StrongCoin is creating a distributed exchange
Online wallet system StrongCoin is launching a new distributed exchange service to purchase bitcoins.
StrongCoin founder Ian Purton already runs an OTC exchange called Bitcoinary. An OTC exchange is different from a traditional exchange such as Mt. Gox or BitStamp, because it doesn’t require you to hold funds in an account, or process trades for you. Instead, it enables people to find each other directly, and arrange a trade themselves.
Now, he’s also creating what he calls a distributed exchange. Operated as part of his StrongCoin encrypted online wallet service, it will pair bitcoin holders with those wanting to purchase them in fiat currency. The difference between this service and Bitcoinary is that users won’t have to manually browse through messages from people offering to trade bitcoins. Instead, it will match them automatically.
StrongCoin’s distributed exchange service will allow bitcoin suppliers to register and make a bitcoin deposit with the site. They will also register the markup that they want to charge, over and above the base market rate, which will come from BitStamp. When someone wants to buy bitcoins, the site will then choose the best available quote from the list for them.
The key to the system is that StrongCoin won’t use its own bank account. Anyone registering to sell bitcoins must make their own bank account available. The site will then give these details to the person buying the bitcoins, and they will pay the fiat money directly to the seller.
The buyer of the bitcoins is protected because the site only passes through orders up to the value of the seller’s bitcoin deposit, explains Purton, meaning that it effectively acts as an escrow service.
“From the user’s point of view the purchase facility is very simple to use with one place to go,” says Purton. “We vet the market makers, and we will only support payment methods that are not reversible.”
He believes that this will fix a lot of problems with traditional exchanges such as Mt. Gox, which runs an order book and manages fiat and bitcoin accounts. It will be quicker than registering with an exchange, he says, making it easier for newcomers to bitcoin. “It’s like Coinbase, but for the rest of the world.”
He also says that it will be simpler to use than sites such as localbitcoins.com, another OTC exchange that competes with Bitcoinary. Purton has posted a message on the BitcoinTalk forum asking for people who want to sell bitcoins.
But whether or not these sites handle fiat currency, they are still enabling others to exchange bitcoin for that fiat currency. Is this likely to bring them under regulatory scrunity?
“I’m not saying that it’s not a worry for me but it’s not enough of a worry for me not to try it,” says Purton, adding that if regulators did descend on StrongCoin or Bitcoinary, he hopes that things wouldn’t be too punitive: “I am hoping that my liability won’t extend to being in court.”
This sanguine approach seems to permeate the OTC trading community. Jeremias Kangas, founder of localbitcoins.com, isn’t worried. He has consulted legal experts, but as localbitcoins is a startup with limited resources, he “hasn’t had time to research the topic in depth,” he says.
Even if regulators did want to target this activity, it would be difficult to effectively target anyone, says Kangas. They would have two potential targets: the sites, and the people using them.
“With OTC trading it is probably more effective to take the trading sites away, but new ones will always pop up to replace the old ones,” he says. “Also the already established trader networks will continue to exist even if individual services are taken down.”
Bitcoin exchanges classified as money services businesses under the FinCEN guidance are forced to comply with the requirements of the 1970 Bank Secrecy Act (BSA). These requirements include the need to implement arduous KYC and AML rules, which can be costly and time consuming. So getting an OTC exchange’s status right under these conditions is important.
The FinCEN guidance issued on 18th March 2013 defines an exchanger as “a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency”.
“Accepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under the regulations implementing the BSA,” it adds. Well, OTC exchanges that take virtual currency and send it on to others to facilitate a trade do that, don’t they?
Patrick Murck, general counsel for the Bitcoin Foundation, believes that exchanges are off the hook, because they don’t “touch the money” by handling fiat currency as part of a transaction.
“When I first read the guidance my initial reaction was that it didn’t pass a ‘smoke test’, because you could construct an exchange that isn’t an exchanger but where all customers are exchangers,” he says. “That’s essentially what localbitcoins and Satoshi Square have created and it maps correctly to the law pre- and post-guidance. Those services never touch the money so there is no registration requirement.”
But things get a bit more complicated for the individuals initiating those trades via the sites.
On the face of it, an individual user is exempt from BSA requirements, and is not considered a money services business, argues Constance Choi, general counsel for Payward, the firm behind bitcoin exchange Kraken. Choi was also instrumental in pulling together the committee for DATA, an industry self-regulatory body designed to help gain regulatory clarity.
“An administrator or an exchange expressly falls within the requirements of the BSA,” she says. “The key question is whether the language of ‘administrator’ or ‘exchanger’ is broad enough to encompass the individual user.”
She doesn’t believe that FinCEN intended to reach the individual user. “That being said, someone engaged in the business of facilitating trades, as opposed to personal direct trading, may fall within the definition of an exchanger,” she says.
Murck also says that individuals selling bitcoin as businesses constitute a knotty problem. “If you sell BTC using those services and you do it ‘as a business’, than you would have to register with FinCEN (if you are selling to US consumers) and possibly with the State. Defining ‘as a business’ is where things get muddy, of course.” His advice to bitcoin sellers? “It’s up to you to know what that means.”
There is one trap into which even mere dabblers will fall, however. Bitcoin miners who sell their bitcoin could be subject to regulatory pressure, says Murck: “If you mine and sell bitcoin, most lawyers I know believe that makes you an exchanger without any further analysis needed.” So if you’re generating coins that you then sell for fiat currency via an OTC exchange, you could be in greater danger of falling under regulatory scrutiny.
As with many regulatory issues with bitcoin, then, some things are clear, while the status of some players is murkier. This will persist presumably until regulators either clarify the language, or until a case is thrashed out in court.
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