The market will reach an equilibrium
There are too many laws in our society, so many that it is impossible to live without breaking them constantly. While I don't live in fear, I do get anxious occasionally that someday cops will show up and start questioning me. For example, perhaps someone used my wireless network to access child porn sites without my knowing about it. Or, one of the programs I'm using for my mining pool had a license agreement that unintentionally prohibits its usage in the way I used it. Because I know that it is impossible to fully comply with the law, the best I can do is to minimize my risk of violation as much as possible.
What Benjamin Lawsky did was to cause people to disrespect the law even further. When you make laws that are difficult to enforce and cover every possible type of behavior, people don't respect lawmakers. Some crimes, like murder, are avoided not only because of the penalty, but because people agree that killing people is ethically wrong. However, manufactured crimes like the ones Lawsky is creating are not generally respected by the population and therefore people will willingly take a limited amount of risk in breaking them because they are not ethically wrong.
The state of the market does not change overnight from everyone in noncompliance to everyone in 100% compliance. Instead, the result of the regulations will be a fragile balance that CEOs agree is where the risks are outweighed by the possibility of making money. For example, most people would gladly spend a year in jail to make $1m. It doesn't make sense to spend a year in jail to make $100k, however, as I could do that elsewhere. Therefore, if the business makes $10m and the risk of going to jail is less than 10% ($10m * 10% = $1m) (and nobody is actually going to be harmed by your actions) then it makes sense to operate your business.
Suppose that the risk of going to jail for operating an unlicensed exchange in Vermont that blatantly serves New York customers is 25%. However, maybe you could reduce the risk to 20% by placing a notice stating that New York customers are banned from using the service. You could further reduce the risk to 15% by banning New York IP addresses, and to 10% by ceasing all ties with and punishing users who are determined by be from New York. You could reduce the risk to 5% if you paid $100k to hire lawyers to file paperwork, but at this point your expected value is past the point where your risk of jail is low enough to justify your continuing operations. Therefore, the equilibrium for you (and the market) is stopping before filing that expensive paperwork, but taking the other measures.
Other exchanges might have factors that make themselves more or less likely to be prosecuted, so they will adjust their compliance actions appropriately until they get to the right level of risk their operators are willing to take. This is the same way it works in drugs; traffickers will raise their prices until the benefits outweigh the risks; the prices go up when the government seizes drugs and go down when there are fewer seizures.
The BTC Guild created a rather arrogant drama over the past few days, stating that they were possibly going to shut down, and that they needed to talk to their lawyers, and so on. As the last part of that shows, it might have made sense to actually talk to the lawyer first before plastering what they were going to do if their lawyer told them to do something. However, most businesses are not likely to follow in the BTC Guild's footsteps. Instead, they will remove themselves from New York, and then evaluate their methods for avoiding New York customers. They will settle on the minimum level of compliance to reduce their risks of being fined to justify the money they are making. Since there is only one state trying to assert its authority, Lawsky isn't going to get anywhere close to 100% compliance. I'd be surprised if 50% of the bitcoin businesses took even token steps to get rid of New York customers.
False bubble is over; long period of stagnation ahead
Some people looked to these regulations as being some sort of catalyst. I think that they could have been, had they been favorable to everyone. Remember, the big complaint of banks was that there wasn't clarity in the regulations, not that they needed certain regulations to operate. Reasonable regulations would have made both banks and everyone else happy enough to start a run. However, these unfavorable regulations and the immense blowback against them creates the most uncertainty bitcoin has had in years.
Every once in a while, there is a period of time where everyone waits for something to happen before making moves. I'd say that this is the beginning of yet another of those periods, perhaps the longest one in bitcoin's history. The regulations need to be published, 45 days needs to pass, the legislators probably need another month to make changes, and then there will be another announcement, and even then there may still be more comments. That means that this period of uncertainty will last at least until October.
