What is a "Bitcoin"?: The Key Question for Virtual Currency Regulation By Elijah Alper

What is a “Bitcoin”?: The Key Question for Virtual Currency Regulation

                                                 By Elijah Alper*

Bitcoin and other virtual currency are becoming more “mainstream.” Virtual currency
proponents were once divided between “enthusiasts” who saw it as an alternative to government
currency that cannot and should not be regulated by any government, 1 and “conformists” who
believe virtual currency must be regulated in some fashion to become widely accepted. 2

That debate is essentially over, and the conformists have won. Regardless of whether virtual
currency “should” be regulated as a philosophical matter, virtual currency startups have quickly
learned that venture funding favors regulatory certainty, and government regulators will not be
convinced to stay away by principled arguments. Instead, federal and state regulators have taken
gradual steps into the virtual currency world, beginning with the Financial Crimes Enforcement
Network (FinCEN) in 2013 3 and followed by the IRS, 4 New York and other states, 5 and to some
extent Congress. 6 Where virtual currency enthusiasts once trumpeted Bitcoin as a way to escape
the government monopoly over money, 7 virtual currency startups now routinely boast of their
compliance with regulatory requirements. 8

         See, e.g., Michael Jackson, Bitcoin and Regulation: Lessons from the Early Days of Skype, Coindesk.com
(May 26, 2014) (“The default position of the products and services derived from bitcoin must be that they are not
to be regulated. They need not be, and the existing rules need not apply. . . . To put it bluntly – every bitcoin actor
should be reading the law very carefully and finding the loopholes.”).
          See, e.g., Walter Frick, Why Bitcoin Entrepreneurs Are Begging for More Regulation, Harvard Business
Review Blog (Mar. 26, 2014), at http://blogs.hbr.org/2014/03/why-bitcoin-entrepreneurs-are-begging-for-more-
regulation/#disqus_thread (“Despite the libertarian ideology often associated with the cryptocurrency, those doing
business in the space are both realistic about the need for regulation and eager to have more of it sooner rather
than later.”); Aaron Sankin, Game over: How libertarians lost the battle for Bitcoin’s soul, Salon.com (Mar. 26,
2014) (quoting Coinbase co-founder Fred Ehrsam as stating, “This is a good avenue for government regulation of
Bitcoin. . . . .If you’re moving bitcoins on behalf of others, it’s probably a good idea that somebody sees what
you’re doing and [makes sure you] have reasonable security measures [in place]”).
         FIN-2013-G001, “Application of FinCEN’s Regulations to Persons Administering, Exchanging or Using
Virtual Currencies,” March 8, 2013.
         I.R.S. Notice 2014-21, March 25, 2014.
         See, e.g., Texas Dep’t of Banking, Supervisory Memorandum 1037 (Apr. 3, 2014) (providing guidance on
regulatory treatment of virtual currency); New York State Department of Financial Institutions, In re Virtual
Currency Exchanges (Mar. 11, 2014) (announcing that New York will consider proposals and applications for a
“BitLicense” virtual currency license);
       Beyond Silk Road: Potential Risks, Threats, and Promises of Virtual Currencies, Hearing of Sen. Comm. On
Homeland Security and Governmental Affairs (Nov. 18, 2013).
        Joe Matonis, The Implications of Bitcoin: Money Without Government, CoinDesk (Jan. 23, 2014), at
http://www.coindesk.com/bitcoin-money-without-government/ (“[B]itcoin is money without government: just as

The Key Question

The consensus that virtual currency should – or at least will – be regulated has launched a new
debate: What should the regulations say, and who should do the regulating?

Absent Congressional action, various U.S. government agencies are unlikely to convene a
summit and work out all virtual currency regulation in one meeting. Rather, as usual, regulators
will regulate what they already know, using rules they already understand. Thus, rather than
make entirely new rules, regulators will likely attempt to apply existing rules to virtual currency
as much as possible. For example, if Bitcoin (the most popular virtual currency) looks like a
security, then expect virtual currency regulations to look like securities regulations, adopted by
the Securities and Exchange Commission (SEC). If Bitcoin looks more like a commodity,
expect those who transact in virtual currency to be subject to the derivative and swap regulations
of the Commodities Futures Trading Commission (CFTC), and so on for other agencies.

Thus the future of virtual currency regulation centers around one fundamental and yet-
unresolved question: What exactly is a Bitcoin? This article identifies possible answers and
briefly discusses their implications.

