Virtual currencies have the potential to revolutionize how consumers buy, trade, and sell goods and services – and government regulators must be prepared to adapt to maintain their effectiveness. One such currency, the Bitcoin, has been featured prominently in the news. The Bitcoin is a digital currency that is based on an open source cryptographic protocol. Bitcoins are traded on a peer-to-peer network with no central governing authority. As of 11:16 AM EST, September 3, 2013, one Bitcoin (BTC) trades for $146.47445 on Mt. Gox, a prominent Bitcoin exchange.
Because only an electronic device is required to transfer Bitcoins, transactions can be made anonymously across international borders with almost no transaction costs. They are also untraceable. For potential Bitcoin owners, these qualities can be problems or opportunities. For instance, an investor who wouldn’t normally consider the Bitcoin market might see an opportunity to avoid government interference or local conflict. Recently, for example, the use of Bitcoins increased in Europe during the Cyprus bailout because the Bitcoin market was seen as a safe haven in a time of economic uncertainty. Unfortunately, the elusiveness of the Bitcoin market also makes it ideal for black market transactions. Weapons, drugs, and other items are increasingly being paid for by criminal organizations with Bitcoins. This creates a strong incentive – and with it – a unique challenge for governments to regulate Bitcoin transactions.
To effectively regulate virtual currencies such as the Bitcoin, governments must start by legitimizing the Bitcoin as a currency. This is crucial because the use of a digital currency must fall under the purview of statutory law – for instance, the definition of “money” in money laundering. Recently, the Financial Crimes Enforcement Network (FinCEN) released a memo regarding virtual currencies. The memo states that virtual currencies such as the Bitcoin are not real currencies because they are not legal tender in any jurisdiction. Thus, a mere user of Bitcoins is cleared of legal obligations. However, the memo also states that entities involved with manufacturing or converting virtual currencies into a real currency are subject to the same reporting and regulatory requirements as other financial institutions. This would mean that a Bitcoin exchange within the jurisdiction of the United States must cooperate and report suspicious activity, among other requirements. In more recent months, U.S. regulators and Bitcoin advocates have been meeting and talking about the challenges associated with virtual currencies.
With regard to regulatory efforts, the FinCEN’s memo is a great start. However, this memo is just that, a memo. There is no explicit statutory guidance regarding virtual currencies. This leaves room for litigation and confusion. In addition, the memo is ambiguous. For instance, when does one move from a user to a converter of Bitcoins? It isn’t clear. What is clear is that more needs to be done in order to effectively police the use of virtual currencies in illegal activities. My solution is simple. Bitcoins should be statutorily deemed a real currency transaction valued as the Bitcoin-to-dollar conversion of the average of the three most prominent Bitcoin exchanges at the time and date of the transaction. Once the amount of Bitcoins in the transaction is determined, it is easy to administer and eliminates the concern of a person using a virtual currency. It is the cleanest solution to regulate the use of virtual currencies for illegal purposes. If a person illegally buys drugs with $10000 or 67.281 Bitcoins, it doesn’t – and shouldn’t – make a difference.