That means that we are again in a bear market. The bubble was one of those smaller false bubbles. It arrived earlier because many people wanted to get in on the action before the rise. Now, there are months ahead of stagnation and panics, as always happens on the downcycles.
I don't think these rules will take effect this year because even after all the time elapses, there is still more. Even if he does come out with a final version on time, it is likely that someone will sue, an injunction will be granted, and the parties will fight it out in court for some time. Whatever is looked back upon as the catalyst for the next bubble, it isn't going to be these regulations. If it is true that big exchanges like Circle just want any regulations to be passed as soon as possible, then this delayed bitcoin development because the court battle now needs to play out.
What was Lawsky thinking?
Given that the regulations came out of left field, it's worth considering how Lawsky could have been so off the mark. Let's consider the likliehood of some possibilities:
1. Lawsky was unconsciously influenced by big business. You may remember that he invited lots of big bankers and big names in the bitcoin industry to the meetings he held over the past few months. These guys have lots of money and undoubtedly suggested regulations to him that favor their companies. If this is true, nobody is at fault for what came out of the meetings: Lawsky just listened to the advice, and the people he interviewed didn't know enough about the troubles faced by startups and non-financial firms because they weren't employed by them. The result is that the end regulations will contain exceptions for startups.
2. Lawsky or a politician supporting him accepted contributions to bend the rules. If this is true, then corruption led him to add things into the regulations even though he himself opposed them. He decided that the political support was necessary for his future ambitions or because he cared more about some other issue on his desk and was willing to "trade" political capital in exchange for that other issue. The result is that the end regulations will be unchanged and most bitcoin businesses will leave New York, or he is sued with a later court battle.
3. Lawsky is ignorant of how bitcoins actually work. The simplest explanation of them all, Lawsky simply is not well-informed as to how the protocol operates. He created a set of rules that is applicable for every currency that came before, when bitcoins are vastly different and can also function as more than a currency. He had no idea of the number of different types of business models other than exchanges that operate in the state. He also was not knowledgable about how software engineering works. If true, his ignorance led him to overlook the severe consequences the regulations would have on other areas of society unrelated to bitcoins. He was completely taken aback by the reaction in /r/bitcoin after he posted the regulations, and you can argue that if he were truly informed, he would have announced the regulations through the normal channels to prevent the embarassment of what happened. The result is that the end regulations will be a complete rewrite that is dramatically different than what is proposed.
4. Lawsky is engaging in a PR campaign. If this case is true, then Lawsky purposely and deceitfully went overboard by placing regulations in the proposal that he knows are unreasonable. He appeared on TV repeatedly and posted on reddit to bolster his credentials and get people to mistakenly trust that he is a good guy before the release, knowing exactly what would happen later. Doing so will allow him to later argue that other members of the Department forced him to add the worst rules, and that he understands small business and supports freedom in open source development. He will apologize for the committee's conduct and then propose new regulations with half as many rules, which still make it infeasible to operate a business in New York. By that time, members of /r/bitcoin will change their minds and accept these new rules because they aren't as bad and because "they always expected that bitcoins have to be regulated." The result is that crippling regulations are still enacted, with modifications that make them just barely feasible for some types of businesses to comply.
5. Lawsky is directly trying to suppress bitcoin adoption. If true, while he appears on TV and posts online, Lawsky simply is lying. He just wants to reduce the usability of bitcoins like China tried to do. The result is that the end regulations will be unchanged and most bitcoin businesses will leave New York, or he is sued with a later court battle.
I'm not going to make a suggestion as to which of the five is accurate. I think that more information will come out over the next few weeks to clarify exactly where these rules came from, and it will help in narrowing down what happened here.
Other
- Days until July 24: 3
- Someone suggested that we count down the 47 days until the end of the comment period on the regulations, but I don't think that's a good idea because the date isn't significant for anything. We could count down until February, which the timeframe we would expect the next bubble (with a peak having occurred in June), but these regulations changed the game so much that we'll need to think more about that.