You can add Matt Mellon, descendant of the famed banking family, to the ranks of the Bitcoin believers. The 49-year-old former chairman for the New York Republican Party’s Finance Committee decided in April that he wanted to get in on the Bitcoin frenzy and called the Winklevoss twins for advice. They linked him up with Alex Waters, a former core Bitcoin developer and the then chief technology officer of Bitinstant, the currently-defunct exchange into which the twins invested $1.5 million. Waters instructed Mellon to buy a new Apple laptop, buy his Bitcoin and then put them into cold storage on USB drives kept at various locations around the States. Mellon says he got the “Bitcoin bug,” losing hours of sleep each night pondering Bitcoin’s possibilities. He and Waters started a conversation about how to make Bitcoin more legitimate in the eyes of banks and the government, so that it can take off and become thehundreds-billion market that investors such as the Winklevoss twins predict. That conversation also involved Yifu Guo, another 20-something like Waters, who became a “Bitcoin millionaire” selling computing equipment dedicated to “Bitcoin mining” though his company Avalon. Now the unlikely trio of two technologists and a Wharton grad is launching Coin Validation, a due diligence service for Bitcoin businesses that they hope will help set regulators’ minds at ease.
It’s a tracking system for Bitcoin ownership that would theoretically weed out ‘bad actors’ – like the Dread Pirate Roberts – from the legitimate Bitcoin business world. Their plan is to compile a database of the known identities associated with Bitcoin addresses in the hope that Coin Validation will become the one-stop-identity shop for law enforcement when trying to find out who’s doing something nefarious with Bitcoin, while providing a red-flag system for businesses who have customers trying to use Bitcoin that’s associated with illicit use.
“Essentially, we’ve been working with regulators for a structured approach for Bitcoin customers to be compliant,” says Waters. “We set up an API to work with their systems and we supply reporting tools they need for their databases. Which bitcoin addresses belong to a person? That’s the problem we’re solving.”
It’s a well-timed announcement, even if the details of how it will work are still vague. The nation’s capital is suddenly paying a lot of attention to the cryptocurrency as its value climbs to new highs. The same month the FEC approved Bitcoin for campaign contributions – as long as it’s immediately cashed in for U.S. dollars – the Senate Homeland Security Committee is putting it in the hot seat during a hearing Monday on the digital currency and its uses “beyond Silk Road.” The cryptocurrency has become a darling of the investor community with its promise of disrupting payment systems, but has lawmakers and regulators spooked by the possibility of its also disrupting law enforcement and taxation systems. Waters, Guo and Mellon think Coin Validation could be the answer regulators are looking for, but the first step in their plan requires a big leap of faith and data: they need Bitcoin businesses to sign up, connect with their API, and share information about their clients to start building an identity database.
One business is already committed: Guo’s Bitcoin mining equipment maker, Avalon. A big question is whether they can get others to sign on as they’ll need a network effect to make the database useful.
On a Monday afternoon in Manhattan, Mellon is showing a bit of his real world sway. The “power room” at the Four Seasons Restaurant on 52nd Street has kept its kitchen open an hour beyond its usual closing time for lunch to accommodate the Coin Validation founders’ team.
“We’re not in this to make money, we’re in it to get it sorted with Congress,” says Mellon, who eschews the dessert menu for a bowl of fresh raspberries. “Cash and credit cards are doomed. The future of payment is international and on the smartphone. I want to break this myth that Bitcoin is only associated with drug dealers and money launderers.”
“This needs to exist for regulators to approve of use of Bitcoin in the U.S.,” says Waters. “We don’t want to be the sheriff of the Bitcoin community. We just want to create an ecosystem of clean addresses.”
In the short term, they talk about a limited database that keeps track only of registered identities and their activities with participating companies, but it’s obvious that their ambitions are grander and that a longer term prospect is to take advantage of the transparency of the Bitcoin system to keep track of which Bitcoin is tainted by associations with black markets. Waters says that the development of that aspect will depend on “community feedback.”
“People say Bitcoin is anonymous, but it’s also completely traceable,” says Guo. “Because the blockchain is already public, your privacy is limited, but a lot of people probably aren’t aware that they are being tracked,” adds Waters.
Sarah Meicklejohn an academic who recently co-authored a paper on linking Bitcoin addresses to Silk Road activity says that a number of companies have approached her about ways to analyze the Bitcoin blockchain for tainted transactions. She says there are a number of challenges — including false negatives and false positives, and the difficulty of identifying associations when black market service changes wallets — but she was intrigued by the idea of building a database of “clean” addresses.
“No one knows the full ground truth of the Bitcoin network,” she says. “But this could be good for flagging and generating suspicious activity reports, as long as it doesn’t come with an absurdly high punishment for accounts that may have been incorrectly flagged.”
Waters expects tensions. Bitcoin’s appeal to many early adopters after all was the freedom that came from its statelessness, its anonymity, and its decentralization. With Coin Validation, he’s proposing a centralized tracking system that he knows won’t sit well with some hardliners in the community.
“The existing Bitcoin community will find this very controversial from a privacy perspective. But it’s simple, straightforward and opt in,” says Waters. Bitcoin businesses will opt in to the system, and customers that don’t want to be in the database would need to not use those businesses.
But what about Bitcoin laundering services and wallets designed specifically to make observation and tracking challenging?
“The average user is not sophisticated enough to launder Bitcoin,” says Guo.
“Typically people doing money laundering will reuse addresses or claim an address has lots of different identities,” says Waters. “This is a first step, not the silver bullet to end money laundering with Bitcoin.”
Waters says there are a few million Bitcoin addresses with positive balances. “If 10% of those were clean addresses, it would substantially improve the regulatory landscape state-side,” he says. He predicts in the future that every user will have at least one address that’s self identified, “or at least every user who wants to do business in the U.S.”