Bitcoin is a cryptocurrency that allows transactions to take place directly between two parties, without the need of a central bank acting as a middle-man. This legal guide explains what Bitcoin is, and covers some of the legal issues facing this new type of currency.
What is Bitcoin?
Bitcoin is a cryptocurrency that allows transactions to take place directly between two parties, without the need of a central bank acting as a middle-man. All transactions are recorded in a public ledger that is maintained by users running the Bitcoin software. Despite the public nature of the ledger, Bitcoin provides a certain degree of anonymity, because transacting in Bitcoin does not necessarily require that the parties identify themselves to an intermediary facilitating the transaction.
Types of currencies
What do we mean exactly when we talk about a "cryptocurrency"? It's important to get our definitions right (this is a legal guide, after all) and to make some distinctions:
- Digital Currencies: Currencies that exists only in digital format. Example: Kenya’s M-Pesa
- Virtual Currencies: Unregulated digital money, accepted among the members of a specific virtual community". Example: Linden Dollars.
- Cryptocurrencies: Digital currencies that use cryptography to secure the transactions and to control the creation of new units. Bitcoin was the first cryptocurrency to be created. Cryptocurrencies are a subset of virtual currencies. Examples: Bitcoin, Litecoin, Dogecoin.
Why does Bitcoin exist?
Bitcoin has a number of features that make it unique. These features have created excitement in certain communities, whilst raising concern in others.
- Lowers transaction costs for exchanges of currency. At present, most major credit card companies impose a transaction fee of around 3%. Bitcoin allows individuals and merchants to transact directly with one another, thus lowering the overall transaction cost.
- No erosion of purchasing power due to inflation. Bitcoin is unlike other fiat currencies (such as the Dollar) because it cannot be printed ad infinitum. The Bitcoin protocol limits the total of coins that can be created to 21 million.
- Currency regulation no longer exclusively controlled by government. The success of Bitcoin has lead to the creation of a host of other cryptocurrencies, none of which are controlled by a central bank.
- Limited ability to steer and manipulate financial markets. Governments can exert control on the value of their currency, for example by reducing or increasing interest rates. Bitcoin does not afford this possibility.
- No bank account required. Users can transact in Bitcoin without needing a bank account. All that is needed is a digital wallet.
- Easier cross-border transactions. Bitcoin is inherently global, and has the potential of cutting in the market for international money transfer, due to its lower transaction fees.
What is the "block chain?"
The Bitcoin system is essentially a public ledger where financial transactions conducted in Bitcoin are tracked and recorded. This public ledger is called the block chain. The block chain contains every past Bitcoin transaction. All new Bitcoin transactions are added to the block chain in order of its time stamp.
The block chain is not controlled by a single government, company, or organization. Rather, all Bitcoin users maintain an up to date copy of the block chain. When a new transaction takes place and is added to the end of the block chain, every single copy of the block chain in the Bitcoin system is updated.
How do I get Bitcoins?
Bitcoins can be obtained in 3 ways:
- A user can exchange conventional currencies (ex: Dollar, Yen, Euro) for Bitcoins for a fee on various online exchanges (ex: Coinbase).
- A user can obtain Bitcoins in an exchange of goods and services with a merchant.
- A user can generate Bitcoins through a process called “mining.” Mining is the process of a user applying their computing power to the block chain to solve the complex math problems that secure the block chain. The amount of Bitcoins that can be mined is proportional to the amount of computer processing power applied - this means that the average Bitcoin user will not have enough computing power to mine even a few Bitcoins.
How many Bitcoins are in circulation?
As of July, 2014 there were 13 million Bitcoins in circulation. However the total number of Bitcoins is capped at 21 million, all of which are expected to be mined by 2140. The current price of Bitcoin is as follows:
Bitcoins are stored in a “digital wallet.” The digital wallet acts as a virtual bank account that allows Bitcoin users to send and receive Bitcoins, pay for goods and services, or save their Bitcoins. Unlike a traditional bank account, digital wallets are not insured by the FDIC. This means that any Bitcoins you keep in a digital wallet are not insured by the United States government against your digital wallet company going out-of-business.
