Federal regulators are increasingly paying attention to Bitcoin, the decentralized virtual currency. Last week, two of the most senior figures of the Bitcoin community trekked to Washington to try convince D.C.'s power brokers that they are eager to work with federal officials. But that may prove easier said than done.

Will the inherent decentralization of Bitcoin make it hard for proponents of the currency make peace with regulators?(weusecoins.com) Will the inherent decentralization of Bitcoin make it hard for proponents of the currency make peace with regulators?(weusecoins.com)

In its early years, Bitcoin seemed like an anti-government movement as much as a technology platform. The currency's decentralized architecture and permanently fixed monetary policy made it attractive to technologists who distrusted the conventional banking system. And federal officials ignored Bitcoin for its first few years, allowing it to operate with minimal regulation.

But Bitcoin's days of flying below the radar are over. A new generation of venture-backed startups is making the currency accessible to ordinary consumers and businesses. Since the start of the year, the value of all Bitcoins in circulation has increased about eight-fold to $1.1 billion. Federal regulators have taken notice. In March, the agency responsible for enforcing the nation's money-laundering laws issued guidelines suggesting that many Bitcoin-based businesses were required to register.

That has put the Bitcoin Foundation in the hotseat. Founded just nine months ago, the foundation provides an official public face for the cryptocurrency. It employs Gavin Andresen, Bitcoin's lead developer. And the organization is in charge of soothing regulators who are worried about the decentralized cryptocurrency being used for illegal purposes.

Last week the foundation sent two of its top officials, Andresen and general counsel Patrick Murck, to Washington for a daylong conference sponsored by Thomson Reuters and the International Centre for Missing and Exploited Children. The Thursday event gave Andresen and Murck a chance to address head-on one of the most explosive criticisms of Bitcoin: that the currency is used to purchase child pornography.

Andrew Oosterbaan enforces laws against child pornography at the U.S. Department of Justice. On a Thursday panel, he argued that the availability of an anonymous virtual currency makes the production of child pornography more profitable. "If they can do it on an anonymous network with an anonymous currency, it becomes somewhat insurmountable for law enforcement," he said.

"There's a myth about Bitcoin that it is an anonymous payment network," Murck said. "That is not true. [Bitcoin has] an open public ledger that shows every transaction."

Murck also emphasized his willingness to work with policymakers to craft the regulations that will govern the Bitcoin economy. "We're all happy to live with the consequences of whatever rulemaking is open and transparent," he said. The problem, he said, is that so far agencies have conducted their deliberations in secret. He urged them to begin a formal rulemaking process that would be open for anyone to participate.

But the reality is that there's only so much the Bitcoin Foundation can do to help law enforcement. If Bitcoin were an ordinary startup, federal regulators might demand that it make changes to its network to accommodate the needs of law enforcement. But while the official Bitcoin software is published by the Bitcoin Foundation, the project is organized as a consensus-driven open source project. That means that even project leader Gavin Andresen doesn't have the authority to make the kinds of major architectural changes that would be necessary to make it work the way the feds are used to.

For example, while it's true that the Bitcoin ledger is public, the network doesn't provide a mechanism for tying Bitcoin addresses to the real-world identities of their owners. That means that even if the police determine that a particular sequence of transactions is connected to illicit activities, they may not be able to figure out who is responsible for the transactions.

Adding a formal mechanism for identity verification would require completely overhauling the protocol, undermining the decentralized architecture that made it successful in the first place. Rank-and-file Bitcoin users likely would refuse to use a version of the Bitcoin software that included a mechanism for identity verification.

In one sense, this makes the Bitcoin Foundation's job easier. Because it has little actual control over the operation of the Bitcoin network, it's easy for the foundation to promise to do everything it can to bring the Bitcoin economy into compliance with federal regulations. Because ultimately the foundation's authority to change the Bitcoin network is extremely limited.