Legal Analysis of Cryptocurrency

Table of Contents



Abstract                   
This paper will first describe the progression of technology on both aspects of hardware and software, the advent of cryptocurrencies, and how they work with blockchain technology. It then will analyze the proposal of a fully electronic, decentralized currency proposed by pseudonym Satoshi Nakamoto in 2008. Next this paper will talk deeply about cryptocurrencies in all its details: how to get started (both using and acquiring coins), the wide gamut of coins, and regulations imposed by the law to buyers and sellers. Lastly, this paper will focus on the laws at a state, federal, and international level. Keywords: bitcoin; cryptocurrency; laws; domestic and international regulations; blockchain technology; decentralized currency; cypherpunks; Satoshi Nakamoto. _____________________________________________________________________
Prior to the emergence of a government-issued monetary system used in circulation among civilizations and tribal communities, bartering was used in lieu of money. Despite this advancement from commodity-based trading to a centralized currency starting around 700BC in modern day Turkey (20), money itself has not undergone any radical changes since its inception until this past decade. As exponential technological progress has been consistently made in computer hardware as a result of Moore’s Law (15) for decades, current low and mid tier computers are thousands of times faster than last generation flagship computers at a fraction of the cost.
To put things into perspective, the popular $5 microcomputer called Raspberry Pi Zero (2017) boasts a single core 1GHz processor with 512 megabytes of random access memory (RAM) and is smaller than a pack of gum. Form factor is a mere 65mm x 30mm. (19). On the other hand the computer that helped NASA land on the moon during numerous Apollo mission was the Apollo Guidance Computer (AGC), which only featured a 2.048 MHz processor and 4 kilobytes of RAM (4). This comparison shows the Raspberry Pi Zero’s processor is roughly 488 times faster than the AGC while sporting 128000 more RAM capacity while costing less than lunch.

This has proved to be an unprecedented advancement in computer science that has never been seen before in any other field of study to date. This astronomical growth has led to a positive effect on software as well. Computers across the board can now run more resource-intensive programs and applications than ever before. These programs solve the hardest problems (21) and perform tasks science fiction had been promising us all for ages like transporting us into another galaxy via virtual reality (14) and self-driving cars powered by artificial intelligence and computer vision (17). Technology itself has seeped into all fields of study and serves to make everyone’s life easier in most if not all aspects of life, one of which is money.

This realization led a subgroup known as the cypherpunks to create various attempts of a virtual currency between the late ‘80’s and early ‘00’s. The main motive was to push the boundaries of computers to create a new, decentralized currency, completely independent of any financial institution or government that relies on its users to power the financial infrastructure in a network protocol called peer to peer networking (P2P) that anyone with an internet access can use. Despite numerous failed attempts (DigiCash, Flooz, Beenz to name a few) in the 1990’s caused primarily between a lack of public interest (very few understood the internet at the time), conflict in organizational leadership, and lack of robustness in the software that powered these virtual currencies at that specific time frame, cryptocurrencies did not catch on. It was not until 2008 that a mysterious person or group of people under the name Satoshi Nakamoto made a proposal of a new currency called Bitcoin in a self published white paper that utilized what eventually become blockchain (12). After decades worth of attempts and the continual progression of technology, Bitcoin proves the most promising option to date.

Such a system drew in crowds of people from all walks of life, notably libertarians who advocated for a free, global market without any government intervention that allowed anyone to purchase anything on ecommerce sites like the infamous Silk Road on the Darknet pseudonymously. This unethical aura connected to cryptocurrencies and its early adopters led to stagnant growth among the dismissive public. The lack of understanding among consumers on a currency used primarily for illegal endeavors during its early inception led to slow adoption. Lawmakers remain to this day unsure how to adopt and create laws surrounding the nebulous concept of a decentralized virtual currency that spans across all geographically international borders.