Are Bitcoin transactions anonymous?
Bitcoin transactions are not truly anonymous. An example of an anonymous transaction would be the exchange of physical currency between two strangers. The strangers can complete the entire transaction without exchanging any personal information.
With Bitcoin, each transaction recorded in the block chain is tied to the individual user’s “digital wallet ID,” rather than the user’s name. This does allow Bitcoin users to easily buy or sell goods and services without any direct connection to their public identity. For this reason, Bitcoin transactions are said to be pseudonymous not anonymous. This is primarily why Bitcoin, and other virtual currencies, have become the primary crypto-currency of marketplaces specializing in the sale of illegal products and services, such as the now defunct Silk Road.
For now, the lack of regulations allows everything to happen.
Frontas, alias of a well-known Bitcoin scammer
United States Legal Issues
Counterfeiting Criminal Statutes
- The U.S. government has a basic governmental interest in enacting laws against counterfeiting of money because of the government interest in protecting the value of the Dollar and thus, the monetary system. Specifically, counterfeiting and forging of U.S. coins, currency, and obligations is subject to criminal sanctions under 18 U.S.C. 478-483. While the counterfeiting statute is typically applied to counterfeits of the U.S. Dollar, at least one case has successfully prosecuted an individual for issuing and distributing “Liberty Dollars,” which were designed as similar to but distinguishable from U.S. Dollars. It is undecided whether the U.S. government could prosecute an individual for use of Bitcoin under a counterfeiting criminal statute.
The Stamp Payments Act of 1862
- The Stamps Payments Act criminalizes the issuance, circulation, or pay out of “any note, check, memorandum, token or other obligation, for a less sum than $1, intended to circulate as money or to be received or used in lieu of lawful money of the United States.” In the 1800’s, Congress approved stamps as currency for fractions of $1 because metal coins were being hoarded by individuals and were effectively taken out of circulation. Congress intended to protect postage stamps from competition by private currencies. The language of the statute seems to focus on tangible forms of currency (ex: check, memorandum, token) rather than a currency that only exists in a virtual medium, such as Bitcoin. However, this statute could still be applicable if Bitcoin became a legitimate competitor with official U.S. tender.
The Electronic Fund Transfer Act
- The Electronic Fund Transfer Act (EFTA) creates rules around the electronic transfer of money from a consumer’s account held at a financial institution. The definition of a financial institution is limited to banks, thrifts, savings associations, and credit unions. Bitcoin is designed to be a peer-to-peer network, thus the system categorically removes the need for a financial institution. Because of this, Bitcoin is unlikely to fall under the purview of the EFTA.
Federal Tax Law
- The IRS has decided to treat Bitcoins as property for taxation purposes. Exchanges of Bitcoins will be treated similarly to stock and barter transactions. This means that Bitcoin “investors” (anyone holding Bitcoin) are treated as stock investors. Bitcoins held for more than a year qualify for the lower tax rates applicable to capital gains (a maximum of 23.8%).
- Ex: purchasing a $6 burrito with Bitcoins purchased for $1 would trigger $5 in capital gains for the burrito eater and $6 in gross income for the taqueria.
Bitcoin’s effect on the Federal Reserve's monetary policy
- The Federal Reserve Bank of the United States establishes monetary policy designed to regulate the flow of money and credit to the U.S. economy in order to achieve stable prices of goods and services and keep unemployment low. The Fed primarily does this through raising and lowering interest rates and printing money. If Bitcoin is adopted by a large population, it would substantially affect the ability of the Fed to use the Dollar to control national monetary policy.
Federal Anti-Money Laundering Laws
- In the United States, engaging in financial transactions that involve proceeds of illegal or terrorist activities or that are designed to finance those activities is illegal. Because money laundering crimes often involve transactions processed by banks, the Bank Secrecy Act (BSA) has imposed many record-keeping requirements on banks and other financial institutions. Under this regulation, all “money services businesses” (MSBs) must file reports of cash transactions exceeding $1,000. MSBs must also must develop and implement anti-money laundering programs to identify and stop such activities. MSBs include banks, as well as dealers in foreign exchange, check cashers, traveler’s check issuers, providers of prepaid access cards, and money transmitters. Currently, Bitcoin exchanges and individuals and businesses that change Bitcoin into U.S. Dollars, or other foreign currency, must register with the Department of Treasury and comply with Bank Secrecy Act requirements.
