Digital currencies encounter an uncertain regulatory landscape as they enter the mainstream.
The Senate recently initiated hearings on digital currencies like Bitcoin—a largely anonymous, “peer-to-peer” currency that gained notoriety following its association with the Silk Road, an online black market.
The Senate Homeland Security and Governmental Affairs Committee and the Senate Committee on Banking, Housing and Urban Affairs each scheduled separate hearings, citing the “increased attention” digital currencies have received “from regulators, law enforcement, investors and entrepreneurs in recent months”—as well as lagging federal regulation.
The hearings began after the Federal Election Commission (FEC) published an advisory opinion allowing political campaigns to accept Bitcoin donations. The FEC opinion is the most recent federal attempt to regulate Bitcoin in the wake of reports drumming an increased use of “digital currencies.” The FEC signaled a departure from other agency regulators, who opt to punish the illicit use of Bitcoins rather than authorize legitimate applications.
Bitcoin—a global currency created and spent within online networks—was developed by Satoshi Nakamoto in response to the 2008 financial crisis. Traded anonymously over peer-to-peer marketplaces, the currency was intended to cushion individuals against national bank collapses. Recently, entrepreneurs have attempted to increase Bitcoin’s viability by creating debit cards and coins. Such entrepreneurs are credited with driving mainstream acceptance, since few retailers currently accept Bitcoin as legal tender.
In the last year, several federal and state regulators have taken aim at Bitcoin, resulting in a hodgepodge of regulation. Some regulatory agencies have attempted to regulate Bitcoin as an investment product—like stocks or bonds—while others have classified Bitcoin as currency.
For example, the Financial Crimes Enforcement Network (FinCEN) recently issued guidance stating that Bitcoin payments were not “money transfers.” Instead, FinCEN proposed that Bitcoin functions like an investment product, which needs to be sold for legal tender at a market rate.
The Securities and Exchange Commission (SEC) agreed. The SEC recently filed a complaint against Bitcoin Savings and Trust, a vendor charged with operating a Ponzi Scheme. In its complaint, the agency treated Bitcoin as a security—a product that must be sold at a market rate in order for the owner to be able to receive legal tender and subsequently buy goods or services. The SEC issued its complaint on the heels of a decision by a Texas federal court stating that Bitcoin is an investment product properly regulated under the Securities Act.
By contrast, state regulators in Virginia and California have argued that Bitcoin constitutes a form of currency. Therefore, any business that sells or buys Bitcoins without a valid “money transfer” license may find itself in breach of state laws.
The Massachusetts Division of Banks agrees. It recently advocated the use of state-issued trading licenses to prevent fraud and abuse during digital money transfers. The New York Department of Financial Services also announced an investigation into a special New York “BitLicense” to formally bring Bitcoin markets under state laws governing traditional “money transmissions” earlier this year.
Some regulators are avoiding the classification question for the time being, devoting resources instead to l on-going investigations. For example, the Internal Revenue Service (IRS) is reportedly investigating the tax implications of Bitcoin transactions, and the Commodity Futures Trading Commission (CFTC) has similarly revealed internal investigations into the feasibility of regulating Bitcoin. However, neither agency has published a formal guidance on Bitcoin use, or a legal definition of digital currencies so far.
At least one Bitcoin exchange marketplace has expressed frustration with the contradictory results of the United States’ decentralized regulatory system. CoinX has noted that “each state has different guidelines and definition as to what money is.”
Throughout the Senate hearings, federal regulators and law enforcement agencies have approached regulation from different angles. Letters submitted to the hearing emphasize a need to expand federal Anti-Money Laundering laws to stem the illicit use of digital currencies. Such measures might classify Bitcoin and other currency exchanges as “financial institutions,” like banks. The measures would also saddle exchanges with bank-like responsibilities. To comply with existing anti-money laundering laws, Bitcoin exchanges would need to create internal controls that record information about users and transactions, and flag “suspicious activity.”
According to the Federal Bureau of Investigation (FBI), Bitcoin has been the currency of choice for more than $1.2 million in illicit sales through the Silk Road. Bitcoin has also been associated with fraudulent currency exchanges, outright cryptocurrency theft, computer viruses, and fake hedge funds. Moreover, several commentators have emphasized that victimized consumers have little recourse in such circumstances. Indeed, Bitcoin was described by the New York state superintendent of financial services as fueling a “virtual Wild West.”
In spite of its controversial past, industry representatives have launched efforts to bolster Bitcoin’s image. Industry leaders recently disclosed plans to create a self-regulatory organization, the Digital Asset Transfer Authority, in an effort to legitimize Bitcoin as a form of currency and ensure compliance with money laundering and other applicable laws.
The FEC’s recent opinion may support these industry aims by indicating that there could be a place for Bitcoin in mainstream campaign financing. According to the FEC, Bitcoin should be regulated as any “in-kind” campaign contribution—like stocks or other investments. Campaigns would have to record and track individual donors, as well as ensure that each donation is valued under $123,200 when made.
Notably, U.S. government agencies have encountered non-legal tender in the past. The IRS and U.S. Department of Justice (DOJ) cited money-laundering concerns when they mounted a case in May against Liberty Reserve, a digital currency website based in Costa Rica. Similarly, the U.S. Attorney’s Office secured a conviction in 2011 against the founder of Liberty Dollar for printing and circulating currency in violation of Article I, section 8, clause 5 of the U.S. Constitution which gives Congress the exclusive authority to “coin Money [and] regulate the value thereof.”
While U.S. regulators grapple with the complexities posed by digital currency, other countries have avoided Bitcoin regulation. For example, in the U.K., regulatory authorities have stated that Bitcoin markets are under no obligation to register for money laundering compliance monitoring. The U.K.’s Financial Conduct Authority (FCA), a financial regulator, has merely stated it was “keeping an eye” on developments. The German Finance Ministry suggested that Bitcoin should only be “lightly regulated”—principally, for tax purposes. Authorities in China—one of the largest Bitcoin markets—are not presently considering any form of regulation over Bitcoin exchanges.
Notably, the European Central Bank (ECB) did publish a report stating that Bitcoin will require future regulation as it becomes more widely accepted, as it could potentially dilute national monetary policies by competing with real currencies. According to the ECB, Bitcoin may interfere with the ability of banks to influence wider interest rates and control inflation.
