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Legal Analysis of Cryptocurrency

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Table of Contents

Keywords: bitcoin; cryptocurrency; laws; domestic and international regulations; blockchain technology; decentralized currency; cypherpunks; Satoshi Nakamoto.

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.

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.

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.

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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