I’LL GLADLY TRADE YOU TWO BITS ON TUESDAY FOR A BYTE TODAY: BITCOIN, REGULATING FRAUD IN THE E-CONOMY OF HACKER-CASH
Derek A. Dion – University of Illinois College of Law and College of Business
Journal of Law, Technology & Policy @ The University of Illinois
This paper explores Bitcoin from a regulatory perspective. Please note Dion’s pure intentions: he explicitly seeks to find a balance between the constitutional/commercial rights of the individual against the government’s role in enforcing crimes against fraud and the drug trade. Nowhere does he state a desire to outlaw Bitcoins; in fact, he does the exact opposite: “This [n]ote will argue that Bitcoin should not be strictly outlawed.”
I have rearranged and extracted key points for discussion. Let’s follow Dion’s lead, beginning with the constitutionality of limiting the use of alternative currencies:
"The Constitution reads: “No state shall… emit Bills of Credit; make any Thing but gold and silver coin a Tender in Payment of Debts…” and that, “[t]he Congress shall have the Power… To coin Money, regulate the Value thereof, and of foreign Coin.” This has been interpreted to mean that states do not have the power to issue their own forms of legal currency because this power is reserved for the federal government.”
Okay, so state governments are out of the picture. Where does the federal government come into the play? Following Veazie Bank v. Fenno (1869), the Supreme Court ruled:
n the exercise of undisputed constitutional powers, undertaken to provide a currency for the whole country, it cannot be questioned that congress may, constitutionally, secure the benefit of it to the people by appropriate legislation. To this end, congress has denied the imposition of counterfeit and base coin to the community. To the same end, congress may restrain, by suitable enactments, the circulation as money of any notes not issued under its own authority. Without this power, indeed, its attempts to secure a sound and uniform currency for the country must be futile.”
So congress can control alternative currencies, but how? The first set of statutes that Bitcoin may fall under would be those directed towards counterfeiters.
The United States has a robust set of counterfeiting laws that prohibit almost any form of legal tender imitation. The statutes expressly punish those who falsely make, forge, or counterfeit “any coin or bar in resemblance or similitude of any coin of a denomination higher than 5 cents or any gold or silver bar coined or stamped at any mint or assay office of the United States …” The counterfeiting statutes are broad and do not simply punish those who attempt to create imitation currency, but also those who attempt to “utter or pass, any coins of gold or silver or other metal, or alloys of metals, intended for use as current money…
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The counterfeiting statutes are concerned not just with undue wealth creation, but competition with U.S. legal tender that could, in aggregate, do damage to the value of the U.S. dollar and American monetary policy. This principal is particularly true in a world where governments have fiat currencies—floating currencies whose value is derived relative to each other and their own purchasing power. Thus, it is illegal for an individual to make or pass currency “whether in the resemblance of coins of the United States… or of original design.”
Uh oh… seems like Bitcoin fits the bill. Not exactly. To understand why we must look at United States v. Bernard von NotHaus et al. (2009):
“Beginning in 1998, the National Organization to Repeal the Federal Reserve Act and the Internal Revenue Code (NORFED) produced gold and silver coins as well as gold-backed dollar bills which it called “Liberty Dollars.” The organization was based in Evansville, Indiana and used a private mint to circulate, according to its claim, $20,000,000 in currency. The advertisements for Liberty Dollars referred to it as “real money” and “currency.” The bills contained inscribed terms such as “Liberty,” “Dollars,” “Trust in God,” and “USA,” and the coins contained images such as the Torch of the Reserves, the Statue of Liberty, and the Bill of Rights.”
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“In March 2011, Liberty Coin creator Bernard von NotHaus was convicted of conspiracy and two counts of counterfeiting. According to von NotHaus, during the trial, prosecutors compared the similarity of Liberty Dollar coins to U.S. coins and successfully made clear the possibility of confusion between the two. In response, the FBI released a press release stating, “It is a violation of federal law for individuals, such as von NotHaus, or organizations, such as NORFED, to create private coin or currency systems to compete with the official coinage and currency of the United States.”
There are a few issues with treating Bitcoins like Liberty Dollars. While Dion notes that private currencies are not per se illegal, Liberty Dollar’s use of terms such as “USA” and “Trust in God” etc… are distinctly characteristic of a counterfeit currency. This would not be an issue for Bitcoin (although a fringe argument might be framed in the context of hashed text in the blockchain fitting this description). A few other issues are raised as well:
“For the purposes of enforcement, the differences between how Bitcoin and Liberty Dollars derive their value are even more important. Liberty Dollars were backed by specie stored in warehouses. Thus, when the FBI seized the specie in the warehouses, the bills lost their value. However, Bitcoins are backed by no specie. Although mining the Bitcoins requires computing power, their value is derived completely by supply and demand— they have no inherent value. Thus, even if a compelling argument could be made that the counterfeiting statute applies to all private currencies, the logistics of seizing Bitcoins becomes extremely problematic.”
