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Bitcoin was created at the peak of the financial crisis in 2008 by a coder going by the alias Satoshi Nakamoto. In 2009, Nakamoto published the first proof of concept for Bitcoin. He left the network in 2010, leaving Bitcoin without leadership. Though Nakamoto himself never truly controlled Bitcoin. According to Bitcoin’s official website, its “protocol and software are published openly and any developer around the world can review the code or make their own modified version of the Bitcoin software.” In other words, the position of a leader is futile in a system that survives based on continuous adaptation from the public.

Bitcoin functions as an open source network within which transactions occur directly between participants without intermediaries. It provides, at least in theory, a secure route for peer-to-peer currency with near perfect anonymity.

Bitcoins are stored on a blockchain ledger , provided to and updated by all holders. According to the New York Times, “Each unit of the virtual currency is nothing more than an entry on a digital ledger, just as most dollars and cents exist only as entries on a bank’s digital ledger.” Its price fluctuates based on the market; in April 2013, it hit $230 per bitcoin, but then dropped to $70 in July, and then rose up to over $600 in November. Bitcoin values are volatile because its worth is based completely on the number of people taking part in the system. Much like stocks being bought and sold, as mining and purchasing increases, Bitcoin’s value rises just as the inverse can occur.

Anyone is able to use Bitcoin, whether it be for payment in exchange for goods and services, for purchase, or for Bitcoin mining. It is not however, an actual legitimate currency, like the U.S dollar or the Euro. Bitcoin, under United States federal law, is a virtual currency. Its virtual currency status disallows it from being legally used to cover finances directly. Exchanging for goods and services is only legal if both parties take part in Bitcoin use; otherwise it is not universally used for such purposes.

Virtual currencies differ from real currencies in that real currencies account for the coin and paper money of any nation. According to the Financial Crimes Enforcement Network, this form of currency has three fundamental characteristics:

[i] It has legal tender

[ii] It circulates in the economy

[iii] It is accepted as a form of exchange in the country that issues it.

Real currency is the tangible cash that people use for day-to-day transactions.

A virtual currency, like Bitcoin, “is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction.” It is only a form of currency that is comparable to the U.S. dollar and other national currencies. That attribute classifies currencies like Bitcoin as a “convertible” virtual currency— a “virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency.”

In the U.S., “convertible” virtual currency is considered a type of property for tax reasons, akin more to common stock held by shareholders. Like common stock, the value of Bitcoins fluctuates, which means that people can incur either gains or losses when spending their Bitcoins. People can also convert Bitcoins, immediately after receiving them, to legitimate currency, making them immune to constant fluctuations. For tax purposes, holding onto Bitcoins for extended periods of time renders the Bitcoin an investment, which means they get taxed as capital gains. Converting Bitcoins to legitimate currency however, make them a source of income, which means they get taxed the income tax rate. Due to their ability to create profit the government can legally tax bitcoins, just as it does to stocks, even though in both cases the tax is not on an existing, tangible currency. Rather, the tax is based on profit incurred.

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Among “convertible” virtual currencies, there are two main factions, centralized and de-centralized currencies. In a centralized repository, “The administrator of that repository will be a money transmitter to the extent that it allows transfers of value between persons or from one location to another.” Centralized currencies have a focal point of operation akin to a central bank. Under these conditions, virtual currency exchange is inherently legitimate and organized. There is accountability amongst exchangers and the intermediary that controls it.

De-centralized currencies encompass the kind of currency “(1) that has no central repository and no single administrator, and (2) that persons may obtain by their own computing or manufacturing effort.” It does not have a centralized authority ensuring the completion of transactions and as a result is not based on legitimacy. Its function does not require it to be held accountable to its customers. There is more freedom for development and, according to the Economist, “it depends instead on a distributed system of trust, based on a transaction ledger which is cryptographically verified and jointly maintained by the currency’s users.”

Bitcoin does not have a centralized authority guiding transactions. It is the product of a continuous amalgamation of code developed by the public. The very nature of its open source network ensures success based upon trust, not organized control.

