A bit of a problem: national and extraterritorial regulation of virtual currency in the age of financial disintermediation.

Author:Pflaum, Isaac
  1. INTRODUCTION II. BITCOIN IS MORE THAN A "VIRTUAL CURRENCY" A. The United States Has Defined Bitcoin as a Convertible Virtual Currency B. Bitcoin is a Distributed Record of Digital Signatures C. Bitcoin Oiunership is Tracked through Transaction Records and Secured Through Cryptography D. The Manner in Which Bitcoin Transactions Are Recorded May Result in Stratification of the Network E. The Bitcoin Network Can Support a Variety of Security Features and Layered Financial Services F. The Number of Bitcoin Units of Exchange is Orders of Magnitude Greater than the Nominal Supply of Bitcoins III. BASEL III, THE BANKING GAP, AND THE HIGH COST OF FOREIGN REMITTANCES A. Basel III and the Dodd-Frank Act May Help Protect Those in the Developing World Who Rely Upon Foreign Banks B. Money Orders Are the Most Popular Alternative Financial Service Purchased by the Millions of Unbanked Households in the United States C. Traditional Banking Services Remain Unavailable or Underutilized by Billions of the World's Poor, But Innovative Alternatives Are Gaining Traction D. Disintermediation of Cross-border Remittances Using Bitcoin Offers Several Potential Advantages Over Nonbank Financial Services E. Bitcoin May Be Particularly Attractive to Those Remitting Funds Into States That Abuse Currency Controls F. Bitcoin Provides an Alternative to the Black Market in Hard Currency for Persons Living in States that Abuse Currency Controls G. The Use of Bitcoin to Lower Transaction Costs on Foreign Remittances Furthers the Expressed Public Policy of the United States and Other OECD Countries H. Bitcoin Offers an Alternative to the Remittance Services Offered by U.S. Banks, Which Are Primarily Limited Due to the Compliance Costs Involved in Dealing with Non-customers IV. RISKS, BENEFITS, AND CHALLENGES RMSED BY THE DISINTERMEDIATION OF FINANCIAL SERVICES A. The Benefits of Bitcoin Must be Weighed Against the Risks Imposed by the Disintermediation of Financial Services B. Anti-money Laundering Efforts Within the United States Illustrate the Difficulty of Developing an International Framework for Regulating Bitcoin C. The Approach Adopted in the United States Towards Regulating Bitcoin can be Significantly Improved D. In Contrast to FinCEN's Efforts, the Regulatory Response Outside the United States Has Been Relatively Modest and Revenue-focused V. EXTRATERRITORIAL APPLICATION OF THE U.S. CRIMINAL CODE A. The Extraterritorial Reach of the U.S. Wire Fraud and Money-laundering Statutes is Extensive B. Vicarious Liability Under the Aiding and Abetting Statute is a Powerful Tool for Regulation of Criminal Activity Involving Bitcoin C. The Structure of the Bitcoin Network is Particularly Suitable to Conspiracy Prosecutions D. International Discovery Devices Extend the Reach of Law Enforcement Authorities Combating Criminal Abuse of Bitcoin E. Recent Guidance on the Tax Status of Virtual Currency Issued by the U.S. Internal Revenue Service May Significantly Enlarge the Population of Bitcoin Users Subject to Criminal Prosecution VI. CONCLUSION I. INTRODUCTION

    The recent global economic crisis has prompted coordinated action regarding financial regulation by governments and central banking authorities, for example, in the form of the Basel III standards issued in December 2010 and subsequently updated in 2011 (Basel III). (1) Half of the world's population, however, remains "unbanked." (2) For the unbanked, reforms such as Basel III have little to offer, since these reforms do not address the fundamental issue that billions of individuals, including millions within the United States lack equitable access to banking services. Banking alternatives such as virtual currency that are secure and operate at low transaction cost may have the potential to fill this gap in the international banking landscape. However, this potential is unlikely to be fully realized unless these alternative financial services comply with the varied national regulatory regimes aimed at combating fraud, money laundering, and terrorism. Unfortunately, in contrast to the coordinated regulatory approach to reforming the international banking system exemplified by Basel III, international cooperation in the area of banking alternatives remains relatively aspirational. In particular, the international regulatory landscape for virtual currencies, such as Bitcoin, is a patchwork of inconsistent and incomplete attempts to counter criminal abuse of the technology that fails to recognize or prepare for the technology's transformative potential. (3)


