Legal Analysis and Commentary from Justia
Posted In Consumer Law

Bitcoin: If You Can’t Ban It, Should You Regulate It? The Merits of Legalization

BitcoinsBitcoin, a so-called virtual peer-to-peer currency, is in the headlines around the globe. Russia is attempting to ban its use. China claims it has banned Bitcoin. Germany has declared that Bitcoin is not legal tender. Even Apple has removed the Bitcoin wallet app Blockchain from its App Store and done so without warning. Blockchain was the last remaining Bitcoin wallet available for iOS devices, causing some disgruntled iPhone users to smash their iPhones on video.

In the U.S., the federal and state governments have not tried to ban Bitcoin. The U.S. Treasury Department has, however, informed parties that issue or exchange Bitcoins that they are subject to federal laws dealing with money laundering, and may need to register as money transmitters and comply with reporting requirements regarding suspicious financial transactions.

Why is there so much fuss about Bitcoin? For two reasons. The first reason is that it is a substitute for official government currency. People are willing to trade in their government-issued money to obtain Bitcoins—hence posing some challenges to the global banking system. The second reason is perhaps the major one: Bitcoins, because they are not widely regulated or under government scrutiny, are used for illegal purposes. In January 2014, U.S. government agents arrested Charlie Shrem, the CEO of Bitcoin exchange BitInstant, charging him with laundering money for customers of the online drug bazaar Silk Road, which has been shut down. Law enforcement is trying to stop the use of Bitcoin on such sites—where people can buy drugs, guns, and illegal pornography.

In this column, I will look at recent attempts to extend legal recognition to Bitcoin, and explain why I believe this is a good thing. While it may be good to clarify that legitimate businesses and consumers may use Bitcoin, it may be too early to determine, what, if any further measures are needed to provide consumers with safety with respect to their Bitcoins. The US Treasury Rules, and other attempts, at the state level, to clarify that Bitcoin may be used for lawful purchases, and that it is subject to regular money-laundering laws, taken together, are likely a prudent approach to the Bitcoin problem at present.

Bitcoin 101—It’s Currency, but Not Government Currency

As I noted in a prior column, Bitcoins can be created seemingly out of thin air —or at least solely from the act of problem-solving. They are created by performing mathematical calculations in order to solve a puzzle. When you’re a part of the Bitcoin network, your computer can try to solve a certain puzzle. When it does so, you get 50 Bitcoins. The puzzle’s difficulty keeps changing, so that only about six computers solve that puzzle per hour. Because not everyone can create Bitcoins, there is a separate market where people can buy Bitcoins that are already in existence.

If Bitcoins can be created by computers, do the coins have any value? The answer is yes. These virtual “coins” have value for the same reason that legal tender or government-issued currency does: People are willing to give you goods or services in order to get your coins. There are even places where you can exchange Bitcoins for cash. You can buy Bitcoins from different sellers and exchanges—where you transfer money in, by bank transfer or other funds transfer, so that you can buy Bitcoins that have already been generated.

And then, once you have Bitcoins, you can use them to purchase goods and services. You download and run the Bitcoin software, and it connects over the Internet to a decentralized network of all Bitcoin users, and it also generates a pair of unique, mathematically-linked keys. One key is private and is kept hidden on your computer. The other is public and a version of it is, in essence, your Bitcoin address. This public key/address is given to other people so that they can send you Bitcoins.

Bitcoins are a secure payment mode. When you perform a transaction, your Bitcoin software performs a mathematical operation to combine the other party’s public key and your own private key with the amount of Bitcoins that you want to transfer. It is practically impossible—even with the most powerful computer—to ascertain the code of someone’s private key from his or her public key, due to encryption.

For some people, it may be just fine to keep their Bitcoins as Bitcoins and not cash them out into government-backed currency like US dollars or Euros. But what if you do want to take some of your hard-earned Bitcoins to use and spend at a place that does not accept Bitcoins? The answer is that you can exchange your Bitcoins for government-issued currency on a number of exchanges that will provide you with floating exchange rates Or, you can store your Bitcoins in secure online “lockers” offered by companies that provide services for the Bitcoin world.

Banning Bitcoin: Why It Is Not the Right Solution

Just this month, the Russian Prosecutor General’s Office noted that Bitcoins and other crypto currencies cannot be used legally in Russia. In support of that conclusion, the Russian law enforcement agency cited a 2002 law signed by Russian President Vladimir Putin that reads, “the official currency of the Russian Federation is the ruble. Introduction of other monetary units and money substitutes is prohibited.”

The Prosecutor General’s Office is also quoted as saying that “The monitoring of the use of virtual currencies shows an increasing interest in them, including for the purpose of money laundering, profit obtained through illegal means.”

