Before the virtual currency "Bitcoin" there was electronic gold. In 1999 the Financial Times described it as "the only cryptocurrency to achieve critical mass on the network". As it continued to grow over the next decade, users eventually opened more than four million accounts,
containing more than $60 million in deposits, backed by nearly four tons of gold, and millions of dollars in transactions on any given day
. Then it all stopped. The founder of e-gold, a Florida-based oncologist and economic history buff named Douglas Jackson, hoped his gold-backed cryptocurrency would become a primary currency to rival the various currencies issued by countries, but instead it became a tool for hackers and drug traffickers. His offices were raided by the FBI and Secret Service in December 2005 and he ended up serving three years of probation, including six months under house arrest,
after pleading guilty to running an unlicensed money transfer business and aiding money laundering. Jackson spent several months trying to trace the traces of former customers of electronic gold to return the money from their accounts, and even contacted clerics in different areas to trace the relatives of the deceased customers. Under the eyes of a court-appointed guard, users were getting far more than they put in, given that the price of gold has soared over the past decade
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. And while he was working to dismantle electronic gold, he was feeling kind of exasperated as he watched a new generation of entrepreneurs usher in Bitcoin, Ripple, Litecoin and other innovations. Despite being one of the pioneers of altcoins, Jackson has rarely spoken publicly since his conviction, and never before Bitcoin. In an e-mail interview with the Financial Times,
when asked if he saw a future for any virtual currencies, given that electronic gold was particularly promising, he answered briefly, "No." The story of e-gold offers a cautionary tale and a number of lessons for cryptocurrency entrepreneurs as they grapple with how to operate it legally in a thicket of regulations. Jackson considered that the fatal mistake that eliminated electronic gold was that it was introducing new users without verifying their identities. "It set things back," he said. "The licenses were limited, or they were revoked retroactively if unusual activity was detected.
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It was great in terms of catching the bad guys before they did anything." The US Treasury Department has been warning bitcoin companies since March that they must comply with know-your-customer laws, which require strict procedures for customer verification, monitoring of accounts, and reporting of suspicious activity. They must also register themselves as remittance companies within most of the 50 US states. The difficulties and costs of these commitments have led to the closure of a number of bitcoin exchanges and brokerage firms, including TradeHill and Bitinstant.
Regulators in New York and California were among those who subpoenaed the first bitcoin companies to testify in connection with the investigations into the currency. In a note to clients, Adam Shapiro of Promontory wrote: “Many cryptocurrency firms appear to have underestimated their regulatory obligations, the AML risks present in their business models, and the degree of interest in the legal opportunities surrounding these risks.” The rules also made banks and other companies feel wary about doing business with bitcoin companies.
It took a few months for Jaron Lukasiewicz, whose Bitcoin derivatives trading platform Coinsetter is set to launch around next year, to find a bank willing to accept his firm as a client, but he is optimistic that entrepreneurs have learned the lessons of e-gold and regulation. .
“Entrepreneurs stepped forward,” he said. “Bitcoin companies are now taking steps towards compliance and introducing KYC procedures.” Bitcoin, which rose to more than $1,000 in price for the first time last week, differs from electronic gold in that it does not depend on a single company to manage the system. Instead, transactions are recorded within a peer-to-peer network of computers. He says this is the biggest lesson of electronic gold
, which is the higher value of an asset-backed currency. His company began distributing what would become more than $20 million in claims, after liquidating the gold vaults that backed the currency, something that would not happen to those using virtual currencies in the event of a glitch. “Suppose a person has one piece of bitcoin in his wallet, which he considers to be equivalent to $500 or $900, or give it a day or two, and the value becomes $20,000, and then assume that some circumstance occurs in a way that effectively prevents it from entering,”
Jackson says. The currency will never circulate again. Who, after six years of non-circulation, will pay this amount of $500 or $20,000, or even just a single penny?”
