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Bitcoin and Mobile Payments pp 55–71Cite as

Palgrave Macmillan

Bit by Bit: Assessing the Legal Nature of Virtual Currencies

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Part of the book series: Palgrave Studies in Financial Services Technology ((FST))

Abstract

“Virtual currencies” are a monetary phenomenon not easily defined. They set themselves at the crossroads between money, investment instruments, possibly commodities, and notwithstanding the fact that they are relatively widespread in practice (Bitcoin is the most prominent example), they are still lacking specific regulation in almost all legal systems. This poses a series of problems and risks that have caught the attention of regulators and market operators, some of whom have recently released important studies highlighting the need for ad hoc rules. The paper aims at giving a brief overview of the legal nature of these currencies and the possible rules which may be applied to them pending the approval of specific legislation.

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Notes

  1. 1.

    There is a wide number of studies and reports, commissioned especially by national and transnational Banking Authorities that have examined the phenomenon of ‘Virtual Currencies’. In some cases these studies also contain tentative assessments of the risks associated with the use of virtual currencies, and/or a series of related ‘warnings’ to the public. References to these documents will be made throughout the text, however some of the most thorough, inter alia, can be recalled: European Central Bank, Virtual Currency Schemes, October 2012, https://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemes201210en.pdf, accessed July 2015; European Banking Authority (EBA), Opinion on ‘virtual currencies’, July 2014, https://www.eba.europa.eu/documents/10180/657547/EBA-Op-201408+Opinion+on+Virtual+Currencies.pdf, accessed July 2015; Law Library of Congress, Regulation of Bitcoin in Selected Jurisdictions, http://www.loc.gov/law/help/bitcoin-survey/regulation-of-bitcoin.pdf, accessed July 2015; Financial Action Task Force, Virtual Currencies. Key Definitions and Potential AML/CFT Risks, June 2014, http://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions-and-potential-aml-cft-risks.pdf, accessed September 2015.

  2. 2.

    The EBA opinion on virtual currencies for example has singled out more than 70 risks across several categories, including risks to users; risks to non-user market participants; risks to financial integrity; risks to existing payment systems in conventional fiat currencies; risks to regulatory authorities (See EBA Opinion on ‘virtual currencies’, 5).

  3. 3.

    For this classification, see ECB, Virtual Currency Schemes, October (2012): 13–15

  4. 4.

    A first-hand illustration of the Bitcoin can be found in the document authored by their (presumed) inventor, who goes under the pseudonym of Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System”, https://bitcoin.org/bitcoin.pdf, accessed September 2015.

  5. 5.

    A sudden raise in their price of ‘purchase’/demand, provoked by an increase in the number of users, might incentivise users not to spend the Bitcoins but rather keep them as ‘scarce chattels’ See ECB, Virtual Currency Schemes, cit., at p. 25, (with some criticisms towards these theories); See also Reuben Grindberg, “Bitcoin: An Innovative Alternative Digital Currency”, Hastings Science & Technology Law Journal 4 (2012): 177 ff.

  6. 6.

    See Ferdinando M. Ametrano, Hayek Money: the Cryptocurrency Price Stability Solution, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2425270), highlighting that Bitcoins could be considered as the practical implementation of the theories of the Austrian School of Economics, especially those on the ‘denationalisation of money’ illustrated by Friedrich A. von Hayek in his book The Denationalisation of Money published in 1976.

    This analogy, however, has also been met by criticism by some scholars who have highlighted that Bitcoins have no intrinsic value comparable to the gold standard nor do they meet the requirement of the ‘Misean Regression Theorem’ according to which acceptance and circulation of money depends on an intrinsic value it possesses (due to the fact that it is rooted in a commodity with purchasing power). See ECB, Virtual Currency Schemes, 23.

  7. 7.

    See i.e. the overview in the Study of the Law Library of Congress, Regulation of Bitcoin in Selected Jurisdictions.