This issue extends to prosecution–there is no de facto figurehead. And to seal the deal, Dion notes that “[f]inally, prosecutors must consider the fact that Bitcoins are not the only digital currency… [and] prosecutors should avoid destroying the technological and economic possibilities of e-currency in a zealous attempt to topple Bitcoin.”
So counterfeiting shouldn’t be a problem, phew. Next up we have the Stamp Payment Acts of 1862. This statute states:
“Whoever makes, issues, circulates, or pays out any note, check, memorandum, token, or other obligation for a less sum than $1, intended to circulate as money or to be received or issued in lieu of lawful money of the United States, shall be fined under this title or imprisoned not more than six months, or both. [18 U.S.C. § 336 (2006)]”
What’s the feasibility of utilizing this statute against Bitcoin? Despite the fact that it is not often used, the Stamp Payments Act could be revitalized to attack Bitcoin. The leading question is whether Bitcoin directly competes with U.S. dollars: “if one takes a more comprehensive view of the term “coin” as part of a collective monetary system, the argument that Bitcoin diminishes the value of the dollar as a whole becomes more palpable.”
So how would it be enforced?
“The act punishes those who issue, circulate, or pay out prohibited tokens. For enforcement persons, it is unclear who “issues” Bitcoin. The most likely candidate is Satoshi Nakamoto. It would be a difficult argument to claim that those who solve block chains are issuing Bitcoin. However, those who solve block chains are aiding in the circulation of the coins. This would implicate anyone who has downloaded the Bitcoin program. Furthermore, Bitcoin exchanges could be found in violation of the Stamp Payments Act for “paying out” cash for Bitcoins.
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“If the government were to choose to regulate Bitcoin through the Stamp Payments Act, it would have to consider the peer-to-peer nature of the currency. Bringing a case against one actor in the Bitcoin system, even a significant one like Mt. Gox, will not bring an ultimate end to Bitcoin trading. However, if the government’s concern is competition with “greenbacks,” removing large trading houses and making the entire system less liquid will discourage all but the most ardent of Bitcoin advocates.”
You might argue that attacking Bitcoin via this statute is not something we will see happen. I agree, partially. At the moment the US and Bitcoin have a relatively amenable relationship (I am not speaking about banks). Say what you will about the Gox-Dwolla fiasco, but in the end of the day Gox did not follow through with their regulatory duties after being given ample time to amend their status as an MSB. However, I do believe that if Bitcoin becomes a serious competitor to traditional currencies and the power structures therein, the US could quickly become hostile towards the Bitcoin community. It seems like this would be the best way to enable that hostility.
Moving on, lets look at the Securities and Exchange Acts.
“By trading Bitcoins for other currency, exchanges are potentially engaged in securities trading, and thus fall within the purview of the Securities and Exchange Comission (SEC)… The Securities Act prohibits an individual who “with intent to defraud, passes, utters, publishes, or sells, or attempts to pass, utter, publish, or sell, or with like intent brings into the United States or keeps in possession or conceals any falsely made, forged, counterfeited, or altered obligation or other security of the United States.” As the statute stands, the Act applies to notes, stocks, investments, and commodities.”
Where does Bitcoin fit into this definition?
“Bitcoins do not fall within the category of “notes”—there is no promise to pay for Bitcoin, though some are willing to trade for them. Nor can Bitcoins be considered a commodity, which refers to tangible goods rather than intangible objects [**btcgsa note: I disagree with this**]. There are more similarities between Bitcoins and stocks—for the more [hashing power] an individual invests in solving block chains, she receives a proportional amount of Bitcoins. However, Bitcoin, of course, lacks the organization of a corporation, and there are no “voting rights” associated with owning more Bitcoins.
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However, Bitcoins themselves seem to fail under [the definition of investments] as well. First, an investment presumes a return in the future. Individuals trading Bitcoins for U.S. dollars are not necessarily looking to eventually cash out their coins for traditional currency, perhaps they merely want to enjoy Bitcoins. Secondly, even if they were, attempting to ride a currency market to the top should hardly be considered a “common enterprise.” But where the securities laws may fail to regulate Bitcoins themselves, they can be used to regulate Bitcoin exchanges.”
Wait… so individuals don’t fall under their purview, but exchanges do? How does that work?
