One of the strategic questions for Bitcoin is how it will interact with regulation. I recall that E-gold has been shut down by the American government under allegations of money laundering and operating a Money Transferring Business without the necessary licenses.

In contrast to E-gold, Bitcoin lacks a single issuer. No government can just shut down one related business and get rid of Bitcoin that way.

But still, for Bitcoin to grow into the mainstream, it would obviously be desirable to get the necessary licenses.

The problem is, it is not entirely clear right now what licenses are necessary. I expect it will take a couple of years before the regulators have figured out what licenses they want to require, and some of the startup businesses in the Bitcoin space have acquired those licenses.

For the time being, it is much easier to say what Bitcoin is not.

This post will just point out that Bitcoin is not “E-money” under the 2009 European Union Electronic Money Directive.

There have been voices asserting the contrary. For example this blog post at Technollama in 2011 said that Bitcoin falls under the Directive. It actually even asserted that Bitcoin is illegal in the EU because no one bothered to get a license under the Directive.

Another example would be more recent. Jon Matonis just posted at Forbes about differences between the US and EU regulations, and wrote this:

The dichotomy between EU and U.S. approaches to e-money becomes even more apparent when one looks at the uniformity of the EU e-Money and Payment Services Directives versus the almost hostile FinCEN guidance on virtual currencies and the incomprehensible patchwork of state money transmitter laws. Because of this, I estimate that the EU currently enjoys at least a five-year head start over its U.S. brethren in accommodating evolving payments efforts.

That sounds a lot like he thinks that the E-money Directive is in some way relevant to Bitcoin, just like Andrés Guadamuz at Technollama quite clearly does.

However, after some discussion at Twitter, the last I read from Matonis before it was too late in Japan for me to answer was this Tweet:

I am referring to preamble sections 7,8 & 12 with service providers issuing e-money based on receipt of bitcoin funds

Well, yes. Obviously, if someone is running an electronic money institution under the Directive, they will fall under the Directive. They will do so whether they accept Bitcoin or not. Accepting Bitcoin doesn’t change anything.

Anyway, let’s just note for further reference that the Directive does definitely not regulate Bitcoin. This runs somewhat counter to intuition, so I expect many people getting it wrong, like Guadamuz did.

The Directive has this definition of electronic money in its Article 2:

“electronic money” means electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions as defined in point 5 of Article 4 of Directive 2007/64/EC, and which is accepted by a natural or legal person other than the electronic money issuer;

That means there needs to be an “issuer” to qualify. For example, with E-gold you had a company named Gold&Silver Reserve issuing e-gold. There is no company issuing Bitcoin. If a customer had e-gold in their account, they had a claim on the issuer (Gold&Silver Reserve) for the equivalent amount of gold (monetary value). With Bitcoin, no one can claim monetary value. All the value a Bitcoin has now comes from the fact that other people are prepared to pay money for a Bitcoin. None comes from an issuer promising to take back Bitcoin at some value or other.

At that point, the whole Directive is not applicable to Bitcoin. Someone wanting to build a Bitcoin exchange in Europe with regulatory approval will need to find some other framework than that of the Directive.

It is an interesting question what that might be. It is an even more interesting question if an exchange located in Japan (*ahem* MtGox *ahem*) could just go ahead and start Mutum Sigillum Germany and apply for a license from BaFin, the German financial regulator, once people have figured out what license to apply for.

Unfortunately, these questions are not easily answered.

In contrast, it is very easy to see that the Electronic Money Directive is, at is stands right now, not the regulatory framework Bitcoin could use in the European Union.

Maybe the EU could amend the Directive and build a new framework for Bitcoin exchanges at some time in the future.

The United States District Court in Maryland has issued a Seizure Warrant against a company called Mutum Sigillum (which seems to be Latin and mean something like “silent seal”). The Warrant authorizes to seize funds of Mutum Sigillum stored at the Dwolla account No. 812-649-1010.

Dwolla operates an online payment service that is open only to residents of the United States. See their Terms of Service, which state:

Dwolla may only be used in connection with United States Financial Institutions: User funds must originate at a United States Financial Institution, and Dwolla will only instruct Veridian to transfer funds to a United States Financial Institution associated with the appropriate Dwolla User.

Mutum Sigillum is an American company owned by Mark Karpeles, who also owns the World’s largest Bitcoin exchange Mt.Gox, located in Japan right next door to my university.

The warrant is accompanied by an affidavit (a sworn statement of facts) by a Special Agent of “Homeland Security Investigations, U.S. Immigration and Customs Enforcement”. This Affidavit is not only a statement of fact, but it also explains some legal theories behind the application for the Seizure Warrant.

The Affidavit establishes that a “Confidential Informant (CI-1)” residing and banking in Maryland was able to send some funds to himself, with Mutum Sigillum and Mt.Gox involved in the process.

In detail: CI-1 opens accounts at Dwolla and at Mt.Gox. CI-1 funds his Mt.Gox over Dwolla. CI-1 buys some Bitcoins at Mt.Gox. CI-1 sells Bitcoins on Mt.Gox, getting back to dollars at his Mt.Gox account. CI-1 directs Mt.Gox to send these dollars to his Dwolla account, where they are right now.

So, the Affidavit has shown that CI-1 was able to send these dollars to himself over this elaborate process.

But, unless I am missing something here, that is not what one could reasonable describe as “transmitting money”. You would need some other party that actually receives funds for that.

This is similar to sex. You are supposed to do it with someone else involved.

