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Regulatory Responses to Bitcoin: 2013 Edition

Op-ed - Regulatory Responses to Bitcoin: 2013 Edition

See also: the 2012 analog of this article.

Correction: the IMF did not actually release the paper linked to in this article; the author was a University of Chicago professor with no direct ties to the organization

In the past three months, regulatory attention to Bitcoin has increased massively. Before March 2013, the Bitcoin community had had little more to go on than some various government reports, permission to use Bitcoin for political purposes from the New Hampshire Deputy Secretary of State, and a casual remark of approval from the Finnish Central Bank. Now that Bitcoin has become so (relatively) successful, however, governments from all over the world are watching, eager to figure out what they think is the best way to integrate cryptocurrencies into the established legal frameworks. The responses from around the world have been sometimes consistent, and sometimes wildly inconsistent even within the same country. This shows clearly an important lesson with regard to the nature of governments: although pro-government and anti-government advocates alike often tend to think of governments as monolithic entities which undertake certain strategies and enact policies in order to achieve speficied, whether benevolent or malevolent, goals, in reality government decision making can often be as disparate and chaotic a process as the private market, with hundreds of entities pulling in hundreds of directions tailored to their own specific interests and perspectives. Once one goes beyond a single country to the entire geopolitical scene, the divide becomes even stronger, albeit with certain general patterns. The purpose of this article will be to look at the government response to Bitcoin from all across the world over the past three months and determine the general trends.

The United States

To most Bitcoiners, the United States has become the epicenter of the great regulatory conflict. In the United States, money transmission regulation is among the most cumbersome in the world; in order to serve the entire country, a money transmitter must obtain a federal money services business (MSB) license from FinCEN and money transmitter licenses from 48 states. However, although the costs of participating in the US are so high, so are the benefits; the majority of Bitcoin businesses, and probably users, are located in the US. So far, excluding long-forgootten one-off statements like the words of Chuck Schumer, we have seen four major regulatory actions relating to Bitcoin:

  • The FinCEN guidance report – this was a document published in March 2013 that essentially sets out the guidelines for what the legal requirements for the various kinds of Bitcoin businesses are. Businesses and individuals simply using Bitcoin as a currency to trade goods and services are in the clear, but those trading bitcoins for other currencies (ie. exchanges) are legally defined as money transmitters, and need both the federal MSB license and an MT license for each state in which they operate or have customers.
  • The MtGox Dwolla Seizure – in May, the Department of Homeland Security, in cooperation with the state government of Maryland, shut down MtGox’s Dwolla account and may now be in the process of a criminal investigation. The charge: operating without a money services business license. MtGox’s US subsidiary, Mutum Sigillum LLC, never obtained the federal MSB license and, when the company first opened their bank account in 2011, claimed that they would not be using their account for money transmission. This particular violation does not even rely on the FinCEN guidance; the claimed money transmission is the act of transmitting money between users’ MtGox accounts and their Dwolla accounts in order to deposit and withdraw USD. Fortunately, this does not significantly affect the rest of the Bitcoin economy; all other major exchanges have had MSB licenses for many months, if not years, and are much more careful in their relationships with banks.
  • The Bitcoin Foundation Cease and Desist– the state government of California has sent a formal letter to the Bitcoin Foundation, the non-profit group that has claimed for itself the role of promoting Bitcoin acceptance and development, demanding that they cease and desist their activities as a money transmitter. The request has taken the Bitcoin community by surprise; the Bitcoin foundation itself does not do any money transmission, and has nothing formally to do with Bitcoin beyond paying grants and a salary for lead developer Gavin Andresen.
  • The GAO Report – the Government Accountability Office has published a report, mentioning Bitcoin numerous times by name, detailing when income received through virtual currencies is taxable. Essentially, economic interaction in virtual currency systems where the only possible exchange is between virtual currency and virtual goods and services, with neither the money nor the goods having any value outside the virtual environment, does not generate taxable income, but trades between physical goods and digital currency, or digital goods and fiat currency, are taxable. The report recommends that the Internal Revenue Service, the main US tax authority, help educate taxpayers about what kind of income in cyberspace is and is not taxable, but mentions that the IRS has specifically decided that it would not create any new rules specific to currencies like Bitcoin. “Given [the] uncertainty,” the report writes, “available funding, and other priorities, IRS made a reasoned decision not to implement a compliance approach specific to virtual economies and currencies.”

