Coin Validation Causes Controversy Among the Bitcoin Community

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Tracking System Proposes New Regulatory Power over Bitcoin

As the digital currency Bitcoin has grown in popularity and price, the increased attention has also brought about threats of regulation and control that could stifle the growth and the original purpose of a semi-anonymous, decentralized protocol.

This week, that threat is in the form of a new company called Coin Validation, at least in the eyes of the avid Bitcoin community.

Coin Validation is a private company founded in 2013 which interfaces with United States government and regulatory bodies in order to facilitate the legal, regulated, and compliant operation of Bitcoin-based money service businesses in the US. Coin Validation aims to provide Bitcoin businesses with a service and guide for operating and remaining compliant in US regulated markets.

More specifically, Coin Validation aims to build a database of real identities connected to Bitcoin wallet addresses, with the goal of finding and weeding out nefarious or illegal activity. The company believes that they can help grease the skids of regulation by offering a solution for business owners to opt in to the tracking program which the government can monitor.

Coin Validation was founded by three individuals: Matt Mellon, former chairman of the New York Republican Party Finance Committee, Alex Waters, former CTO of Winklevoss-backed BitInstant, and Yifu Guo, a young entrepreneur and owner of Avalon who has made a fortune selling Bitcoin mining equipment.

Coin Validation Team

Photo by Forbes. Read more about Coin Validation at

Fear and Controversy Among Bitcoiners

The news of this proposal comes at an interesting time. Bitcoin has soared to its highest price ever, over $400, and mainstream media is all over it. The anonymous drug marketplace Silk Road was seized by federal authorities, and yet a Silk Road 2.0 popped up less than a month later. And the government is holding hearings next week to discuss the key risks and opportunities with Bitcoin business leaders in Washington.

Bitcoin was born in 2009 as a counter-culture vehicle. It was created by a person, or group, that no one has ever met and only goes by the pseudonym Satoshi Nakamoto. The system was designed to allow for commerce and trade without trust or government control. Anarchists and libertarians immediately fell in love with the crypto-currency and its perfect design.

But as the Bitcoin economy has grown, now over $5 billion, the currency has moved from the archives of Reddit into the pages of the Wall Street Journal, and more sophisticated players have entered the market to try to sustain growth. One of these is the Bitcoin Foundation, a non-profit organization that “standardizes, protects and promotes the use of Bitcoin cryptographic money for the benefit of users worldwide.” Another is the for-profit startup Circle Internet Financial, founded by veteran Jeremy Allaire.

Read: Circle, A High Profile Bitcoin Startup, Raises $9M with Seasoned Team

Some of the early adopters of Bitcoin, however, seem to resent these new organizations like a child resents his or her parents at a certain age.

“What uniqueness about Bitcoin will be left if it remains no more an open source currency? It will turn useless and won’t serve the actual purpose that Satoshi made it to” wrote one user on a Bitcoin forum.

Another user wrote, “BOYCOTT anything that places control of bitcoin to any authority (Verisign, US FinCEN, Bitcoin Foundation or Anything) – instead of being a very decentralized payment network and digital currency.”

Other users have provided more of an academic criticism of the Coin Validation scheme. In addition to tracking, there is a proposal to “taint” Bitcoins that have been used by bad actors, creating what is called a redlist. Think of this like confiscating money used in a drug deal. Here is an explanation of redlisting by Mike Hearn, an integral member of the Bitcoin Foundation.

Consider an output that is involved with some kind of crime, like a theft or extortion. A “redlist” is an automatically maintained list of outputs derived from that output, along with some description of why the coins are being tracked. When you receive funds that inherit the redlisting, your wallet client would highlight this in the user interface. Some basic information about why the coins are on the redlist would be presented. You can still spend or use these coins as normal, the highlight is only informational. To clear it, you can contact the operator of the list and say, hello, here I am, I am innocent and if anyone wants to follow up and talk to me, here’s how. Then the outputs are unmarked from that point onwards. For instance, this process could be automated and also built into the wallet.

The problem with using a redlist lies in the way bitcoins are fungible by design. Tainting bitcoins should simply take them out of the economy, but instead sophisticated criminals could use Bitcoin laundering services to exchange tainted bitcoins with clean units, and the tainted currency could end up in the wallet of an unsuspecting consumer who would end up holding the bag.

Overall, it creates an additional layer of complexity possibly tied to a central authority on what is an elegant, decentralized protocol.

Who Would Benefit from Coin Validation?

The biggest benefit from a Coin Validation concept at scale would come to Bitcoin exchanges, like Coinsetter, Mt.Gox, and Bitstamp. Each of these exchanges require users to jump through hoops to validate their identity, and run the risk of aiding criminal activity if their exchanges are used for laundering or illegal trade. A Coin Validation scheme would pass the buck from the exchanges to a centralized system of trust.

Another group that might benefit is small businesses that want to accept Bitcoin for payment. Currently, any merchant who starts accepting Bitcoin has similar risks to those facing exchanges. Would a service that certifies Bitcoins and Bitcoin wallets make this easier? Surely. But would it make payment processing more expensive? Undoubtedly.

Coin Validation’s proposal is not too dissimilar from some of the early services to come to the Internet, like SiteAdvisor or TRUSTe. The goal of those services was to help consumers know whether a website was trustworthy or not. Coin Validation wants to do the opposite, help businesses and governments know if customers are trustworthy.

What’s Next?

It’s unclear how much momentum Coin Validation has, and it’s also unclear whether the U.S. Government cares about the concerns of the most vocal Bitcoin purists.

One thing is clear though: any attempt to centralize authority on Bitcoin will be met with fierce resistance from early adopters. And it’s important to remember that early adopters happen to be the same people who control Bitcoin mining, the critical step in providing liquidity and sustainability to the currency.

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One Response to Coin Validation Causes Controversy Among the Bitcoin Community

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