Whenever a new competitor threatens an established industry, you can always count on entrenched competitors to use any strategy they can to frustrate the new competing technology.  Our economic history is replete with examples of this phenomena.

The virtual currency industry, which is rapidly growing, is a threat to traditional financial companies.  As more e-commerce websites and Internet businesses embrace virtual currencies, there is likely to be attempts to squash them through regulatory requirements.

Virtual currencies have to be regulated – there is no doubt.  Otherwise, criminals and other unsavory elements can rely on virtual currencies to facilitate criminal activities, store the proceeds of crime and evade all anti-money laundering laws.   The virtual currency industry knows that they only way to survive is to negotiate appropriate regulations.

The United States is already taking clear action to address the risks they pose. The U.S. Financial Crimes Enforcement Network (FinCEN) published guidelines on the use of virtual currencies, classifying anyone dealing with them as “money transmitters,” which requires the entity to obtain an official license and maintain appropriate capital reserves. As stated in the guidelines, “The definition of a money transmitter does not differentiate between real currencies and convertible virtual currencies, the same rules apply to brokers and dealers of e-currency.”

There is concern that states, at the behest of established financial industry competitors, will set capital reserve requirements at exorbitant levels in order to squelch real competition.  For example, Bitcoin could be limited in its use to a handful of businesses that could afford to meet the regulatory requirements.   In the end , the question will be determined in how broad the definition of a money transmitter is defined at the states and what specific requirements will be imposed on virtual currency companies.

California, for example, has passed a bill to amend the state’s money transmission laws, lowering the capital requirements for licensees by as much as 50 percent. The ruling paves the way for more companies to enter the virtual currency space with the full backing of the state government.

The reality is that virtual currencies need to resolve any ambiguities surrounding their operations if they want to gain acceptance in the economy.  Bitcoin will never become mainstream until its status is defined.

Unfortunately, there appears to be some confusion over Bitcoin’s legal status.  Tradehill, the second-largest online virtual currency exchange, recently shut down because of confusion by its non-online customers over the legality of Tradehill’s relationship with Bitcoin.

Bitcoin exchanges will be prosecuted unless they secure a federal transmitting license.  For example, in May, the United States seized $5 million from a Bitcoin exchange because of a failure to obtain such a license.  The New York Department of Financial Services is investigating over 20 digital currency companies.

Regulation of virtual currencies will ensure that they are integrated into the financial system.  The risk is that competitors will use such regulations to stifle competition.  When it comes to money and finances that is always a worry.

Germany recently legalized Bitcoin and is now taxing profits from Bitcoin.  In the last five years, Bitcoin has increased from zero to over $260 per coin, and been used in hundreds of millions of transactions.  It is fast catching up to Pay Pal as a competitor.

Virtual currency companies have to comply with the law and should seek appropriate levels of regulation to promote the public’s perception of virtual currencies use in lawful transactions and commerce.  If they become associated with criminal and terrorist elements, virtual currencies will be doomed to fail.