Crypto currency and law
Armel Njoya, EO-201i, KNEU
Each fiduciary currency in the world is created, released and controlled by a single entity – in most cases, a central bank. By law, ordinary citizens are only allowed to buy, sell or keep money. If someone tries to create a sum of money, they will inevitably find themselves behind bars.
As the use of crypto currency becomes more and more common, law enforcement, tax authorities and legal regulators around the world are trying to focus on the concept of crypto currency and where is it located. It exactly within existing regulations and legal frameworks.
This is how we will first define cryptocurrency, then talk about concerns about cryptocurrencies, the legality of cryptocurrency, quote the opinion of some regulators, payments in Bitcoins (for businesses), and finally the imposition.
I. DEFINITION OF CRYPTO CURRENCY AND HISTORY
A cryptocurrency is a digital or virtual currency designed to work as a medium of exchange. It uses cryptography to secure and verify transactions as well as to control the creation of new units of a particular cryptocurrency. Essentially, cryptocurrencies are limited entries in a database that no one can change unless specific conditions are fulfilled.
There have been many attempts at creating a digital currency during the 90s tech boom, with systems like Flooz, Beenz and DigiCash emerging on the market but inevitably failing. There were many different reasons for their failures, such as fraud, financial problems and even frictions between companies’ employees and their bosses.
Notably, all of those systems utilized a Trusted Third Party approach, meaning that the companies behind them verified and facilitated the transactions. Due to the failures of these companies, the creation of a digital cash system was seen as a lost cause for a long while.
Then, in early 2009, an anonymous programmer or a group of programmers under an alias Satoshi Nakamoto introduced Bitcoin. Satoshi described it as a ‘peer-to-peer electronic cash system.’
It is completely decentralized, meaning there are no servers involved and no central controlling authority. The concept closely resembles peer-to-peer networks for file sharing.
One of the most important problems that any payment network has to solve is double-spending. It is a fraudulent technique of spending the same amount twice.
The traditional solution was a trusted third party – a central server – that kept records of the balances and transactions.
However, this method always entailed an authority basically in control of your funds and with all your personal details on hand.
In a decentralized network like Bitcoin, every single participant needs to do this job. This is done via the Blockchain – a public ledger of all transaction that ever happened within the network, available to everyone. Therefore, everyone in the network can see every account’s balance.
Every transaction is a file that consists of the sender’s and recipient’s public keys (wallet addresses) and the amount of coins transferred. The transaction also needs to be signed off by the sender with their private key. All of this is just basic cryptography. Eventually, the transaction is broadcasted in the network, but it needs to be confirmed first.
Within a cryptocurrency network, only miners can confirm transactions by solving a cryptographic puzzle. They take transactions, mark them as legitimate and spread them across the network. Afterwards, every node of the network adds it to its database. Once the transaction is confirmed it becomes unforgeable and irreversible and a miner receives a reward, plus the transaction fees.
Essentially, any cryptocurrency network is based on the absolute consensus of all the participants regarding the legitimacy of balances and transactions. If nodes of the network disagree on a single balance, the system would basically break.
However, there are a lot of rules pre-built and programmed into the network that prevents this from happening.
Cryptocurrencies are so called because the consensus-keeping process is ensured with strong cryptography. This, along with aforementioned factors, makes third parties and blind trust as a concept completely redundant.
II. THE LEGALITY OF CRYPTOCURRENCY
The legal status of cryptocurrencies varies substantially from country to country and is still undefined or changing in many of them. While some countries have explicitly allowed their use and trade, others have banned or restricted it.
According to the Library of Congress, an “absolute ban” on trading or using cryptocurrencies applies in eight countries: Algeria, Bolivia, Egypt, Iraq, Morocco, Nepal, Pakistan, and the United Arab Emirates. An “implicit ban” applies in another 15 countries, which include Bahrain, Bangladesh, China, Colombia, the Dominican Republic, Indonesia, Iran, Kuwait, Lesotho, Lithuania, Macau, Oman, Qatar, Saudi Arabia and Taiwan.
In the United States and Canada, state and provincial securities regulators, coordinated through the North American Securities Administrators Association, are investigating “bitcoin scams” and ICOs in 40 jurisdictions.
Various government agencies, departments, and courts have classified bitcoin differently. China Central Bank banned the handling of bitcoins by financial institutions in China in early 2014.
