Bitcoin was founded on the principles of decentralization, meaning that the cryptocurrency was not regulated by the central authority in the way that a traditional (or fiat) currency would be. As Bitcoin, and the blockchain technology behind it, remains quite new and in the early stages of its evolution, authorities are still trying to get to grips with what exactly the technology is before attempting to come up with a plan about how to deal with it, especially in relation to taxation and money laundering issues.
Currently, there is no uniform international approach to Bitcoin and its legality will depend on where in the world that you reside. However, as authorities gain more experience and knowledge about Bitcoin, and the cryptocurrency industry in general, it is likely that at least a certain minimum levels of regulation will come into place in the vast majority of countries. In addition, the huge gains being made by the cryptocurrency this year has meant that authorities are feeling that urgency about regulating the sector, with over 30 global regulators having announced various approaches to cryptocurrency regulation in recent months.
What are the concerns?
Not long after its inception, Bitcoin had gained the attention of regulators as a result of its popularity amongst vendors and customers on the Dark Web, an area of the internet that was rife with illegal trade in items ranging from weaponry to illegal drugs. For example, the infamous Silk Road marketplace only accepted Bitcoin on its site in order to ensure anonymity for its customers. The infamy of Bitcoin, and the subsequent closing down of the marketplace by the FBI, to US Senator Charles Schumer explicitly referring to Bitcoin as a “surrogate currency” that enabled criminal activities.
In addition, the semi-anonymous and decentralized nature of Bitcoin meant that authorities feared that it would be used for money laundering. For example as early as April 2012 the FBI indicated that the lack of regulation could mean that Bitcoin could be used for illegal activities by criminals, especially when offshore exchanges were available.
Other issues arising include the fact that as Bitcoin has risen in value, its usefulness when it comes to making transactions has fallen and it is being used more and more to store value, leading to the possibility of a bubble. It is suggested that the vast majority of Bitcoin transactions over the last 12-24 months have been for speculation purposes, with the volatility of the asset and the demands (and resulting expense) that the sudden surge of interest has placed on the currency making it increasingly unsuitable for everyday transactions.
Current Approach to Regulation
Although a small number of countries have restricted or banned Bitcoin, most countries allow Bitcoin to be used, while a patchwork of regulations having been put in place in different. The decentralized nature of Bitcoin makes it very difficult to enforce restrictions on Bitcoin, even in those countries that have banned it. Below, we have a look at the approach of a number of different jurisdictions.
The US does not yet have a uniform approach to the regulation of Bitcoin at a Federal or State level. The Federal Reserve does not have a policy towards the regulation of Bitcoin, although it has said that it may be a matter that they will have to consider at some point in the future, The Financial Crimes Enforcement Network (FinCEN), an agency within the US Treasury Department, published guidelines about cryptocurrencies as early as 2013, which suggested that although using cryptocurrency for purchasing legal goods and services was not illegal, the mining or trading of bitcoin as well as the operation of exchanges on which Bitcoins are traded would fall under the label of “money transmitters “ and would be subject to the same Anti-Money Laundering (AML) and Know Your Client (KYC) measures as other money service businesses. FinCEN has also been involved in an action again the Russian-domiciled BTC-e exchange for a breach of US AML laws, which was the first action taken against a non-US based exchange.
The US Securities and Exchange Commission (SEC) have yet to issue any regulations on Bitcoin or cryptocurrencies. However, they have issued a number of warnings about the volatility and risk of fraud in the sector, including a warning from the chairman of the SEC in November 2017 relating to the risks surrounding ICO’s. The US Commodity Futures Trading Commission (CFTC) has designated Bitcoin to be a commodity, and although the CFTC does not regulate Bitcoin directly, it does have authority in respect of commodity futures that are directly connected to Bitcoin. For example, the CFTC recently accepted a proposal by the Chicago Mercantile Exchange to allow Bitcoin and other cryptocurrency to be cleared in the same manner as other products, which could have a major effect on the value of Bitcoin.
At a State level there have been various approaches taken by individual States, particularly in relation to the regulation of exchanges or other money transmitters. Some States, such as New York, have made attempts to make specific licensing regimes that are applicable to cryptocurrency exchanges whereas other states, such as Texas, continue to apply existing financial laws and regulations to the use of cryptocurrencies. However, the effect of this licence in New York was considered by some to be a stifling of the fintech industry’s use of cryptocurrency in that State. In fact, the New York Bitlicence is currently being challenged by the Bitcoin Foundation, who are increasingly active in lobbying against large scale regulation of the industry. The Bitcoin Foundation has stated its opinion that the US government is increasing federal and state regulation of Bitcoin in the US with a view to “control and stifle the adoption and use of so-called ‘virtual currencies’ such as Bitcoin.”
The EU has taken a more open approach to Bitcoin than the US, as well as offering less ambiguity. Indeed, the EU already had a framework to govern the use of electronic money before the invention of Bitcoin, which was adaptable to fit cryptocurrencies such as Bitcoin.
