A look at US legal regulation of digital currency from Bitcoin

Abstract: On January 20, 2016, the People's Bank of China's digital currency seminar released a positive signal that the central bank will launch its own digital currency. The discussion of digital currency and blockchain technology occupied the front page of the media, but for ordinary people, the concept of digital currency may still be vague. Bitcoin may be the earliest understanding of digital currency for most people.

Bitcoin has the characteristics of "decentralization" and "anonymity", which seems to conflict with the central bank's plan to launch digital currency to "enhance the central bank's control over money supply and money circulation". So what kind of framework should the legal supervision of digital currency be carried out under, and what changes and breakthroughs are needed in technology? "Talking about the Legal Supervision of Digital Currency" will take you through the development history of digital currency, clarify the concept of digital currency, learn from foreign legal discussions and practices on digital currency supervision, and explore the future of Chinese digital currency.

The United States currently treats Bitcoin as a commodity, which is regulated by the CFTC. However, in the process of Bitcoin's development, the regulatory agencies involved are much more complicated. James Gatt and Elesa S. Broeker, the authors of the article "U.S. Legal Regulation of Digital Currency from the Perspective of Bitcoin", are partners and senior lawyers at B.B.B.R. LLP. The article outlines the different classifications of Bitcoin and the different regulatory measures applicable under the existing legal framework in the United States. From the perspective of regulatory agencies, banking regulators, the U.S. Securities and Exchange Commission (SEC), the U.S. Commodity Futures Trading Commission (CFTC), and the U.S. Internal Revenue Service (IRS) all have different perceptions and regulatory measures on Bitcoin; from the perspective of regulatory entities, federal laws and state laws also have obvious differences in their attitudes and treatments of Bitcoin.

I. Measures taken by various regulatory agencies

(1) Banks - Bitcoin is a "convertible virtual currency" and "money transmission business" is regulated by the Banking Security Law, and money laundering issues are of concern.

The Banking Security Act establishes strict customer identity authentication, transaction records and reporting, and other anti-money laundering requirements for financial institutions. The definition of financial institutions in the Banking Security Act includes "money transmission services", which means "receiving cash, funds, or other things with cash substitute value and transmitting them to another person or another region by any method." Bitcoin can be used as a substitute for cash value. If a person receives Bitcoin and transmits its value to another person or another region, then generally this person should meet the definition of "cash transmission services" in the Banking Security Act.

The Financial Crimes Enforcement Network (FCEN), the enforcement agency of the Banking Safety Act, issued guidance on virtual currencies (VC Guidance) on March 18, 2013. The Guidance defines virtual currencies as "a medium of exchange that functions as money in certain circumstances...but does not currently have the status of legal tender." The Guidance specifically states that Bitcoin is a "convertible virtual currency," which means a virtual currency that has an equivalent value or a fungible value to real money. Whether the Banking Safety Act can be applied to virtual currencies depends in part on whether it is a convertible virtual currency. FinCEN defines three types of people in Bitcoin transactions: 1. Users are people who use Bitcoin to consume goods or services for themselves; 2. Traders are people (institutions) who participate in the exchange of Bitcoin for real money, funds or other virtual currencies; 3. Managers are people who participate in the issuance or recall of Bitcoin (i.e., "miners"). FinCEN pointed out that the exchangers and administrators of convertible currencies are equivalent to providing cash transmission services, and therefore fall within the jurisdiction of the Banking Security Act, while users do not. FinCEN's three administrative rulings further define some special virtual currency miners, special software service providers and investors, and lessors who provide system services for mining as not money service businesses (MSBs), and therefore are not subject to the jurisdiction of the Banking Security Act. In general, whether a Bitcoin user or other related service provider is an MSB depends on the purpose of the Bitcoin: if the Bitcoin is not held for personal use, it should be an MSB, and thus needs to meet the requirements of the Banking Security Act.

Sections 1956 and 1957 of the Federal Money Laundering Control Act of 1986 are the most basic anti-money laundering regulations. Traditional money laundering methods include three steps: placement, layering, and integration. Section 1956 prohibits any knowing participant from participating in any financial transaction to help conceal or disguise the proceeds of illegal funds. "Knowledge" includes deliberate indifference and intentional blindness. Section 1957 also has legal sanctions for third-party institutions that knowingly help pay, receive, and spend illegal funds over $10,000.

(2) SEC - "Mining" contracts are "investment contracts"

The Securities and Exchange Commission (SEC) has issued risk warnings to Bitcoin investors: 1) Such investments are not insured by the Securities Investor Protection Corporation and the Federal Deposit Insurance Corporation; 2) Such investments have a history of high volatility; 3) Certain local or national governments may ban Bitcoin transactions; 3) Bitcoin may be stolen and Bitcoin exchanges may be shut down due to fraud, technical failures, hackers or malware; 4) Bitcoin does not have an established credit record mechanism.

