What I'm calling "The UK Bitcoin Exchange Problem" is that currently, there are few options for buying/selling bitcoins for GBP bank transfers in the UK (see various posts on here).

It would be nice (and potentially lucrative!) to solve this problem.

There are a number of marketplaces such as localbitcoins and bitbargain that match individual UK buyers and sellers, but buy-sell spreads are very high (over 10%) and there is some level of risk involved for buyers.

There is the possibility of transferring money in EUR/USD to non-UK exchanges - e.g. bitcoin-24, mt-gox, but that's slow, fairly expensive and introduces currency risk.

Previously there have been several exchanges that accept GBP bank transfers but they all seem to close or stop accepting GBP bank transfers.

This is somewhat surprising since there is a reasonable amount of interest in bitcoins in the UK, and the UK "Faster Payments" system allows bank transfers to be sent in minutes at very low cost.

So why no UK exchanges?

Some folks claim this is because the UK banks are threatened by bitcoin, and rush to shut down accounts used by bitcoin exchanges.

However, I doubt the banks are that paranoid - it seems more likely to me that bitcoin exchanges have their bank accounts frozen due to their accounts showing up as the destination for stolen funds.

For example, if a criminal hijacks a UK bank account (a common problem in the UK) and transfers the stolen money to the bitcoin exchange account, there is a good chance that the banks will flag that exchange account as "potentially dodgy" since it received stolen money, and then freeze it once several transfers like it happen.

So what can be done?

The fundamental problem as I see it is that the bank account used by the exchange to receive funds is a single point of failure - if the banks freeze it, the exchange cannot operate since users cannot deposit or withdraw GBP funds.

The solution then is to move to a decentralized system where the exchange no longer relies on a single bank account.

The trading activity on the exchange - that is, exchanging bitcoins for cleared GBP funds - can still remain mostly centralized.

The bit that needs decentralizing is the conversion of GBP funds in bank accounts to/from cleared GBP funds that can be used on the exchange. This is sometimes called "clearing" - as in a financial "clearing house".

(There has been talk of the Ripple system as a really, really decentralized solution - but that's solving a much bigger and harder problem!).

So here's an idea for the start of a possible, simple solution ...

As normal, users have two balances with the exchange - a bitcoin balance and a GBP cleared funds balance.

However, the exchange is cashless - end-users can only deposit and withdraw funds via "Payment Processors" (which are independent of the exchange).

Suppose jbloggs wants to buy some bitcoins. Here's what happens:

jbloggs registers with the exchange.
jbloggs makes a bank transfer to a Payment Processor.
The Payment Processor instructs the exchange to transfer exchange funds from the Payment Processor's exchange account to jbloggs exchange account.
jbloggs can then buy bitcoins on the exchange.

Later, jbloggs sells bitcoins on the exchange and receives exchange funds in return.
jbloggs then instructs the exchange to transfer exchange funds from his exchange account to the Payment Processor's exchange account.
The Payment Processor makes a bank transfer to jbloggs.

In return for taking on fraud risk and looking after the funds, the Payment Processors take a small commission on all deposits and withdrawals.

In return for providing trading and account management services, the exchange takes a small commission (in bitcoins) on all trades.

I'd be interested to hear people's thoughts on this? Could it work? What would stop it working?