Like most modern cryptocurrencies, Bitcoin uses an immutable ledger, more commonly known as a blockchain, which is a digital record for all transactions processed through cryptocurrencies. Blockchain is able to trace back all transactions made for an item in a matter of seconds. Like all cryptocurrencies, Bitcoin is able to validate and process these transactions through mining, which is simply the process of lending one’s computer to the decentralized system to validate transactions through very complicated math problems that only a supercomputer can prove. This ensures that the consumer is paying the correct amount to the seller and vice versa. Since all transactions are seen by other users (also known as node in Nakamoto’s white paper) publicly, the public verifies among other nodes that also watch the transaction to validate it. As a result, the more nodes using a cryptocurrency like Bitcoin, the more secure it becomes.

Blockchain is very appealing for companies. Walmart for example is using the relatively new technology to track transactions of raw materials and the products devised through these raw materials. One example of this is when the board of Walmart executive got together in a room. In the center of the room was a pack of mangoes. The goal was to find the farm in which the mangoes where grown, where they were shipped to, how old they were, and when they sold through the traditional way. This herculean task took the team two intense weeks. At the end of the two weeks, the team was able to find out where the mangos were from. At a follow up board meeting, the executive running the meeting showed the rest of the board where the same mangoes were grown, shipped, and sold in roughly two seconds using blockchain technology. This could potentially stopped widespread food poisoning epidemics from occurring and allows Walmart to become a more transparent company. Like Walmart, IBM is now using blockchain to reduce overall financial disputes by 75% because the immutable ledgers are public for anyone to look up (2).

Miners, people who mine for Bitcoin are incentivized by given a small fraction of a Bitcoin once the transaction is verified and their mining was validated by other miners. This has led to an exponential increase of people and speculative investors joining the cryptocurrency ecosystem. Consequently, the math problems are becoming increasingly difficult to solve so only a supercomputer or an ASIC (application specific integrated circuit), a computer designed for mining will suffice any feasible gains. Aside from that, most people actually lose money because of the immense amount of electricity needed to power their computers to make these minuscule gains. As of right now, most people just buy Bitcoin and other cryptocurrencies online from a secure website. Previously, cryptocurrency users purchased coins through an online vendor that was originally a failed video game website called Mt. Gox. Despite handling close to 70% of all Bitcoin transactions in 2014 (11), Mt. Gox filed for bankruptcy due to multiple attacks on the company’s website that led to various heists between 2011 and 2014 with a whopping $460 million dollars worth of Bitcoin being stolen from the company in one breach alone. This again shook the confidence of the cryptocurrency world. Coinbase attempts to learn from Mt.Gox’s mistakes.
Almost all cryptocurrency investors today use Coinbase, an intuitively designed interface that values security. After creating an account via the Coinbase website or through their mobile app, users are greeted with straightforward, easy to read charts and tickers that display fluctuating prices for various currencies. Buying virtual currency is as simple as buying something off of Amazon. One simple just has to enter the amount they would like to purchase and select whether they want to pay with credit or debit card (4%) which takes at most two days to be processed or through their bank account (1%) which takes four to five days. Using the same interface, users can sell cryptocurrencies in exchange for USD. The last prominent feature is the ability to send and request money from other users (3).
Between all the inescapable hype in media, excessive speculative investing, and controversy regarding cryptocurrency as a whole, there has been a conundrum among politicians and lawmakers on how to regulate the newly adopted technology that spans beyond state and country borders. The rest of this paper will focus primarily on domestic laws among various government organizations that are currently in place to interpret what cryptocurrency is and how to regulate it.
There are currently three prominent states leading the cryptocurrency revolution: California, Connecticut, and New York. A relatively recent nullification under Bill No. 129 that had prohibited anyone under California law from allowing circulating as money other than USD. This repeal signed by Governor Jerry Brown on June 29, 2014 has helped usher in a plethora of cryptocurrencies and has helped cryptocurrency businesses, notably the previously mentioned online coin vendor Coinbase (3) to flourish.