The Potential Answers

Is a Bitcoin a type of “currency”? At this point, the U.S. federal regulatory consensus is that
virtual currency, including Bitcoin, is not “currency.” FinCEN said that virtual currency is not
“currency” because under existing FinCEN anti-money laundering regulations “real” currency
consists only of the “the coin and paper money of the United States or of any other country that
(1) is designated as legal tender and that (2) circulates and (3) is customarily used and accepted
as a medium of exchange in the country of issuance.” 9 According to FinCEN, virtual currency is
not “currency” because it does not have legal tender jurisdiction in any jurisdiction. 10 In March
2014, the IRS determined that virtual currency is not “currency” under federal tax law, citing
FinCEN’s definition of currency. 11

one cannot separate the bitcoin network from the bitcoin monetary unit, one cannot separate the bitcoin network
effect from its central banking implications.”).
         See, e.g., Erik Wilgenhof Plante, Building Trust In Bitcoin Through Compliance And Regulation (May 8,
2014), at http://blog.itbit.com/blog/2014/5/2/with-disruption-comes-regulation-and-trust-a-note-from-our-
newest-team-member (quoting leading virtual currency exchange CEO as stating “regulatory compliance is our
number one priority and we pride ourselves on having the highest standards in the industry”).
         See supra note 1.
        FinCEN’s definition of “currency” requires only that potential currency be accepted as legal tender in any
one country. So if a single small jurisdiction accepts Bitcoin as legal tender, then technically Bitcoin would become
“currency” under FinCEN and IRS rules, which might dramatically change how Bitcoin is regulated.
         See supra note 2.

The decision that virtual currency is not “currency” already has major implications for virtual
currency regulation. For example, virtual currency transactions are not subject to FinCEN or
IRS currency reporting requirements, such as those that require businesses and financial
institutions to report most currency transfers of more than $10,000 in a single day. 12 Virtual
currency is taxed as if it were property, such that gain or loss is realized on disposition of the
virtual currency, and based on the IRS’ currency exchange rules. 13

Is a Bitcoin a “thing of value”? This is the current position under federal law, subject to change.
In March 2013, FinCEN decided that virtual currency was “value” and not “currency,” allowing
the agency to apply existing rules governing transmissions of “value” to the new technology of
virtual currency. FinCEN’s money transmission regulations encompass persons who accept and
transmit not just currency but any “value that substitutes for currency.” 14 FinCEN concluded
that virtual currency exchanges or administrators are money transmitters under existing rules
because they receive “value” (i.e., virtual currency) for the purpose of transmitting it to others. 15
Others virtual currency actors, such as miners, investors, and people who use Bitcoin to purchase
goods and services, are not money transmitters because they are obtaining virtual currency
“solely for the user’s own purposes and not for the benefit of another,” and these activities
involve neither “acceptance” nor “transmission” of virtual currency. 16

If Bitcoin is merely a “thing of value,” then exchanges and other actors may be subject to federal
law requirements for money transmitters. These are relatively straightforward: Money
transmitters must register with FinCEN, maintain an anti-money laundering program, file
suspicious activity reports with the government, 17 and report information for transactions over
$3,000, 18 but they are less regulated than banks, securities firms, or other financial institutions.
Virtually all states, however, have separate licensing rules for money transmitters, usually
consisting of a lengthy application process and bond requirement. Compliance with all of those

        See 12 C.F.R. § 1010.310 (rules for currency transaction reports); 26 U.S.C. § 6050l (requiring reporting by
persons engaged in a trade or business who receive of more than $10,000 in cash in related transactions).
         See supra note 2.
         31 C.F.R. § 1010.100(ff)(5)(i).
         See supra note 1.
         FinCEN, Interpretive Rulings FIN-2014-R001, FIN-2014-R002 (Jan. 30, 2014).
        See 31 C.F.R. Part 1010.122 (providing rules for money transmitters and other money services
        See 31 C.F.R. § 1010.410(f) (commonly known as the “travel rule” because it requires information about
senders and, if available, recipients to “travel” with the fund transfer instructions).

different state laws imposes a significant burden on companies, particularly startups, who may
need to obtain dozens of state licenses. 19

Is a Bitcoin a “consumer financial product”? If so, Bitcoin transactions with consumers may be
subject to significant regulation by the Consumer Financial Protection Bureau (CFPB), which
oversees nearly two dozen consumer financial laws. The CFPB has broad authority to regulate
any “consumer financial product or service,” which includes activities such as extending credit,
taking deposits, or providing “stored value or payment instruments.” 20 Even if virtual currency
itself does not fit into one of these categories, companies that deal in virtual currency – for
example by aiding virtual currency consumer payments or holding virtual currency for
consumers – may be subject to CFPB jurisdiction. 21 Commercial Bitcoin transactions, or
companies that do not provide services to consumers, would be largely exempt from such rules.

