The mainstream media has taken a predictable turn in their treatment of the series of regulatory incidents regarding Bitcoin-related services this month. Technology Review wrote that Bitcoin is now growing "in a manner disappointing to some early enthusiasts" now that Bitcoin exchanges are eager to work hard on achieving regulatory compliance. Laissez Faire Books' Jeffrey Tucker wrote a long plea arguing against "regulating Bitcoin like dollars", and on June 2 CNBC followed up with the most alarmist article of all: according to them, Bitcoin is "sacrificing its soul to survive" the regulatory onslaught.
However, what all of these journalists have somehow completely failed to realize is that the talk about whether or not Bitcoin will be "regulated" completely misses the point. First of all, all of the regulation in question is currently completely targeted not on internal Bitcoin businesses, but on Bitcoin exchanges - that is to say, the intersection between Bitcoin and fiat currency, which is heavily regulated already. The closest that any government so far has come to regulating actual Bitcoin services is the half-hearted SEC investigation of pirateat40's Ponzi scheme in 2012. Second, and much more importantly, Bitcoin is not, and never was intended to be, a clever legal scheme for evading regulations by virtue of not being classified as a fiat currency. The idea that regulators would simply sit back and allow such a loophole to continue to exist and simply nullify their regulatory agendas is highly naive wishful thinking at best.
Rather, the reason why so-called crypto-libertarians are attracted to Bitcoin so much is that much of it is unregulable on a practical level. True, in order to get bitcoins through an exchange you will need to give up identifying information and satisfy exchanges' KYC policies, but once you're in the Bitcoin system you're all clear. Blockchain.info offers a mixing service that lets you trade your bitcoins for "anonymized" bitcoins at a 0.5 fee, deleting all records of the transaction 8 hours after the fact, and one can also take advantage of Silk Road's mixer by simply depositing and withdrawing into Silk Road. While blockchain.info can be legally compromised, good luck subpoenaing "Dread Pirate Roberts". One can even use more ordinary Bitcoin services that offer accounts as unintentional mixers by simply depositing and withdrawing from them; between actual mixers and such makeshift constructions one can do as much mixing as one's paranoia demands. At the Bitcoin conference, two separate ideas were presented for decentralized mixers, allowing users to anonymize their bitcoins without trusting anyone at all. Thus, the potential to preserve one's anonymity by using Bitcoin remains completely intact, and no regulation short of banning Bitcoin outright will change this. Coinlab's attempts to create a legitimate front for Bitcoin do not in any way hinder the activities of drug users on Silk Road, and the activities of Silk Road need not interfere with exchanges' and regulators' efforts to promote more universally agreeable uses of digital currency.
If you are a regulator reading this article, the question you may be asking is, why shouldn't I be worried? One answer is, although it can be very hard to detect specific activity within the Bitcoin system, moving large quantities of money out of Bitcoin undetected remains very difficult. If you sell the bitcoins at an exchange, the transaction will get recorded. If you use them directly to buy anything of very high value (eg. a car or house), that will also get recorded. Thus, while Bitcoin certainly does empower the small-time drug user buying $50 worth of marijuana on Silk Road, large-scale financial movements will remain easy to detect, and even anonymizing mixers get less effective the more money you try to put through them. Moving large quantities of money into Bitcoin is similarly difficult.
The second answer is a more pragmatic one. While the Bitcoin economy itself has grown by a factor of ten since last year, Silk Road, judging by the number of posts on its forum, has only doubled in size. This is similar to the growth of the internet; in 1995, scaremongering about the massive growth in online child pornography was all the rage. Now, however, we realize that as technologies mature more mainstream uses naturally take over, and the prosperity that resulted from having a platform for free and open worldwide communication may have done more to fight child pornography than stricter prohibition ever could.
This brings me to the next point: Bitcoin is not like Liberty Reserve. While FinCEN may or may not be correct in its pronouncement that Liberty Reserve was "mostly" used for criminal activity, Bitcoin has a number of positive attributes that Liberty Reserve does not. Liberty Reserve was a truly convoluted system to use, with users needing to go through a system of "exchangers" in order to get in or out, each one of which took up to a 5 fee. LR itself took a further 1 fee for transactions. Aside from its anonymity, the only redeeming trait that Liberty Reserve had was its lack of chargebacks, making it useful for a limited set of industries such as multi-level marketing. Bitcoin is completely different. Aside from its more controversial privacy properties, Bitcoin lets anyone send money from anywhere to anywhere in the world with minimal (often zero) fees. It is nearly instant, and is in many cases much easier to use than more traditional banking systems. It's also very easy to develop software for, since all of the algorithms are open source and require no registration with any particular third parties (although there are third party services that can help).
Given all of these properties, there is no way to make a digital currency that does NOT offer some way of providing anonymity; if you make a digital payment system that allows users to construct cryptographically signed transactions, it will necessarily be possible for users to anonymously come together over an internet forum and apply the decentralized mixer protocol to it. And even without fancy cryptography, if a currency is international it will necessarily be possible for someone to set up an anonymous mixer in a jurisdiction that has different ideas about the correct balance between privacy and regulatory interests (especially when "taxes" paid directly to particularly malleable government officials are involved).
Government regulators like FinCEN have been notably quiet on Bitcoin itself lately. The FinCEN guidance in March 2013 mentioned decentralized virtual currencies, exchanges and even mining, but took great care never once to utter the word Bitcoin. The government spokesman discussing the Liberty Reserve shutdown similarly avoided mentioning Bitcoin itself, even when asked a question specifically about it. This suggests one likely conclusion: regulators are well-aware of the fundamental impossibility of fully regulating sufficiently advanced digital currency systems that was described in this article, and are treading carefully to take a pragmatic, watchful approach to see just how much information they can gather.
Under this interpretation, FinCEN undersecretary David Cohen, when stating that "exchange providers that comply with the law have nothing to fear from Treasury", was speaking the truth. At this point, it is highly unlikely that mainstream Bitcoin exchanges will be struck down by state departments because they do not yet have quite all forty eight state money transmitter licenses needed to comply with the guidance; FinCEN knows that Bitcoin exchanges exist, and if they wanted to use this avenue to take Bitcoin exchanges down they could have done so a month ago. Bitcoin-based online stock exchanges and gambling platforms may be a future target; SatoshiDice did feel the need to block US users several weeks ago. As for Silk Road, for all the talk of Bitcoin "losing" its anonymity, every single Silk Road-related arrest to date has involved either buyers reselling drugs to too many people in physical space or searches and seizures within the postal system. The regulators are fine, Bitcoin is fine, and the future of crypto-libertarianism is fine. Stop worrying.