We know how Bitcoin Prohibition would end

During a Senate Finance Committee hearing yesterday, Sen. Joe Manchin (D-W.Va.) asked the new Fed chairwoman, Janet Yellen, about Bitcoin. It's no secret that Manchin dislikes and distrusts the cryptocurrency, describing it in a letter to the heads of the government's financial regulatory bodies as encouraging "illicit activity" as well as being "highly unstable and disruptive to our economy." Yellen, however, doesn't appear to hold such strong views:

Former Fed Chairman Ben Bernanke took a similar view:

In other words Yellen and Bernanke see Bitcoin as I do — not as a fully fledged currency but as a payments system. The Fed has a mandate to regulate the U.S. banking system, including U.S. bank-holding companies, U.S. branches of foreign banks, state-chartered banks, and corporations through which U.S. banks carry out international banking. Bitcoin is not part of the traditional banking system. So the Fed has no mandate to regulate or interfere with experimental technologies like Bitcoin (or Litecoin or Dogecoin).

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Of course, this is something of a double-edged sword. Bitcoin deposits on (for example) exchanges like Mt. Gox aren't insured by the FDIC like deposits in U.S. banks, and the Bitcoin ecosystem has no lender of last resort in case of a liquidity crisis. So people participating in the Bitcoin ecosystem are taking a risk by experimenting with a new technology. But that is the point of Bitcoin — it exists as a global, unregulated, decentralized, voluntary system. While the U.S. dollar is legal tender for payment of debt and taxes, Bitcoin is legal tender nowhere.

Yellen did not entirely rule out government regulation of Bitcoin, though. She told Manchin, "It would be appropriate for Congress to ask questions about what the right legal structure would be for digital currencies."

So, if Manchin can convince a majority of the House and the Senate, as well as the president, that Bitcoin should be banned, then he can have his wish, and Bitcoin (or cryptographic currency generally) can be outlawed. Whether he can actually do that remains to be seen. Regulators see legitimate uses for cryptocurrencies. And although Manchin sees Bitcoin as a means to tax evasion and illicit activity because of its supposed untraceability and anonymity, it is certainly no more untraceable and anonymous than paper dollars or, for that matter, lumps of gold and silver. It might even be less so because every transaction is recorded in the block chain.

Probably a little regulation — to make sure that U.S. Bitcoin businesses pay tax on their profits, for example — makes sense. But a ban cannot work.

Even if Bitcoin and other cryptocurrencies were outlawed entirely, there's no reason to believe that they would go away. The decentralized, global, and cryptographic nature of these currencies means their exchange would be a pretty hard activity to eradicate. The federal government has fought a 40-year war on drugs at massive cost, but drug usage continues, all while Latin American drug lords build vast drug empires on the profits from the lucrative U.S. drug market, just as Al Capone did on liquor during the Prohibition era. A ban on Bitcoin might stop legitimate businesses from using it, but not the black market or grey market.

I don't know why Manchin is so vehemently anti-Bitcoin. Perhaps he sees it as a challenge to the government's power to coin money and regulate the value thereof. But if Bitcoin is such a thing, then so are PayPal, Visa, MasterCard, Western Union, and other virtual currencies like Linden Dollars. People have the right to experiment with technology. Cryptographic currency is a very new technology, and while of course there are risks to users and some people who use it for illicit purposes, lots and lots of people see potential benefits to using it. Should we ban the internet just because some people use it to distribute child pornography or incite violence? No. Criminalizing the entire Bitcoin ecosystem is a similarly illogical idea.

At best, Manchin's quest to prohibit Bitcoin is a road to another long, expensive war-on-drugs-style mess. Janet Yellen is smart to keep away from it.