Digital metal: regulating Bitcoin as a commodity.

Author:Prentis, Mitchell
 
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Contents Introduction I. Bitcoin's Basics A. Bitcoin's Goal and Purpose B. Bitcoin Transactions C. Bitcoin Generation and Acquisition II. Bitcoin's Current State of Regulation A. FinCEN's Treatment of Bitcoin B. IRS Treatment of Bitcoin C. SEC v. Shavers III. Bitcoin's Identity Crisis A. Bitcoin Is Not a Currency B. Bitcoin Cannot be a Security IV. Why Bitcoin is a Commodity A. Bitcoin is a Commodity Because of its Economic Function B. Bitcoin Fits Within the CEA's Definition of a Commodity V. Advantages to Treating Bitcoin as a Commodity A. CEA and CFTC Regulation B. Treating Bitcoin as a Commodity Would Result in More Efficient Tax Treatment VI. Bitcoin Consumer Protection Regulation A. Why and Where Bitcoin Consumer Protection Regulation Is Needed B. Regulatory Need 1: Impose Reserve Requirements on Bitcoin Exchanges C. Regulatory Need 2: Ensure that Bitcoin Users Understand the Risk of the System Conclusion INTRODUCTION

The time has come for regulators to settle upon a system of oversight for Bitcoin. (1) When the fledgling online payment network debuted in 2009, a single bitcoin was worth about a half a cent. (2) Since then, the value of bitcoins has skyrocketed, resting around $400 as of December 2015, (3) but reaching as high as $1,200 in the fall of 2013. (4) As the value of individual bitcoins has increased, so has public interest in the new technology. (5) Over 1.4 million people in the United States, and over 5.5 million in the world, have downloaded the Bitcoin software, (6) and millions of dollars' worth of bitcoins are exchanged every day. (7) This growing interest has led investors to develop improved infrastructure and to offer ancillary services, in order to ease the public's use of Bitcoin and to encourage the continued growth of the Bitcoin economy. (8)

Whether you believe that Bitcoin is the payment system of the future or an outright scam, it is undeniable that Bitcoin continues to gain traction and prominence in the global economy. (9) Bitcoin simplifies online purchases and lowers the transaction costs of making online payments, (10) replicating for users the ease and security of in-person, cash purchases. (11) Due to Bitcoin's complex and still young technology, however, regulators have been hesitant to issue guidance and provide oversight to the nascent Bitcoin economy. (12) This lack of regulation has led many to rob and abuse the Bitcoin system, costing consumers millions of dollars. (13)

As it becomes easier for ordinary people to invest in, and use, Bitcoin, the United States needs to develop a regulatory framework to manage Bitcoin. But, before a robust regulatory system can be developed to protect consumers, regulators need to settle upon what, exactly, Bitcoin is. Until Bitcoin is definitively categorized, regulatory efforts will be inconsistent, inefficient, and, likely, contradictory.

In this Note, I will argue that Bitcoin should be categorized and regulated as a commodity. This treatment would be consistent with the economic behavior of Bitcoin's users and would provide a clearer regulatory path for Bitcoin's future. Additionally, categorizing Bitcoin as a commodity would provide increased clarity to existing regulatory efforts. Part I of this Note will briefly discuss the basic technological underpinnings of the Bitcoin system. Part II will quickly survey the current regulatory landscape around Bitcoin. Part III will examine Bitcoin's identity crisis and explain why Bitcoin should not be categorized as a currency or a security--the two other categories vying for Bitcoin's inclusion. Part IV will explain why Bitcoin is a commodity, and Part V will examine the legal advantages of treating Bitcoin as a commodity. Finally, Part VI will examine how treating Bitcoin as a commodity can provide needed consumer protection regulation in the Bitcoin economy.