In Russia, though cryptocurrencies are legal, it is illegal to actually purchase goods with any currency other than the Russian ruble. Regulations and bans that apply to bitcoin probably extend to similar cryptocurrency systems.
Cryptocurrencies are a potential tool to evade economic sanctions for example against Russia, Iran, or Venezuela. Russia also secretly supported Venezuela with the creation of the petro (El Petro), a national cryptocurrency initiated by the Maduro government to obtain valuable oil revenues by circumventing US sanctions.
In August 2018, the Bank of Thailand announced its plans to create its own cryptocurrency, the Central Bank Digital Currency (CBDC).
III. CONCERNS ABOUT CRYPTOCURRENCIES
In many jurisdictions, the authorities are still struggling to understand Bitcoin, let alone define it in legal terms. Many concerns have been raised over its decentralized nature. It seems only natural for governing authorities to be worried on a financial community that can’t be fully controlled.
This also extends to exchanges and protection of people’s funds. While US-based exchanges have to be regulated, there are plenty of offshore platforms that don’t. Indeed, the cryptocurrency history has been filled with instances of exchanges suddenly shutting down and running away with people’s funds.
The most famous of such cases is the closure of the notorious exchange Mt.Gox. At the beginning of 2014, formerly the most prominent Bitcoin exchange in existence filed for bankruptcy due to technological problems and the apparent theft or loss of 744,000 of its users Bitcoins. That number made up about six percent of 12.4 mln Bitcoins in circulation at the time.
Bitcoin’s ability to be used semi-anonymously is another cause for concern. Even though every single transaction is recorded in the Blockchain, it is very easy for users to stay almost completely anonymous, as those records only contain the public keys and the amount of funds transferred.
Most of these concerns were voiced after a dark web market Silk Road gained mainstream-media attention, as Bitcoins were the only form of payment accepted there. The market was since shut down by the FBI, but the authorities are still worried about Bitcoin’s appeal among the traders of illegal goods and services.
Moreover, it is feared that Bitcoin’s semi-anonymity and decentralized nature can be exploited in money laundering and tax evasion schemes.
IV. REGULATORS’ OPINIONS
- SEC — Securities and Exchange Commission
The Securities and Exchange Commission has been notably quiet on the subject of Bitcoins, especially compared to regulatory bodies in other countries. In 2014, they published an investor alert, in which they warned people that Bitcoin users can be targeted by fraudsters.
The SEC has recently investigated a cryptocurrency initial coin offering (ICO) called ‘DAO.’ which was hacked and about $50 mln worth of Ether coins were stolen. In this investigation, SEC focused primarily on whether DAO coins constituted a security.
The report concluded that investing money in a token, expecting a profit which derives from the managerial efforts of other people makes a cryptocurrency a security and requires appropriate regulation.
However, SEC’s report focused entirely on Initial Coin Offerings, and Bitcoin is way past that. So, any regulations SEC is likely to impose, will most likely only concern newcomers to the market.
Whether Bitcoin can be treated as a security depends on the particular transaction, but SEC has decided that any firm using Blockchain technology to trade securities would need to register as an exchange, Alternative Trading System (ATS) or broker/dealer.
2. FinCEN — Financial Crimes Enforcement Network
According to FinCEN’s guidance on cryptocurrency, ‘virtual currency,’ as they call it, is defined as a ‘medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency.’ The guidance only addressed convertible virtual currency like Bitcoin that can either act as a substitute for real currency or has an equivalent in existing currency.
‘Users’ of virtual currency are not considered an MSB (Money Serving Business) under FinCEN’s regulations. This means that if you obtained Bitcoins to pay for goods or services, you are not subject to MSB registration, reporting and recordkeeping regulations.
In contrast, ‘exchangers’ and ‘administrators’ are considered money transmitters, and therefore are required to comply with FinCEN’s regulations. The guidance defines ‘exchangers’ as people engaged as a business in the exchange of Bitcoins and other digital currencies, while ‘administrators’ are engaged as a business in putting virtual currency into circulation.
In July 2017, in its first action against a foreign-located MSB operating in the U.S., FinCEN imposed a £110 mln penalty on BTC-e exchange, arresting one of its operators and seizing the site’s domain.
3. Federal Reserve
The US Federal Reserve is the world’s most influential banking entity, as it controls the global reserve currency – the US dollar. They are very interested in digital currencies and the technology associated with them, having published thorough papers on both Bitcoin and Blockchain.
