Bitcoin's Main Stumbling Block: Navigating The Law

Bitcoin was created in the wake of the 2008 global financial crisis to operate outside of central governments, banks, and financial institutions. Other digital and virtual currencies, also called cryptocurrencies, appeared soon afterwards. Because Bitcoin is so new, government regulations are still minimal. However, users can expect greater government oversight in the coming years.

In 2009, a programmer going by the pseudonym Satoshi Nakamoto introduced Bitcoin, partially in response to the financial crisis. Nakamoto wanted a currency that governments and banks could not easily manipulate. Bitcoin is defined by code and has no physical form or intrinsic value. It is completely decentralized and can be exchanged anonymously without incurring any financial service fees. These same traits have made Bitcoin attractive for criminal activities and a challenge to regulators, enforcement agencies, and tax authorities.

Prone to Cybercrime

Because Bitcoin can be used anonymously, it is attractive for illegal financial transactions such as money laundering and buying narcotic drugs online. In 2013, the FBI shut down Silk Road, an online black market best known for illegal drug trade that used Bitcoin as currency. The government seized millions of dollars worth of Bitcoins in the process. The U.S. Marshal later auctioned off a portion of these confiscated Bitcoins. In a 2014 Forbes magazine article, then Executive Director of the Bitcoin Foundation, Jon Matonis, said the auction proves that Bitcoin isfungible and possesses a market-based legitimacy.

As a currency with no physical presence that is stored online, Bitcoin is also attractive to hackers and thieves. Several Bitcoin storage and exchange companies have suffered major thefts. In early 2014, Japan-based Mt. Gox, then the largest digital currency exchange in the world, was forced to declare bankruptcy when it discovered hackers had stolen $477million work of Bitcoins. In March 2014, a Canadian Bitcoin storage company called Flexcoin lost approximately $650,000 worth of Bitcoins.

Current Bitcoin Legal Framework

Because it is still so new, there are no international laws regulating Bitcoin. Each country regards Bitcoin differently and regulations are constantly evolving. This article focuses on the stance of U.S. financial authorities as other governments may look to the United States for precedent.

The U.S. Department of Treasurys Financial Crimes Enforcement Network (FinCEN) issued its first guidance about digital currency in March 2013 (document) followed by another in January 2014 (document). These guidance discussed Bitcoin participants, categorizing them as users, exchangers, and administrators. FinCEN further defined exchangers and payment processors as money transmitters whose actions fall under the laws governing money services business (MSB) within the Bank Secrecy Act (document). Once any business or individual falls under FinCENs definition of money services business, the entity must meet registration requirements and adhere to a range of anti-money laundering, recordkeeping, and reporting responsibilities. BitPay is one of the Bitcoin-related companies already registered with FinCEN.

The number of businesses and merchants (like Overstock (OSTK), Dish Network (DISH), and Dell) accepting Bitcoin is increasing. Many merchants have expressed interest in a derivative products (and derivative markets) through which their exposure to Bitcoin price fluctuations could be hedged. Derivatives are a popular way to hedge risk through products such as futures, forwards, options and swap. Many registered trading platforms are ready to list Bitcoin derivative products. The Tera Exchange, a registered SEF (swap execution facility) with the U.S. Commodity Futures Trading Commissions (CFTC) already has a CFTC-regulated product called USD/XBT Swap. The product protects the value of Bitcoin by locking in a dollar price.

The U.S. Commodity Futures Trading Commissions held their Global Markets Advisory Committee meeting in October where it discussed various aspects of Bitcoin (though it made no formal announcement afterwards). In a December 2014 speech, CFTC Chairman Timothy Massad said that some aspects of virtual currencies will fall under the agencys jurisdiction.

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Bitcoin's Main Stumbling Block: Navigating The Law