Despite the hype that Bitcoin has received over the past year, it wasn’t actually the first successful digital currency. That honor goes to E-gold, an online digital currency backed by $20 million worth of actual gold that launched all the way back in 1996. Their optimistic slogan was “Better money,” the same hope shared by Bitcoin fanatics today. But if its users are lucky, Bitcoin won’t meet the same fate as its ancestor.
Launched by oncologist Douglas Jackson and attorney Barry Downey, E-gold reached over a million users by 2002. In 2008, the company was processing over $2 billion in transactions annually, acting as an exchange for the currency similar to the Mt. Gox or BTC-E exchanges for Bitcoin, processing e-commerce transactions for markets like rare metal trading, online gambling, and Web-based donation services.
What made E-gold unique was its combination of old-money biases and new-money technology. At its heart, E-gold was a digital update of the gold standard, which even the U.S. government officially gave up in 1971: users knew they owned a tiny part of the gold bars held in reserve, providing the theoretical value of their digital currency. That real gold, which came complete with serial numbers of individual gold bars published online, served as a way to establish trust in the new currency much the same way that Satoshi Nakamoto’s mysterious algorithm that slowly releases a limited number of coins provides the numerical basis for faith in Bitcoin.
Bitcoin has learned from the cautionary tales that came before it. Entrepreneurs looking to build businesses around the currency are now constantly worrying about how to meet regulation rather than get around it.
However, as quickly as E-gold succeeded, it plummeted. In 2004, the government decided that E-gold didn’t quite classify as a currency that fell under regulation, and the company seemed like it was in the clear. But just two years later, in 2006, the definition of money transmitting—an act that requires an official license—was broadened to include moving not just official national currency but any form of value, including digital currency. The policy change was enforced over the next few years, with new FinCEN guidelines in 2008.
E-gold was charged with illegal money transferring in 2008 with added allegations of money laundering, and eventually accepted a plea bargain. The government seized E-gold’s assets, including both digital currency and actual gold, which were liquidated to the tune of $90 million. The proceeds went to refunding E-gold users who could prove that they bought in to the system.
One of E-gold’s successors, Liberty Reserve, was launched in 2006 by Arthur Budovsky, who had fled the U.S. that year after his earlier e-currency start-up, Gold Age, encountered legal trouble. Budovsky incorporated his business in Costa Rica allegedly in an attempt to evade the law. In fact, the start-up seemed to encourage breaking the rules. For an added fee, Liberty Reserve promised anonymity to its users, and the currency exchange quickly became a haven for criminal activity.
In 2009, the company was told it, too, needed a money transmitter license to operate, and in 2011 was denied a Costa Rican business license; Liberty Reserve continued to operate out of shell entities around the world. Budovsky was eventually indicted by the U.S. government in 2013, implicated in over $6 billion worth of money laundering as illicit funds passed through its servers, the largest money laundering charge in history. The prosecutor working on the case deemed the business a “black market bank” and linked it to crimes including identity theft, investment fraud, computer hacking, and child pornography.
Now, Budovski is claiming that the FBI only targeted him after he refused to give the government his source code in 2011. “I refused. It’s like asking Coca-Cola for their secret formula,” he said, arguing that the U.S. just wants to “protect its monopoly on financial transfer platforms.”
Bitcoin has a lot in common with these two earlier examples of digital currencies. It had a murky beginning—no one is sure who actually wrote the code that runs it, though there are suspicions—and it continues to face attacks from hackers who steal users’ holdings from exchanges. Some exchanges are suspected of being elaborate Ponzi schemes where those users cashing out are financed by the many more buying in as Bitcoin becomes mainstream.
There are some significant differences that separate Bitcoin from the cautionary tales that came before it. Entrepreneurs looking to build businesses around the currency are now constantly worrying about how to meet regulation rather than get around it. Many have money transmission licenses, or work through companies that do. The government and businesses alike want to keep track of where Bitcoin money is flowing and to keep it out of the wrong hands.
However, the currency has recently been implicated in money laundering cases of its own. In late January, Charlie Shrem, the founder of the digital currency exchange BitInstant, was arrested in New York, charged with money laundering and operating an illegal money transferring business. Shrem and his collaborator Robert Faiella are accused of selling over $1 million in Bitcoin to users of the Silk Road, a notorious online marketplace where digital currency was swapped for guns and illegal services until it was shut down last year.
Shrem’s BitInstant was by all appearances a legitimate business. It received $1.5 million in investment funding from the Winklevoss twins, who are heavily involved in Bitcoin start-ups and run a hedge fund based on the digital currency. (The twins have taken care to distance themselves from Shrem’s arrest, which is separated somewhat from his work on BitInstant.) But by involving himself in the dark side of the Bitcoin market, Shrem gambled his company’s legitimacy and became a poster child for the argument that digital currencies should be tightly regulated. If the currency’s legal applications can’t be separated from the black markets that first made it popular, why should it be allowed to persist?
The Silk Road represents the underside of Bitcoin, the hazy arena that E-gold and Liberty Reserve dabbled in. Though plenty of alternatives have popped up, the market’s very public closure represents a significant milestone in the gradual adoption of digital currencies into the legal monetary system: Companies have to go legitimate or they will be shut down.
“It may be appropriate to regulate any transaction that involves an unregulated intermediary converting Bitcoin to dollars on behalf of a third party,” said Barry E. Silbert, the founder of Bitcoin Investment Trust, during recent hearings on Bitcoin held by the New York State Department of Financial Services.
Alongside legal safety, the result of increasing regulatory attention is a stable Bitcoin market. As myself and many others predicted in the past months, scrutiny on digital currencies’ illegal applications has made them more dependable and useful as actual currency. After several booms and busts of hundreds of dollars, the price of Bitcoin has leveled out around $950 over the past two months, not so far from its all-time high of $1,242 last November. As the Washington Post’s Bitcoin price charts show, the currency’s value is more level than it has been in a while, and that’s a good thing for its long-term viability as well as discouraging to the kind of profiteering that digital currency black markets once enabled.