Currencies created online offer flexibility and privacy, but could also be used to launder money or promote fraud

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A Senate committee is looking onto virtual currencies Many supporters of Bitcoins say rules will help prevent fraud Some fear government regulation will stifle innovation in online trading

WASHINGTON — A Senate committee is investigating whether to establish regulations for online virtual currencies such as Bitcoins.

Bitcoins, a widely used virtual currency, are an alternative to money online. Unlike regular money, Bitcoins are not backed by any government or company. The currency is circulated without intermediaries such as banks. This online currency, sometimes called a libertarian’s dream, is not regulated or taxed. This may soon change.

The Senate Homeland Security and Government Affairs Committee sent letters last week to the Departments of Treasury, Homeland Security and other government agencies seeking details on how they oversee the use of virtual currencies, part of an investigation begun several months ago. The letters came on the heels of 22 subpoenas issued Aug. 12 by the New York Department of Financial Services to Bitcoin businesses asking questions about their policies to prevent money laundering and to provide consumer protection.

Digital currencies demand a holistic and whole-government approach in order to understand and provide a sensible regulatory framework for their existence, committee Chairman Tom Carper, D-Del. and Sen. Tom Coburn, R-Okla. the top Republican on the committee, wrote in the letters.

The agencies have been asked to provide information to the Senate committee by the end of August.

Patrick Murck, Bitcoin Foundation’s general counsel, praised the committee for proactively seeking out a productive dialog with the Bitcoin community and authorities.

Murck said, New York is trying to set the policy for the entire country. It is highly questionable if they have any jurisdiction on the issues they are trying to address.

Bitcoins can be created or mined on your computer. Without banks to validate transactions, the task of weeding out fraudulent transactions falls on the users. Some users called miners solve complex mathematical problems to verify transactions. They, in turn, get paid in Bitcoins for their work.

Bitcoins do not have any inherent value, but they can be exchanged for other currencies. The exchange rate for a Bitcoin, which fluctuates wildly, is nearly $120 at Mt. Gox, a Bitcoin exchange.

Multiple attempts have been made at creating rules to oversee virtual currency operations.

In March, the Treasury Department’s Financial Crimes Enforcement Network released guidelines that brought Bitcoin businesses under the same umbrella of laws as other money services businesses.

FinCEN guidance was a starting-gun shot for the industry, said Marco Santori, a business attorney and chairman of the Bitcoin Foundation’s Regulatory Affairs Committee. It signaled that bitcoins were not contraband, but a legitimate form of value transfer.

Alan Reiner, developer of the Bitcoin software Armory, endorsed regulating Bitcoins to avoid an unregulated system that is used mainly in black markets.

Bitcoins work by harnessing the power of computers of the users. It cannot be shut down because there is not one owner or authority, Reiner said.

Bitcoins put power in the hands of people who use it, Reiner said. It is going to do to money what e-mail did to written communication.

This makes it a difficult system to control. This nearly anonymous currency fuels more than $1.2 million in sales of contraband items, including guns and drugs online, according to a study by Nicolas Christin, a researcher at Carnegie Mellon University. Transactions cannot be easily traced back to users, making it a law enforcement nightmare.

Some of the means of fighting financial crimes such as money laundering do not work on digital currencies because of the lack of a regulating authority. If the Senate investigation were to lead to regulations, public-private partnerships would be needed to detect financial crimes, Murck said.

Bradley Jansen, director of the Washington-based Center for Financial Privacy and Human Rights, said the Treasury Department’s March guidance was poorly written and served only to stifle innovation. This guidance has raised more questions than it has answered, he said. Applying our failed banking policies on Bitcoins is a bad idea and may be the definition of insanity.

Regulations are a necessary evil that the Bitcoin community is willing to accept, Reiner said.

Bitcoin cannot survive as a mainstream concept unless it has governments’ approval, he said.

The economy as a whole stands to gain if the Senate committee investigation leads to clearer rules, Santori said. Jobs will be created, tax money will be collected, customer funds will be safeguarded, and the public will benefit from a highly sophisticated and efficient value transfer system.