  8. 8.

    Some observers have, however, highlighted that these functions are not really fully carried out by Bitcoins due to a series of practical reasons, including, inter alia, their limited circulation in practice in retail transactions for the purchase of goods and services, and the complexity in actually measuring prices in Bitcoin. See David Yermack, “Is Bitcoin a Real Currency? An economic appraisal”, NBER Working Paper No. 19,747, December 2013 9–11.

  9. 9.

    In a recent, rather known case decided in the United States, (SEC v. Shavers, US District Court, Eastern District of Texas, (2013), 2013 US Dist. LEXIS 110018), concerning a Ponzi scheme carried out using Bitcoins, the Court stated, inter alia, that Bitcoins are a form of currency; the Securities Act of 1933 defines a ‘security’ as ‘any… investment contract’ and the Court, applying the so-called ‘Howey test’ set down by the Supreme Court in SEC v. W.J. Howey Co., (328 US 293, (1946)), held that Bitcoins can be qualified as investment contracts (that is, according to the test, ‘any contract, transaction, or scheme involving (1) an investment of money, (2) in a common enterprise, (3) with the expectation that profits will be derived from the efforts of the promoter or athird party’); thus Bitcoins constitute an investment of money for the scope of the Securities Act.

  10. 10.

    The idea of a limited quantity of coins (though not yet reached) may have, inter alia, been at the basis of two ‘Bitcoin rushes’ that took place in 2011 and in 2013. This mechanism has been severely criticised by many, including, for example, the economist Paul Krugman, inter alios, in a few op-eds published by the New York Times that have been quoted extensively: “Golden Cyberfetters” published on 7 September 2011, followed by “BitCoin is Evil”, published on 28 December 2013.

  11. 11.

    See David Yermack, “Is Bitcoin a Real Currency? An economic appraisal”, 15, who takes into account the data on Bitcoin exchange rates with major fiat currencies as of 2013.

  12. 12.

    Directive 2009/110/EC of 16.9.2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions, in OJ L267, of 10 October 2009, at p. 7.

  13. 13.

    This system has thus been defined as ‘partially anonymous’; See Reuben Grindberg, “Bitcoin: An Innovative Alternative Digital Currency”, 164.

  14. 14.

    See Giulia Arangüena, “Bitcoin: una sfida per policymakers e regolatori”, in Diritto mercato tecnologia,

    Quaderno Anno IV, n.1 (2014): 23; Reuben Grindberg, “Bitcoin: An Innovative Alternative Digital Currency”, 168.

  15. 15.

    A particularly ‘famous’ complementary currency, ex multis, that is currently adopted at a local level and has reached an interestingly high level of circulation is the ‘Bristol Pound’; this money can even be used to pay local taxes. For an overview on the functioning of this complementary currency, see http://bristolpound.org/.

    For an overview of American case law dealing with complementary currencies, see Reuben Grindberg “Bitcoin: An Innovative Alternative Digital Currency”, 182 ff.; see also Nicolei M. Kaplanov, “Nerdy Money: Bitcoin, the Private Digital Currency, and the Case Against Its Regulation”, Temple University Legal Studies Research Paper, 2012, (available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2115203) (viewed July 2015).

  16. 16.

    This was the legal claim (breach of contract) brought forth in 2012 by some users of Bitcoins who had been robbed of their virtual wallets stored on the Bitcoinica platform following a hacker attack. The users claimed that Bitcoinica had breached its contractual duties in not ensuring sufficient safety measures against hacking (See https://docs.google.com/file/d/0B_ECG6JRZs-7dTZ5QS0xcUkxQjQ/edit?pli=1) (viewed October 2015).

  17. 17.