Federal Securities Regulation
- This section pertains to investments purchased with Bitcoin. In August 2013 the United States District Court for the Eastern District of Texas held that it had subject matter jurisdiction over possible fraud in investments purchased with Bitcoin, based on the court's finding that investments purchased with Bitcoin are securities. This ruling subjects all investments purchased with Bitcoin to Securities and Exchange Commission (SEC) regulations
International Legal Status: North America
Canada has no laws or regulations pertaining to Bitcoin. In January 2014, the Department of Finance stated that Canada does not consider Bitcoin to be legal tender. They stated that “only Canadian bank notes and coins are recognized as legal tender in Canada.”
Canadian Revenue Agency has announced that it will tax Bitcoin in two ways:
- Transactions for goods and services will be treated as a barter and taxed accordingly.
- The profit made from buying or selling Bitcoin for speculative purposes could be considered income or capital and taxed as a security.
International Legal Status: South America
The Argentinian Government has not released a statement pertaining directly to the use of digital currencies. However, The National Constitution of Argentina dictates that the Central Bank is the only authority able to issue legal currency. This means that Bitcoin cannot be used to cancel legal debts or obligations.
As of May 2014, the Central Bank of Bolivia has officially banned any currency or coins not issued or regulated by the government from being used in commerce. The bank further stated that merchants are prohibited from listing the price of goods and services in any currency that has not been approved by Bolivia's government.
In April 2014 Brazil's tax agency announced that it will treat digital currencies as financial assets. This means that there will be a 15% capital gains tax imposed on Bitcoin transactions at the time of sale. However, the government has stated that those who sell less than 35,000 reals (R$) (equal to $16,000) will not have to pay the tax. Thus, Bitcoin users in Brazil will not be responsible for calculating capital gains taxes when making routine customer purchases. Finally, the tax authority is requiring an annual account declaration for any individuals who have more than R$1,000 in digital currency holdings.
The Colombian government has not released an official statement about the regulation of Bitcoin, however in March 2014 the EL Tiempo newspaper reported that the government is close to outlawing Bitcoin transactions.
In July 2014 the National Assembly of Ecuador banned Bitcoin and other decentralized digital currencies.
However, the country has simultaneously established guidelines for the creation of a government run digital currency. These new guidelines permit the government to make payments in "electronic money."
In March 2014 the Bank of Mexico issued a general warning to the public about the inherent risks of using cryptocurrencies. Following the warning, the Bank stated that financial institutions regulated in Mexico "are not authorized to use or carry out any operations with digital currencies." It is still unclear whether banks are merely prohibited from transacting with digital currencies, or if banks must terminate relationships with businesses transacting in digital currencies as well.
International Legal Status: Europe
In December 2013 the European Banking Authority (EBA) issued a warning about virtual currency addressing investment risk, fraud, tax evasion, and other crimes. In early 2014 the EBA sent the European Commission and European Parliament guidelines for the regulation of digital currencies. The EBA instructed financial institutions to refrain from buying, holding, or selling digital currencies until these new rules are in place.
The Belgian Minister of Finance has stated that it is not necessary to regulate the Bitcoin System right now. However, in January 2014 the National Bank of Belgium issued a warning that digital currencies are not issued by a central authority and thus are at risk for volatility, fraud, and business non-acceptance.
In April 2014 Bulgaria's National Revenue Agency (NRA) stated that income from the sale of digital currencies, such as Bitcoin, will be treated as income from the sale of financial assets and taxed at a rate of 10%.
Cyprus has stated an intention to become a hub for Bitcoin business in the European Union. Cyprus has created the world's first physical Bitcoin savings institution, Neo, and a streamlined payment processor, called Bee, that can be used by individuals and businesses.
The Danish government does not consider Bitcoin to be "real", physical money. Bitcoin is considered a private asset and any gains are tax exempt and losses are not tax deductible. However, companies that exclusively trade or speculate in digital currencies will have gains taxed.
