Earlier this week, Coinbase terminated its services in Hawaii due to major changes made to local regulatory frameworks toward digital currencies including Bitcoin.

Similar to some regulators like the state of New York, Hawaii has decided to take a difficult and reckless approach in regulating Bitcoin users and startups.

Cash requirement

The Bill for an Act 1481 passed by the House of Representatives of the State of Hawaii was drafted to present improvements in “economic development.” The bill formally requires Bitcoin exchanges including Coinbase to hold the same amount of US dollars or cash to their reserves of digital currencies - i.e. Bitcoin, Litecoin and Ether.

The newly passed regulation demands Bitcoin exchanges to obtain an identical amount of cash to their Bitcoin reserves, which is simply not possible for Bitcoin exchanges or trading platforms that process tens of millions of dollars on a daily basis.

In particular, the basis of the impractical regulation passed by the Hawaii Division of Financial Institutions (DFI) is questionable, as the local authorities don’t require the same regulatory framework for Fintech service providers in the region.

Alibaba wouldn’t have made it

For instance, if Alibaba’s financial arm Ant Financial’s $60 billion financial network Alipay were asked by the Hawaii government to comply with an identical regulatory framework when it expands to the US, the company will be forced to terminate its service immediately as they will not be able to provide a cash reserve to support it 175 mln transactions per day.

An interesting aspect of this regulation is that it could actually be applied to Fintech service providers like Alipay that are based on fiat money. Since Alipay processes transactions in yuan, it wouldn’t be surprising if the government required the company to keep a cash reserve which is equivalent to that of their IOUs.

However, Bitcoin is a separate, independent and decentralized currency or store of value. Its value is not dependent on cash and it is not based on any type of fiat money on any basis. Bitcoin is its own network, currency and asset and its value is solely determined by the market.

Therefore, requiring Coinbase to maintain a cash reserve equivalent to the value of their Bitcoin storage is like demanding a gold exchange to keep a fiat storage which is equivalent to the value of their gold depository.

In full consideration of the inefficiency, impracticality and illogical reasoning behind the regulation of the Hawaii authorities, Coinbase decided to terminate its service in the state indefinitely.

Coinbase stated:

“Although Coinbase securely maintains 100% of all customer funds on behalf of our customers, it is impractical, costly, and inefficient for us to establish a redundant reserve of fiat currency over and above customer digital currency secured on our platform.”

Juan Suarez from the Coinbase legal team further emphasized that the regulatory demand from the state of Hawaii to hold the equivalent cash value of their Bitcoin reserve provides no benefit to both the company and users, as their operation is based on their ability to liquefy the assets of users at their demand.

“Nothing to protect customer funds”

Moreover, Suarez explained that the policy of Hawaii would negatively impact Bitcoin businesses of any size, as it takes away a significant amount of budget from the company which would otherwise be used for operations, development and most importantly, improvement of security measures.

Suarez wrote:

“To repeat: DFI’s dollar-collateral policy does nothing to protect customer funds. To the contrary, compliance with this policy would siphon millions of dollars away from critical operations, recruitment and retention of expert staff, and constant reinvestment in the business necessary to guarantee the security of customer digital currency. We cannot accept this tradeoff.”

The termination of Coinbase services in Hawaii is a great example of regulators attempting to provide guidance to a technology which they don’t fully understand. If they aren’t capable of understanding the economic and technological basis of Bitcoin, regulators should not try to pass impractical regulations until they acquire the necessary knowledge to do so.

Also, if regulations are drafted to assist, guide and help businesses to grow, it is only logical for the government to talk to leading Bitcoin exchanges and key players like Coinbase, similar to what People’s Bank of China did with local exchanges such as BTCC, Huobi and OKCoin.