The relevant American statute, 18 USC § 1960, helpfully provides a definition of “money transmitting”.

(2) the term “money transmitting” includes transferring funds on behalf of the public by any and all means including but not limited to transfers within this country or to locations abroad by wire, check, draft, facsimile, or courier;

“Transfer funds” means getting them to someone else. The only one doing that in this case is Dwolla. Both CI-1 and Mutum Sigillum are just normal users of the money transmitting service Dwolla provides.

The recent FinCen Guidance of March 2013 makes in principle the same point:

The term “money transmission services” means “the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.” (Emphasis added).

CI-1 transferred the funds to himself. No other person involved. And he transferred them from Maryland to Maryland. No other location involved.

The above analysis is just common sense. Mt.Gox is a user of money transfer services, not a provider. If they were still dealing in “Magic the Gathering” cards that would be even more evident. But the fact that they are operating an exchange in Bitcoin doesn’t change that fact.

The March FinCen “Guidance” has some more specific language on Bitcoin, which is rather confusing. Here it is:

A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter. By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter. In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.

One could indeed read this as meaning that in the opinion of FinCen, operating an exchange (like Mt.Gox) does, means that they are also in the business of transmitting money.

If so, such an opinion is entirely without merit.

Sure, if CI-1 buys a Bitcoin from some other third party (TP), then Mt.Gox transfers that Bitcoin from TP to CI-1, and the dollars in CI-1′s account to TP.

But that is an exchange of things of equal value, at the market price when that exchange happens. It transfers exactly zero funds from CI-1 to TP, and exactly zero funds from TP to CI-1.

Even if it was possible to somehow get away with this overly broad construction of 18 USC § 1960 the Application for the Seizure Warrant seems to assume, there is the added question why a Japanese company operating in Shibuya, Tokyo, would be obliged to follow this American law. Didn’t the American occupation of Japan end in 1952?

I got myself a brand new shining Bitcoin address that starts with my name as the first six characters after the initial “1″. Here it is:

1KfLenzmpCEjNhdNs2Y6txuaJAFLUNzfjZ

And here is a QR code for this:

I used the great service at “Bitcoin Vanity” for finding this particular address. They charged me only 0.004 Bitcoin, which is around 50 cents now. Ordering the address and calculating the resulting private key was a very smooth process. I would also like to mention that with their setup they never get the private key for this address themselves. At least that’s what they say, and I don’t have any reason not to believe that.

This is called a “vanity” address. But I think there are very good reasons besides wanting to see your name more often for having such an address. It has a number of advantages over a random address.

For one, it is easier to remember. I can just remember the “1KfLenz” part. Then I can head over to blockchain.info and search with that, which gives me a page containing the full address as well as the transaction history of that address.

That of course means I can write down just “1KfLenz” and be done when I want to communicate that address to somebody else. This is basically the same advantage as a URL shortener gives me. I am running my own URL shortener for most pages I reference in my writings or in classroom scripts. For example, my second global warming science fiction novel “Tasneem” (FREE PDF file available!) gets “k-lenz.de/7″ as an URL, which is slightly shorter than “k.lenz.name/LB/?p=9141″, and more convenient.

Another way to think of this is as a parallel to domain names. Those are easier for people to remember, compared to IP numbers. That’s why we have them.

And there is another big advantage. Not for me, but for people using Bitcoin for larger payments.

Assume that buyer A (based in Germany) paid EUR35,000 to the Bitcoin address of seller B (based in Japan). Then, all of a sudden, B complains that the funds have not reached him. A would need to prove that he has paid in any later lawsuit. With a traditional bank transfer he would of course have the bank records to prove his payment. Under current international regulations all wire transfers come with names of both parties attached, so as to prevent money laundering.

The latest international standard requiring this is recommendation 16 in the February 2012 recommendations of the Financial Action Task Force against money laundering. As an aside, let’s just note that these don’t mention Bitcoin yet. It was able to fly under the radar at the time. Under that standard, information on the beneficiary needs to be kept with all wire transfers.

The EU is not yet requiring keeping records on payees. Right now Regulation (EC) No 1781/2006 of the European Parliament and of the Council of 15 November 2006 on information on the payer accompanying transfer of funds requires records only on the identity of the payer. But this is supposed to change, the Commission has proposed changing the rules to require also records on the payee.

Anyway, with a bank wire transfer, usually A will be able to just point to the bank transaction records. He doesn’t need to insist on a receipt, which may be difficult to get with B sitting at the other side of the World.

But with a Bitcoin address? How exactly does A prove that the address he sent his Bitcoins to actually belongs to B?

That becomes much easier if the address in question identifies B as the payee in its first characters, and B has published it in different ways he can’t change later. For example, if you tweet some address, you can’t edit that later. For example, if B has registered that address with some third party which does not change anything later on request, that would do the trick as well.

One may also note that this adds some security, especially if the address in question is longer.

Anyone can find another address with “1KfLenz” as the first seven digits. But searching for “1KfLenzmPC” (only three digits more) would already cost over 700 Bitcoin, or over $70,000 at the excellent service provider “BitcoinVanity” I bought my address from. Searching for “1KfLenzmpCE” (four digits more) is too difficult for them to even quote a price. The difficulty goes up very fast with only a couple of added digits.

So if some large company you may have heard of gets “1CocaCoLa777″ (11 digits) for its address, anybody trying to direct a payment to another address starting the same way would need to invest substantial funds to find it. That would deter most people from even trying.