For Bitcoin enthusiasts, there's no more important question for Bitcoin than that of its legal status.
Earlier this year, Bitcoin was most frequently cited as a way to launder money or purchase drugs. In October, the U.S. government shut down Silk Road, a controversial market on which buyers and sellers could transact for such services as drugs delivered direct to your door.
After the raid, Bitcoin plummeted, a sign that the biggest single use of Bitcoin was illegal transactions.
However, with the mess at Silk Road cleaned up, regulators seem to be changing their tone. Just yesterday, the U.S. Department of Justice said Bitcoin could be a legal means of exchange. Meanwhile, the FEC is debating whether or not political candidates should be allowed to accept Bitcoin donations.
The cynic in me likes to believe potential regulators have an embedded incentive to allow Bitcoin to carry on without interference. If left alone, the numerous Bitcoin millionaires of the world might just back their next run for office.
How the government could regulate Bitcoin
Because Bitcoin is a decentralized payment processor -- millions of "miners" help process Bitcoin payments -- the legal reach of the government doesn't go very far. The regulatory powers of the Federal Reserve were explained by Ben Bernanke, who said the following in a letter:
In general, the Federal Reserve would only have authority to regulate a virtual currency product if it is issued by, or cleared or settled through, a banking organization that we supervise.
That is to say, the Federal Reserve doesn't have the power to regulate Bitcoin transactions on the peer-to-peer system it uses today. Its regulatory power stops at its power to regulate the banks.
So, while the Fed can't simply regulate Bitcoin, it can affect how easy, fast, or possible it is to buy Bitcoin with funds from your bank account. Of course, it would have little power to stop cash for Bitcoin transactions offline, and outside the banking system.
What's at stake in Bitcoin
Big businesses have a lot to gain -- and lose -- from widespread Bitcoin adoption. Visa (V 0.94%) and MasterCard (MA 1.04%), which process trillions of dollars in debit and credit card transactions, risk losing some of their competitive position to a cheaper alternative.
Bitcoin start-up CoinBase allows merchants to accept Bitcoin for a 1% fee, far less expensive than the typical 2.9% fee plus $0.30 per transaction most credit card merchant fees charge for payment processing.
On the other hand, retailers have the most to gain. Retailers have taken on credit card fees in the past, noting that processing fees are one of biggest expenses for some small retailers, second only to the actual wholesale cost of their merchandise.
Considering most retail stores operate on small margins -- Wal-Mart's net profit margin was only 3.6% in the last 12 months -- Bitcoin could potentially add billions of dollars to retailers' bottom lines.
There's a lot at stake, including about $8 billion of Bitcoin at the current market price. For now, it appears the government may keep its hands out of Bitcoin's rabid growth.
