Bitcoins, here represented by gold coins, are a virtual currency produced by an algorithm that miners run on computers using open-source software. (Zach Copley/Wikimedia)

As the virtual currency bitcoin becomes more prevalent and commercialized, lawyers are getting involved.

The State Bar of Georgia’s international law section held a panel discussion April 3 to explain how bitcoin works and how it is regulated, to the extent it can be. About 25 lawyers and an FBI agent turned out for the lunchtime panel at Kilpatrick Townsend & Stockton.

Panelists were Lauren Giles, part of Alston & Bird’s payment systems team; Thomas Krepp, an assistant U.S. attorney for the Northern District of Georgia, and FBI Special Agent William Ware, who handles cybercrimes.

Bitcoin is generated by complex mathematical algorithms instead of the U.S. Treasury. A mysterious Japanese mathematician named Satoshi Nakamoto is thought to have created the cryptocurrency, but no one knows for sure.

“It is a means of exchange that is not endorsed or authorized by any government,” Giles said.

Bitcoin holders are anonymous and can transact it globally via the Internet, unburdened by fees and regulations, which is both the appeal and the risk. The cryptocurrency attracted notice for its use in criminal activities last year when the U.S. government shut down Silk Road, an online drug-selling website that accepted payment only in bitcoin.

But the discussion last week focused on legitimate transactions. Since the first bitcoins were created five years ago, exchanges have sprung up for people to buy and sell them, using dollars or other fiat currencies, and an increasing number of businesses accept them as payment.

Bitcoin usage and regulation is a fast-evolving area. When Giles started preparing for the panel in February, she said, Mt. Gox, one of the world’s most active bitcoin exchanges, had just declared bankruptcy and no one knew how the IRS would treat the virtual currency.

“The percentage of Americans who’d even heard of bitcoin was about half of what it is today. So a lot has happened in eight weeks,” Giles said.

Two weeks ago, just in time for 2013 tax filing, the IRS said it will treat bitcoin as a taxable asset, not a currency. “Lots of bitcoin holders are going to be very surprised that they have a tax liability,” said James Noble, the head of the bar’s international law section, who organized and moderated the panel. Now they must keep good records of their bitcoin holdings and transactions, he added.

The IRS ruling makes advising clients on bitcoin transactions more difficult, Noble said. He likened bitcoin to a chameleon that changes color with the situation. Whether it is treated as an asset or a currency means different legal regimes could apply for various parts of a transaction. “If the bitcoin creator is U.S.-based, he owes a whole lot of money to the U.S. government,” Noble added.

Most bitcoin holders are investors, not transactors, Giles said.

Worth as little as 30 cents in its early days, a bitcoin’s current value is $452.38, according to BTCQuote.com, so early bitcoin holders may have realized significant capital gains.

The value has fluctuated wildly, rising to about $1,000 in November on some exchanges, then falling to about $400 after Mt. Gox shut down. The Tokyo exchange in March said it lost 850,000 bitcoin, worth almost $500 million at the time, to hackers and poor accounting.

The panelists explained how bitcoin works. People called miners provide the enormous computing and electrical power required to calculate the complex algorithms that maintain the bitcoin system, using free, open-source software. The computations verify and then record bitcoin transactions in a public registry, called the block chain. In return, an algorithm awards miners newly generated bitcoins. The foundational algorithm allows for 21 million bitcoin and about half have been created.

Each bitcoin is identified by a unique serial number or public key. Users store and exchange them using wallet software.

The algorithms also keep the system secure, said Krepp. Even so, there have been many reported instances of bitcoin theft. To steal a bitcoin, a hacker steals the serial number or public key associated with it.

Identifying the thieves is difficult. “That’s my job. It’s very hard to determine who it is,” said Ware, the FBI agent. “If someone really knows what they’re doing with bitcoin, they are virtually impossible to trace.”

A lawyer in the audience asked how the value of bitcoin is established, since the cryptocurrency is not backed by anything tangible such as gold. Bitcoins have value because people will accept them as payment, Giles said.

Bitcoin adherents “would say those transacting in dollars put their faith in the U.S. government while those transacting in bitcoin put their faith in a mathematical algorithm,” Krepp added.

One concern with bitcoin transactions, Giles said, is that there are no consumer protections. Once bitcoin is transferred, the previous holder can’t get it back, even if there is theft or fraud. If an exchange shuts down, participants lose their bitcoin. By contrast, the FDIC insures bank accounts for up to $250,000, giving depositors some protection.

LocalBitCoins.com lists bitcoin buyers and sellers by city so they can make a face-to-face exchange. In Atlanta it lists six individuals offering bitcoins at prices from $510 to $687. Ashaw596, who asks for $510 in cash, prefers to meet on the Georgia Tech campus or at a Starbucks with wifi.

Instead of insurance or regulatory oversight, LocalBitCoins.com provides the number of transactions and feedback scores for each vendor, akin to eBay. Ashaw596, for example, has made five trades and has a 100 percent satisfaction rating by buyers. “Fast and smooth,” was one buyer’s comment.

Regulatory issues come into play with bitcoin exchanges. A business that exchanges bitcoins for dollars or other currency is classified as a money services business, and federal regulations apply, Krepp said.

Money services businesses must register with the Treasury Department’s Financial Crimes Enforcement Network, known as FinCEN. They are required, among other things, to have anti-money laundering policies and file suspicious activity reports. Otherwise, an enterprise is subject to prosecution and its accounts will be seized, Krepp said.

A growing number of businesses are accepting bitcoins as payment. Giles said many small merchants use a payment processor instead of holding bitcoins and converting them into dollars because they don’t want to deal with the regulatory and record-keeping requirements.

But to her knowledge, no banks are holding bitcoins. Giles explained that bitcoin is a payment system that competes with banks. Bitcoin transactions have no fees or lower fees because they do not have to comply with the same consumer protection and regulatory laws.

As bitcoin payments become more widespread, transactors may want to partner with banks to convert bitcoins into dollars, Giles said, but that is not the vision of bitcoin’s creators. “It’s the dream of a frictionless global exchange system that people are invested in.”

Whether bitcoin works out or not, Ware said, cryptocurrency is the future. “Banks are going to have to adapt or become obsolete.”