In general, there appear to be two strands of thought with regard to Bitcoin inside the US government. First of all, there is a desire to recognize digital currencies as the next great innovation in the financial system, and simply figure out how to apply existing legal rules and standards to them. Following the Liberty Reserve shutdown in May, FinCEN chief Jennifer Calvery specifically said that Liberty Reserve was an isolated incident and Bitcoin exchanges that follow the rules “have nothing to fear from Treasury”.

Others, however, have a dimmer view of Bitcoin. The major piece of evidence for this is, once again, the Liberty Reserve case, although this time it is from a “Notice of Finding” by the Department of the Treasury. In the report, the author writes that “Liberty Reserve is also a completely irrevocable payment system and digital currency. The fact that transactions are irrevocable, meaning that they cannot be reversed or refunded in the event of fraud, makes it a highly desirable system for criminal use and a highly problematic one for any legitimate payment functions.” This can easily be interpreted as an indictment of Bitcoin; at the very least, it suggests that there are many people in FinCEN that would agree with the previous statement, and so have a reason to see Bitcoin as a whole (and therefore, by extension, all modern cryptocurrencies in general) as a fundamentally undesirable system.

Finally, the Bitcoin Foundation cease and desist is likely to be one of two things: either simply the result of ignorance and confusion, not realizing the difference between a company and a nonprofit industry organization, or, as one post on Hacker News suggests, an attempt to expand the definition of money transmission to include the Bitcoin Doundation’s activities. The FinCEN report is not binding on state governments, so once other state governments become more “institutionally aware” of Bitcoin’s existence we may well see forty eight different approaches to handling it in forty eight states.

Outside the US

Outside the United States, there has been comparatively very little attention on Bitcoin; the few governments that have spoken out have mostly simply stated that Bitcoin earnings are taxable; usually, income earned in bitcoins is considered to be essentially equivalent to barter income, which government agencies around the world have already generally agreed is taxable for many decades. In that regard, we have:

  • The Australian Taxation Office has confirmed that Bitcoin transactions will be taxable. In fact, the ATO went a step further, discounting the claim that Bitcoin’s privacy properties will make the organization’s job especially difficult. “Bitcoin is no more anonymous than physical cash and the ATO has experience in working with earlier forms of ­anonymous electronic money systems, and with physical cash, which are relevant for responding to new and emerging ­systems,” ATO commissioner Michael Hardy told the Australian Financial Review.
  • The Dutch government confirmed that although Bitcoin does not legally qualify as electronic money income earned in bitcoins is still taxable because the relevant income tax laws simply mention “income”, not “income as money”.
  • The Canadian government specified that Bitcoin is indeed taxable in two ways: as barter if bitcoins are provided as income or sold as goods and services, or as capital gains if a Bitcoin user buys bitcoins at a low price and sells them at a higher price.
  • Germany, interestingly enough, has taken a different tack. In Germany, a financial expert in the FDP, a classical liberal political party that is currently the third largest in the parliament, started an inquiry into Bitcoin’s tax status that led to a surprising answer: that, due to a technicality in German tax law, capital gains earnings on Bitcoin (ie. buying low and selling high) are tax-free if the buy and sell are separated by at least a year. Barter taxes on earning bitcoins in exchange for goods and services still apply.

