Last week, New York’s Department of Financial Services became the first state to propose comprehensive regulations governing virtual currencies.The move reaffirmed the position held by the agency’s head, Benjamin Lawsky, as the leading government voice on a technology that has befuddled regulators and terrified law enforcement personnel.“First and foremost,” said Marco Santori, a lawyer at Nesenoff & Miltenberg who represents dozens of clients working with Bitcoin, the world’s leading virtual currency, “the DFS gave us an opportunity that other regulators aren’t giving us” by allowing industry participants to comment on the proposed regulations.A change of heartLawsky wasn’t always so open-minded about the technology. “If virtual currencies remain a virtual Wild West for narcotraffickers and other criminals,” he warned last August, they would “threaten our country’s national security.

”Nor was he willing to hear what Bitcoin operators had to say during his office’s initial probe into the technology. At the time of his announcement, his office issued 22 subpoenas against Bitcoin-related entities without first consulting with industry leaders.His aggressive posture, combined with his public excoriation of the virtual currency on CNBC, made him a pariah among Bitcoin’s backers while crowning him as the technology’s most outspoken regulator at the time – a title he has yet to concede.A technology under siegeThe timing for the digital currency could not have been worse. Bitcoin, which can change hands anonymously in most instances, was the scourge of law enforcement as the preferred currency of choice on Silk Road, the underground Web site created to serve as a forum for criminal transactions.The Treasury Department’s financial crimes unit – FinCEN – had already issued rules applying anti-money laundering rules to virtual currencies.

Two separate Senate committees were also investigating the newfangled technology championed by its supporters as an alternative to fiat currencies like the dollar and euro.Of all of Bitcoin’s potential regulators, from the Securities and Exchange Commission to the Federal Reserve Bank to the Commodity Futures Trading Commission at the federal level to dozens of banking and financial bodies on the state level, Lawsky’s office emerged as the most aggressive of the lot.Lawsky’s regular media appearances throughout the fall and winter only heightened the stakes as his office scheduled hearings on virtual currencies for January.Lawsky’s new outlookIn a room in downtown Manhattan packed with eight camera crews and rationed seats to meet the overwhelming demand, Lawsky presented a changed attitude. Over two days of questions and answers with venture capitalists, law enforcement personnel, lawyers, and others, Lawsky praised many of Bitcoin’s attributes such as the technology’s ability to promote faster, lower cost, financial transactions.With lawmakers and regulators trying to discern whether preexisting laws would apply to a technology that didn’t neatly fit into any simple categories, Lawsky’s announcement of a special license designed specifically for virtual currencies served as the big announcement of the hearings.

Since then, Lawsky has espoused the benefits offered by the virtual currency while trying to mitigate its dangers. From the tech sector’s point of view, it has been a welcome change to actions taken by the IRS and the SEC, which issued guidelines governing virtual currencies with little input from industry players.Unlike the dismissive remarks made by such financial icons as former Federal Reserve Chairman Alan Greenspan and JPMorgan Chase CEO, Lawsky’s positive comments about a technology that others within the financial establishment found unstable and pedestrian provided an added boost to Bitcoin.Bitcoin befuddles regulatorsYet, developing a regulatory framework for virtual currencies has not been easy.

“Fashioning appropriate guardrails for virtual currencies presents challenging questions for regulators,” Lawsky acknowledged at the January hearings.“Virtual currency is not easily categorized within the divisions we traditionally think about when it comes to the financial system (such as banks, insurers, or money transmitters). It’s neither fish nor fowl.”Currently, Bitcoin serves as an alternative currency, a commodity, and money transfer system. Over time, its underlying framework (called the Bitcoin protocol) may develop into a global ledger and information transfer system along with applications that are unforeseeable at this point in time.

This protean nature explains, in part, why the IRS categorized Bitcoin as property while FinCEN treated the technology like a traditional fiat currency.As it is, government officials have traditionally struggled to keep up with fast-paced technologies. Years after the widespread usage of social media, for example, regulators have yet to come up with a set of comprehensive privacy laws despite many concerns about how social media companies collect user information.For Lawsky, this meant that while his office sought to tailor its regulations to the new technology, it was also determined to institute safeguards to protect consumers, require compliance with money laundering laws, and impose other obligations that entrepreneurs working with virtual currencies have found overbearing.With virtual currencies, however, there has been more urgency.

While the technology’s potential is immense – venture capitalists like Netscape founder Marc Andreessen have touted it as the biggest innovation since the emergence of the internet two decades ago – its use by criminals for everything from money laundering to drug sales to child pornography has compelled government agencies to take action.They are not the only ones to complain. As a decentralized currency not bound to any central bank or government and traded like digital cash, Bitcoin has historically attracted libertarians who have railed against the government’s imposition into the arena.Many within these ranks hope to preserve Bitcoin’s ability to shield users from government oversight. Others simply think that governments won’t be able to oversee a decentralized technology with a global reach no matter what laws they institute.A divided responseFor many of Bitcoin’s supporters, the DFS’s regulations represent a gross overreach by the government.

“Let’s be truthful, this exposes the consumer,”wrote a leading Bitcoin advocate, Erik Voorhees, of Lawsky’s regulations. “It renders him a serf upon a farm of information production – used for purposes both benevolent and vile, without any say in the matter.”Investors like the Winklevoss twins, on the other hand, who have poured millions of dollars into Bitcoin start-ups or have acquired a large number of bitcoins, have welcomed the government’s involvement. The legitimacy and certainty that comes with government regulation enhances their investments by paving the way for Bitcoin to gain mainstream acceptance and widespread usage.

Whatever the response to Lawsky’s proposed regulations, the effort made by his office to develop a customized set of rules for a new technology cements his position as the leading government voice on virtual currencies.His actions are also a far cry from his initial attitude towards Bitcoin. Like much of the public, his outlook has evolved into one of greater acceptance of the mistrusted technology, a progression reflected in the rules submitted by his office.Some of Bitcoin’s backers, at least, have welcomed this new perspective. “Venture capitalists,” said Santori of these proposed regulations, “are saying ‘well done.’”