Is a Bitcoin a “commodity”? If so, then certain virtual currency transactions would be heavily
regulated, while others might be subject to little regulation (apart from the FinCEN rules on
money transmission discussed above). Bitcoin and other virtual currency appear to meet the
Commodities Futures Trading Commission’s (CFTC’s) definition of “commodities,” which
includes “goods and articles…and all services, rights and interests…in which contracts for future
delivery are presently or in the future dealt in.” 22 Virtual currency is a “good” or “interest,” and
it has a volatile market price that could support, now or in the future, contracts for subsequent

Here, too, the classification of Bitcoin as a “commodity” by itself would determine much of the
regulation that applies. Commodities are regulated by the CFTC, and the CFPB is prevented
from exercising any authority over CFTC-regulated activities by persons registered with the
CFTC. 23 But only certain commodities activities are substantially regulated by the CFTC,
namely commodities futures and swaps that involve “future delivery” rather than involve

          E.g., Va. Code. Tit. 6.2, Ch. 19 (requiring application and bond of up to $1 million to be licensed as a
money transmitter). Because virtually currency business usually operate over the Internet, they must either file for
a money transmitter license in every state where customers may reside, or explain to each interested state why it
is not a money transmitter under that state’s particular laws.
         12 U.S.C. § 5481(15).
         The CFPB also enforces existing regulations that it may determine apply to virtual currency, such as its
recently amended rules governing remittance transfers, which are transfers of money by a consumer in the United
States to a foreign individual. See 12 C.F.R. § 1005.30 et seq.
         7 U.S.C. § 1A(4).
         12 U.S.C. § 5517(j) (“The [CFPB] shall have no authority to exercise any power to enforce this title with
respect to a person regulated by the Commodity Futures Trading Commission.”).

immediate or near-immediate delivery. 24 Other virtual currency “commodity” transactions may
not be subject to significant CFTC regulation, and other agencies may choose not to regulate
those transactions in deference to the CFTC.

Is a Bitcoin a “security”? If so, Bitcoin transactions would become heavily regulated just like
other security transactions. For example, Bitcoin “issuers,” however defined, would likely have
to register with the SEC, parties may have public reporting obligations, and transactions could be
subject to insider trading and other anti-fraud rules.

Thus far, the SEC has sent mixed signals regarding whether it believes the securities laws apply
to virtual currency. 25 In November 2013, SEC Chair Mary Jo White told the Senate Homeland
Security committee that “[w]hether a virtual currency is a security under the federal securities
laws, and therefore subject to our regulation, is dependent on the particular facts and
circumstances at issue.” 26 Assuming the SEC agrees with other regulators that virtual currency
is not “currency,” then it will be a security if it is an “investment contract,” which is defined
using a the multi-part test set forth by the Supreme Court in SEC v. W. J. Howey Co., 27 or “an
instrument commonly known as a ‘security,’” which depends on an vague “economic reality”
test. 28

It is not at all clear whether virtual currency will be deemed to satisfy either of these criteria. It
does seem clear, however, that rather than inventing new rules, the SEC will apply these existing
tests in decide whether and how to regulate virtual currency.

      The term “future delivery” is defined narrowly and does not cover future delivery of actual physical
commodities. See 7 U.S.C. § 1A(19).
         In July 2013, one federal magistrate judge held that Most interestingly, a federal magistrate judge recently
found that Bitcoin is a currency and that interests purchased with Bitcoin may be securities, but at this point that
decision appears to be an outlier. See SEC v. Shavers & Bitcoin Savings and Trust, Memorandum Opinion re:
Subject Matter Jurisdiction, No. 4:13-CV-416 (E.D. Tex. Aug. 6, 2013) (“Bitcoin is a currency or form of money, and
investors wishing to invest in [Bitcoin Savings and Trust] provided an investment of money.”).
       Letter from Mary Jo White, SEC, to Sen. Thomas R. Carper, Chairman, Committee on Homeland Security
and Governmental Affairs (Aug. 30, 2013), at 1.
       328 U.S. 293, 298-99 (1946) (setting forth test that asks, in relevant part: (1) Is there an investment of
money?; (2) Is there a common enterprise?; and (3) Is there an expectation of profits from the efforts of the
promoter or a third party?).
          See, e.g., SEC v. Turner Enterprises, Inc., 348 F. Supp. 766 (D. Ore. 1972).
          Elijah Alper is a senior associate at WilmerHale’s Washington, D.C. office and a Young Lawyer Liaison to the Deposit
Products and Payment Systems Subcommittee. Mr. Alper has helped expand WilmerHale’s Bitcoin and virtual currency
practice. He has spoken and written on virtual currency matters to help explain these concepts to the legal community, and he
assisted clients ranging from established financial institutions to individuals and startups on compliance applicable regulations
and identify best practices.


As they inevitably tackle Bitcoin and other virtual currency, regulators will ask not whether
virtual currency “should” be regulated, but instead whether virtual currency is a type of
something already covered by existing regulations. And to determine that “type,” regulators will
likely look at Bitcoin, the most popular virtual currency, and ask, “What is it?”

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