Friday, December 6, 2013

The Legalities of Bitcoin

The phenomenon of Bitcoin has taken the financial world by storm. A form of currency, although it came into existence only in 2009, it has increased exponentially both in usage and value. It has been said that the value of Bitcoin has appreciated by a whopping 5,000% in less than a year. This form of currency has gained momentum in India as well, as this report in the Mint suggests.

US Court Decision: “Securities”

While the concept of Bitcoin is novel (and I must confess I’m still trying to get to grips with its foundation, features and implications), it is bound to give rise to numerous legal and regulatory issues. Before setting out some of the more general legal issues, it is appropriate to discuss a U.S. court ruling that considers the issue of whether Bitcoin-related investments constitute securities. A post on The Race to the Bottom Blog has a discussion on Securities and Exchange Commission v. Trendon T. Shavers.

In that case, the United States District Court for the Eastern District of Texas was concerned with the question whether Bitcoin-related investments were “securities” and hence subject to the jurisdiction of the Securities and Exchange Commission (SEC). The defendant, Shavers, was the founder and operator of Bitcoin Savings and Trust (BTCST) and solicited Bitcoin in principal investments from BTCST investors. The investors suffered losses and hence the SEC brought an action against Shavers and BTCST on the ground that they have made misrepresentations regarding the nature of the investments and had defrauded the investors. Shavers adopted the argument that SEC had no jurisdiction because the investments were not “securities” because Bitcoin is not money, and is not regulated in the US. He also argued that no money changed hands. The court did not accept Shavers’ arguments and instead ruled in favour of the SEC.

The court first set out the principal characteristics of Bitcoin after relying on prevailing legal academic literature:

Bitcoin is an electronic form of currency unbacked by any real asset and without specie, such as coin or precious metal. Derek A. Dion, I’ll Glady Trade You Two Bits on Tuesday for a Byte Today: Bitcoin, Regulating Fraud in the E-Conomy of Hacker-Cash, 2013 U. Ill. J.L. Tech & Pol’y 165, 167 (2013). “It is not regulated by a central bank or any other form of governmental authority; instead, the supply of Bitcoins is based on an algorithm which structures a decentralized peer-to-peer transaction system.” Id. Bitcoin was designed to reduce transaction costs, and allows users to work together to validate transactions by creating a public record of the chain of custody of each Bitcoin. Id. Bitcoin can be used to purchase items online, and some retail establishments have begun accepting Bitcoin in exchange for gift cards or other purchases. …

In order to constitute “security” the court had to first be satisfied that the investments constitute an investment of money. The court answered in the affirmative:

It is clear that Bitcoin can be used as money. It can be used to purchase goods or services, and as Shavers stated, used to pay for individual living expenses. The only limitation of Bitcoin is that it is limited to those places that accept it as currency. However, it can also be exchanged for conventional currencies, such as the U.S. dollar, Euro, Yen, and Yuan. Therefore, Bitcoin is a currency or form of money, and investors wishing to invest in BTCST provided an investment of money.

The scope of what amounts to a “security” is quite wide, and it is therefore not surprising that Bitcoin-related investments are ensnared within its ambit.

Other Legal Issues

At a more general level, it appears that Bitcoin is yet to be specifically prohibited or regulated, although there are moves to study the implications of Bitcoin from a legal and regulatory perspective. Moreover, whether subject to regulation or not, Bitcoin will likely give rise to implications under several areas of the law, including taxation, consumer protection, money laundering, and so on.

It is not clear if the regulatory authorities in India have begun to consider the implications of Bitcoin, but that might be required in the near future, particularly if this form of currency becomes more popular in usage. The Reserve Bank of India (RBI) will certainly be seized of the issues, given its mandate to regulate the market for currencies. Going by the US example in the Shavers case, the Securities and Exchange Board of India (SEBI) will have to consider the implications from an investment or securities regulation stand-point.

Bitcoin has already spawned a new genre of academic literature that examines the financial and legal implications of the concept. The following is a sampling:




4. Is Bitcoin a Real Currency? by David Yermack.

7 comments:

aquixot said...

The very lately mooted novel idea, dubbed to be largely but, in one's own opinion, thoughtlessly classified as 'innovative', seems to be, just as the nomenclature itself, quite amusing or funny, but for wrong reasons. Not to regret; of course, at least for the present. To reflect for a while, however, is that not a sad but helpless reaction commonly surfacing, causing a lump in the throat, every time a non-expert and seemingly half- baked concept or a changed concept of its kind is thrown up and starts catching up among the humanity for reasons unknown or readily decipherable. Despite being fully conscious and quite aware of the inherent risk- foreboding- “it is bound to give rise to numerous legal and regulatory issues.”

Mandar said...

Timely post this one. Some thoughts :

1. Another source that comes to mind is a policy paper authored by Jerry Britto of the Mercatus Center of the George Mason University- Here's the link :
http://mercatus.org/sites/default/files/Brito_BitcoinPrimer.pdf.