    The legal vacuum concerning the regulation of Bitcoins does not only refer to the monetary issues and to the private law ones. Criminal law has had to deal with different crimes carried out on virtual currency platforms (especially trade of a variety of illegal goods and services paid for in Bitcoins); the funding of illegal activities using Bitcoins; money laundering; fraud; theft of Bitcoins from a platform; seizure of Bitcoins in case a platform is ‘shut down’ (i.e. Silk Road in 2013) and the ensuing problem of disclosure of the names of the subjects who buy and sell/transfer these digital ‘tokens’ (UK, Australia and South Africa have approved specific key disclosure laws for this last hypothesis: the refusal to provide the cryptographical keys to the authorities can be a criminally pursued).

  18. 18.

    Article 4 A of the U.C.C. in the USA, for example, in its transposition in many States has been formulated so as to extend its applicability beyond transfers made through the banking system, and so as to comprise payments made by ‘other subjects’ as well. See Rhys Bollen, “The Legal Status of Online Currencies: Are Bitcoins the Future?”, Journal of Banking and Finance Law and Practice 24 (2013): 23–25.

  19. 19.

    Directive 2007/64/EC of 13 November 2007 on payment services in the internal market, in OJ L319 of 5 December 2007, 1

  20. 20.

    See also, ECB, Virtual Currency Schemes, 43.

  21. 21.

    Proposal for a Directive of the European Parliament and of the Council on payment services in the internal market, [final compromise text], 2 June 2015, (available at http://data.consilium.europa.eu/doc/document/ST-9336-2015-INIT/en/pdf).

  22. 22.

    Such was the outcome of a judgement (diffusely quoted) given by the French Commercial Court of Creteil in 2011 (judgement of 6 December 2011) that considered the activity of conversion of real currencies into digital currencies and vice versa carried out on some platforms as the equivalent of the provision of a payment service; and that as such, the activity is subject to authorization and control by the Surveillance Authority.

    A similar qualification was given in the document released by the US Financial Crimes Enforcement Network (FinCEN), (US Department of Treasury) in 2013 (available at http://fincen.gov/statutes_regs/guidance/html/FIN-2013-G001.html, viewed October 2015) as an interpretative guide on the applicability of the US Bank Secrecy Act to persons creating, obtaining, distributing and exchanging virtual currencies. According to the interpretation given by the FinCEN, the conversion between real and virtual currencies carried out on some platforms qualifies as an activity of money transmission and thus falls under the scope of the Bank Secrecy Act. Following the release of this document, one of the then largest platform operating in Bitcoins, Mt. Gox, requested and obtained a licence as a Money Service Business (thus undergoing anti-money laundering and anti-terrorism controls).

  23. 23.

    An interesting position in this sense is the one taken by the German Federal Authority for the Supervision of the Financial Sector, the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), that in a recent Regulation from 2013 considered Bitcoins as ‘units of account’ included within financial instruments that serve as ‘substitute money’, and whose use for a commercial scope requires an authorization under the German banking law (the Kreditwesengesetz). See also Giulia Arangüena, “Bitcoin: una sfida per policymakers e regolatori”, 21.

  24. 24.

    Such is not only the outcome of the quoted FinCEN document, it is also, indirectly, the possible outcome of other documents: i.e. the Bank of Italy recently issued a Communication (Banca d’Italia, “Avvertenza sull’utilizzo delle cosiddette ‘valute virtuali’” of 30 January 2015) according to which, while the private use and acceptance of virtual currencies in payment for goods and services are legal activities, the emission and conversion of virtual currency schemes without authorization may be sanctioned as a violation of the statutes that reserve banking activities and payment service activities only to authorized subjects (see articles 130, 131, 131-ter of the Testo unico bancario (d.lgs. n. 385/93) and article 166 of the Testo unico delle disposizioni in materia di intermediazione finanziaria (d.lgs. n. 58/98)).

  25. 25.