In terms of actually regulating Bitcoin exchanges, non-American governments appear to be fairly lax. In Canada, for example, FINTRAC, the Canadian government’s equivalent to FinCEN, sent a letter to Bitcoin exchanges saying that Bitcoin exchanges are “not, at this time, engaged as a money services business in Canada as per the Proceeds of Crime (Money Laundering) and Terrorist Financing and its associated Regulations.” The report continues: “In fact, your entity doesn’t provide the services of remitting and/or transferring funds for the sake of the service. The transfer of funds is simply a corollary of your actual service of buying and selling virtual currency. Therefore, you do not have to register your entity with us.” For Bitcoin businesses, currently Canada looks like a safe haven, and over the past three months Bitcoin business in Canada has increased massively. The Toronto Bitcoin meetups now have a few dozen attendees every time (up from ten at the first one in November), and, a company seeking to create the technical infrastructure for Bitcoin exchanges, has chosen to base itself in Vancouver. European governments have not made any such specifically positive measures toward Bitcoin, but so far they have proven themselves remarkably hospitable by inaction. The one major European government action, the takedown of Bitcoin24, was justified by suspected dishonesty on the part of the exchange, not any claims of legal illegitimacy of Bitcoin or the business of Bitcoin exchange itself.

The International Level

At the international level, government agencies are definitely watching. At the World Bank, a discussion panel was held on the legal and regulatory challenges behind Bitcoin, and two of the four panel discussions were about illicit commerce. The IMF has not actually released anything relating to Bitcoin yet, but one paper has one paper by a University of Chicago professor has put forward an argument essentially stating that, if Bitcoin becomes a larger part of the global economy, it will become part of the IMF’s responsibility to protect Bitcoin if malefactors attempt to destabilize it. The paper even went so far as to suggest that member nations should consider “grant[ing] the IMF more direct control over Bitcoin by granting it and other digital currencies quasi-membership status” – perhaps, purists would argue, allowing Bitcoin to be manipulated like gold (if gold is indeed being manipulated), but at the same time securing its legitimacy to an extent that makes the FinCEN guidance pale in comparison.

But there are also reasons to be worried. In an article in the G8 summit magazine (see page 60), John Lyons, the chief executive of the International Cybersecurity Protection Alliance wrote that “alternative payment mechanisms, such as Bitcoin and a host of others, can enable criminal and terrorist groups to launder money and fund their operations”, and then proceeded to advocate that governments simply ban these mechanisms. “If treasuries and financial institutions around the world were to block those transactions,” Lyons continues, “and permit only legitimate currencies to be used on the internet through regulated payment service providers and cards (such as Visa, MasterCard and American Express), then the flow of many billions of dollars to criminal groups would be stemmed.” The article’s tone is brazen; the article literally contains the recommendation that governments “outlaw alternative payment mechanisms for trading currencies online” – not rogue payment mechanisms, or terrorist-friendly payment mechanisms, but specifically payment mechanisms that are alternative; that is to say, payment mechanisms that fall outside the status quo.

Lyons’ words were published in the magazine that was read by hundreds of high-level government officials at the G8 summit but, fortunately for alternative payment system developers and enthusiasts, the ICSPA is not a government organization; the organization is rather a single-issue nonprofit, much like the World Wildlife Fund, and the article itself was nothing more than an opinion post by one of its members. Furthermore, MtGox published an ad in the very same magazine, seeking to reach out to government officials and pull them in the opposite direction. In general, the international opinion toward Bitcoin is very much undecided, and there is plenty of room for maneuver.


Make no mistake: this is only the beginning of government attention and regulation of digital currencies. In 2011 and 2012, Bitcoin was much smaller and less significant than it is now, and governments produced an appropriate response: write a few papers but generally leave it alone. Now, the stakes are ten times higher, and so governments are willing to spend ten times as much effort. If Bitcoin becomes ten times more popular still in 2014, we can expect ten times as much governmental attention as we are seeing now. Many believe that the US government will slowly, but steadily, increase regulation on Bitcoin to the point of outright banning any services that attempt to interface it with the existing economy.

Others believe that Jennifer Calvery is genuinely speaking the truth when she says that she is in favor of digital currency innovation in general. Outside the US, the outlook appears to be considerably more positive, although the US government is known for employing various strategies to push its own legal frameworks on the rest of the world – assuming, that is, that it manages to come up with a consistent internal opinion on Bitcoin in the first place. We are only now entering the eye of the storm, as the regulatory issues that are now being raised are every bit as significant – arguably much more significant, than those surrounding the regulation of cryptography in the 1990s. Then, the permissive solution won. We can only hope, and work together to ensure, that the same happens with cryptocurrency today.