Harvard Journal of Law & Technology

Volume 27, Number 2 Spring 2014

COINING BITCOIN’S “LEGAL-BITS”: EXAMINING THE

REGULATORY FRAMEWORK FOR BITCOIN AND VIRTUAL
CURRENCIES

Matthew Kien-Meng Ly*

TABLE OF CONTENTS

I. INTRODUCTION .............................................................................. 588

A. What Are Currencies? .............................................................. 589
B. Virtual Currencies.................................................................... 589
II. BITCOIN........................................................................................ 590
A. What Is Bitcoin? ...................................................................... 590
1. Introduction ........................................................................... 590
2. The Ecosystem ...................................................................... 591
a. Bitcoin Mining ................................................................... 591
b. Bitcoin Exchanges.............................................................. 592
c. Merchants .......................................................................... 592
d. Innovative Ventures ........................................................... 592
B. Why Are People Using Bitcoin? ............................................... 593
C. What Is the Problem?............................................................... 594
1. Criminal Activity................................................................... 595
2. Tax Evasion ........................................................................... 595
3. Investment Scams .................................................................. 596
III. HOW CAN THE LEGAL SYSTEM HANDLE VIRTUAL
CURRENCIES SUCH AS BITCOIN? ................................................... 596
A. Bank Secrecy Act ...................................................................... 596
B. Securities Regulations .............................................................. 597
C. Stamp Payments Act of 1862.................................................... 598
D. Electronic Fund Transfer Act of 1978 ..................................... 599
E. Uniform Commercial Code ...................................................... 600
IV. GOVERNMENT ACTIONS RELATED TO BITCOIN .......................... 600
A. FinCEN’s Guidance on Virtual Currencies ............................. 600
B. California’s Department of Financial Institutions’
Cease-and-Desist Letter to Bitcoin Foundation .................... 602
C. Bitcoin Asset Seizures and Arrests ........................................... 603

* Harvard Law School, J.D. Candidate, 2015; B.ASc., Electrical Engineering, University
of Waterloo, 2007; I would like to thank Harvard Law School Professor Todd D. Rakoff for
his insightful comments and guidance on this Note. I would also like to thank Aaron
Frumkin and the rest of the editors and staff of the Harvard Journal of Law and Technology
for their feedback and tireless effort throughout the process. Finally, thank you to Diana Lai,
my family, and friends for their support and encouragement.
588 Harvard Journal of Law & Technology [Vol. 27

1. Crackdown on Silk Road....................................................... 603

2. Mt. Gox Assets Frozen .......................................................... 603
D. Regulatory Developments as of April 2, 2014 ......................... 604
1. New York State Department of Financial Services
Inquiry into Virtual Currencies ....................................... 604
2. Bitcoin Foundation Meeting with Federal Regulators .......... 604
3. Senate Committee Looks into Virtual Currencies ................. 605
4. Internal Revenue Service Virtual Currency Notice:
Virtual Currency Is Property for U.S. Federal Tax
Purposes .......................................................................... 605
V. WHAT DO THE RECENT GOVERNMENT ACTIONS MEAN
FOR BITCOIN’S FUTURE? ............................................................... 606
A. Businesses Exchanging, Buying, and Selling Bitcoins ............. 606
B. Merchants Accepting Bitcoin as an Alternative Payment
Currency ................................................................................ 607
C. Non-Miner Users ..................................................................... 607
D. Miners ...................................................................................... 607
VI. FINAL THOUGHTS ....................................................................... 608

I. INTRODUCTION

The “virtual currency” and “Bitcoin” phenomena have recently

garnered a great deal of media and regulatory attention.1 However,
many people do not understand what virtual currency, let alone
Bitcoin, is and how it works. Fewer still know how to interpret the
reports of government “crackdowns” on Bitcoin businesses. This pa-
per explains what Bitcoin is, why people use it, and why the govern-
ment should care. In addition, this paper contemplates whether any
existing legal frameworks may be used to regulate Bitcoin: Which
laws can be leveraged? How can they be leveraged? What has the
government done to regulate Bitcoin thus far?
The laws affecting Bitcoin have changed dramatically since 2013
when regulators began to recognize Bitcoin as a currency. Businesses
engaging in Bitcoin transactions now may be required to meet strict
reporting and record-keeping standards. In addition, they may be re-
quired to implement anti-money laundering programs. Individual us-
ers and businesses alike will need to comply with the applicable tax

1. See, e.g., If Bitcoin Remains Impractical, Treasury Will Let It Be, BLOOMBERG
BUSINESSWEEK, http://www.businessweek.com/articles/2014-03-18/if-bitcoin-remains-
impractical-treasury-will-let-it-be (last visited May 7, 2014); Putative Bitcoin Founder
Categorically Denies It, N.Y. TIMES, http://www.nytimes.com/2014/03/18/business/media/
man-named-by-newsweek-issues-denial-on-bitcoin-claim.html?_r=0 (last visited May 7,
2014); Why Warren Buffet Is Wrong on Bitcoin, CNBC, http://www.cnbc.com/id/
101504218 (last visited May 7, 2014).
No. 2] Coining Bitcoin’s “Legal-Bits” 589

regimes as well. Because the regulatory framework of Bitcoin is a new

development, the future of applicable laws remains uncertain.

A. What Are Currencies?

Currency is broadly defined as “[t]okens used as money in a

country.”2 The Financial Crimes Enforcement Network (“FinCEN”),
an Agency of the United States government, defines currency as “the
coin and paper money of the United States or of any other country that
[i] is designated as legal tender and that [ii] circulates and [iii] is cus-
tomarily used and accepted as a medium of exchange in the country of
issuance.” 3 FinCEN terms these currencies “real currencies.”4 Alt-
hough currencies like the United States Dollar (“USD”) used to be
backed by commodities such as gold,5 today, most real currencies are
fiat currencies, which are merely backed by their respective govern-
ments.6 By controlling the money supply, governments are able to
influence the value of their currencies.7 Relatively stable currency
values are achieved by public trust in the continued rational govern-
ment manipulation of the money supply.8

B. Virtual Currencies

In contrast to a real currency, a virtual currency is a “medium of

exchange that operates like a currency in some environments, but does
not have all the attributes of real currency.”9 The key difference be-
tween virtual currency and real currency is that virtual currency does
not have legal tender status in any jurisdiction.10 In other words, a
virtual currency is one that is not administered or issued by a sover-
eign.