Jerry does a great job of cutting through some of the fog and shine light on this important development in Payment systems and currencies.

2. In its Financial Stability Report of June 2013, the RBI has in fact taken note of the rise of the digital currencies; but at present its policy is merely to wait and observe the actions of its counterparts in other jurisdictions. When it does show on the regulatory radar, interesting questions will arise under the Payment Systems Act of 2007 and the regulations for semi-closed loop, open loop money framed thereunder as well as the areas that you flagged off.

In particular, because of the lack of an intermediary and the presence of an open ledger in lieu thereof, the Block Chain- where the miners validate the transactions (and get paid in return), it would be an open issue as to who is the payment system provider under the 2007 law (which requires payment system providers to register with the RBI). The issue is that hitherto, payment systems required a third party intermediary to "keep the books" Bitcoin jolts that conventional payment system mechanism and replaces it with a framework where "the book" is kept on the Block Chain and validated by peer miners. Clearly, the money transfer operations are performed, but not through a payment system provider, as understood by conventional commerce. The RBI will likely notify regs for digital currencies to clarify these and other issues.

3. Because the federal court interpreted the expression, "money" to mean any currency and not necessarily fiat, (as Shaver invited it to hold), the issue as to whether BTCST investment constituted note was rendered moot; nonetheless, BTCST investment would have been found to be a security even under that limb given the nature of enterprise Shaver seemed to have run. Shaver essentially took a demand liability towards the investors ("until you withdraw your funds..") and the paper evidencing that would qualify as a note. Shaver probably took a punt on a narrow interpretation of the expression, money (which only means the legal tender) to bail him out; the Court rightly declining his invitation.

Mandar said...

P.S. Just noticed that the David Yermack hyperlink leads the reader to a different paper on ssrn. Here's the correct link : http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2361599

vswami said...

The concept of "Bitcoin', mainly brainchild of technocrat, having been set rolling,seems to be on its course, that too at an increasingly fast pace.
To add, for the exclusive benefit of those , in minority as yet, interested n improving upon their general grasp / knowledge of the new found 'mining'- high-tech - byproduct but remaining unbridled hence unregulated-thus-far:
wld. refer a media column, -Bitcoins: Plenty of enthusiasm, but a long way left to go"- Xcerpt:
"But most of the interest around Bitcoin comes from speculators," he ... "The RBI will be watching the discussions around Bitcoin with a lot of ...' and as commented, -
<> Not at all surprising that unlike as is commonly witnessed in regard to other sensational topics in recent times of this kind, on this one on 'Bit coins'; so far just a solitary comment has been ventured; that too in the guise of a intriguing poser, waiting for an answer . A couple of possible reasons , as gathered and understood, though simply vaguely, could be that, - as of now it is in wide circulation mostly for peer -to- peer transactions and among high-end speculators. Be that as it may, for simply academic interest, without going into the merits or otherwise of the points sought to be canvassed 'for' , any common enthusiast may look up @ , Response to Andrew Sorkin’s “Render Unto Caesar, but Who Backs the Bitcoin?” in the NYT.
Suggest to, do look up = if you care for,and derive pleasure in sharing, just in doing it.

vswami said...

OFFHAND > Attention is drawn to several print media columns on the topic of, - Bitcoins; in particular, this one in TOI, -Bitcoins: Plenty of enthusiasm, but a long way left to go . As noted, not at all surprising that unlike as is commonly witnessed in regard to other sensational topics in recent times of this kind, on this one on 'Bit coins'; so far just a solitary comment has been ventured; that too in the guise of a intriguing poser, - prima facie unclear in its purport- waiting for an answer . A couple of possible reasons, as gathered and understood, though simply vaguely, could be that, - as of now it is in wide circulation mostly for peer -to- peer transactions and among high-end speculators. Be that as it may, for simply academic interest, without going into the merits or otherwise of the points sought to be canvassed 'for' any common enthusiast may look up @ , Response to Andrew Sorkin’s “Render Unto Caesar, but Who Backs the Bitcoin?” in the NYT. So the indication is so strong that the surrounding controversies on the new found by-product of ‘mining’ (in technocrat’s language) cannot but remain inconclusive. Even so, the fact that as has been its wont in such matters, the concept and its circulation has found a favourable reaction and nod by the US, the trend setter Obama , in one’s view, does not deserve nut be cautioned, keeping in mind its inherent pitfalls, to be regarded a sure guide for the good to be scrupulously gone by and adopted by other nations such as India, especially at this time when the economy has the dreaded wolf is waiting at the doors.

Umakanth Varottil said...

@Mandar. Thanks for pointing to this. The link has been corrected.

Esha Goel and Aonkan Ghosh said...

Your post inspired us to research more on Bitcoins. We have put up a note on the same on our blog - http://thelawgical.blogspot.in/

we are looking forward to your suggestions on the same.