Trust in turn does not always connote truth or legality. Bitcoins are notorious for their part in illegal transactions. Recently, suspects Pascal Reid and Michel Abner Espinoza, were charged with money laundering in Florida. Reid received an additional count for being an unauthorized money transmitter. The first charge for Bitcoin in connection to money laundering, this can open a discussion into new regulations for the network.

Supporters of Bitcoin want the last count to be dismissed, arguing that Reid cannot be a transmitter because Bitcoin is not a valid currency and because he acted alone in a peer-to-peer transaction. The issue with this argument is that Bitcoin, while not “real “ currency, is still a type of currency. Under its classification of a de-centralized virtual currency, the Financial Crimes Enforcement Network states,

A person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.

Federal law has legal grounds to charge Reid as an unauthorized transmitter because he allegedly sold $25,000 worth of Bitcoins to a Secret Service agent during an undercover operation in effect making himself the transmitter, despite his lone action, and violating federal law in the process.

Money laundering is not the first criminal offense to be associated with Bitcoin. Bitcoin is vilified for its association with illegal drugs. The anonymity, fast transactions, and virtually free global network allows for drug trade to thrive. Law enforcement cannot effectively track down the members of the drug trade, and as one site goes down, more are created to replace the international network of illicit goods. While, like federal money, Bitcoin is used for legitimate business transactions, its utility in illegal exchanges is incomparable to standard currencies, as money trails are easier track than Bitcoin trails.
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Problems that arise from Bitcoin’s legality question the possibility of virtual currency becoming a credible long-standing official currency for the future. The likeliness of virtual currency like Bitcoin, an un-centralized currency, becoming a universal currency in the United States or otherwise, is slim because the risks that arise from such a network far outweigh any reward individuals may receive from it.

In 2013, the North American Securities Administration Association (NASAA) ranked virtual currency in its list of top ten threats for investors. The U.S. Securities and Exchange Commission warns investors of the heightened risks of fraud associated with new technology, like Ponzi schemes. For example, in July 2013, in the legal case SEC vs. Shavers, the defendant was charged for an alleged Bitcoin based Ponzi scheme. The SEC also warns that, “Scam artists may take advantage of Bitcoin users’ vested interest in the success of Bitcoin to lure these users into Bitcoin-related investment schemes.”

Bitcoin has the potential to alter the basis of domestic and international finance for the better, but it is far ahead of its time. The world does not have the safeguards that are necessary for effectively introducing it as a universal system.

While virtual currency can eventually become a feasible option for society, the heightened risks today of being defrauded, coupled with the currently limited ability of government to effectively protect the public in such cases, produces a combination that would prove to be fatal for future generations under a universal virtual currency policy.

However, with an evolution in the techniques that combat fraud and other crimes associated with virtual currency, society would be able to truly enjoy the perks that systems like Bitcoin boast. Changes will refortify, to a certain extent, the public’s right to privacy, as well as open new international connections on a purely financial level, ultimately spreading financial welfare throughout the globe.

 

-Louisa Saakian

 

Sources:

The Economist:

http://www.economist.com/news/technology-quarterly/21590766-virtual-currency-it-mathematically-elegant-increasingly-popular-and-highly

Bitcoin:

https://bitcoin.org/en/faq

The New York Times:

http://www.nytimes.com/2015/11/05/business/bitcoin-basics.html?_r=0

Financial Crimes Enforcement Network:

https://fincen.gov/statutes_regs/guidance/html/FIN-2013-G001.html

IRS:

https://www.irs.gov/pub/irs-drop/n-14-21.pdf

Washington Post:

https://www.washingtonpost.com/news/the-switch/wp/2014/08/01/bitcoin-isnt-a-currency-bitcoin-advocates-argue/

Washington Post:

http://www.washingtonpost.com/news/the-switch/wp/2014/03/25/got-bitcoins-heres-how-the-irs-says-to-pay-them-on-your-tax-return/#

U.S. Securities and Exchange Commission:

https://investor.gov/news-alerts/investor-alerts/investor-alert-bitcoin-other-virtual-currency-related-investments#.U2vvUfldXAu

 

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