2. Currency, BUSINESSD ICTIONARY, http://www.businessdictionary.com/definition/

currency.html (last visited May 7, 2014).
3. Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using
Virtual Currencies, DEP’T OF THE TREASURY FIN. CRIMES ENFORCEMENT NETWORK 1
(Mar. 18, 2013) (alteration in original) (quoting 31 CFR § 1010.100(m)) (internal quotation
marks omitted), available at http://fincen.gov/statutes_regs/guidance/pdf/FIN-2013-
G001.pdf [hereinafter FinCEN].
4. Id.
5. Is U.S. Currency Still Backed by Gold?, BD. OF G OVERNORS OF THE FED. RESERVE
SYS. (Aug. 2, 2013), http://www.federalreserve.gov/faqs/currency_12770.htm.
6. See Vincent Scheurer, The Magic of Money, THE MOTLEY FOOL (July 1, 2011),
http://news.fool.co.uk/news/investing/2011/07/01/the-magic-of-money.aspx.
7. See Back to Basics: What Is Money?, INT’ L MONETARY FUND (Sept. 2012),
http://www.imf.org/external/pubs/ft/fandd/2012/09/basics.htm.
8. See id.
9. FinCEN, supra note 3, at 1.
10. Id.
590 Harvard Journal of Law & Technology [Vol. 27

II. BITCOIN

A. What Is Bitcoin?

1. Introduction

Introduced in 2009, Bitcoin is a virtual currency that exists solely

in electronic form. A program running on the Internet processes and
logs every Bitcoin transaction in a public ledger. 11 The Bitcoin system
functions in a distributed manner: No legal entity controls or adminis-
ters Bitcoin.12 Additionally, no sovereign or commodity backs the
currency.13 Thus the value of a bitcoin is determined solely by public
perception, trust, and adoption,14 causing great volatility. On April 1,
2014, the value of one bitcoin was approximately $478 USD.15
Bitcoins are created through a process called “mining,” wherein
users provide computing power to process Bitcoin transactions, and in
return may earn transaction fees in the form of bitcoins.16 Tasked with
processing and confirming transactions, each mining machine holds a
copy of the public ledger. 17 The Bitcoin algorithm is programmed to
release bitcoins in decreasing quantities up to a total of twenty-one
million bitcoins.18 No additional bitcoins will be created once this
number is reached. As of April 2014, approximately twelve million
bitcoins had been mined and are in circulation.19
In addition to mining, users may also obtain bitcoins by purchas-
ing them on various online exchanges, through peer-to-peer transfers,
or by receiving them as payment for a product or service.20 Once ob-
tained, bitcoins reside in a person’s digital wallet much like cash re-

11. FAQ — Bitcoin, How Does Bitcoin Work?, B ITCOIN PROJECT, https://bitcoin.org/en/
faq#how-does-bitcoin-work (last visited Dec. 3, 2013).
12. See FAQ — Bitcoin, Who Controls the Bitcoin Network?, BITCOIN PROJECT,
https://bitcoin.org/en/faq#who-controls-the-bitcoin-network (last visited Dec. 3, 2013).
13. See FAQ — Bitcoin, Why Do Bitcoins Have Value?, BITCOIN PROJECT,
https://bitcoin.org/en/faq#why-do-bitcoins-have-value (last visited Dec. 3, 2013).
14. Id.
15. Value obtained from the Bitstamp website. Bitstamp — Buy and Sell Bitcoins,
BITSTAMP, https://www.bitstamp.net (last visited Apr. 1, 2014).
16. FAQ — Bitcoin, How Does Bitcoin Mining Work?, BITCOIN PROJECT,
https://bitcoin.org/en/faq#how-does-bitcoin-mining-work (last visited Dec. 3, 2013).
17. See FAQ — Bitcoin, What if I Receive a Bitcoin When My Computer Is Powered
Off?, B ITCOIN PROJECT, https://bitcoin.org/en/faq#what-if-i-receive-a-bitcoin-when-my-
computer-is-powered-off (last visited May 7, 2014).
18. FAQ — Bitcoin, How Are Bitcoins Created?, BITCOIN PROJECT, https://bitcoin.org/
en/faq#how-are-bitcoins-created (last visited May 7, 2014).
19. Total Bitcoins in Circulation, BLOCKCHAIN, https://blockchain.info/charts/total-
bitcoins (last visited May 7, 2014).
20. FAQ — Bitcoin, How Does One Acquire Bitcoins?, BITCOIN PROJECT,
https://bitcoin.org/en/faq#how-does-one-acquire-bitcoins (last visited Dec. 3, 2013).
No. 2] Coining Bitcoin’s “Legal-Bits” 591

sides in a physical wallet. Ultimately, bitcoins resemble cash in digital

form and can be used to purchase goods and services.21
Since its introduction in 2009, Bitcoin has witnessed increasing
popularity and adoption. For instance, not only are online businesses
accepting bitcoins as payment, but traditional brick-and-mortar retail-
ers are also beginning to accept bitcoins.22 Despite this increased ac-
ceptance, the value of bitcoins remains highly volatile. In 2013, the
market price of a bitcoin fluctuated between $13 and $1200 USD.23

2. The Ecosystem

The ecosystem supporting Bitcoin has been growing exponential-

ly. Notably, there are three main categories of systems: (1) the Bitcoin
mining community; (2) Bitcoin exchanges; and (3) merchants who
accept bitcoins as payment for goods and services. In addition, there
are numerous innovative ventures based on Bitcoin, from Bitcoin au-
tomated teller machines (“ATMs”) to Bitcoin-based investment in-
struments.

a. Bitcoin Mining

As mentioned above, Bitcoin mining is a process wherein users

provide computing power to process Bitcoin transactions. Because the
Bitcoin algorithm releases new bitcoins in declining numbers, it be-
comes more difficult to mine for bitcoins as time progresses.24 As a
result, there is an entire industry dedicated to mining bitcoins, where
users build high-powered computers for the sole purpose of mining. 25
There are also numerous Bitcoin mining contractors whose primary
business is to rent out computing power to mine for bitcoins.26

21. FAQ — Bitcoin, Is Bitcoin Secure?, BITCOIN PROJECT, https://bitcoin.org/en/faq#is-

bitcoin-secure (last visited May 7, 2013).
22. Use Bitcoins in the Real World, USEBITCOINS.INFO, http://usebitcoins.info/index.php/
bitcoin-in-the-real-world#!/catid=12;2;21;3;22;10;13;17;20;15;16;9;4;11;6;18;1;14;25;24;
23;19 (last visited May 7, 2014); Ashley Boncimino, Where You Can Shop with Bitcoin in
Chicago, CHICAGO BUSINESS (June 13, 2013), http://www.chicagobusiness.com/article/
20130613/NEWS08/130619907/#; see also, e.g., Kashmir Hill, Living on Bitcoin for a
Week: The Journey Begins, FORBES (May 1, 2013), http://www.forbes.com/sites/
kashmirhill/2013/05/01/living-on-bitcoin-for-a-week-the-journey-begins.
23. BITCOIN CHARTS, http://bitcoincharts.com/charts/mtgoxUSD#rg60zczsg2013-01-
01zeg2013-12-31ztgSzm1g10zm2g25zv (last visited May 7, 2014).
24. FAQ — Bitcoin, How Are Bitcoins Created?, supra note 18.
25. See FAQ — Bitcoin, What Do I Need To Start Mining?, BITCOIN PROJECT,
https://bitcoin.org/en/faq#what-do-i-need-to-start-mining (last visited Dec. 3, 2013).
26. See, e.g., MinerCloud — Bitcoin, Litecoin and Dogecoin Miner Contractor,
MINERC LOUD, http://minercloud.com (last visited Nov. 14, 2013).
592 Harvard Journal of Law & Technology [Vol. 27

b. Bitcoin Exchanges

Bitcoins also can be bought and sold on Bitcoin exchanges. 27

These exchanges match buyers and sellers, and help create a market
for bitcoins.28 Due to the volume of transactions, these exchanges play
a vital role in establishing the value of bitcoins. Similar to stock ex-
changes, users can buy and sell bitcoins in exchange for popular cur-
rencies such as dollars or euros.29 A few prominent Bitcoin exchanges
include Mt. Gox,30 Bitstamp, and BTCN.31

c. Merchants

Merchants are a key component of the Bitcoin ecosystem. To be

sure, Bitcoin would be of little use as a currency without merchants
who accepted it as payment for goods and services. Many online mer-
chants accept bitcoins.32 Additionally, a number of brick-and-mortar
retailers located throughout the United States have begun to accept
bitcoins.33 These retailers are typically located in large urban centers
such as San Francisco and New York.34

d. Innovative Ventures

In addition to the three main categories of systems in the Bitcoin

ecosystem, there have been a plethora of innovative ventures that
draw on the development of Bitcoin. For example, on October 29,
2013, Robocoin started deploying Bitcoin ATMs.35 These ATMs al-
low users to purchase bitcoins in person.36 Some large retailers such
as Wal-Mart are also allowing users to purchase bitcoins.37 Social
game developer Zynga announced that they will accept Bitcoin for

