Bitcoins and the Law, Part IV
By: Raphael Qiu
There are a number of different statutes that regulate virtual currencies like Bitcoin. At the federal level, Article 1 Section 8 of the Constitution grants the federal government the power to “coin money, regulate the value thereof, and of foreign Coin…” This could be applied to Bitcoin since it could be considered “foreign Coin” as it originated in Japan. In addition, US counterfeiting statutes could be applied to Bitcoins just as they were used by US authorities in their case against the Liberty Dollar currency, which was a private currency that was circulated in the US and somewhat resembled US federal currency.
Another avenue for regulation is the Securities and Exchange Act because bitcoins could be considered securities since they are financial assets that can be traded for other currencies or good and services. However, the prevailing view, which has been supported by the Director of the SEC’s Division of Corporate Finance, is that Bitcoin should not be considered a security because it is not backed up by an entity or asset. The Securities and Exchange Act define securities as investment contracts or other instruments commonly known as securities which involve investors investing money, an expectation of profits from the investment, and substantial third-party control of the enterprise.
Furthermore, attorneys like John Nelson have argued that Bitcoin would fail to qualify as a security under the risk capital test established by the 1972 Oregon case, SEC v. Glenn Turner Enterprises. The risk capital test looks at whether the investor of the purported security subjects his money to the risk of an enterprise over which he has no managerial control. Nelson claims that Bitcoin does not satisfy this test because it involves a computer processing investment rather than a monetary investment and because there is no managerial control due to its decentralized nature. William Hinman, the Director of the SEC’s Division of Corporation Finance, has clarified that current offers of Bitcoin and Ether are not securities because purchasers no longer expect a person or group to carry out essential managerial or entrepreneurial efforts. However, initial coin offerings may be considered securities since the purchase is intended primarily as an investment rather than for consumption to use in order to buy goods or services.
Nevertheless, some courts have ruled that certain Bitcoins transactions are securities and are thus subject to SEC regulation. In the case of SEC v. Shafers, the SEC charged Shafers with soliciting and misusing investors’ Bitcoins and thereby violating the registration and anti-fraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Exchange Act. Starting in November of 2011, Shafers ran a Bitcoin investment company which allowed him to solicit over $4.5 million worth of Bitcoins by promising investors up to 1% interest daily. While Shafers claimed that the Bitcoin investments were not securities, the District Court for the Eastern District of Texas held that they were because Bitcoin is a form of currency and Shafers’ investors provided an investment of money. The Court then examined the common enterprise requirement of securities and found that it was satisfied because the investors were reliant on Shafers’ knowledge of Bitcoin markets and his connections. Lastly, the Court held that the third requirement of securities, that there be an expectation of profits, was satisfied since the investors were clearly expecting profits as Shafers had promised up to 1% interest daily.
In addition to the federal government, states are also taking an active hand in regulating Bitcoin. In June of 2014, California passed a new law that granted Bitcoin and other virtual currencies the same status as legal money. Regulators could also take a page from the prosecution of digital currencies like e-Gold which was held to be in violation of the US Patriot Act’s prohibition against operating a money transmitter business without an appropriate license.
Other statutes that can be applied include the Bank Secrecy Act and the Money Laundering Statute. The Bank Secrecy Act requires all financial institutions, which would include currency exchanges that trade Bitcoin, to report all transactions over $10,000. These reporting requirements would help to decrease criminal activities as Bitcoin transactions would no longer be totally anonymous. Even if a Bitcoin company fails to comply with the self-reporting requirements, the government could acquire a search warrant and seize the company’s assets.
On the other hand, some countries have responded to Bitcoin by restricting its use and exchange. In December of 2013, the Chinese central bank banned financial institutions from trading in Bitcoins though it did not ban trading platforms from dealing with bitcoin. Although this move caused the price of a Bitcoin to drop by $300, it has not reduced the popularity of Bitcoin in China. According to a recent Goldman Sachs report, at least 80% of all Bitcoin transactions are driven by the Chinese yuan not to mention the fact that China is home to the world’s largest Bitcoin mines, which contain large computer networks that are used to mine for Bitcoins.
In spite of the uncertainty surrounding bitcoins, more companies, online sites, and marketplaces are accepting bitcoins at an exponential rate while the number of bitcoin ATMs doubled over 2016. Thus, it is important to engage in due diligence or seek out a legal firm like Marcum, P.C. before deciding whether to accept or use virtual currencies like bitcoin.
Nicolas Wenker, Online Currencies, Real-World Chaos: The Struggle to Regulate the Rise of Bitcoin, 19 Tex. Rev. L. & Pol. 145, 185 (2014)
“Why Bitcoin isn’t a security under federal securities law”. http://www.lextechnologiae.com/2011/06/26/why-bitcoin-isnt-a-security-under-federal-securities-law/
“Goldman Sachs Report says Bitcoin could shape future of finance”. http://www.coindesk.com/goldman-sachs-report-says-bitcoin-could-shape-future-of-finance/
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