The European Central Bank has classified Bitcoin as a ‘convertible decentralized virtual currency’. The European Banking Authority (EBA) has advised European banks not to trade in any cryptocurrencies until a regulatory regime was put in place. In 2016, the European Parliament agreed to set up a taskforce to monitor cryptocurrencies with a view to combating money laundering and terrorism. The European Commission has further proposed that cryptocurrency exchanges and digital wallets would be subject to regulation in order to prevent tax evasion.
The current rapporteur of the first Blockchain Resolution of the European Parliament has suggested that the benefits of a framework of rules in respect of the blockchain industry would allow for companies and customers operating in the sphere to act on a level playing field. She stated that without certainty about regulation, it is unlikely that the required scalability of the technology will be able to occur. She further proposed that ICOs, for example, should be defined within their own structure, rather than any attempt be made to make it fit into the current regulatory structures of securities or commodities. This approach is in line with the view of the Bitcoin Foundation themselves, who have stated that any premature regulation of Bitcoin “might put it into a box it might not fit into later on.”
Although legal for individuals in China, there has been a clampdown on the trading of Bitcoin in 2017, with multiple exchanges having to delay or pause Bitcoin withdrawal services. This clampdown arrived in tandem with an increase in the Chinese media noting the dangers of cryptocurrency as a tool for criminal activities, which suggests that this has been a de facto regulation of Bitcoin. In addition, officials in the People’s Bank of China have noted that Bitcoin exchanges operating in China needed strict supervision and a form of licensing.
The other area in which authorities are increasingly looking at how regulation will be implemented in respect of Bitcoin is in the area of tax. Due to the semi-anonymity of Bitcoin, it can potentially be used to hide assets and assist in reducing taxation. There is no uniform international approach on how profits made from trading in Bitcoin or other cryptocurrencies should be taxed. For example, the EU has declared that the trading of cryptocurrencies should not be subject to VAT on the basis that the exchange transactions were a supply of services rather than a supply of goods, which is an approach that was also taken by the UK prior to the EU ruling. In the US, the IRS confirmed in 2014 that it would treat cryptocurrencies such as Bitcoin as property instead of a currency. This means that any profits made from Bitcoin investment is charged at each investor’s capital gains rate as opposed to their ordinary income rate.
There are a number of potential approaches that authorities could take when it comes to the regulation of Bitcoin.
- Cryptocurrency providers and exchanges will act as regulators of the currency by ensuring that AML and KYC regulations are complied with. Some of the existing exchanges, such as Coinbase, already enforce these regulations.
- Governments could take the nuclear option and completely block Bitcoin, or other cryptocurrencies that don’t abide by government regulation. As noted above, this would be difficult to enforce as governments have thus far found it difficult to completely block access to websites.
- Governments could alternative impose limited prohibitions, such as banning the sale of real-life goods in exchange for cryptocurrency in order to avoid Bitcoin being used as payment for illegal goods.
- Governments could also selectively regulate the industry, especially in respect of taxation. This is similar to the current UK and EU approach. This would result in some of the fundamental areas of the industry being regulated, such as tax and AML, without widespread regulations being put in place.
- Governments could provide supporting mechanisms whereby the consensus of users would enforce their own ‘community standards’. The downside of this approach is that it may result in regulators allowing illegal or fraudulent activity to go unchecked.
The EU proposals for regulation have followed broadly the approach taken by the French government, which included the following proposals:
- In order that users cannot remain anonymous, ensure that exchanges and intermediaries require proof of identity upon opening accounts.
- Publish a set of instructions for both consumers and regulators in respect of the taxation of virtual currencies.
- Propose caps on payments that can be made in cryptocurrencies, similar to caps that are already in place in respect of cash transactions.
- Regulate, at an EU level, any companies that offer exchanges between cryptocurrencies and fiat currencies.
According to Steve Keen, the Head of the School of Economics, History and Politics at Kingston University in London, the regulation of Bitcoin is inevitable. He noted that the existence of a futures market in Bitcoin means that there is likely to be a drop in price due to the variety of positions that can be taken in Bitcoin. He also suggested that there are possibilities that, without regulation, hard forks could be forced upon users. He has suggested that the futures market in Bitcoin means that holders of the asset are now linked to a greater extent to the financial system, meaning that what happens in other markets can affect the price of Bitcoin.
However, across the industry there are various opinions and drivers for regulation. For some, the regulation of Bitcoin would add legitimacy to the cryptocurrency. However, for others Bitcoin is low on the priority list as it is not a pressing issues. In addition, the cryptocurrency industry itself are opposed to large scale regulation that would negatively affect the decentralized nature of Bitcoin. The other issue, as suggested above by the EU approach, is that the regulators remain unsure about what or how to regulate. Fitting the cryptocurrency industry into the existing structures is likely to stifle the industry. However, to create a new regulatory and tax structure purely for cryptocurrency like result in significant expense on the taxpayer.
The year 2017 has seen cryptocurrencies break away from being a niche industry used by the tech industry to become something far more mainstream. This breakout has resulted in Bitcoin becoming a buzzword in the office and in the home. As a result, it has become almost inevitable that regulation in some form or another is on the way. However, the big questions that remain are what form will such regulations take and what effect will they have on the industry.