In December 2013, The People’s Bank of China, the country’s central bank, banned financial institutions and payment services from Bitcoin-related business. This was done “in order to avoid harm to the public and to the legal monetary status of the renminbi [a.k.a. the yuan] that might occur as a result of “excessive speculation” in Bitcoin and other virtual goods, said the statement. Third party service providers were also told to stop offering clearing services to Bitcoin exchanges.

But prohibiting Bitcoins’ use won’t make people stop using the currency. Indeed, it is precisely because Bitcoin can currently be used in a way that provides anonymity and allows people to buy from entities that are currently unregulated, that Bitcoin is used. Some people don’t like to use money issued by the government. Others value the privacy of a currency that is not accounted in the same way that bank transactions are. Still others find that Bitcoins are worth more than legal tender these days, with problems in the Euro zone and other countries. Some consumers feel that virtual currencies may be more efficient, and may offer newer, more flexible ways to pay for thing across borders. Prohibition would be overinclusive; it takes a product that has multiple uses—many of them legitimate—and tries to ban it or wish it out of existence.

The criminal side of Bitcoin’s use is what has garnered most headlines. Websites like Silk Road, which allows people to buy drugs online and underground take Bitcoins. On October 2, 2013, the FBI shut down Silk Road, arrested Ross William Ulbricht, and identified him as the founder and chief operator “Dread Pirate Roberts.” The FBI reported seizing $3.5 million worth of Bitcoins during the sting.

In November 2013, Forbes and Vice reported that Silk Road 2.0 was being run by the former administrators of the site. In November, a similar site called Sheep Marketplace was deemed a scam after it lost $100 million in users’ bitcoins in an alleged hack. And just last week, administrators of the revived Silk Road claimed cyber attackers had somehow spirited away all the Bitcoins it held in escrow—valued at $2.7 million.

Illegal marketplaces have existed in the past and will continue to spring up in the future. We don’t ban money or cash simply because it can and will be used for illegal purposes. (and the way things are going with these exchanges, they may operate so poorly as to go out of business based on poor security). As with Bitcoin, such an exchange can be used in a criminal manner or for mundane purchases.

Banning Bitcoin is difficult to do Since Bitcoin is not issued by a government, it can still be created. Then regulators will have to spend time figuring out who is using it—and then may only end up penalizing businesses that are using it legitimately. Regulated websites like news site Reddit, and blog creation site WordPress accept Bitcoins. Virgin Galactic, Richard Branson’s space travel company, accepts Bitcoins. Perhaps the largest retail site to accept Bitcoins is Overstock.com. Other companies—including PayPal—have publicly contemplated accepting Bitcoin.

So rather than ban the Bitcoin, another alternative would allow some regulatory help. Should governments allow Bitcoin to keep operating, as an alternative to banks and to using government-issued currency? The answer is yes—but we should not over-regulate the Bitcoin at the outset.

What Two States Are Doing Regarding Bitcoins

The question of how to deal with Bitcoin is becoming a regulatory priority, as adoption of the virtual currency spreads and governments panic. But for consumers and businesses , the global legal landscape is murky.

More governments are coming out with pronouncements and opinions on how Bitcoin should be treated under their law. Many countries, such as Germany, have declared that Bitcoin is not legal tender, and cannot be used to pay taxes or government obligations. Other nations, such as Canada, have said that income earned from Bitcoin activity is taxable. Most countries are in a wait-and-see mode: “At the moment, we’re studying Bitcoin and we have no plan to issue a regulation on it,” a spokesperson for the Bank of Indonesia told the Jakarta Globe in December.

Senator Tom Carper of Delaware, the Chairman of the Homeland Security and Governmental Affairs Committee, tasked the Law Library of the U.S. Congress to survey 40 jurisdictions and the European Union to see which ones have already regulated Bitcoin, and in what manner. The Law Library recently released its report.

The conclusion? Not many countries have yet enacted laws to address new forms of virtual currency. Nonetheless, “ [t]here is widespread concern about the Bitcoin system’s possible impact on national currencies, its potential for criminal misuse, and the implications of its use for taxation.” China and Brazil appear to have the most specific laws to date. The Chinese government has declared the Bitcoin illegal to use as a currency, while the Brazilians have set out a legal framework for its adoption under Law No. 12,865.

As it turns out, the US, where most Bitcoin users live, is at the head of the pack when it comes to regulation.

