Bitcoin and other cryptocurrencies have been a hot-button topic in the last few years. Some hail them as the harbinger of a new monetary future, others write them off as passing fads. But personal opinions aside, what are the legal ramifications of using this new form of commerce?
What is Cryptocurrency?
In order to explore the legalities of bitcoin and other cryptocurrencies, first, we should review what this currency is and how it is used.
Also known as digital currency, cryptocurrency exists on something known as blockchain. Imagine a chain built of blocks. Each block represents a transaction, and these are strung together in the order that each transaction occurs. In the case of cryptocurrency, the first block would be the first transaction, the second would be the next transaction, and so on. All of these blocks are displayed on a publically-accessible ledger so that anyone who looks at the ledger can see the history of each transaction on that chain from its very first to its most recent.
The ledger and all of its blocks are built using a technology known as cryptography, a unique kind of computing far more accurate than a human accountant. Blockchains are connected to a broad network of computers which has powerful implications in cybersecurity. Every new block that is to be added to a chain must be simultaneously recorded by a team of computerized validators known as “nodes” spread throughout the network, making it extremely difficult for hackers to infiltrate the system.
In viewing a blockchain ledger, a person is able to see the entire history of every Bitcoin in circulation. No one owns the ledger, but by virtue of its design, it is nearly impossible for anyone who uses it to cheat. Blocks that have already been recorded cannot be edited or removed, you can only add new blocks to a chain. Tampering with an existing chain only serves to invalidate each of the blocks that follow an amended block.
What is Bitcoin?
Bitcoin is simply one type of cryptocurrency. It’s a brand name and is one of close to 1,000 peer-to-peer currencies used in modern-day commerce. Some others include:
- Ethereum
- Ripple
- Dash
- Litecoin
- Monero
- Tether
- Faircoin
- Blocknet
- Walton
So, imagine selling an apple to a person in exchange for one Bitcoin. Although used to make a trade, Bitcoin does not exist as a physical currency. So, because this is not a regular transaction where money transfers from the person’s bank (or a similar payment system) to yours, how will you know that the person you are selling to actually has a Bitcoin? And how will this digital currency transfer to you?
Well, when the person you are selling the apple to gives you a Bitcoin, a message is sent to all of the nodes in a network saying that one Bitcoin is going from that person’s account – or virtual wallet – to yours. Every node then amends the ledger to show one Bitcoin being subtracted from your customer’s account and showing where that Bitcoin has now been added to your account. This is all done through cryptography, so each transaction is recorded in exactly the same way and all of the networks must agree that the transaction is valid before creating an actual block to add to the chain.
Note: Bitcoin and blocks on the chain are often confused for one another, but it is important to keep in mind that a block is not a bitcoin, but rather a permanent, immutable record of a bitcoin transaction.
Now, before those transactions can be used to create a new block in the chain, the nodes must compete to solve a deeply complex mathematical equation. The block to be added contains the information that all of the nodes recorded, but only one is rewarded with creating a block to be placed on the actual ledger. If the nodes did not compete, then the transaction would be recorded several times despite only occurring once. The whole process takes about 10 minutes from the time the transaction begins until it is completed and a block is added.
Is Bitcoin Legal?
Bitcoin and other cryptocurrencies are completely legal to use as a form of exchange. In fact, no government regulation applies to individual consumers who trade in digital currency, at all.
In the United States, virtual currencies are not regarded as legal tender. The same is true in most parts of the world. So far, only Japan and Switzerland have approved Bitcoin and other cryptocurrencies as legal tender.
According to the Commodity Exchange Act, in the United States, cryptocurrencies are regarded as a commodity. To the Internal Revenue Service, they are property.
While the Financial Crimes Enforcement Network (FinCEN) does not regulate individual Bitcoin and cryptocurrency users, it does regulate individuals and companies who act as money exchangers or who act as transmitters just as they do with other transmitters like PayPal and Moneygram. Anyone acting in this capacity is required to register with FinCen. Registered transmitters are further required to report any individual user who makes a transaction of $10,000 or more in a day, even if this benchmark is reached through a series of smaller transactions.
Caution and Cryptocurrency
While virtual currencies are legal for individuals who want to trade digital currency in exchange for products or services, Bitcoin and other cryptocurrencies do come with a bit of caution. Here are just a few of the largest concerns legal and financial experts cite, which are more easily associated with cryptocurrency:
- Blockchain transactions can be completely anonymous, which opens the door to illegal sales and other transactions.
- Because blockchain is decentralized, no one is responsible for reporting suspicious or outright criminal activity.
- Due to sophisticated encryption methods, it is difficult to freeze Bitcoin and other cryptocurrencies when suspicious or criminal activity is discovered.
The criminal story of Silk Road offers the most famous example of bitcoin being used for clandestine purposes. In 2013, the Federal Bureau of Investigations shut down a bitcoin-based black market known as Silk Road after the site’s owner, Ross Ulbricht, placed an ad on a Bitcoin forum using his own Gmail address that allowed investigators to trace his whereabouts and arrest him. Currently serving life in prison without the possibility of parole, Ulbricht was convicted of seven different crimes relating to distributing illegal drugs, running a criminal enterprise, computer hacking, money laundering, and selling false identities.
Criminals rely heavily on the anonymity provided by virtual currencies and, in fact, use them as preferred tools of their respective trades. Despite cryptography used to encrypt transactions and shield user identities, regulations do apply to how this technology can be used and investigators diligently monitor blockchains for criminal activity.
The legalities of Bitcoin and other cryptocurrencies may change over time as consumers begin using virtual currencies to pay for goods and services. For now, however, individuals engaging in legal trading for purchases and payments can rest assured they are within the law in doing so.