    "Virtual currency" is a medium of exchange circulated over a network, typically the Internet, that is not backed by a government (4)--an "electronic form of currency unbacked by any real asset and without specie, such as coin or precious metal." (5) Bitcoin was designed to reduce transaction costs, (6) and it allows users to work together to validate transactions by creating a public record of the chain of custody of each bitcoin. (7) Bitcoin can be used to purchase items online, and some retail establishments have begun accepting bitcoin in exchange for gift cards or other purchases. (8) In a recent report, the Government Accountability Office (GAO) described Bitcoin as "a decentralized digital currency that uses a peer-to-peer computer network to move bitcoins around the world" and "a privately issued digital currency that exists only as a long string of numbers and letters in a user's computer file." (9) As the GAO report notes, the Bitcoin Network uses cryptography to prevent what is commonly referred to in Bitcoin circles as "double-spending." (10)

    1. The United States Has Defined Bitcoin as a Convertible Virtual Currency

      In the United States, the Treasury Department Financial Crimes Enforcement Network (FinCEN) issued regulations on March 18, 2013, addressing "convertible" virtual currency, such as Bitcoin, that "either has an equivalent value in real currency, or acts as a substitute for real currency." (11) The Department of Treasury regulations define currency (also referred to as "real" currency) as "the coin and paper money of the United States or of any other country that [i] is designated as legal tender and that [ii] circulates and [iii] is customarily used and accepted as a medium of exchange in the country of issuance." (12) According to the Treasury, in contrast to real currency, "virtual" currency such as Bitcoin is a medium of exchange that operates like a currency in some environments but does not have all the attributes of real currency. (13) In particular, virtual currency does not have legal tender status in any jurisdiction. (14) Outside of the United States, governments have begun to recognize the necessity of dealing with the issue of Bitcoin's characterization as well. (15)

    2. Bitcoin is a Distributed Record of Digital Signatures

      The Bitcoin technology was first described by one or more individuals in a paper published to the Internet under the pen name "Satoshi Nakamoto" in March 2009. (16) The Satoshi paper defines a bitcoin as "a chain of digital signatures" (17) recorded by a distributed time-stamp server in a cryptographically secured ledger called the "Block Chain." (18) Technologically, Bitcoin is nothing more than a combination of several commonplace technologies developed over the past ten years or so to support Internet commerce and peer-to-peer networking. (19) The principal components of Bitcoin are a distributed database that stores transaction records, the Block Chain, and a telecommunications network for broadcasting and validating those transactions, the "Bitcoin Network." (20)

    3. Bitcoin Ownership is Tracked through Transaction Records and Secured Through Cryptography

      The Bitcoin Network maintains the Block Chain as a shared ledger of all transactions conducted in bitcoin, including the parties to each transaction, the value of bitcoin transferred, and the conditions under which the transferee may "spend" the value of bitcoin they have received. (21) The Block Chain itself is merely a computer file maintained by many network participants, which is updated each time a new valid block of transactions is added to the Block Chain. (22) Transactions are broadcasted to network participants on a peer-to-peer basis globally over the Internet. (23) Certain participants, referred to as "Miners," receive these transactions, validate them against the ledger entries stored in the Block Chain, and attempt to incorporate valid transactions into blocks, (24) which are time-stamped using a cryptographic hash function subject to a "proof-of-work" requirement, discussed infra at notes 35-37 and accompanying text, and added to the Block Chain. (25) New blocks are broadcasted globally across the Network and saved by the many network participants in the United States and elsewhere, who each independently maintain copies of the Block Chain. (26) Each time a new block of transactions is incorporated into the Block Chain, the Miner responsible receives a reward of newly created bitcoin and sometimes a commission. (27)

      Ownership of bitcoin means the ability to transfer it to others. (28) The ability to transfer bitcoin is determined by the previous transferor's use of script signatures. (29) Typically, the script signature associated with a transaction will instruct the Bitcoin Network to verify the identity of the transferee against a value stored in the transaction itself. (30) The network will validate a subsequent transaction only if the transferee can provide a private key that corresponds to a value stored in the previous transaction record, wherein the new transferor may in turn include a new condition that must be met before the next owner can spend the bitcoin. (31)

      Ownership of bitcoin further rests upon control over the wallet storing the private key or keys that may be used to spend the bitcoin assigned to the wallet owner's public Bitcoin address or...

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