27. FAQ — Bitcoin, How Does One Acquire Bitcoins?, supra note 20.
28. See, e.g., Bitstamp — Buy and Sell Bitcoins, supra note 15.
29. Id.
30. Mt. Gox closed down in February of 2014 and filed for bankruptcy on February 28,
2014, after losing approximately 750,000 of its customers’ bitcoins. See MtGox Gives Bank-
ruptcy Details (Mar. 4, 2014), BBC NEWS, http://www.bbc.com/news/technology-
26420932.
31. BITCOIN CHARTS, http://bitcoincharts.com/charts/volumepie (last visited Nov. 14,
2013).
32. USEBITCOINS, http://usebitcoins.info (last visited Nov. 14, 2013).
33. Use Bitcoins in the Real World, supra note 22.
34. See id.
35. Jon M. Chang, First Bitcoin ATM Installed in Vancouver Coffee Shop, ABC NEWS
(Oct. 30, 2013), http://abcnews.go.com/Technology/bitcoin-atm-conducts-10000-worth-
transactions-day/story?id=20730762.
36. Id.
37. How Do You Buy Bitcoins in America?, H OW D O YOU BUY BITCOINS,
http://howdoyoubuybitcoins.com/in/united-states (last visited Nov. 14, 2013).
No. 2] Coining Bitcoin’s “Legal-Bits” 593

some of their online social games.38 Arguably one of the more inter-
esting examples is the Winklevoss twins’ Bitcoin Exchange Traded
Fund (“ETF”), allowing investors to invest in a fund holding bitcoins
much like they would invest in a mutual fund holding securities.39 As
of April 1, 2014, the Securities and Exchange Commission had not yet
approved the ETF.40

B. Why Are People Using Bitcoin?

Why use a virtual currency like Bitcoin instead of a real currency

such as the USD? The USD can be bought and sold on exchanges (the
foreign exchange market) and is accepted by all merchants in the US,
and electronic payment systems such as debit and credit (Visa, Mas-
terCard, American Express) are established for it.41 Despite these ar-
guments for using the USD rather than virtual currencies, Bitcoin is
being adopted rapidly. Two main benefits of using Bitcoin are privacy
and convenience.42
Because bitcoins are transferred peer-to-peer without an interme-
diary, transacting in bitcoins provides users with high levels of priva-
cy.43 Transferors and recipients of bitcoins remain nearly
anonymous.44 Other than the equivalent of an account number, no
personal information is recorded in the Bitcoin ledger.45 Nor is per-
sonal information available by cross-referencing account numbers.46
In other words, transferring bitcoins is much like transferring cash,
except it is performed over the Internet, which allows bitcoins to be
transferred to anyone anywhere in the world nearly anonymously.

38. See Olga Kharif, Bitcoin Tops $1,000 Again as Zynga Accepts Virtual Money,
BLOOMBERG (Jan. 6, 2014), http://www.bloomberg.com/news/2014-01-05/bitcoin-tops-1-
000-again-on-adoption-by-zynga-amid-wider-usage.html.
39. See Nathaniel Popper & Peter Lattman, Winklevoss Twins Plan First Fund for
Bitcoins, N.Y. TIMES (July 1, 2013), http://dealbook.nytimes.com/2013/07/01/first-name-in-
the-first-fund-for-bitcoins-winklevoss.
40. See Winklevoss Brothers Offer an Index To Track Price of Bitcoin, N.Y. TIMES (Feb.
19, 2014), http://dealbook.nytimes.com/2014/02/19/before-a-bitcoin-fund-comes-a-price-
index.
41. See How Is Bitcoin Different from the Dollar? (Nov. 19, 2013), FORBES,
http://www.forbes.com/sites/karlwhelan/2013/11/19/how-is-bitcoin-different-from-the-
dollar/; see also Bitcoin Seen as Little Threat to Payment Firms (Feb. 24, 2014),
BLOOMBERG, http://www.bloomberg.com/news/2014-02-24/bitcoin-seen-by-payment-
networks-as-little-threat-to-dominance.html.
42. See FAQ — Bitcoin, What Are the Advantages of Bitcoin?, B ITCOIN PROJECT,
https://bitcoin.org/en/faq#what-are-the-advantages-of-bitcoin (last visited May 7, 2014).
43. Id.
44. See FAQ — Bitcoin, Is Bitcoin Anonymous?, BITCOIN PROJECT, https://bitcoin.org/en/
faq#is-bitcoin-anonymous (last visited May 7, 2014).
45. See id.
46. See id.; see also Protect Your Privacy, THE BITCOIN FOUNDATION,
https://bitcoin.org/en/protect-your-privacy (last visited May 7, 2014).
594 Harvard Journal of Law & Technology [Vol. 27

Bitcoin also offers high levels of convenience. As mentioned

above, bitcoins can easily be transferred to anyone, anywhere in the
world. In addition, there are few, if any, transaction fees associated
with transfers.47 In contrast, using established payment systems incurs
relatively sizeable transaction fees.48 This difference allows Bitcoin
users to make payments that may otherwise be impractical due to
transaction costs.
Another benefit of Bitcoin, albeit possibly unintended, is that it
provides financial stability where a national currency is unstable. 49
For instance, in 2012, the Iranian Rial was experiencing hyperinfla-
tion.50 At the same time, there was a shortfall of USD in Iran due to
sanctions by the United States and its allies.51 Unable to buy the more
stable USD and faced with holding onto the hyper-inflating Rial,
some Iranians turned to bitcoins as a haven for financial stability. 52
The value of bitcoins was deemed more stable than the Rial and funds
could easily be transferred into and out of Iran over the Internet.53

C. What Is the Problem?

As mentioned earlier, one of the primary benefits of Bitcoin is

anonymity in transactions. However, it is precisely this characteristic
that drives many of the concerns related to Bitcoin.54 Numerous arti-
cles have been written about Bitcoin and other virtual currencies be-
ing used as tools to support criminal activity such as money
laundering and buying illegal goods.55 There is also the potential for