The SEC does not give a clear definition of Bitcoin, but rather decides whether Bitcoin transactions fall within the scope of investment activities defined by the SEC based on specific circumstances. In Shavers' case, investors invested money in a "mining pool" in the hope of sharing the profits from Bitcoin "mining." However, the SEC ruled that Shavers actually created a Ponzi scheme because his so-called "mining pool" was actually false advertising. The court ruled that the investment products of Shavers' company Bitcoin Savings & Trust met the definition of an investment contract, so Bitcoin can be considered a security product. The 1993 Securities Act of the United States defines three basic characteristics for investment contracts: first, investment of money, and Bitcoin does need money to be purchased; second, there is a community (a common enterprise), Bitcoin miners who use the computing power of computers to continuously mine, and maintainers who continuously authenticate and update Bitcoin transaction records. The network they form can be regarded as a community because they have a common goal, that is, they hope that Bitcoin can appreciate; third, they hope to profit from this community rather than relying on the efforts of investors themselves. For most Bitcoin holders, the purpose of holding Bitcoin is to hope to gain the benefits brought by the appreciation of Bitcoin. Therefore, investment contracts are the best concept that can classify Bitcoin into the scope of SEC supervision.

(3) IRS - Taxed as "property", high volatility brings "tax base" problems

The IRS (Internal Revenue Service) has issued guidance applicable to Bitcoin and other convertible currencies, treating virtual currency as a type of property subject to federal tax. Different taxes apply to Bitcoin depending on its use: virtual currency payments to employees are taxable for employees, and employers must report them, and these payments are subject to federal income tax withholding and payroll taxes; virtual currency payments to independent contractors and other service providers are taxable and subject to self-employment tax rules; and the characterization of gains or losses from virtual currency transactions or sales depends on whether the virtual currency is a "capital asset" in the hands of the taxpayer; among them, the income from the sale of goods or services is taxed on the fair market price of Bitcoin in U.S. dollars on the date of receipt. If the fair market value of the asset is different from the taxpayer's virtual currency adjusted basis (adjusted basis) - the base price when the virtual currency is obtained - it will be treated as a taxable gain or loss for the taxpayer. But the question is how to determine which period of acquisition cost should be used for the paid Bitcoin.

(4) CFTC

The Commodity Futures Trading Commission (CFTC) currently (at the time of this article) lacks relevant guidance. The main duties and functions of the CFTC are to regulate the U.S. commodity futures, options and financial futures and options markets, protect market participants and the public from fraud, market manipulation and unfair business activities related to commodity and financial futures and options, and ensure the openness, competitiveness and financial reliability of futures and options markets. In September 2014, TeraExchange launched a swap transaction based on Bitcoin, which was reportedly approved by the CFTC. This swap transaction mainly protects the rights and interests of Bitcoin holders by locking in the US dollar value of Bitcoin and providing insurance against price fluctuations. There are many companies currently considering issuing a virtual currency based on gold or other commodities. The CFTC will closely monitor and regulate these activities.

2. Differences among States

In the laws of various states in the United States, there is a great deal of autonomy in the interpretation of money services laws, the core of which is how to define money and monetary value.

California's definition of currency is limited to sovereign currencies, while the definition of monetary value may be extended to virtual currencies; Texas has stated that certain virtual currency traders are subject to their money service laws, among which third parties that provide virtual currency and sovereign currency conversion transactions are generally within the scope of their legal supervision; Kansas defines virtual currency as neither currency nor monetary value based on Black's Law Dictionary, so unless sovereign currencies are involved, virtual currency transactions are not subject to its legal supervision; Idaho defines virtual currency as a payment tool based on its definition of currency, so the issuance, sale and conversion of Bitcoin requires a money transmitter license. New York State believes that it is not enough to simply apply the existing legal framework to virtual currencies. On July 17, 2014, they issued a BitLicense regulatory draft, which requires individuals and companies engaged in virtual currency-related services to have formal licenses and follow corresponding regulations at a fairly broad level.

3. Bitcoin Extended Services

The article also introduces several cutting-edge Bitcoin services. One is digital currency based on gold or other commodities, which will be regulated by the CFTC; one is physical Bitcoin, such as Casascius Coin, but such physical coins may violate the Stamp Payments Act of the United States; another is DNS (domain name system) based on the Bitcoin protocol, which will be used in the ownership registration system; the last one is the smart contract and third-party custody system (Smart Contracts and Escrows) using the Bitcoin protocol. However, the formation and execution of smart contracts still need further improvement of the law.