Connecticut has also followed suit more recently (October 2017) by issuing the Connect Money Transmission Act which allows entrepreneurs to start cryptocurrency businesses as long as they get a license to do so and New York City became the first place in the world to have a physical cryptocurrency exchange trading floor in 2013, directly next to the New York Stock Exchange. Virtual money does pose a direct benefit to those running political campaigns. Under the Federal Election Campaign, non connected political campaigns can accept up to $100 worth of Bitcoin per contributor per election. So, regardless of whether a political figure is for or against the digital currency, they can certainly benefit from it through their campaigns.
As of right now, the Internal Revenue Service and most of its counterparts internationally do not recognize cryptocurrencies as a form of currency. Instead these financial organizations see cryptocurrencies as an asset like property or an intangible good since most cryptocurrencies were not issued by a central bank of a country with a few exceptions to experimental government programs in countries like Russia and Venezuela in order to fight inflation. Since it is seen as an asset, it is taxed as an asset. This means that the IRS requires citizens to report all transactions, buying, selling, investing, or using cryptocurrencies for goods or services which the IRS considers bartering (1). This means that selling Bitcoins at a price higher than they were purchased will incur a capital gains tax based determined by the difference one buys and sells a Bitcoin. Mining itself however does not need to be reported.


The Conference of State Bank Supervisor (CSBS), a federal organization that strives to protect and make advancements to the US banking system views virtual currency similarly to the IRS. The CSBS does not see Bitcoin or other cryptocurrencies as currency by defining it as “a digital representation of value used as a medium of exchange, a unit of account, or a store of value, but does not have legal tender status recognized by the US government” (9). The result of this statement is that under Title 18 U.S.C. Section 470-483, the CSBS does not protect digital currencies from counterfeit since they are not recognized as a legitimate form of currency like the US dollar is.

The Bank Secrecy Act (BSA) imposes record keeping requirements on banks and other financial institutions by enforcing these organizations to file reports of transactions of exceeding amounts set by the Secretary of the Treasury. The Treasury’s Financial Crimes Enforcement Network does not require citizens or companies that report virtual money into USD to report their earnings. In a luring article titled “Could a Civil War-Era Law Stamp Out Bitcoin?”, Wired magazine author Robert McMillan speculates a 152-year-old law forbidding “any American from issuing a check, note, or token that’s worth less than $1” (10) and since Bitcoins are seen as tokens and can be fragmented into values less than a dollar, one could be inadvertently be breaking a law imposed during the Civil War era. The law in question is called the Stamp Act of 1862, which has not received this much attention since it was enacted. Despite the legal scholars debating whether this act poses as a threat to Bitcoin or not, University of Illinois law student Derek Dion states his skepticism in regards to the government taking action anytime soon in a published paper on Bitcoin in the University of Illinois Journal of Law Technology and Policy, believing the government will leave Bitcoin alone as long as the currency follows more established federal laws and users do not use the currency for illegal activity. At the time of this paper (April 2018), not a single Bitcoin user has faced any legal repercussions as a result of the Stamp Act of 1862 and this pattern is not likely to change in the foreseeable future.

Despite being treated as an asset instead of money, digital cash is protected by the Federal Trade Commission. In this context, the FTC prohibits and protects against “unfair or deceptive acts or practices in or affecting commerce” (7) meaning that they are protected like money. One famous event in which the FTC protected cryptocurrency users was with the now-defunct Missouri startup Butterfly Labs. Butterfly Labs was a cryptocurrency mining equipment company that sold ASICs that were computers specifically built to mine virtual money. In spite of its almost-instant hype and promising sales, the company became loathed by customers and the media alike due to its failure to deliver 20,000 of computers. The other portion of computers that the company shipped were delivered exceptionally late to the point that they already obsolete and in many cases, not working. This led to thousands of customers complaining to the FTC, which took action in September 2014 (6). After shutting down Butterfly Labs, the FTC Twitter page stated, “At least $20 million, and potentially up to $50 million” was collected in sales from customers (18).