47. See Advantages, supra note 42.

48. See Bitcoin Seen as Little Threat to Payment Firms, supra note 41; see also Bitcoin
Targets Payments Business Giants Visa to JPMorgan (Jan. 22, 2014), BLOOMBERG,
http://www.bloomberg.com/news/2014-01-22/bitcoin-targets-giants-visa-to-jpmorgan-with-
lower-cost-payments.html.
49. See Max Raskin, Dollar-Less Iranians Discover Virtual Currency, BLOOMBERG
BUSINESSWEEK (Nov. 29, 2012), http://www.businessweek.com/articles/2012-11-29/dollar-
less-iranians-discover-virtual-currency.
50. See Jon Matonis, As Inflation Rages in Iran, Bitcoin Software Not Available, FORBES
(Oct. 9, 2012), http://www.forbes.com/sites/jonmatonis/2012/10/09/as-inflation-rages-in-
iran-bitcoin-software-not-available.
51. See Raskin, supra note 49.
52. Id.
53. Id.
54. See Kashmir Hill, Congress Is Nervous About This Whole Bitcoin Thing, FORBES
(Aug. 15, 2013), http://www.forbes.com/sites/kashmirhill/2013/08/15/congress-is-nervous-
about-bitcoin/.
55. See, e.g., id.; Kashmir Hill, The FBI’s Plan for the Millions Worth of Bitcoins Seized
from Silk Road, FORBES (Oct. 4, 2013), http://www.forbes.com/sites/kashmirhill/2013/10/
04/fbi-silk-road-bitcoin-seizure; Marc Santora, William K. Rashbaum, and Nicole Perlroth,
Online Currency Exchange Accused of Laundering $6 Billion, N.Y. TIMES (May 28, 2013),
http://www.nytimes.com/2013/05/29/nyregion/liberty-reserve-operators-accused-of-money-
laundering.html.
No. 2] Coining Bitcoin’s “Legal-Bits” 595

tax evasion.56 In addition, due to the unclassified nature of Bitcoin,

there is the potential for investment scams.57

1. Criminal Activity

A prime example of Bitcoin being used in criminal activity is the

Silk Road online marketplace, launched in February 2011.58 Based on
Bitcoin, this marketplace facilitated the exchange of illegal drugs and
weapons for bitcoins — with all parties cloaked in anonymity.59 Crim-
inal activity is not limited to just Bitcoin; anonymity exists for other
virtual currencies as well. In 2006, an online currency named Liberty
Reserve was founded in Costa Rica.60 Liberty Reserve allowed users
to transfer money with minimal personal information recorded and did
not verify the identity of its users.61 In 2013, the co-founder of Liberty
Reserve pleaded guilty to money laundering for laundering proceeds
from credit card fraud, identity theft, investment fraud, child pornog-
raphy, and narcotics trafficking through the operations of Liberty Re-
serve.62

2. Tax Evasion

Another problem area of Bitcoin is its potential facilitation of tax

evasion. Like many other governments, the U.S. government taxes
income. There are two main ways for bitcoins to generate income.
First, because the value of a bitcoin fluctuates, bitcoins can be sold at
higher values than the original purchase price and thus generate a net
income gain for the seller.63 Second, bitcoins can be received by mer-
chants as payment for goods and services and therefore be taxable as

56. Robert W. Wood, Bitcoin: Tax Evasion Currency, FORBES (Aug. 7, 2013),
http://www.forbes.com/sites/robertwood/2013/08/07/bitcoin-tax-evasion-currency.
57. See George Frey, Banshee Bitcoins: $5 Million Worth of Bitcoin Vanish in China, RT
(Nov. 12, 2013), http://rt.com/business/banshee-bitcoin-vanish-china-601; see also SEC
Charges Texas Man with Running Bitcoin-Denominated Ponzi Scheme, U.S. SEC. EXCH.
COMM’ N (July 23, 2013), http://www.sec.gov/News/PressRelease/Detail/PressRelease/
1370539730583#.UoVzwfmsh8E.
58. See Doug Gross, Web’s Black Market Peddles Drugs, Guns and More, CNN (Oct. 4,
2013), http://www.cnn.com/2013/10/04/tech/web/internet-black-market.
59. See James O’Toole, Feds Seize $28 Million in Bitcoins from Alleged Silk Road Oper-
ator, CNNMONEY (Oct. 25, 2013), http://money.cnn.com/2013/10/25/news/economy/
bitcoins-silk-road.
60. Co-founder of Liberty Reserve Pleads Guilty to Money Laundering in Manhattan
Federal Court, U.S. DEP’T OF JUSTICE (Oct. 31, 2013), http://www.justice.gov/opa/pr/
2013/October/13-crm-1163.html.
61. Santora, supra note 55.
62. Co-founder of Liberty Reserve Pleads Guilty to Money Laundering in Manhattan
Federal Court, supra note 60.
63. See FAQ — What About Bitcoin and Taxes?, BITCOIN PROJECT, https://bitcoin.org/
en/faq#what-are-the-advantages-of-bitcoin (last visited May 7, 2014).
596 Harvard Journal of Law & Technology [Vol. 27

though the merchant received USD.64 Ultimately, due to the anonymi-

ty provided by Bitcoin, there is the potential for individuals to with-
hold reporting Bitcoin-related income and thus evade taxes.65

3. Investment Scams

An additional concern stemming from Bitcoin is the potential for

investment scams. Due to the difficulty in classifying Bitcoin, oppor-
tunistic individuals may engage in activities that swindle unsuspecting
people of their bitcoins while skirting the law. For example, although
the case is still ongoing, it is alleged that the owner of Bitcoin Savings
and Trust, Trendon T. Shavers, operated the equivalent of a Ponzi
scheme.66 Shavers solicited investments in bitcoins, promised interest
to investors, improperly paid investor withdrawals with new invest-
ments of bitcoins, and misappropriated bitcoins for personal use.67 In
the summer of 2013, the Securities and Exchange Commission
(“SEC”) charged Shavers with defrauding investors in a Ponzi
scheme.68 In his defense, Shavers argued that Bitcoin investments
were not securities because Bitcoin is not money and is not regulated
by the United States.69 Thus he argued that he did not violate any U.S.
securities laws.

III. HOW CAN THE LEGAL SYSTEM HANDLE VIRTUAL

CURRENCIES SUCH AS BITCOIN?

The government could leverage a few legal frameworks should it

choose to regulate Bitcoin and virtual currencies. The most relevant
frameworks include: (1) the Bank Secrecy Act; (2) Securities Regula-
tions; (3) the Stamp Payments Act; (4) the Electronic Funds Transfer
Act; and (5) the Uniform Commercial Code.