California is currently considering amending its laws to make it clear that consumers may use Bitcoin. More specifically, California is considering an amendment to Section 107 of the State’s Corporations Code, relating to business associations) introduced by California State Assembly member and Chairman on Banking and Finance Roger Dickenson on January 15, 2014. “AB-129 Lawful money: alternative currency” specifies that “current law which bans the issuance or circulation of anything but lawful money of the United States does not prohibit the issuance and use of alternative currency.” At present, in California, it appears that the Bitcoin may not be legal under existing state law.

California’s is an example of a positive step that lawmakers and regulators can take: If old laws are unclear—and seem to prohibit Bitcoin, then they should be examined and possibly amended, or a guidance should be published to make it clear when Bitcoin can be used. Some of the newspapers have referred to this as “legalization.” However, I think of it as clarification, making crystal-clear that Bitcoin is not per se illegal.

In March 2013, the U.S. Treasury Department’s Financial Crimes Enforcement Network, which polices money laundering, said that virtual-currency firms may be regulated as money transmitters. That move may set off a race among states, which license such firms, to determine if and how their laws apply.

The U.S. Treasury has noted that companies or individuals that serve as sellers or exchangers for Bitcoin, now have reporting requirements and licensing requirements as money transmitters. (Bitcoin investors and miners will be exempt from this rule.) But some companies find themselves having to register with the feds, or face being prosecuted as unlicensed money transmitters.

The Treasury regulation is meant to prevent crime and money laundering—and uses reporting as a way to achieve that end. The federal law does create new burdens for these companies—but the requirements relate to reporting, and do not create larger burdens around large licensing fees, minimum capital requirements or restrictions on how money held by sellers or exchanges is invested.

What may cause more headaches for Bitcoin sellers is state regulation. As part of federal compliance, such companies now need to obtain state licenses. State licensing requirements, which apply to traditional money transmitters like Western Union, and even PayPal, may create barriers to entry for smaller or newer market entrants.

The New York State Department of Financial Services, which may be a model for other states, is now considering Bitcoin-specific regulation.

In February 2014, the New York State Department of Financial Services (DFS) held a two-day hearing on how to regulate Bitcoin and other virtual crypto currencies. The purpose of the hearing was to consider whether or not New York regulators should have a direct role in overseeing the use of virtual crypto currencies, or if existing federal regulations are enough.

One question on the agenda is whether New York should establish what has been called a “BitLicense.” A BitLicense or some other type of license may be a prudent way to keep sellers on a regulator’s radar screen, not only for purposes of law enforcement, but also for consumer-protection purposes. These companies are holders (at least for a brief time) of our money—either as they move Bitcoins, or exchange them, or hold our Bitcoins in a virtual bank or vault. In each case, there are funds at stake—and regulators want to make sure that those funds are not stolen, lost, or otherwise depleted.

But the question remains, what sorts of requirements are necessary to ensure consumer protection, without putting such companies out of business? Some commentators say licensing and registration is good, but that regulators would tread carefully before asking such companies to post high-security bonds, and other types of security measures.

So, while banning Bitcoin is not the answer, it seems that the regulatory landscape is still murky. California is taking a good step to clarify existing laws. Let’s hope that New York—as a state that was first out of the gate when it came to regulating virtual currency—also gets the balance right.

Anita RamasastryAnita Ramasastry is the UW Law Foundation Professor of Law at the University of Washington School of Law in Seattle, where she also directs the graduate program on Sustainable International Development. She is also a member of the Law, Technology and Arts Group at at the Law School. Ramasastry writes on law and technology, consumer and commercial law, and international law and globalization.
Print this page
  • eldueno

    Barter and fence-post trading have always been and will continue as exchange means for goods and services. Apparently Bitcoin has for some folks attractions above gold, chickens and ‘money’ which some institutions fear. I don’t see how a government can ban or regulate this medium of exchange anymore than banning alcohol

  • broey77

    umm what? Government backed currency is secured by the full faith and credit of the issuing government. BitCoin is not backed by anyone. It CAN go to $0 of value and is the same as trading in penny stocks, comic books, or any other asset. Stocks have value, but they are not currency. Substitute the word “currency” with the word “Asset” and you would stop being so inaccurate. On a income statement, assets are classified separate then money with assets requiring you to determine market rate and then adjust that market rate yearly as it appreciates or depreciates in value.

    Eventually someone will sue the bitcoin foundation and exchanges for trying to make bitcoin look like a currency (Bitcoin coins for instance). You are basically buying a baseball card, an asset, it could increase in value or it could drop tomorrow. There is nothing secure in it, nothing protecting it, you can lose everything.

    • Alex Detmering

      why isn’t bitcoin a currency?

      fyi, the average lifetime of fiat currency is 27 years. So much for the “full faith and credit.”

      • Sunjeon

        It can be used like gold but not a currency

 

Access this column at http://j.st/Zgnq