the surface, Bitcoin appears like an account number using a combination of numbers and letters. Therefore, Bitcoin addresses are pseudo-anonymous like a bank account number, with no associated real-world identity. For a closer look: a Bitcoin address is composed of a string using 27 to 34 alphanumeric characters, such as the following example: 89uEbMgunupXsBVTewXjtqbBv5MndwjKlo. 

Checks and Bank Accounts – The Predecessors of Bitcoin Addresses and Wallets

Cryptographic coins are simply a digital representation of assets. Let me draw a comparison with more traditional means of payment. A Bitcoin address is like a check number, and its corresponding account is from where the payment is drawn. The Bitcoin wallet is the software tool that provides the addresses. The wallet itself never 'contains’ Bitcoins. You just need the right access code, and you can access your wealth from practically any place in the world with an internet connection. To control Bitcoin, one has to store the private key on a computer or save it to the server of a wallet service. Bitcoins themselves are not sitting somewhere on a central cloud on the web. Instead, they are verified through the blockchain, a giant file that exists as a copy on millions of individual computers.

To be continued. Further Reading:

  • T. Geller. “Up and Running with Bitcoin.” http://www.lynda.com/Business-Finance-tutorials/Up-Running-Bitcoin/167065-2.html, June 2014
  •  “How do I get a Bitcoin address?” https://bitcoin.org/en/getting-started
  • R. Grinberg. “Bitcoin: An Innovative Alternative Digital Currency.” Hastings Science and Technology Law Journal. Vol. 159, 2012.
  • “The Economist Explains: How Does Bitcoin Work?” The Economist. April 12, 2013.
  • A. Blundell-Wignall. “The Bitcoin Question: Currency Versus Trust-less Transfer Technology.” OECD Working Papers on Finance, Insurance and Private Pensions. June 2014. P 14.

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