“Bitcoin exchanges bring together willing buyers and sellers. More importantly, they have a virtual trading floor, which was a crucial distinction in a case like [Bd. of Trade of City of Chi. v. SEC, 923 F.2d 1270, 1272 (7th Cir. 1991)]. Unlike the computer program Delta, the Bitcoin exchanges behave in ways “generally understood” to be a currency exchange.”
Enforcement?
“Were the exchanges to fall under the purview of the securities laws, they would be forced to make a number of changes. First of all, an exchange would have to register with the SEC. It would also have to file a number of public reports which could have a double benefit—informing potential investors on the full reality of Bitcoin investment, while providing the government with useful information that it previously had lacked. Most importantly, the exchanges would be liable for instances of fraud. This would force them to invest in self-policing mechanisms.”
The definitive outcome of this sort of enforcement would be increased transaction costs on the various exchanges. Beyond that it would have [relatively] limited oversight over the Bitcoin community. Finally, and most well known, prosecutors could attack Bitcoin exchanges through the use of anti-money laundering laws. Once again we are presented with regulations that can only operate in one avenue of the Bitcoin ecosystem: the exchanges.
“Because Bitcoin exchanges trade from U.S. dollars (and other currencies) to Bitcoin and back, they are currency exchanges. Thus, they are subject to the requirements of the Bank Secrecy Act. FinCEN has released a recent press release specifically stating an interest in regulating all money service businesses, including Bitcoin, whether they are U.S. companies or not.310 Specifically, Bitcoin exchanges are required to report exchanges greater than $10,000, register with FinCEN, and begin self-policing for instances of fraud.”
Historical examples of enforcement (to varying degrees) of this statute include e-Gold and PayPal. Note that it would not be in the US government’s best interest to shut down all exchanges, because “if regulators were to use the Money Laundering Act to close Mt. Gox and others, they would be missing an opportunity to use the exchanges as a pipeline to information on criminal behavior.”
With that in mind, what would be a reasonable course to regulation? Dion believes that the best solution would be as such:
“Using the weight of the Money Laundering Acts, the government can leverage the exchanges into keeping a record of their transactions, policing suspicious trades, and making the necessary reports to regulatory agencies. In so doing, it must consider the success story of PayPal over the relative failure of e-Gold.
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In the long run, the Bitcoin exchanges should fall within the purview of the SEC. They should be forced to report large transactions and be subject to the rigorous accounting standards of the Financial Accounting Standards Board. They should be subject to the securities laws, which help to eliminate opportunities for fraud. Like other financial institutions, the exchanges should face rigorous audits by the IRS and be compelled to supply their traders with information to file Form 1099(b).
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Where these attempts fail, prosecutors can also rely on the federal wire fraud statute, which has a broad purview and could be used to prosecute just about any scheme, scam, or fraud committed within Bitcoin.”
And finally: “… the DOJ, SEC, FBI, and Drug Enforcement Agency should each maintain a small division that specializes in investigating the illegitimate use of electronic currencies.”
Okay, so what’s the takeaway from this? Before I get into that I’d like express my opinion on the matter of regulation; specifically, this point is directed towards those Bitcoiners who are averse to any and all regulation (for it would undermine the inherent value of Bitcoin’s pseudo-anonymity and general principles of decentralization). I would argue that such a perspective is close-minded and disrespectful to the possibility Bitcoin holds for our future. The SEC and anti-money laundering laws only go so far in attacking the bitcoin ecosystem (if you consider them an attack at all). At no point does that devalue the philosophy of bitcoin.
To assume that Bitcoin can continue to operate outside the purview of the government while continuing to grow is unreasonable; if you have a hope and vision that Bitcoin will game-change the payment system and reach those who do not have access to banks or other legitimate financial infrastructures, it is only fair that you recognize the need for state-sponsored oversight. Without such a regulatory framework, fear of an uncertain outcome for Bitcoin will stifle adoption in the US (and similar countries). It is important to appeal to the greatest possible audience. Regardless, it’s time we [as a community] embrace what is coming and do our best to champion the philosophy of bitcoin in the face of regulation.
As for Dion’s work, we have learned a few things as it relates to Bitcoin’s regulation: counterfeit laws are a non-issue, we needn’t worry about them; the Stamp Act is not an immediate threat (although it could become one); the SEC wants its share of the pie; and finally FinCEN (this goes without saying) has and will flex their muscles. This is the reality of the US regulatory environment (barring new legislation, of course).
What do you guys think? Did he miss anything?
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Original post:
https://btcgsa.wordpress.com/2013/06/10/regulating-bitcoin-in-the-us-a-technical-analysis/Source (pdf):
http://illinoisjltp.com/journal/wp-content/uploads/2013/05/Dion.pdf