  1. BITCOIN'S BASICS

    1. Bitcoin's Goal and Purpose

      In 2009, a computer programmer, working under the name Satoshi Nakamoto, released a paper called "Bitcoin: A Peer-to-Peer Electronic Cash System," giving birth to the Bitcoin network. (14) The goal of Bitcoin was to provide a network where "pseudonymous entities" could transfer value online, using a decentralized medium, free from government interference. (15) The central advantage that Bitcoin sought to provide users was the ability for '"two willing parties to transact directly with each other without the need for a trusted third-party' or intermediary (or central issuer or payment system), where the basis of the transaction's security is 'cryptographic proof instead of trust.'" (16)

      Bitcoin achieved its goal through the creation of a computer network that verifies exchanges as they happen. Every time a transaction occurs, the system reports the transaction to all other computers in the network. Because all transactions are reported to the network, a transferor cannot fake a transaction by not actually sending anything to the transferee. (17) A Bitcoin transaction can only be successfully completed if the rest of the computers in the network verify that the transaction actually happened. (18) Prior to Bitcoin, secure online transactions could only be conducted with the help of a third party, like a bank or PayPal, ensuring that funds were transferred when they were claimed to be, and that no one was cheating the system. (19) The need for an intermediary to provide security for transactions increased the transactions' costs. (20) In the Bitcoin network, these kinds of intermediaries are no longer necessary, allowing transactions to be conducted more efficiently. (21)

      Additionally, the Bitcoin system was designed to operate as a medium of exchange that existed without the interference of any centralized government or authority. (22) Instead of a medium of exchange backed by precious metal or government fiat, Bitcoin is not backed by anything and instead relies on the strength of its algorithms and the large computer network supporting its system to give it value. (23) This algorithm controls the supply of Bitcoin, causing bitcoins to be created and introduced into the market at an exponentially decreasing rate. (24) Bitcoin's software ensures that "there will never be more than 21 million bitcoins in circulation, which should occur around 2025." (25) This feature is attractive to some Bitcoin users because it removes the possibility of a central authority meddling with the monetary supply, in much the same way as a gold-backed currency functions. (26)

      Today, Bitcoin users can spend their bitcoins on an ever-increasing array of goods and services. (27) Many retailers have begun accepting bitcoins for online purchases, including Dell, Overstock.com, and Microsoft. (28) Also, brick-and-mortar stores are beginning to accept bitcoins. (29) For instance, in Cleveland Heights, Ohio, several restaurants and retail stores, dubbed "Bitcoin Boulevard US," have begun accepting payment in bitcoins. (30)

      Finally, Bitcoin offers its users the prospect of conducting online transactions in an anonymous manner. (31) Because the system verifies its own transactions, and third parties are not necessary to confirm the identities of individuals, neither transacting party need know the identity of the other to trust that the transaction will take place. This anonymity is designed to mirror the level of anonymity found in cash transactions. (32) Bitcoin critics worry, however, that this feature may ease the transaction of illegal activity. (33)

    2. Bitcoin Transactions

      Bitcoins themselves are nothing more than computer files, like a word document or an .mp3; they "can be destroyed or lost just like cash." (34) In order to send a bitcoin from one party to another, the transferor simply designates the address of the recipient, and sends the bitcoin across the Bitcoin network, similar to sending an email. (35) To secure these transactions, the Bitcoin network employs "public key encryption." (36) Each Bitcoin user has two mathematically related keys associated with himself or herself: a public key and a private key. (37) The public key identifies the user on the network, and is visible to all other network members; it acts as the address for files to be sent to. (38) The private key is known only to the user and acts as the "password" to authorize the sending of bitcoins to other public key addresses. (39)

      When a bitcoin is sent from one user to another, the bitcoin file is given a unique serial number. (40) The new serial number is generated through a cryptographic process that combines the bitcoin's old serial number with the transferee's public key. (41) The new serial number is broadcast to all the other computers running the Bitcoin program, and those computers work to decode the new serial number against the public key that the bitcoin was transferred to. (42) This decoding process verifies the transaction and ensures that it actually took place, securing the transaction and system. (43)

      Each time a transaction takes place, and the Bitcoin network successfully verifies a transaction, the transaction is logged into the Bitcoin "block-chain." (44) Each bitcoin has a block-chain associated with it, acting as a timestamp for each time it was transferred, and, since the entries are partially based on each transferee's public key, a record of who the transferee was each time the bitcoin was sent. (45) In order for a bitcoin to be transferred again, its block-chain must meet the standards of the network. (46) The chief purpose of the block-chain is to ensure that bitcoins cannot be "double-spent" or counterfeited. (47)

      The block-chain allows the Bitcoin network to operate anonymously because the only identifier of each Bitcoin user is their public key. (48) So, while it is possible to track all of the transactions that a single user enacted, the user's identity is never disclosed. (49) Some have argued, however, that with advances in network mapping technology, the identities of users on the...

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