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Recently we noted that illegal drug purchases are around half a percent of Bitcoin transactions, which is far from the existential threat that it has been made out to be. Instead, the most common usecase for Bitcoin is online gambling.

Satoshi Dice is the most popular Bitcoin denominated online gambling site. Today it checks IP addresses to screen out residents of the US and other jurisdiction where online gambling is illegal, but that has not always been the case. The interesting thing about Satoshi Dice is that it was publicly traded on MPEX, a Bitcoin denominated stock exchange, until it was bought last month for $11M. As such, until being acquired Satoshi Dice reported its financials.

The way that Satoshi Dice works is that there are a number of publicly-known static addresses to which a bettor sends her Bitcoins as a bet.  Each address has known odds and a predetermined winning payout.  For a win, Satoshi Dice sends back the bet amount multiplied by the payout multiplier.  For a loss, Satoshi Dice sends back 0.05% of the original wager as confirmation that the system worked properly.  This means that each Satoshi Dice bet generates 2 transactions on the Bitcoin network.  In June 2013, there were 12.4k daily bets, implying 24.8k transactions on the Bitcoin network.  According to Blockchain.info, there were about 48.4k Bitcoin transactions per day in June. So in June 2013, Satoshi Dice represented 51% of network volume in terms of number of transactions.

That being said, most Satoshi Dice transactions are small. Also according to their financial reports, the average daily volume of BTC bets on Satoshi Dice in June was 10.5k (including initial bet and payout). Again, according to Blockchain.info, the average daily BTC transaction volume in June was 213.8k. So in June 2103, Satoshi Dice represented about 5% of transaction volume denominated in Bitcoin.

There are other online gambling sites, notably Just-Dice, which was launched on June 20th. It has rapidly grown to an average daily volume of 7.8k BTC per day so far in August. Since Satoshi Dice no longer reports transaction volume since being bought, it is hard to tell if Just-Dice is additive to the Satoshi Dice volume or if it has taken share, but in the most aggressive case, it would represent another 4% of all Bitcoin transaction volume. In the last two months, Just Dice had raised over $5M USD worth of investment, suggesting that there are many who believe that online gambling with Bitcoin will continue to have a bright future.

In any event, online gambling represents at least 10x the transaction volume of Silk Road and the other Bitcoin drug marketplaces.

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With the backdrop of both Congress and the NY Department of Financial Services launching investigations into Bitcoin, regulation is top of mind for everyone in the Bitcoin ecosystem.

So far the only definitive statement about how Bitcoin will be regulated in the US came from the FinCEN guidance in March of this year. But even this left me with a number of questions. If I buy or sell Bitcoins at an exchange as an individual, will I be considered a money service business (MSB)?  If a Bitcoin miner sells Bitcoins for dollars, will she be considered an MSB?  What about a merchant who is accepting Bitcoins for the sale of goods or services?

I attended last week’s National Money Transmitters Association (NMTA) conference on virtual currencies compliance, which brought together top regulators, litigators, and entrepreneurs, and got some of these questions answered. I was relieved to learn that the likely answers to my questions above were “probably not”, “probably not, but a closer call”, and “probably not”.  But even so, leading legal experts in virtual currencies regulation are still somewhat uncertain about these answers (see presentation by Judith Rinearson, partner at Bryan Cave).

One thing though was very clear. Startups dealing with Bitcoin and other virtual currencies need to make sure they have the proper money transmission licenses before beginning operations.  Getting to market quickly is always important for startups, but should not be done at the cost of compliance coverage. There is a $0 threshold for liability, and ignorance is no defense.  You have to have your MTL framework in place before you do your first transaction.

Having world-class anti-money laundering (AML) and know-your-customer (KYC) policies and procedures in place is also crucial. Once again, claiming ignorance of criminal activity happening through your business is not a viable defense. You do not need to have criminal intent to have criminal liability.  As Jean-Jacques Cabou of Perkins Coie put it, “if you take the suitcase of drugs across the border, you’re on the hook even if you don’t know what’s in the suitcase.”  The same applies with Bitcoin—if someone is laundering money with Bitcoin through your business, you’re on the hook whether or not you know about this activity.

Some startups are innovating around their business model so as not to strictly fall under the current definition of a money transmission business.  Marco Santori of Nesenoff & Miltenberg cited some examples of Bitcoin white-labeling businesses. In hardware, there are companies thinking about providing white-label Bitcoin ATM services to entities already operating ATM networks. In software there are companies thinking about providing Bitcoin exchange services to entities that already have banking relationships and money transmitter licenses.

Opinions were mixed about if this approach of obeying the letter but not the spirit of the law is a viable approach. Some of the legal experts at the conference were supportive of these approaches as a clever way to potentially sidestep or at least postpone the lengthy and expensive process of acquiring state money transmission licenses.  Others expressed concern that regulations may change to retroactive render these approaches untenable.  This is an area where regulation is actively being crafted. Startups that are trying to control their own regulatory destiny by acquiring the appropriate licenses are taking the safest, although longest and most expensive approach.

Participants on the industry panel all expressed their intent to be fully compliant with federal and state regulations, and Constance Choi, general counsel at Payward (Kraken), even spoke about having stricter AML/KYC policies than a typical bank.  With this as the backdrop, an interesting conversation emerged around anonymity and privacy in Bitcoin.  Anonymity, or more precisely pseudonymity, is one of the key features of Bitcoin for some early Bitcoin adopters. It is precisely this feature that government regulators find most concerning as it may enable money laundering, as cash does.

However, fully-public transparency as an alternative goes too far.  This is a stricter standard than applies to the current financial system. An extreme version of the world where each Bitcoin address is publicly tied to an individual would sacrifice financial privacy.  Because of the public nature of the Bitcoin ledger, everyone would know exactly how much in Bitcoin each person owned, including competitors, customers and casual acquaintances. This would massively hinder adoption. People will not want their entire financial transaction history to be public.

The industry panel instead suggested a system whereby virtual currency companies know their customers and can provide detailed information to regulators when appropriate, but the mapping between Bitcoin address and individual is not made public.  This is a world where we sacrifice anonymity afforded by the Bitcoin protocol, but preserve consumer financial privacy.

I’m glad that the NMTA hosted this conference to further the dialogue between industry participants and compliance experts as this is the most important issue for the Bitcoin ecosystem.

 

Follow us on Twitter @lightspeedvp @chendave

 

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Although many have shown a lot of angst about Bitcoin use on Silk Road, buying drugs is far from a major use of Bitcoin.

As the recent Forbes Article about Dread Pirate Roberts, the man behind Silk Road, points out, Silk Road is estimated to be doing about $30-45M in annual revenue. They also report that Atlantis, a newly launched competitor to Silk Road, did around $500k in revenue in the first two months of operation, so annualized to about $6M. Combined we’re talking at max $50M in annual revenue. Now it isn’t good that $50M of drugs is being sold for Bitcoin, but this needs to be put into context for total Bitcoin transaction volume. According to Blockchain.info, average daily Bitcoin transaction volume has been around $25-30M for the last 30 days. That annualized out to about $9-11 billion in annualized transaction volume. So about 0.5% of Bitcoin transactions were to buy drugs.

Wikipedia claims that the illegal drug trade constitutes 1% of world GDP. Bitcoin seems to underindex to other payment mechanisms for buying drugs.

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Well it looks like the Department of Homeland Security is investigating Mt. Gox and the primary complaint is operating an unlicensed money transmittal business. Things do not look good for Mt. Gox. Its US accounts are being seized. This …

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