A. Bank Secrecy Act

Codified in Title 31 of the Code of Federal Regulations Chapter

X, the Currency and Foreign Transactions Reporting Act of 1970,
commonly referred to as the Bank Secrecy Act (“BSA”), was enacted
in response to concerns that financial institutions were facilitating

64. Id.
65. Wood, supra note 56.
66. See SEC Charges Texas Man with Running Bitcoin-Denominated Ponzi Scheme, su-
pra note 57.
67. Id.
68. Id.
69. Kirsten Salyer, Ponzi-Scheme Charge Is Good News for Bitcoin, BLOOMBERG (Aug.
7, 2013), http://www.bloomberg.com/news/2013-08-07/ponzi-scheme-charge-is-good-
news-for-bitcoin.html.
No. 2] Coining Bitcoin’s “Legal-Bits” 597

money laundering.70 As such, the BSA is also sometimes referred to

as an “anti-money laundering” law.71 The Act requires U.S. financial
institutions to assist U.S. government agencies in detecting and pre-
venting money laundering.72 Among other provisions, the specific
requirements for financial institutions (i.e., money services business-
es) include the need to “register with the government, implement anti-
money laundering procedures,” and keep records.73 Additionally, fi-
nancial institutions are required to report cash transactions exceeding
$10,000 and suspicious activity, including money laundering, tax eva-
sion, or other criminal activities.74
The BSA would be more relevant to governing businesses as op-
posed to individuals transacting in bitcoins. Specifically, Bitcoin ex-
changes and other related businesses allowing the exchange of
bitcoins for other currencies would fall under the purview of the BSA.
If the BSA is applicable, any business that facilitates transactions of
currency for bitcoins would be required to register with the govern-
ment, implement anti-money laundering procedures, and meet strict
reporting requirements, possibly undermining the beneficial anonymi-
ty of Bitcoin transactions. The implication would be that the benefit of
anonymity in Bitcoin transactions could be undermined for its users.
The key question is whether Bitcoin has the legal status of a cur-
rency for the purposes of the BSA. To be sure, almost any object can
exhibit the main characteristic of a currency — its acceptance as pay-
ment for goods and services — yet many objects do not have the legal
status of a currency.

B. Securities Regulations

Codified in 15 U.S.C. § 78, the Securities and Exchange Act of

1934 (“SEA”) governs the exchange of securities and contains, among
other things, registration, disclosure, and antifraud provisions.75 Nota-
bly, if the SEA is applicable, it may be used to govern Bitcoin ex-
changes and other businesses that exchange bitcoins for currency and
vice-versa. Securities are broadly defined under the SEA to include
notes, stocks, and investment contracts. The question here is whether

70. See FinCEN’s Mandate from Congress, DEP’T OF THE TREASURY FIN. CRIMES
ENFORCEMENT NETWORK, http://www.fincen.gov/statutes_regs/bsa (last visited May 7,
2014).
71. Id.
72. Id.
73. Reuben Grinberg, Bitcoin: An Innovative Alternative Digital Currency, 4 HASTINGS
SCI. & TECH. L.J. 159, 204 (2012); See Am I an MSB?, FINANCIAL CRIMES ENFORCEMENT
NETWORK, http://www.fincen.gov/financial_institutions/msb/amimsb.html (last visited May
7, 2014).
74. FinCEN’s Mandate from Congress, supra note 70.
75. See 15 U.S.C. § 78 (2012).
598 Harvard Journal of Law & Technology [Vol. 27

Bitcoin falls within one of these categories. Currencies are not within
the scope of the SEA.76
The answer appears to be that Bitcoin would not be considered a
security for SEA purposes. It lacks the characteristics that are com-
mon to any of the three general categories enumerated as securities.
First, Bitcoin does not have note-like characteristics, as it is not an
instrument for which the maker promises to pay a sum of money to
another party.77 Second, Bitcoin cannot be classified as stock, because
holding a bitcoin does not confer rights to the holder such as the “right
to receive dividends” or “voting rights.”78
Finally, it is unlikely that Bitcoin will be considered an invest-
ment contract.79 The Supreme Court has stated that an investment
contract for SEA purposes requires the following four elements: (1) a
person invests money; (2) the money is invested into a common en-
terprise; (3) profits are expected from the investment; and (4) the ex-
pected profits are generated solely from the efforts of the promoter or
a third party.80 Here, while a person pays money to buy bitcoins, that
person is not investing in Bitcoin. Paying money to purchase a good
or even another currency is not, in and of itself, an investment. In ad-
dition, the money used to buy bitcoins does not go to a common en-
terprise that is expected to generate profits from the efforts of the
promoter or a third party.81

C. Stamp Payments Act of 1862

The Stamp Payments Act (“SPA”), enacted in 1862, prohibits the

issuance and circulation of any token “for a less sum than $1, intended
to circulate as money or to be received or used in lieu of lawful mon-
ey of the United States.”82 The purpose of the Act was to protect the
value and use of U.S. coins against unofficial competing currencies. 83
Prior judicial decisions indicate that the “Act is unlikely to apply to
anything that (1) circulates in a limited area, (2) is redeemable only in
goods, [or] (3) does not resemble official U.S. currency and is other-
wise unlikely to compete with small-denominations of U.S. curren-
cy.” 84 The relevant question here is whether bitcoins detract from the

76. See id. at § 78(c).

77. See Derek Dion, Note, I’ll Gladly 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, 176–77 (2013).
78. See Grinberg, supra note 73, at 195 (quoting Landreth Timber Co. v. Landreth, 471
U.S. 681, 686 (1985)) (internal quotation marks omitted).
79. See id. at 196–98.
80. S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298–99 (1946).
81. See Grinberg, supra note 73, at 196–98.
82. 18 U.S.C. § 336 (2012).
83. See Grinberg, supra note 73, at 183.
84. See id. at 185.
No. 2] Coining Bitcoin’s “Legal-Bits” 599

use of U.S. coins. At the current state of adoption, Bitcoin does not
seem to be reducing the demand for U.S. coins. There are simply not
enough uses (merchants and retailers accepting Bitcoin) for Bitcoin to
be a competing currency. Even if the government decides that Bitcoin
falls under the scope of the SPA, there may be significant challenges
to enforcing the law.
The key issue with enforcement is the absence of a central author-
ity that creates and manages bitcoins. As mentioned above, bitcoins
are created and awarded by the Bitcoin software program running on a
network of computers on the Internet. Without attributing the creation
of bitcoins to specific persons or entities, who would the government
prosecute? Thus, at least in the current ecosystem, not only is Bitcoin
unlikely to fall within the scope of the SPA, but enforcement of the
law also seems impractical.

D. Electronic Fund Transfer Act of 1978

The Electronic Fund Transfer Act (“EFTA”) was enacted in 1978

and provides a “framework establishing the rights, liabilities, and re-
sponsibilities of participants in electronic fund and remittance transfer
systems.”85 Because bitcoins exist electronically, and thus transfers
between users are performed electronically, the EFTA seems applica-
ble to Bitcoin, at least at first glance.
A closer examination suggests, however, that it is unlikely that
Bitcoin falls under the scope of the EFTA. The EFTA is designed to
apply to financial institutions engaging in or facilitating electronic
fund transfers.86 Whether the EFTA is applicable to Bitcoin depends
on whether Bitcoin is a financial institution and whether Bitcoin per-
forms electronic fund transfers. As mentioned above, Bitcoin is a
software program that runs on the Internet. It is not a financial institu-
tion (it is not even a recognizable legal entity), nor does it hold ac-
counts belonging to customers.87 Thus the Bitcoin software program
is not a financial institution for the purposes of the EFTA. In addition,
Bitcoin does not “order, instruct, or authorize a financial institution” 88
to transfer funds electronically. Transfers are initiated by users, and
are performed peer-to-peer without an intermediary.

85. 15 U.S.C. § 1693(b) (2012).

