Following a series of multimillion-dollar thefts and losses, federal regulators want to step up their oversight of virtual currency bitcoin. But bitcoin—a nationless digital money that uses cryptography to control its creation and transactions—doesn’t fit neatly in any regulatory box.
“There’s an incredible interest in regulating this at the federal level,” said Kenneth Russak, a commercial-finance specialist at Frandzel Robins Bloom & Csato.
Potential overseers include the Federal Trade Commission, the Commodity Futures Trading Commission, the U.S. Securities and Exchange Commission and the Consumer Financial Protection Bureau. All are charged with protecting consumers or investors from fraud, but their jurisdiction over bitcoin transactions is unclear.
“All of these agencies are pounding square pegs against round holes,” said Perkins Coie counsel Joe Cutler, a member of a practice the firm has set up to advise on virtual currencies. “None of the regulations covering traditional financial services contemplate in their defined terms these new virtual currencies.” About 12 million bitcoins are now in circulation, with a value of $8 billion.
In February, the world’s biggest bitcoin exchange, Mt. Gox, lost $400 million of its customers’ money when hackers stole 750,000 bitcoins. Once taken, the coins—like cash—cannot be traced.
Since then, more bitcoin exchanges have been hit. On March 3, Canadian start-up Flexcoin announced it was shutting down after about $600,000 in bitcoins were stolen. On March 4, multicurrency exchange Poloniex had 12 percent of its bitcoins stolen. And on March 24, Vircurex, based in China, announced it was freezing some accounts after it lost “a significant number” of bitcoins and other digital currencies in cyberattacks.
Bitcoin defenders acknowledge there’s a problem. “Events in the last few months have shown the acute need for better security, sounder and more mature bitcoin businesses and wider consumer adoption,” Bitcoin Foundation global policy counsel Jim Harper wrote in a March 14 foundation blog post.
Bitcoin, which allows person-to-person payments without a financial institution acting as intermediary, has very low or nonexistent transaction fees. With no currency exchange fees, it also makes international sales easier and cheaper.
In some ways, more regulation could help bitcoin’s growth by bolstering consumer confidence, Russak said. “Some sort of government regulation might make these [digital] currencies more attractive to consumers. It’s kind of the Wild West now.”
At the same time, the lack of regulation is precisely what has made bitcoin appealing to many of its first users. In some instances, they included criminal enterprises, such as online drug bazaar Silk Road, which used bitcoins as its exclusive method of payment. The FBI shut down Silk Road in October.
The Treasury Department’s Financial Crimes Enforcement Network, or FinCen, was the first federal overseer to offer bitcoin guidance. In March 2013, FinCen said that people who exchange bitcoins for real money and those who “mine” them on behalf of others must register as money-service businesses and comply with money-laundering laws under the Bank Secrecy Act.
In a seemingly contradictory holding, the Internal Revenue Service on March 25 held that, for tax purposes, bitcoins are property, not currency, and are subject to capital gains. The decision is likely to cause considerable accounting headaches, especially since there is no de minimis exception for small transactions. “Potentially, if you want to buy a cup of coffee [with bitcoins] you have to calculate your capital gains,” Jerry Brito, a senior research fellow at the Mercatus Center at George Mason University, testified before the House Committee on Small Business on April 2.
Lawyers said the Federal Trade Commission may emerge as the leading regulator of bitcoin transactions.
“This has been a pretty activist FTC when it comes to consumer protection, in particular in the context of the digital world,” said Steptoe & Johnson LLP partner Jason Weinstein, a specialist in privacy and data security. “I wouldn’t be surprised if the FTC started looking at whether [bitcoin] exchanges are fully and adequately notifying consumers about the risk of theft and loss.”
Weinstein said the FTC could find the authority to do so under Section 5 of the Federal Trade Commission Act, which bars unfair or deceptive conduct. He also said the FTC might look at whether exchanges have taken reasonable security measures to protect consumers’ accounts. An FTC spokesman declined comment.
The Consumer Financial Protection Bureau (CFPB) might also assert jurisdiction over bitcoin transactions. The agency in January proposed a rule that would allow it to supervise international money-transfer providers for the first time. Such providers would have to give consumers 30 minutes after payment to cancel a transfer for any reason and would be responsible for certain types of errors.
All bitcoin transactions, by contrast, are final and irrevocable.
Stephen Middlebrook, general counsel of FSV Payment Systems Inc., speaking during a March 28 webinar on bitcoin sponsored by the American Bar Association, said the CFPB rule as written doesn’t seem to contemplate virtual currency, “but given that remittance payments are something that a lot of people are talking about as a product that bitcoin and other cryptocurrencies would be useful in, I think it would be very interesting to look at the CFPB rules and see if they might apply.”
The Securities and Exchange Commission is another potential regulator. Arnold & Porter counsel Andrew Shipe, also speaking during the ABA webinar, said bitcoin is not a stock, bond, note or investment contract and so “does not fit into the definition of a security.” While bitcoins can be bought and sold for speculative purposes, that doesn’t make them securities, either—a piece of antique furniture could also be bought and sold for speculative purposes, he said.
And bitcoin doesn’t quite fit the definition of a commodity, which is usually thought of as something tangible, like wheat or cotton. However, Shipe said, if an organization were to list and trade bitcoin futures, “That would turn bitcoins into a commodity.”
Bart Chilton, who stepped down as a commissioner at the Commodity Futures Trading Commission in March, has asserted that the agency could regulate bitcoins. “If somebody’s buying it and holding it for the future, then it’s something that we at least could regulate, squarely,” Chilton said on CNBC in May.
An agency spokesman in a written statement said: “The CFTC has not yet taken any actions with regard to bitcoin, so we decline to comment.”
To Cutler of Perkins Coie, the agencies are “playing a bit of hot potato” when it comes to bitcoin. “Until federal and state legislation clarifies the nature of virtual currencies…it is hard to imagine that all of these disparate regulatory agencies will magically agree on what to do.” •