The fact that a financial giant like Federal Reserve invested man-hours into understanding the concept of Bitcoin speaks volumes about how influential the currency is becoming.
However, the organization has repeatedly issued warnings about the risks associated with digital currencies.
Recently, the Federal Reserve stated that they are keeping very ‘close attention’ to Blockchain, describing it as something that ‘could ameliorate or exacerbate traditional financial risks.’ A US Fed Governor was also quoted saying that digital currencies could make it easier to hide illegal activities.
Janet Yellen, the US Federal Reserve chair, was recently quoted saying that the Fed is currently researching into introducing its own digital currency. If that happens, the U.S. will join the crypto market with their own, official and state-controlled cryptocurrency.
4. FINRA — Financial Industry Regulatory Authority
The self-regulatory organization for U.S. brokers has been quite active in terms of defining Bitcoin, completing guides and issuing warnings for its clients.
What is interesting, is that in its report on Distributed Ledger Technology FINRA implied that the widespread use of Blockchain technology could impact the organization’s core business practices. Specifically, the way FINRA members self-regulate in the areas of Anti Money Laundering and Know Your Customer policies, asset verification, business continuity, surveillance, payments and even record-keeping.
5. OCC — Office of the Controller of the Currency
In its 2016 paper, the office of the US Treasury proposed a possibility of moving forward with considering applications from fintech companies to become special purpose national banks (SPNBs). This initiative is set to provide companies that wish to become limited purpose digital banks with a unified federal regulatory regime.
However, as of November 2017, there are still some significant political and legal uncertainties surrounding this initiative.Moreover, the OCC released another optimistic paper in which it called for the formation of a ‘responsible innovation’ department. They are planning to launch offices in Washington, New York and San Francisco to spur the growth of emerging technologies, including digital currencies.
V. ACCEPTING PAYMENTS IN BITCOINS(FOR BUSINESS)
It’s legal for businesses both big and small to accept Bitcoins payments. Assuming, of course, that it’s a well-natured business that sells goods and services for regular currency and chooses to accept Bitcoin as another legal way to pay. Any business accepting Bitcoin payments is also required to pay taxes on income received through Bitcoin.
Bitcoin has been recognized as a convertible virtual currency, which implies that accepting it as a form of payments is exactly the same as accepting cash, gold or gift cards.
According to a Virtual Currency Guidance, which was first released by the Internal Revenue Service (IRS) in 2014, cryptocurrencies like Bitcoin are to be treated as property instead of as currency and to be taxed as such. However, it isn’t as simple as it might sound.
For instance, if you buy something worth $300 with your Bitcoins, it means that you just sold an asset. You either made a profit or a loss on that sale, depending on the Bitcoin’s value when you bought it and when you sold it. Whether it counts as an ordinary or a capital gain, short or long term depends on the circumstances.
The regulation is not entirely clear, but the IRS is trying to crack down on reporting. In the year 2015, only 802 people paid taxes on Bitcoin profits. The IRS is apparently using special software to track down Bitcoin tax cheats.
A bipartisan bill, which calls for a tax exemption for transactions under $600, was recently introduced in the House of Congress. If it passes, it will make lives of small, day-to-day traders much easier. Until then, it is recommended to keep records of all Bitcoin-related activities.
When it comes to trading Bitcoins, the records kept must contain the same information as stock or forex brokerage statements: date, description, quantity, price and fees. If you’re mining, you might need to know when the Bitcoin proceeds were attained.
Businesses accepting Bitcoins as a form of payment need to record reference of sales, the amount received in BTC and the date of the transaction. If sales taxes are payable, the amount due is calculated based on the average exchange rate at the time of sale.
At the end of our analysis, it was a question for us to define cryptocurrency, then talk about concerns about cryptocurrencies, the legality of cryptocurrency, quote the opinion of some regulators, payments in Bitcoins (for companies ), of taxation. It turns out that cryptocurrency is a virtual currency that people commonly use today for their transaction.
Moreover there are problems in the use of this currency: the payment network little developed although growing, risk of deflation / hyperinflation due to insufficient or too large monetary creation (quantity of bitcoins limited in term for example.
Also that companies can very easily use this currency to settle a debt and where to collect due debt.
In addition the legal status of this currency is not yet defined. We think that the cryptocurrency once the legislation put in place could thus revolutionized the world.
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