86. See Nikolei M. Kaplanov, Nerdy Money: Bitcoin, the Private Digital Currency, and
the Case Against Its Regulation, 25 LOY. CONSUMER L. REV. 111, 137–38 (2012).
87. Id. at 157–58.
88. 15 U.S.C. § 1693a (2012).
600 Harvard Journal of Law & Technology [Vol. 27

E. Uniform Commercial Code

Although not binding law, the Uniform Commercial Code

(“UCC”) has been adopted in one form or another by a majority of
states.89 The UCC sets out a framework to govern sales and other
commercial contracts.90 A quick analysis suggests that the UCC can
be used to validate Bitcoin transactions rather than limit Bitcoin use;
whether Bitcoin is considered a currency or property does not affect
the use of bitcoins in transactions under the UCC.91 If it were consid-
ered a currency, Bitcoin would be treated like a foreign currency un-
der the UCC.92 Transactions involving foreign currencies are recog-
recognized.93 On the other hand, if Bitcoin were considered property,
then transactions involving bitcoins in exchange for goods would be
treated as barter transactions.94 In both cases, the UCC would recog-
nize and validate transactions involving bitcoins.

IV. GOVERNMENT ACTIONS RELATED TO BITCOIN

The U.S. government has taken several steps toward regulating

Bitcoin. The most important law leveraged by the government has
been the Bank Secrecy Act. In early 2013, FinCEN, the Agency au-
thorized to enforce the Bank Secrecy Act, issued guidance on the ap-
plicability of regulations to virtual currencies.95 Since then, both
federal and state authorities have been actively scrutinizing Bitcoin
activities. Notices have been issued and investigations have com-
menced, and in some instances authorities have arrested individuals
and seized assets.

A. FinCEN’s Guidance on Virtual Currencies

On March 18, 2013, FinCEN issued an interpretive guidance doc-

ument titled “Application of FinCEN’s Regulations to Persons Ad-
ministering, Exchanging, or Using Virtual Currencies.”96 The
document was meant “to clarify the applicability of the regulations
implementing the Bank Secrecy Act . . . to persons creating, obtain-
ing, distributing, exchanging, accepting, or transmitting virtual cur-

89. States Adopting the UCC, US LEGAL, INC., http://uniformcommercialcode.

uslegal.com/states-adopting-the-ucc (last visited May 7, 2014).
90. Uniform Commercial Code, US LEGAL, INC., http://uniformcommercialcode.
uslegal.com (last visited May 7, 2014).
91. See Kaplanov, supra note 86, at 163–64.
92. Id.
93. See id.
94. Id at 164.
95. FinCEN, supra note 3.
96. Id. at 1.
No. 2] Coining Bitcoin’s “Legal-Bits” 601

rencies.”97 The goal was to clearly delineate which of an entity’s ac-

tivities would make the entity a money services business (“MSB”)
and thus subject to FinCEN’s registration, reporting, and recordkeep-
ing regulations for MSBs.98 Although there is no specific mention of
Bitcoin in the guidance document, the timing of the release seems to
suggest that it was issued in part due to Bitcoin’s increased adoption.
The document distinguishes between “‘users,’ ‘administrators,’
and ‘exchangers.’”99 As defined, a user is one who “obtains virtual
currency to purchase [real or virtual] goods or services.”100 Users are
not considered MSBs for the purposes of FinCEN’s regulations. 101
Administrator is defined as “a person engaged as a business in issuing
(putting into circulation) a virtual currency, and who has the authority
to redeem (to withdraw from circulation) such virtual currency.” 102
An exchanger is defined as “a person engaged as a business in the
exchange of virtual currency for real currency, funds, or other virtual
currency.”103 An administrator or exchanger who “(1) accepts and
transmits a convertible virtual currency or (2) buys or sells convertible
virtual currency for any reason is [considered] a money transmitter
under FinCEN’s regulations, unless a limitation to or exemption from
the definition applies to the person.” 104 Money transmitters fall under
the umbrella of MSBs, and thus administrators and exchangers who
engage in money transmission are considered MSBs for the purposes
of FinCEN’s regulations.105
The guidance document also categorizes three different types of
virtual currencies: “e-currencies and e-precious metals; centralized
convertible virtual currencies; and de-centralized convertible virtual
currencies.”106 The de-centralized virtual currencies (“DVCs”) catego-
ry is the most applicable to Bitcoin. The guidance document notes that
a DVC “has no central repository and no single administrator,” and
“persons may obtain [units of the currency] by their own computing
or manufacturing effort.” 107 Following the guidance for the DVC cat-
egory, a person who creates units of a currency and uses them to pur-
chase goods or services falls under the “user” category.108 In contrast,
a person who creates units and sells those units to another for real cur-

97. Id.
98. See id.
99. Id.
100. Id. at 2.
101. Id. at 1.
102. Id. at 2.
103. Id.
104. Id. at 3.
105. Id. at 1.
106. Id. at 3.
107. Id. at 5.
108. Id.
602 Harvard Journal of Law & Technology [Vol. 27

rency is considered a money transmitter rather than a user.109 In addi-

tion, a person is considered an exchanger if the person accepts units of
a DVC from one person and transmits them to another person as a
substitute for a currency.110
The guidance document suggests two major implications for
Bitcoin. First, a user purchasing goods or services with bitcoins, with-
out more, is not a money services business. However, the act of sell-
ing bitcoins, whether as an individual (provided that the coins were
mined by the individual), or as a business, makes the actor a money
transmitter and thus subject to FinCEN’s regulations for MSBs. Se-
cond, it appears as though any business that facilitates the conversion
between Bitcoin and USD will be considered an exchanger under the
guidance document and will also be subject to FinCEN’s regulations
for MSBs. Ultimately, with the exception of merchants, all other busi-
nesses transacting in Bitcoin will have to meet registration, reporting,
and record-keeping requirements in accordance with the implement-
ing regulations of the BSA — neutralizing some, if not all, of
Bitcoin’s anonymity benefits.

B. California’s Department of Financial Institutions’ Cease-and-

Desist Letter to Bitcoin Foundation

On May 30, 2013, California’s Department of Financial Institu-

tions (“CADFI”) issued a cease-and-desist letter to Bitcoin Founda-
tion (“BF”), a “not-for-profit organization established to standardize,
protect and promote the use and adoption of Bitcoin.”111 The letter
stated that BF may be “engaged in the business of money transmission
without having obtained the license or proper authorization required
by the California Financial Code.”112 In addition, the letter notes that
it is also a federal violation to engage in money transmission without
the appropriate state license, or without registering with the U.S.
Treasury Department in accordance with the regulations implement-
ing the BSA.113

109. See id.

110. Id.
111. Rick Fischer, Obrea O. Poindexter & Matthew Ly, Bitcoin Receives Cease and De-
sist Order Evidencing Increased Regulatory Scrutiny of Virtual Currency, SOCIALLY
AWARE BLOG (July 25, 2013), http://www.sociallyawareblog.com/2013/07/25/bitcoin-
receives-cease-and-desist-order-evidencing-increased-regulatory-scrutiny-of-virtual-
currency; see also Jon Matonis, Bitcoin Foundation Receives Cease and Desist Order from
California, FORBES (June 23, 2013), http://www.forbes.com/sites/jonmatonis/2013/06/23/
bitcoin-foundation-receives-cease-and-desist-order-from-california; About, BITCOIN
FOUNDATION, https://bitcoinfoundation.org/about (last visited Feb. 16, 2014).
112. Letter from Paul T. Crayton, Senior Counsel, Cal. Dep’t of Fin. Institutions, to
Bitcoin Found. (May 30, 2013), available at http://www.scribd.com/doc/149335233/ca-
state-cease-and-desist-may-30#page=1.
113. See id.
No. 2] Coining Bitcoin’s “Legal-Bits” 603

Interestingly, BF does not seem to engage in commerce related to

Bitcoin.114 According to the BF website, their main mandate is to im-
prove the Bitcoin software and to promote Bitcoin.115 It is unclear in
what capacity BF engages in the business of money transmission as
noted in the letter. Nevertheless, CADFI’s action demonstrates that
Bitcoin is attracting both state and federal regulatory attention.