Cryptocurrency users are also protected under the Securities and Exchange Commission (SEC), which serves to protect investors from unfair security markets. Defendant Trendon Shavers was under scrutiny for conducting a Ponzi scheme through his cryptocurrency business Bitcoin Savings and Trust (BTCST) by promising prospective investors at least 7% interest rates per week by using virtual money from new investors to pay off old investors. Shavers argued that digital money is not a security because they are not regulated by the US government and therefore the court had no jurisdiction over them since they are not securities. The counterargument the SEC made was that under US Code Section 77b, a security is broadly defined as a “note, stock, […], or investment contract” (8) and that an investment requires three criterion: 1) an investment of money 2) in a common enterprise 3) with the expectation of profits from the promoter or third party. The court ruled in favor of the SEC, finding Shavers guilty of defrauding his investors out of 700,000 Bitcoins (roughly $4.5 million). Consequently, the court required Shavers and BTCST to pay “more than $40 million in disgorgement and prejudgment interest, and orders each Defendant to pay a civil penalty of $150,000” (16) and serve for 18 months in prison. The Financial Action Task Force (FATF) operates at an international level and serves “to combat money laundering, terrorist financing, and other related threats to the integrity of the international financial system” (5). Two notable FATF reports are the 2014 and 2015 editions, both of which assess potential risks involved in using cryptocurrencies that FATF combats against. The task force is wary of cryptocurrencies and their wicked origins of allowing individuals to pseudonymously purchase illegal entities on the internet like illicit drugs, prostitution, and unregistered firearms. Although FATF disapproves of the immoral utilization of digital currency to bypass state, federal, and international laws to purchase highly illegal items and services, the financial organization acknowledges that cryptocurrency in and of itself is not bad or morally wrong.

Like FATF, the European Central Bank (ECB) has spent a great deal of speculation on the hot topic of virtual money. In October 2012, the ECB determined that the growth of digital currencies will carry a need for international cooperation in developing a regulatory system. It also mentions how a decentralized, non-government issued currency can be a sharp double edged sword. On the dark side of things are those who purchase illegal items and services online as previously stated.On the good side of the scale are charity groups, entrepreneurs, and law abiding citizens who utilize cryptocurrencies in legal ways. In a joint effort between charity groups and entrepreneurs who have their eyes set on potential opportunities found in third world countries, the two forces are ushering in cryptocurrencies as a plausible alternative from traditional government issued legal tender susceptible to inflation or, in a country like Zimbabwe’s case, hyperinflation where a one hundred trillion dollars is worth only $0.40 USD (13).

The October 2012 study was intentionally vague as the growth of digital cash like Bitcoin or Ethereum has exploded beyond general public’s expectation and as a result the organization, and the world as whole, needs time to let the pandemonium that is cryptocurrencies play out before any international regulatory proposals can be announced.

In short, the breakneck pace cryptocurrencies are progressing and the bewildering complexity surrounding them are taking the world by storm and demanding the attention of the public. As with all capitalist societies, money plays an essential in everyone’s life by providing meaning to one’s life through the work they do, the ability to live by paying for food, medicine, and other necessities, own property, and promote a common good through taxes like civil infrastructure, public education, and government-owned employees like police officers and firemen who protect communities.

Since money affects us all one way or another, one should not take cryptocurrencies lightly. Surely, the inescapable hype, speculative investing, and volatility raise a few warning flags for skeptics and critics alike, but the idea of cryptocurrencies dissipating altogether in a few years seems even more dubious. Regardless of the outcome in which one type of cryptocurrency may reign supreme over the thousand of other coins available or the inevitable burst of the cryptocurrency bubble in the near future, the timing is right for cryptocurrencies and the technological resources are all there: they are likely not going anywhere.

While legislators continually scrutinize over cryptocurrencies and shoehorn traditional laws around them as they see fit, cryptocurrencies are being adopted globally by new users faster. While it is unlikely that everyone will jump aboard the crypto-bandwagon, crypto-bandwagon, science fiction notion that we as humans will one day live in a world with one universal, decentralized digital currency that spans across all borders that everyone has access to may come sooner than most anticipate. Until then, the world patiently awaits.


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