The Estonian Government does not regulate or control Bitcoin. However, the Bank of Estonia monitors financial transactions that use Bitcoin. Estonia has the second highest number of internet searches for the term “Bitcion,” second only to Russia.
In September 2013 Finland issued a regulatory guide to Bitcoin which imposed capital gains tax on Bitcoin, and taxes mined Bitcoin as earned income.
In January 2014 Finland classified Bitcoin as a commodity upon determining that it did not meet the Central Bank's definition of a currency.
In January 2014 the French Senate held hearings about Bitcoin. The tone of the hearings were wildly regarded as positive and making Bitcoin illegal was not seen as an option. In April 2014 the French Ministry of Economy and Finance stated that although Bitcoin is not officially recognized by the government, revenues generated from transacting in digital currency is subject to taxation.
Germany has adopted progressive Bitcoin policies. Bitcoin is categorized as a form of private money, and the German government has exempted Bitcoins held for over a year from the 25% capital gains tax.
Iceland has banned Bitcoin and other digital currencies. Buying Bitcoin from outside Iceland is illegal because it constitutes a movement of capital out of the country, which is result of legislation passed after the banking crisis of 2008. Selling goods or services for cryptocurrencies is also banned.
Holland has stated that Bitcoin and other cryptocurrencies are treated as any other currency for tax purposes.
Slovenia's Ministry of Finance has stated that Bitcoin is subject to income tax, like any other non-monetary income, and the tax would be calculated based on the Bitcoin-Euro exchange rate at the time of the transaction. Selling Bitcoin is not subject to capital gains tax in Slovenia.
Sweden considers Bitcoin as a means of payment. Bitcoin exchanges must register with Sweden's Financial Regulator
In February 2014 Russia's General Prosecutor's Office stated that "the official Russian currency is the Ruble. The use of any other monetary instruments or surrogates is forbidden." The statement went on to specifically classify Bitcoin as a monetary surrogate and stated that Bitcoins use by private citizens and legal entities is not allowed.
In August 2014 the Ministry of Finance proposed a ban on the issuance of Bitcoin and any operations involving cryptocurrencies.
Ukraine's Central Bank has stated that businesses related with digital currencies must register with the agency and abide by existing laws related to the management of electronic money. The Central Bank has given no further guidance.
In March 2014 the UK tax department, HMRC, stated that it will treat Bitcoin like any other form of payment for tax purposes. Specifically, "in all instances, VAT will be due in the normal way from suppliers of any goods or services sold in exchange for Bitcoin or other similar cryptocurrency."
In August 2014 Chancellor George Osborne announced a new government initiative that will explore the potential role of virtual currencies in Britain's economy. The results of this initiative will pave the way for a future regulatory framework for cryptocurrencies in Britain.
International Legal Status: Asia
In December 2013 the People's Bank of China (PBoC) issued a statement prohibiting financial institutions from engaging in Bitcoin business and transferring funds to/from Bitcoin exchanges. A later statement by the PBoC banned third-party payment processors from dealing with Bitcoin Exchanges. Within days of these statements, the price of Bitcoin worldwide crashed from a record high of $1200 to $600 (a 50% drop).
The PBoC maintains that despite these regulations, there has been no move to discriminate against Bitcoin use in China and Bitcoin exchanges have been allowed to remain open for business.
In January 2014 Hong Kong's Secretary for Financial Services and the Treasury issued a general warning about the risks of using Bitcoin. However, the region has otherwise remained hands-off in its approach to Bitcoin and has affirmatively stated that Bitcoin does not pose a threat to the financial system if it is not widely adopted.
In February 2014 Indonesia's Central Bank stated that that Bitcoin and other virtual currency are not currency or legal payment instrument in Indonesia. The Central Bank encourages society "to be careful toward Bitcoin and other virtual currency. All risks related to the ownership/use of Bitcoin should be borne by the owner/user of the Bitcoin and other virtual currency." Bitcoin is allowed to exist in Indonesia and people are allowed to buy, sell and own Bitcoin as long as it is not used as a medium of payment.