C. Bitcoin Asset Seizures and Arrests

There have been numerous arrests and asset seizures related to

Bitcoin use. Two of the more notable incidents occurring in 2013 in-
clude the crackdown on the Silk Road website and the asset seizure of
Mt. Gox.

1. Crackdown on Silk Road

In early October of 2013, the FBI seized the Silk Road website,
widely known as a marketplace for drugs and other illegal goods. 116
The FBI also arrested the owner of the website, William Ulbricht, on
charges of narcotics conspiracy, computer hacking conspiracy, and
money laundering conspiracy in connection with the operations of the
Silk Road website.117 By October 25, 2013, government authorities
had seized more than 33.6 million USD worth of bitcoins belonging to
Ulbricht.118 After the seizure of the Silk Road website and the arrest
of Ulbricht, authorities arrested frequent users of the Silk Road mar-
ketplace.119

2. Mt. Gox Assets Frozen

In May of 2013, U.S. authorities seized the assets of Mt. Gox, one
of the world’s largest Bitcoin exchanges at the time.120 The seizure
was based on suspicions that Mt. Gox was engaging in the business of

114. See BITCOIN FOUNDATION, supra note 111.

115. Id.
116. Manhattan U.S. Attorney Announces Seizure of Additional $28 Million Worth of
Bitcoins Belonging to Ross William Ulbricht, Alleged Owner and Operator of “Silk Road”
Website, FBI (Oct. 25, 2013), http://www.fbi.gov/newyork/press-releases/2013/manhattan-
u.s.-attorney-announces-seizure-of-additional-28-million-worth-of-bitcoins-belonging-to-
ross-william-ulbricht-alleged-owner-and-operator-of-silk-road-website.
117. Id.
118. Id.
119. Raphael Satter, Silk Road Drug Busts: 8 More Arrested, USA TODAY (Oct. 8,
2013), http://www.usatoday.com/story/news/world/2013/10/08/silk-road-busts/2946925.
120. Kashmir Hill, The Feds Are Cracking Down on Mt. Gox (Not on Bitcoin), FORBES
(May. 15, 2013), http://www.forbes.com/sites/kashmirhill/2013/05/15/the-feds-are-
cracking-down-on-mt-gox-not-on-bitcoin.
604 Harvard Journal of Law & Technology [Vol. 27

money transmission without an appropriate license.121 Notably, the

grounds for seizure seem to follow the language of the March FinCEN
guidance document on virtual currencies.122 In late February of 2014,
Mt. Gox shut down its website and subsequently filed for bankruptcy
on February 28, 2014, after losing approximately 750,000 of its cus-
tomers’ bitcoins following a security breach.123

D. Regulatory Developments as of April 2, 2014

Much like the price of Bitcoin, which has exploded from $13 to
$1200 in 2013,124 the number of regulatory developments concerning
Bitcoin has increased dramatically as well. This section highlights
some of the significant regulatory events since June of 2013.

1. New York State Department of Financial Services Inquiry into

Virtual Currencies

On August 12, 2013, the New York State Department of Finan-

cial Services (“NYDFS”) issued a memorandum regarding its inquiry
into virtual currencies.125 The goal of the inquiry was to develop the
“appropriate regulatory guidelines that . . . should [be] put in place for
virtual currencies.”126 The memorandum states that the “emergence of
Bitcoin and other virtual currencies has presented a number of unique
opportunities and challenges.”127 In addition, NYDFS notes that it has
made “requests for information from virtual currency firms,” and that
it is concerned that “virtual currency exchangers may be engaging in
money transmission,” an activity regulated by the NYDFS.128

2. Bitcoin Foundation Meeting with Federal Regulators

On August 26, 2013, representatives from the Bitcoin Foundation

met with Federal Regulators to discuss Bitcoin.129 The meeting was
geared towards educating regulators on Bitcoin technology.130 Ac-

121. Stacy Cowley, Bitcoin Exchange Mt. Gox Lands in Feds’ Crosshairs, CNNMONEY
(May 16, 2013), http://money.cnn.com/2013/05/16/technology/bitcoin-mt-gox.
122. See Hill, supra note 120; see also FinCEN, supra note 3.
123. See MtGox Gives Bankruptcy Details, supra note 30.
124. BITCOIN CHARTS, supra note 23.
125. Notice of Inquiry on Virtual Currencies, N.Y. STATE DEP’T OF FIN. SERVS. (Aug.
12, 2013), available at http://dfs.ny.gov/about/press2013/memo1308121.pdf.
126. Id.
127. Id.
128. Id.
129. Jesse Hamilton & Olga Kharif, Bitcoin Foundation Meets with U.S. Regulators, Law
Enforcement, BLOOMBERG (Aug. 27, 2013), http://www.bloomberg.com/news/2013-08-
26/bitcoin-group-to-meet-with-federal-regulators-law-enforcement.html.
130. See id.
No. 2] Coining Bitcoin’s “Legal-Bits” 605

cording to the Treasury Department spokesman, the meeting was part

of the Treasury’s “ongoing dialogue with virtual currency provid-
ers.”131 In attendance were representatives from the FBI, Internal
Revenue Service (“IRS”), Federal Reserve, Office of the Comptroller
of the Currency, Federal Deposit Insurance Corporation, and Secret
Service.132

3. Senate Committee Looks into Virtual Currencies

In October of 2013, it was reported that the Senate Committee on

Homeland Security and Governmental Affairs had recently launched
an inquiry into Bitcoin and other virtual currencies.133 The goal of the
inquiry was to gather information and guidance from financial regula-
tors and law enforcement agencies.134 A letter soliciting information
in accordance with this inquiry noted that the “expansive nature of
this emerging technology demands a holistic and whole-government
approach in order to understand and provide a sensible regulatory
framework for their existence.”135 In addition, “the federal govern-
ment must make sure that potential threats and risks are dealt with
swiftly; however, we must also ensure that rash or uninformed actions
don’t stifle a potentially valuable technology.”136

4. Internal Revenue Service Virtual Currency Notice: Virtual

Currency Is Property for U.S. Federal Tax Purposes

On March 25, 2014, the IRS issued a notice declaring that it will
treat virtual currencies such as Bitcoin as property rather than curren-
cy for federal tax purposes.137 The notice indicated that the IRS will
apply the same “general tax principles [that apply] to property trans-
actions [] to transactions using virtual currency.” 138 The result is that
any value gains or losses from the sale or exchange of bitcoins fall

131. Id. (internal quotation marks omitted).

132. Id.
133. Senate Committee Looks into Virtual Currencies, BSA/AML UPDATE, Oct. 15,
2013, at 1.
134. Id.
135. Id.
136. Id.
137. See IRS Virtual Currency Guidance: Virtual Currency Is Treated as Property for
U.S. Federal Tax Purposes; General Rules for Property Transactions Apply (Mar. 25,
2014), INTERNAL REVENUE SERVICE, http://www.irs.gov/uac/Newsroom/IRS-Virtual-
Currency-Guidance; see also IRS Says Bitcoin Is Property, Not Currency (Mar. 25, 2014),
FORBES, http://www.forbes.com/sites/joeharpaz/2014/03/25/update-irs-says-bitcoin-is-
property-not-currency.
138. See Notice 2014-21, INTERNAL REVENUE SERVICE, http://www.irs.gov/pub/irs-
drop/n-14-21.pdf.
606 Harvard Journal of Law & Technology [Vol. 27

under the capital asset tax regime, and accepting bitcoins for payment
will trigger the income tax regime.139

V. WHAT DO THE RECENT GOVERNMENT ACTIONS MEAN FOR

BITCOIN’S FUTURE?

