Three Reasons the BitLicense Regulations Wouldn’t Have Prevented the Mt. Gox Collapse

Ben Lawsky, Superintendent of Financial Services at the New York State Department of Financial Services, recently took to Reddit to reveal his new BitLicense regulatory scheme. He explains his justification below:

We recognize that not everyone in the virtual currency community will be pleased about the prospect of a new regulatory framework. Ultimately, though, we believe that setting up common sense rules of the road is vital to the long-term future of the virtual currency industry, as well as the safety and soundness of customer assets. (We think the situation at Mt. Gox, for example, made that very clear.)

The failure of Mt. Gox is the primary example that regulators, and proponents of regulation, point to in order to show why we need state restrictions on Bitcoin businesses.

This claim is misleading. The proposed BitLicense regulatory scheme wouldn’t have prevented the Mt. Gox collapse, for three reasons.

1. Mt. Gox isn’t in New York State, or the United States.

The intended goal of proposing regulations on Bitcoin businesses in New York State is to force companies who have customers in New York to comply with these regulations, and to put pressure on other legal jurisdictions to create their own regulations. However, there are many reasons why Mt. Gox (or other foreign Bitcoin companies) may have simply ignored the new regulations. New York State certainly does have a lot of sway in the finance and banking industries, but their word is not binding in all legal jurisdictions and they cannot claim that their regulations will protect consumers in foreign countries.

2. Regulated companies also fail.

Bernard L. Madoff Investment Securities LLC was a Wall Street firm. They defrauded customers of more than ten billion dollars, which is more than the entire market cap of Bitcoin at the moment. Maddoff’s firm was regulated, and even investigated by the regulatory agencies, and it still got away with massive fraud. There’s no guarantee that regulation inherently protects consumers. It can have the opposite effect, causing customers to not to their due diligence because they instead trust the regulatory agencies (the 2008 financial crisis shows this trust is often misplaced).

3. Mt. Gox wouldn’t have existed under a strict regulatory scheme.

If Mt. Gox did feel compelled to adhere to a BitLicense scheme from the beginning, it almost certainly wouldn’t have existed at all. The compliance costs for a startup are simply too great, particularly in an infant industry like Bitcoin.

In this sense, Lawsky might be technically correct in saying that the BitLicense might protect customers in some cases. In a similar fashion, I could eliminate credit card fraud overnight by shutting down all the credit card companies.

Yes, the Mt. Gox collapse was terrible, but we shouldn’t overlook the years that Mt. Gox provided a valuable service to the Bitcoin community. All of that early trading wouldn’t have occurred, and the path to wider Bitcoin acceptance is uncertain.

The BitLicense could completely strangle Bitcoin startups in the US, meaning customers won’t see new services at all. This will undoubtedly prevent some future failures, but only by assuring there are no future successes.

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