Bitcoin is of interest to law enforcement, tax authorities, and legal regulators, all of which are trying to understand how it fits into existing frameworks. The legality of your bitcoin activities will depend on who you are and what you are doing with it.
Bitcoin has proven to be a contentious issue for regulators and law enforcers, both of which have targeted the virtual currency in an attempt to control its use. We are still early on in the game, and many legal authorities are still struggling to understand the cryptocurrency, let alone make laws around it. Amid all this uncertainty, one question stands out: is bitcoin legal?
The answer is yes, depending on what you’re doing with it. Read on for our guide to the complex legal landscape surrounding bitcoin. Most of the discussion concerns the US, where many of the legal dramas are currently playing out.
What are the concerns about bitcoin?
is bitcoin legalGovernment agencies are increasingly worried about the implications of bitcoin, as it has the ability to be used anonymously, and is therefore a potential instrument for money laundering. In particular, law enforcers seem to be concerned about the decentralized nature of the currency.
As early as April 2012, the FBI published a document highlighting its fears around bitcoin specifically, drawing a distinction between it and centralized digital currencies such as eGold and WebMoney. It voiced concerns that while US-based exchanges are regulated, offshore services may not be, and could be a haven for criminals to use bitcoin for illicit activities without being traced.
Bitcoin was the only a form of currency when trading on Silk Road, an anonymous marketplace that was only accessible over the TOR anonymous browsing network, and which was closed by the FBI in October 2013. Silk Road was commonly used to sell goods that are legal in many countries, including narcotics. This prompted US Senator Charles Schumer to call for the site to be shut down, explicitly linking it to bitcoin, which he called a “surrogate currency”. The US Drug Enforcement Administration seized bitcoins from a US resident for purchasing a controlled substance in June 2013.
Who regulates it?
Regulators will vary on a per-country basis, but you can expect to see national financial regulators interested in bitcoin and other virtual currencies, potentially along with regional regulators at a sub-country level.
FinCEN
In the US, the Financial Crimes Enforcement Network (FinCEN), which is an agency within the US Treasury Department, took the initiative. It published guidelines about the use of virtual currencies. FinCEN’s March 18, 2013 guidance defined the circumstances under which virtual currency users could be categorized as money services businesses (also commonly known as money transmitting business or MTBs). MTBs must enforce Anti-Money Laundering (AML) and Know Your Client (KYC) measures, identifying the people that they’re doing business with.
CFTC
The US Commodity Futures Trading Commission (CTFC), which looks after financial derivatives, hasn’t announced regulation yet, but has made it clear that it could if it wanted to.
SEC
The US Securities and Exchange Commission (SEC) hasn’t issued solid regulations on virtual currencies, but its Office of Investor Education and Advocacy published an investor alert to warn people about fraudulent investment schemes involving bitcoin. In particular, it warned of Ponzi schemes, after charging Texas resident Trendon T Shavers, aka ‘pirateat40’, founder and operator of Bitcoin Savings and Trust, with allegedly raising 700,000 bitcoins by promising investors up to 7% weekly interest.
Legislative branch
The SEC case has forced the legislative branch of government to consider bitcoin’s legal status. Shavers had claimed that he could not be prosecuted for securities fraud, as bitcoin wasn’t money. However, Judge Amos Mazzant issued a memorandum arguing that bitcoin can be used as money.
In August 2013, the US Senate wrote to several law enforcement agencies, inquiring about the threats and risks relating to virtual currency. The letters included this one to the Department Of Homeland Security, fretting about the lack of a paper trail for regulators and enforcement agencies to follow for virtual currency transactions. It requested policies and guidance related to the treatment of virtual currencies, and information about any ongoing strategic efforts in the area.
November saw responses from the various agencies. The Department of Homeland Security was the most worried about the criminal threat from illicit use of bitcoin, while the Department of Justice, the Federal Reserve and the Department of Justice all acknowledged the legitimate uses of virtual currencies. The SEC argued that “any interests issued by entities owning virtual currencies or providing returns based on assets such as virtual currencies” were considered securities and thus fell under its remit.
US states
Each US state has their own financial regulators and laws, and each approaches bitcoin differently. California and New York have been particularly aggressive in their pursuit of bitcoin-related organizations, for example, while others, such as New Mexico, South Carolina, and Montana, don’t regulate money transmitting businesses. There is a list of state approaches to money transmitter laws here.
In May 2013, California’s state financial regulator issued a letter to the Bitcoin Foundation, a nonprofit organization designed to promote bitcoin, warning it that it may be a money transmission business, and threatening people there with potential fines and jail time.
Then, in August 2013, the New York Department of Financial Services issued subpoenas to 22 bitcoin-related companies, although these letters were more conciliatory, asking for a dialogue to develop appropriate regulatory guidelines for the digital currency industry. Since then, New York has proposed issuing “BitLicenses” – licenses for bitcoin-based businesses – and will be holding hearings on the subject.