In the past year, Bitcoin has witnessed increasing adoption and

popularity. The Bitcoin ecosystem is expanding exponentially in the
United States and in many parts of the world. In response, the U.S.
government has taken steps to define and govern uses of Bitcoin. The-
se actions have implications for Bitcoin-related activity going for-
ward. The actions generating the most impact include FinCEN’s
guidance letter noting that virtual currencies are considered money for
purposes of the regulations implementing the BSA, and the IRS’s
guidance noting that virtual currencies such as Bitcoin will be treated
as property for federal tax purposes.
The most obvious implication is that there will be increased regu-
lation and scrutiny of entities transacting in Bitcoin and other virtual
currencies. With virtual currencies being treated as money for BSA
purposes, businesses transacting in bitcoins need to ensure that they
meet the applicable regulatory provisions. Although the majority of
the impact will be on businesses, individual users of bitcoins need to
be aware of potential tax implications as well. There are four types of
actors in the Bitcoin system that may feel the impact of regulation:
(1) businesses exchanging, buying, and selling bitcoins; (2) merchants
accepting Bitcoin as an alternative payment currency; (3) non-miner
users; and (4) miners.

A. Businesses Exchanging, Buying, and Selling Bitcoins

Businesses buying, selling, or facilitating the transfer of bitcoins

(e.g., Bitcoin exchanges) will likely be more extensively governed.
Notably, the implementing regulations of the BSA promulgated by
FinCEN will need to be followed by all money services businesses
transacting in bitcoins. Among other things, these businesses will be
required to register as a form of MSB with FinCEN,140 implement
anti-money laundering procedures, and meet strict reporting and rec-
ord-keeping requirements, such as recording detailed customer and
transaction information.

139. See Bitcoin Is Property, Not Currency, In Tax System: IRS (Mar. 25, 2014),
BLOOMBERG, http://www.bloomberg.com/news/2014-03-25/bitcoin-is-property-not-
currency-in-tax-system-irs-says.html.
140. FinCEN, supra note 3. Businesses may also have to register with an equivalent state
agency.
No. 2] Coining Bitcoin’s “Legal-Bits” 607

B. Merchants Accepting Bitcoin as an Alternative Payment Currency

Based on the March FinCEN guidance document, there do not

seem to be additional requirements for businesses accepting Bitcoin as
an alternative payment currency for goods or services. However,
based on the IRS Virtual Currency notice, these businesses will need
to report Bitcoin income for tax purposes much as they are required to
do for USD income. 141

C. Non-Miner Users

These users are individuals who obtain bitcoins through means

other than mining. There are two consequences for these users: (1) the
increased record-keeping requirement on Bitcoin businesses dimin-
ishes the anonymity and privacy aspects of Bitcoin use; and (2) gains
incurred from Bitcoin transactions are subject to capital gains taxa-
tion.142 The requirement that businesses keep detailed customer in-
formation means that the privacy benefit of transacting in bitcoins is
diminished. This will likely deter illegal uses; however, assuming the
majority of Bitcoin users engage in only legal uses, this will not sub-
stantially chill Bitcoin use overall. To be sure, using bitcoins will still
provide convenience and financial security benefits.
Those using their bitcoins to pay for goods and services are not
considered money transmitters for the purposes of the BSA’s imple-
menting regulations.143 However, it is unclear under the FinCEN
guidance whether users who sell their bitcoins for profit would be
considered money transmitters. In addition, based on the IRS Virtual
Currency notice, gains from buying and selling bitcoins are subject to
capital gains taxation.144

D. Miners

For FinCEN purposes, miners who subsequently use their bitcoins

to pay for goods and services are not considered money transmit-
ters.145 However, miners who sell bitcoins that they obtained through
mining efforts are considered money transmitters.146 These miners

141. See IRS Virtual Currency Guidance: Virtual Currency Is Treated as Property for
U.S. Federal Tax Purposes; General Rules for Property Transactions Apply, supra note 137
and accompanying text.
142. See id.
143. FinCEN, supra note 3, at 2.
144. See IRS Virtual Currency Guidance: Virtual Currency Is Treated as Property for
U.S. Federal Tax Purposes; General Rules for Property Transactions Apply, supra note 137
and accompanying text.
145. Id. at 5.
146. Id.
608 Harvard Journal of Law & Technology [Vol. 27

will need to register with FinCEN and are subject to the implementing
regulations of the BSA. In addition, based on the IRS Virtual Curren-
cy notice, bitcoins obtained through mining activities are subject to
standard income taxation.

VI. FINAL THOUGHTS

The use of virtual currencies and Bitcoin in particular is growing.

As the economy and commerce is becoming more globalized, curren-
cies that are not tied to a sovereign are increasingly appealing. The
growing adoption of Bitcoin on a global scale might indicate that the
currency is here to stay. As a result, governments — including the
U.S. Government — can no longer ignore virtual currencies like
Bitcoin. The recent increase in regulatory developments for virtual
currencies suggests that the government understands this. Intriguingly,
such government regulatory efforts may have the effect of legitimiz-
ing the virtual currency, and possibly further driving market adoption.
Both established and new businesses considering Bitcoin adop-
tion need to be aware of the latest regulatory requirements to stay on
the right side of the law. Depending on the business, this could mean
adhering to the BSA requirements of record keeping and reporting,
and staying in line with anti-money laundering provisions. In addition,
all businesses transacting in Bitcoin should be aware of the applicable
tax requirements for virtual currencies. Ultimately, because virtual
currency regulation is a relatively new development and the govern-
ment is still trying to fully understand the technology, businesses
should keep a pulse on regulatory agencies for any new laws that may
apply to them.
Although there is a need for regulators to get ahead of the virtual
currency phenomenon, they should be cautious about over-regulation.
Excessive regulation can stifle the development and innovation of this
technology within U.S. borders. At the moment, there seems to be low
risk associated with allowing the virtual currency technology to de-
velop, while there is significant risk in stifling its development. Al-
lowing free-market development of the technology can ensure that the
United States is a leader in the technology if it gains widespread adop-
tion. Of course, there would be consequences to free-market partici-
pants if Bitcoin and other virtual currencies generally prove to be a
dying fad, but this is true for participants in any new technology. Be-
cause Bitcoin is being adopted on a global scale, over-regulation in
the United States could entail economic consequences for the country
in relation to the rest of the world. In the event that the technology
gains widespread adoption, other countries with fewer regulations
could take the lead with virtual currency technology and innovation,
leaving the United States behind.