    The Italian legislation for example excludes Bitcoins from the category of ‘financial instruments’ (see d.lgs n. 58/1998 (Testo unico delle disposizioni in materia di intermediazione finanziaria) at article 1-bis, 2nd comma and article 1-bis 4th comma, excluding means of payment from the notion of ‘investment instruments’ and excluding any instrument, not explicitly enumerated, within the notion of ‘financial products’ and sphere of application of the law (article 1, 1st comma, letter u)). This entails that the whole ‘MiFID system’ (as set down by Directive 2004/39/EC of 21 April 2004 on Markets in Financial Instruments in OJ L 145, 30 April 2004, p. 1 and by Directive 2014/65/EU of 15 May 2014 on markets in financial instruments (so-called MiFID2) in OJ L 173 of 12 June 2014, p. 349) will also be inapplicable to virtual currencies.

  26. 26.

    See footnote 24 quoting the Document released by the US FinCEN and the Communication by the Bank of Italy.

  27. 27.

    For example, Bitcoins could be considered as ‘financial products’ under the Australian Corporations Act 2001 when considering them as ‘a facility’ through which non-cash payments are made. See Bollen, “The Legal Status of Online Currencies: Are Bitcoins the Future?”, 20.

    See also footnote 9 for references on recent US case law.

  28. 28.

    The Governments of Japan and Finland have officially classified Bitcoins as a commodity. The Internal Revenue Service of the United States in 2014 declared that Bitcoins, for the sole purpose of taxation, can be assimilated to property. Thus revenue taxes for US citizens on operations using Bitcoins will be applied with reference to the date of the operation. See Giulia Arangüena, “Bitcoin: una sfida per policymakers e regolatori”, 21; Maria Letizia Perugini, Cesare Maioli, “Bitcoin: tra moneta virtuale e commodity finanziaria”, available on http://ssrn.com/abstract=2526207, 10 ff and 1.

  29. 29.

    For more details on taxation and Bitcoins, see Chap. 10 in this book.

  30. 30.

    See for example, on taxation of ‘virtual property’ acquired on online games, Leandra Lederman, “‘Stranger than Fiction’: Taxing Virtual Worlds”, in 82 NYU Law Review 1620, 2007.

  31. 31.

    See Section 3 on Barter transactions and Section 39 on Transactions in securities of the Canada Revenue Agency Interpretation Bulletin.

  32. 32.

    Taxation of gains on Bitcoins would fall under the scope of article 55, inciso IV of the Regulamento do Imposto de Renda de 1999.

  33. 33.

    Case C-264/14 of 22 October 2015.

  34. 34.

    Directive 2006/112/EC of 28 November 2006 on the common system of value added tax in OJ L 347 11 December 2006, 1.

  35. 35.

    European Court of Justice, Skatteverket v. David Hedqvist.

  36. 36.

    And thus transactions in Bitcoins do not fall within the scope of the exemption from VAT laid down in article 135(1)(f) of the Directive for transactions in securities.

  37. 37.

    A risk highlighted, inter alia, by the EBA in its Opinion on Virtual Currencies, 44.

  38. 38.

    The interest of the European market in this sense is quite evident, as demonstrated by the studies carried out by the ECB and the EBA which focus especially on the problem of the risks associated with the use of digital currencies.

  39. 39.

    See, for example, the potential and (limited) instruments of intervention at the disposal of the IMF in case of a speculative attack by a private digital currency against the value of a real currency, Nicholas A. Plassaras, “Regulating Digital Currencies: Bringing Bitcoin within the Reach of the IMF”, Chicago Journal of International Law 14 (2013): 377.

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  1. Law School, University of Roma Tre, Roma Tre, Italy

    Noah Vardi (Associate Professor)

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  1. University of Siena , Siena, Italy

    Gabriella Gimigliano

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Vardi, N. (2016). Bit by Bit: Assessing the Legal Nature of Virtual Currencies. In: Gimigliano, G. (eds) Bitcoin and Mobile Payments . Palgrave Studies in Financial Services Technology. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-137-57512-8_3

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  • DOI: https://doi.org/10.1057/978-1-137-57512-8_3

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