Private sector companies (banks)
Several banks have stopped accounts owned by people operating bitcoin exchanges. In at least one case, this was because the bank was unhappy that the company involved did not have a money transmitting business (MTB) account.
The US Senate addressed the issue of banking and federal regulation in a set of hearings, held in November. The hearings were exploratory in nature and may not lead to legislation, but feedback from agencies included acknowledgements that there were legitimate uses for the coin.
What this means to you
The legality of bitcoin depends on who you are, and what you’re doing with it. There are three main categories of bitcoin stakeholder. Someone may fall under more than one of these categories, and each category has its own legal considerations.
Users
These are individuals that obtain bitcoins, and either hoard them or spend them. Under the FinCEN guidance, users who simply exchange bitcoins for goods and services are using it legally.
FinCEN: “A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter.”
Miners
According to the FinCEN guidance, people creating bitcoins and exchanging them for fiat currency are not safe.
FinCEN: “By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter.”
Miners seem to fall into this category, which could theoretically make them liable for MTB classification. This is a bone of contention for bitcoin miners, who have asked for clarification. This issue has not to our knowledge been tested in court.
Exchanges
Exchanges are defined as MTBs.
FinCEN: “In addition, 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.”
Taxation
US tax form
In 2009, the US Internal Revenue Service (IRS) posted information about the tax applications of using virtual currencies inside virtual economies, arguing that taxpayers can receive income from a virtual economy and could be required to report it as taxable income. However, it based this largely on guidance related to bartering, gambling, business, and hobby income.
However, the IRS has not yet posted guidance on ‘open flow’ virtual currencies that can be used outside of virtual economies. In a 27-page report [PDF] published in May 2013, the US General Accounting Office (GAO) called for more guidance from the IRS on this issue.
The IRS responded that its guidance could now be taken to cover virtual currencies as used outside of virtual economies. It added that it was also looking at the potential tax compliance risks posed by anonymous electronic payment systems, and was working with other federal agencies on the topic.
In June 2013, the director of an IRS unit that investigates cyber threats also told the Financial Times that the use of “cyber-based currency and payment systems” to hide unreported income from the IRS is a threat that it was “vigorously responding to”. And at Senate hearings in November, FinCEN director Jennifer Shasky Calvery confirmed that the IRS would be releasing more guidance on virtual currencies. In short, don’t expect to evade taxes by earning bitcoins instead of fiat currency.
What is the industry doing?
The industry has responded to growing regulator concerns in several ways.
Several companies created a committee to form a self-regulatory body called DATA, designed to encourage open conversation with regulators.
The Bitcoin Foundation formed committees to offer legal guidance, steer policy, and liaise with regulators.
Exchanges have been attempting to secure MTB licenses at the state and federal levels, and some have avoided doing business with US customers until this is resolved.
Other countries
United Kingdom
Meetings with policymakers in the UK in September suggested that bitcoin-based businesses would not have to register with regulators, at least for the time being, while they consider their regulatory position. The most recent message from the UK suggests that bitcoins won’t be treated as money, but will instead be classified as single-purpose vouchers, which could carry a value-added tax (sales tax) liability on any bitcoins that are sold.
Germany
Germany is perhaps the most advanced country when it comes to regulating bitcoin and virtual currencies. Although some issues remain unresolved, the German government has exempted bitcoin transactions held for over one year from 25% capital gains tax. It also categorized bitcoin as a form of private money.
Finland
Finland issued a regulatory guide to bitcoin in September, which imposed capital gains tax on bitcoins, and taxes bitcoins produced by mining as earned income.
Sweden
Sweden’s Finansinspektionen financial regulator now considers bitcoin as a means of payment, following guidance issued last year. Exchanges must register with it and meet the requirements faced by other financial institutions.
Israel
The Israeli Tax Authority is said to be considering a tax on bitcoin, but no statements have been made at the time of writing. However, the Israel Bar Association considers the virtual currency an appropriate form of payment for attorneys.
Thailand
In July 2013, reports suggested that Thailand had banned bitcoin. In fact, as some suggested, some of the exchanges were still trading, and the Bank of Thailand, which was the entity that was supposed to have banned bitcoin, doesn’t have the legal power to do so. As of August 2013, the Bank of Thailand was simply considering whether to give the exchange in question a license.
“Because they have not been granted a license this does not automatically mean that an individual in Thailand selling or buying bitcoins with a bitcoin exchange in another country, e.g. Mt. Gox, is breaking the law,” said Bank of Thailand Governor Prasarn Trairatvoraku.
India
India’s central bank is said to be “watching” bitcoin. It is gathering information in an attempt to understand the virtual currency, but has said that it is not interested in regulating it at present.
Canada
Canada has announced that it will tax bitcoins in two ways. Transactions made for goods or services will be treated under its barter transaction rules, while its Transactions in Securities document says that profits made on commodity transactions could be income or capital. It confirmed these rules in November 2013.
Source: Coindesk.com