Heads or tails: how Europe will become the global hub for Bitcoin business if the United States does not reexamine its current regulation of virtual currency.

Author:Ficcaglia, Gregory V.
 
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  1. INTRODUCTION

    In the fall of 2008, a mysterious author writing under the pen name Satoshi Nakamoto published an article envisioning a digital payment system known as Bitcoin. (1) Designed as an alternative to government-issued fiat currency that can be transmitted between users like cash without the assistance of a third-party such as a bank, Bitcoin is a decentralized, peer-to-peer digital payment system controlled by an algorithm which issues Bitcoin based on the number of users participating in the network. (2) Although Bitcoin eschews governmental oversight by design, the growing popularity of Bitcoin as a form of payment that can be used anywhere around the globe presents novel issues for regulators attempting to define Bitcoin's role alongside traditional currencies while also protecting the interests of their citizens. (3) There is no international consensus regarding Bitcoin's legal status, although Germany and the United Kingdom have issued preliminary regulations aimed at establishing Bitcoin as a method of payment similar to that of a traditional fiat currency. (4) In contrast, the Internal Revenue Service has defined Bitcoin and other "convertible virtual currency" as a type of property. (5) In order to facilitate the use of Bitcoin as a method of transmitting digital payments at a low cost both domestically and internationally, and to ensure U.S. based Bitcoin companies remain competitive in the future, the United States must rethink its current definition of Bitcoin. (6)

    This Note explores the emerging technology of Bitcoin, and how it is revolutionizing the global marketplace by creating a digital form of payment that is untethered from the control of a central bank. (7) Part II will discuss the history, development, and usage of Bitcoin as a virtual currency. (8) Part III will describe the current U.S. regulatory environment surrounding Bitcoin and other virtual payment systems. (9) Part III will also discuss the current international regulatory environment, focusing particularly on regulations set forth in Germany and the United Kingdom regarding Bitcoin. (10) Part IV of this Note will analyze the benefits of revising current regulations in the United States to reflect broader support in the international community for using Bitcoin as a payment system. (11) In conclusion, Part V of this Note will describe the potential benefits of consistency among international Bitcoin regulations, especially if the United States adopts a forward-thinking regulatory scheme that mirrors those adopted by Germany and the United Kingdom. (12)

  2. HISTORY

    1. A Brief History of Bitcoin and Virtual Currency

      Bitcoin, as the most recent iteration of virtual currency thus far, follows in the footsteps of many unsuccessful predecessors, incorporating some of their most useful features while simultaneously building new solutions to avoid the same failures. (13) Although many virtual currency schemes developed independently of the existing financial system, banks have also been searching for a digital solution to increase the speed and decrease the cost of transactions since the late 1990s. (14) By the time of the 2008 financial collapse, trust in traditional financial and banking institutions was at an all-time low. (15) Nakamoto's Bitcoin caught the attention of a largely libertarian, anti-establishment base of users who believed that the currency would eventually eliminate government-issued fiat currency entirely. (16) These same users also eschewed government regulations by postulating that its anonymity, global reach, and lack of a central issuing authority would make it hard to regulate, if not impossible. (17) Although this libertarian contingent still exists as a part of the wider Bitcoin community, Bitcoin's evolution in recent years trends toward the currency becoming a useful, regulated payment system for businesses and individuals. (18)

    2. How Bitcoin Works

      1. How a Bitcoin Transaction Happens

        Bitcoin is "an electronic payment system based on cryptographic proof instead of trust," allowing parties to exchange Bitcoin directly with each other over the internet without the need to use a third party payment clearinghouse to approve and confirm the transaction. (19) Ownership of a Bitcoin transfers through a user's public address that is a unique identifier for each user's wallet, an application programmed to connect a user and their Bitcoins to the network. (20) Each coin contains the previous user's private address, which is used by other computers on the network to ensure each Bitcoin is not spent more than once. (21) Individuals confirm transactions by offering their computing power to the network to maintain the transaction ledger by linking "blocks" containing a string of numbers that represent the time when each transaction occurred (also known as a "hash"). (22) Users who donate computing power to the network are called "miners," and they receive new Bitcoin as an incentive to continue to donate computing power to the network every time their computer discovers a block of transactions and solves the hash algorithm before any other computers. (23)