In December 2013 the Reserve Bank of India issued a warning about Bitcoin. This led to virtually all Bitcoin exchanges in the country choosing to suspend operations. One Bitcoin exchange reports being raided by government officials and another exchange said tax officials visited their premises to investigate how digital currencies could be managed and taxed. A few exchanges have since re-opened.
Japan's ruling party, the Liberal Democratic Party (LDP), has created a committee to investigate cryptocurrencies and has stated that Bitcoin"is not a currency, but taxable." Currently, Bitcoin is treated as a good and is subject to taxation. Gains on exchange rates are also taxable.
The government has also prohibited banks from "brokering in Bitcoin transactions or opening accounts holding the virtual unit." There is still much ambiguity around what these regulations mean, however the Japanese government is generally considered curious about Bitcoin rather than hostile.
In July 2014 the National Bank of the Kyrgyz Republic stated that using Bitcoin, and other digital currencies, as a means of payment is illegal.
Malaysia's Central Bank has stated simply, "The Central Bank does not regulate the operations of Bitcoin."
The Monetary Authority of Singapore (MAS) has stated that "it will not interfere" with Bitcoin business. In January 2014 the government stated that Bitcoin will be treated as a good or asset, rather than a currency, for tax purposes. As a good, Bitcoin will be subject to VAT or sales tax when traded to and from local currency. Goods purchased with Bitcoin will also be subject to sales tax. Bitcoin as an investment asset is not taxed in Singapore, as Singapore does not have a capital gains tax.
In March 2014 MAS announced that it will regulate virtual currency exchanges and ATM's for the purpose of addressing money laundering and terrorist financing. These intermediaries will be required to verify the identity of their customers (which could potentially destroy the anonymity traditionally associated with Bitcoin usage) and report any suspicious activity.
The Central Bank of the Republic of China has warned against Bitcoin use and has stated that regulators will block any attempt to install Robocoin Bitcoin ATMs in Taiwan.
In the Summer of 2013 Bitcoin was widely considered to be banned in Thailand. However, in March 2014 the government issued a statement about Bitcoin warning that Bitcoin is not currency and that it comes with inherent risks. This is considered a more positive government sentiment towards cryptocurrencies.
In February 2014 Vietnam's Central Bank effective banned Bitcoin by forbidding financial institutions from using digital currencies as a means of payment or from offering services in exchange for Bitcoin. Vietnam is only one of two countries to outright ban Bitcoin.
International Legal Status: Middle East
In February 2014 the Bank of Israel issued a generic warning about the investment risks and dangers of fraud, money laundering, and terror financing that come with Bitcoin usage. However, the Israeli Tax Authority has yet to issue guidance on how/if Bitcoin will be taxed.
In August 2013 the Israel Bar Association ruled that Bitcoin is an appropriate form of payment for attorneys and authorized its member lawyers to accept it.
In February 2014 the Central Bank of Jordan prohibited banks, financial companies, payment processors, and currency exchanges from dealing with digital currencies, including Bitcoin.
In January 2014 the Central Bank of Lebanon warned that Bitcoin did not offer consumer protections, has a volatile price, and was often used for criminal purposes. The bank further advised consumers and businesses not to use digital currencies.
International Legal Status: Oceania
In December 2013 the Reserve Bank of New Zealand commented that Bitcoin was "interesting," but issued a warning about the risks associated with Bitcoin's price volatility.
The Australian Tax Office (ATO) has stated that income and profits derived from Bitcoin transactions are taxable. Transferring Bitcoins to another party would subject the transaction to the Goods and Services Tax and Bitcoin profits would be subject to the capital gains tax.
Sources used for this guide
- Bloomberg. http://www.bloomberg.com/news/2013-12-05/china-s-pboc-bans-financial-companies-from-bitcoin-transactions.html
- CoinApex. http://blog.coinapex.com/2014/05/major-u-s-law-firm-mclaughlin-stern-accepts-bitcoin/
- CoinDesk. http://www.coindesk.com/information/is-bitcoin-legal/
- Wikipedia. https://en.wikipedia.org/wiki/Bitcoin