It is difficult for regulators and law enforcement to keep up with creative new ways in which criminals choose to store and trade money.  This is especially true in the Internet-age where anonymity and ease of communications and transactions are available.

Regulators are now wrestling with the intractable issue of virtual currencies.  Everyone has been reading about Bitcoin as the new viper of virtual currency.  But the Bitcoin phenomena is nothing really new; Amazon, Facebook, and Ebay have created their own virtual currencies, and more are likely to follow.

At the heart of the virtual currency issue is the fact that companies using technology can create their own virtual currency without falling under the statutory and regulatory definitions of a “financial institution.”  As a result, regulators are developing a severe headache in trying to bring these operations into some legal and regulatory classification which will allow them to oversee and protect these operations from being used by criminals to launder criminal proceeds.

Bitcoin is a different animal all together than the other virtual currency models.  Bitcoin was started by an undisclosed group of Japanese programmers who created a digital currency which is not backed by any central government but depends on the virtual Internet marketplace to value the currency.  Bitcoin is the product of computer programmers – nothing more and nothing less.  Bitcoin’s most valuable commodity is anonymity at every stage of the trading of the currency.

There are a fixed number of Bitcoins which are available and the price of each is bid up anonymously by Bitcoin consumers who remain anonymous.  The Bitcoins themselves are stored around the globe on a set of unknown or undisclosed computers.

Bitcoin’s only vulnerability is its choke point – exchanges which convert Bitcoins into traditional currencies and value.  The US government recognizes this chokepoint and is starting to scrutinize their activities but there still is a long way to go in terms of regulation and understanding Bitcoin.  FINCEN issued regulations this year requiring virtual currency exchanges like Bitcoin exchanges to register with the federal government.  Even at the exchange level, Bitcoin currency holders are anonymous and there are no disclosure requirements – every transaction takes place anonymously.

Money launderers are attracted to BItcoin like a bee to honey for obvious reasons.  Anonymity is a criminal’s currency.   Bitcoin provides the ability of criminals to acquire goods and services while protecting their anonymity.

Bitcoin faces a very difficult political and practical issue – if Bitcoin does not develop some mechanism to help the government prevent money laundering, the government will have no choice but to bring Bitcoin operations under federal regulatory and legal strictures.  Statutes and regulations are easy to use if necessary to define Bitcoin in a way that brings it under federal control.

Recognizing the significance of the problem, Congress is focusing on the issue as well.  The Senate Homeland Security Committee reached out to the Department of Homeland Security to ask for details on how DHS planned to address the risk of virtual currencies.  State regulators across the country are pursuing Bitcoin with a vengeance, especially in California.

The federal government eventually will respond to the Bitcoin and virtual currency industry.  The question will be how and when – the virtual currency industry will be shaped by these important actions.