      2. Bitcoin Mining

        Miners maintain the universal ledger of all transactions by searching for "blocks" of Bitcoin transactions on the network in return for a small payment of new Bitcoins upon discovery of a new block. (24) The algorithm "self-regulates" the release of new Bitcoin by increasing the difficulty of the calculation which miners' computers are required to resolve in order to discover a new block of transactions. (25) The difficulty increases according to the number of miners connected to the network. (26) Additionally, the Bitcoin reward issued to miners decreases over time. (27) Bitcoin's supply of coins is limited to twenty-one million, distributed over time to individuals operating Bitcoin mines until 2140. (28) This finite supply, in connection with the self-regulated release of coins, plays an important role in valuing Bitcoins against traditional fiat currencies. (29) Due to the development of computers specifically tailored to Bitcoin mining, the average user must purchase Bitcoin with fiat currency at an "exchange" in order to participate in the Bitcoin economy. (30)

      3. Bitcoin Exchange Banks

        A Bitcoin exchange allows users to buy and sell Bitcoin with other virtual currency or fiat currency. (31) These exchanges allow users to exchange currencies anywhere in the world, and serve as the entry point to the Bitcoin economy. (32) Although regulation of these entities varies, the general trend in the international community is to apply anti-money laundering and "know your customer" disclosure requirements in order to assist governments in combating Bitcoin's use as a payment medium for illegal activities. (33) Exchanges are vulnerable to cyberattack, and users' virtual currency holdings in Bitcoin exchanges are not insured. (34) Largely, these institutions mirror their traditional counterparts in that they adapt the concept of currency valuation to the Bitcoin economy, and are thus regulated and appropriately defined under existing legal frameworks. (35)

    3. How Bitcoin is Used

      1. Bitcoin as a Digital Substitute for Cash

        Since Bitcoins operate on self-verifying networks, users may transfer funds instantly to anyone who has a Bitcoin wallet as if they were paying with cash. (36) Many merchants currently accepting Bitcoin operate solely online. (37) Bitcoin has seen some of its greatest successes as a form of payment in countries with unstable currencies or with strict capital controls in place. (38) Additionally, Bitcoin is often a cheaper way for individuals to make international remittance payments, as it provides a near-instantaneous manner of transferring value with relative ease and low cost between countries with different currencies. (39) Despite the potential benefits for merchants and banks alike, Bitcoins are primarily held as investments in Western and other developed countries. (40)

      2. Bitcoin as an Investment

        Although Bitcoin was originally intended to be an alternative to fiat currency and allowed for digital cash-like payments over the internet, a majority of individuals hold Bitcoins as investment property. (41) Regulators in the United States and Europe have found difficulties in legally defining Bitcoin as a currency. (42) Notable figures in traditional finance and the tech industry have shown an interest in the currency, furthering the image of Bitcoin as a tool for investment. (43) Market forces in the Bitcoin economy may also play a role, as price volatility constantly threatens the value of a user's Bitcoins. (44) The current tax classifications of Bitcoin in the United States, coupled with other definitions and regulations, are largely designed to support the use of Bitcoins as investments as they seem to create a disincentive for users who wish to spend virtual currency by classifying it as a capital asset subject to a lower rate of tax after it has been owned for one year. (45) Current proposals in the United States and elsewhere, however, reflect the changing understanding of the technology and the currency itself by proposing new rules related to the taxation and regulation of Bitcoin. (46)

  3. FACTS

    1. The History of U.S. Regulation of Bitcoin

      1. The United States' Definition of Currency and Current Legislative Proposals Aimed at Redefining Bitcoin

        Regulators in the United States have defined Bitcoin as a "convertible virtual currency." (47) Although Bitcoin may possess many of the requisite characteristics of a fiat currency, it is distinguishable in that it can accommodate a wide range of direct peer-to-peer transactions with low cost and high efficiency that cannot be accomplished using fiat currency without a third-party clearinghouse. (48) These distinct abilities played a role in the Internal Revenue Service's (IRS) decision to classify Bitcoin as property for tax purposes. (49) Though this determination is...

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