22 March 2014


'Regulating Cryptocurrencies in the United States: Current Issues and Future Directions' by Sarah Jane Hughes and Stephen T. Middlebrook in (2014) 40(813) William Mitchell Law Review explores 
the state of virtual currencies and their regulation in and by the United States and the States. It offers thoughts on which models of regulation might suit virtual currencies best. It also surveys recent enforcement actions brought by the Departments of Treasury, Justice and Homeland Security against providers of virtual currencies or comparable electronic stored value. It concludes that issuers and users of virtual currencies are not being realistic if they think that the United States will not regulate virtual currencies for some purposes.
The authors comment
Since virtual currencies first came into the marketplace in the 1990s, those responsible for monetary policy, federal anti-moneylaundering and economic sanctions programs, along with federal and state consumer protection regulators, payment systems operators, businesses, and consumers have grappled with understanding how these “currencies” work, whether they should be deemed “lawful” payment methods in the United States, and, if so, the manner and extent to which they should be regulated. Regulatory activity related to offering virtual currencies has come in fits and starts, with a burst of intensity in 2013 spurred by the attention to and use of a special form of virtual currency known as a cryptocurrency.
This article reviews developments in 2013 that pertain to cryptocurrencies and their transactors and evaluates them against the backdrop of long-established and more recent federal and state licensure, payments systems, anti-money laundering, economic sanctions, and consumer protection regulation. It also touches upon transactors’ desires for anonymity and security in their transactions and related information and discusses how the technologies upon which cryptocurrencies are based may be adapted to support both other payment methods and electronic commerce in general.
Part II describes cryptocurrencies in the market in 2013. Part III reviews the precursors to the current state of regulation in the United States, particularly the federal government’s prosecution of e-gold, Ltd. In Part IV, we evaluate FinCEN’s initial guidance on virtual currencies, which it published in March 2013, and discuss industry reaction to the new rules. In Part V, we review recent actions by legislators, other federal regulators and some state actors. Part VI analyzes the federal government’s 2013 enforcement actions against Mt. Gox Co. Ltd. (“Mt. Gox”), and Liberty Reserve, which closely followed FinCEN’s March guidance. And, in Part VII, we ask—and make some modest efforts to answer—the core question: what does the future hold for cryptocurrency? The brief conclusion in Part VIII relies in part on the legal history of concepts of “money” and “legal tender” in the United States since 1862 and concludes that it is unrealistic to imagine that cryptocurrencies will not face regulation in the United States for some or all of the purposes mentioned in this article.
They conclude
No cryptocurrency issuer, exchanger, or user should have expected that the government of the United States—or any other government for that matter—would allow any significant storage of value in its “currency” without deciding to regulate the issuer or central exchange involved in some manner. 
Why? Because that is what governments have been doing to protect both trade and their own seigniorage rights for at least the past 500 years. By 1605, for example, the English courts were already convinced of the Crown’s right to control what constituted “legal tender” and who could issue “legal tender.” The federal government’s exclusive right to issue “coins” is expressed in the U.S. Constitution. When Congress enacted the Stamp Payments Act of 1862, the National Currency Act of 1863, and then the National Bank Act of 1864, it expressed its conviction that it alone had authority to declare what qualifies as “legal tender.”
The Supreme Court agreed with Congress in a series of famous decisions beginning shortly after the National Bank Act was enacted. In Veazie Bank v. Fenno, the Supreme Court upheld Congress’s imposition of a tax of ten percent imposed on state and national banks paying out “notes” of individuals or state banks used for circulation, likening this tax to the payment of duties. The Court specifically recited a number of facts about the manner in which Congress has taken charge of legal tender, including (1) denying the quality of legal tender to foreign coins, (2) providing a law against counterfeits and base coin on the community, (3) restraining the issue of notes not issued under its own authority, and (4) observing that without the power to control these aspects of legal tender, Congress’s “attempts to secure a sound and uniform currency for the country must be futile.” The Supreme Court was even more forceful in holding the 1860s “legal tender” acts constitutional, both as to contracts entered into before and after their passage. The Court’s opinion discussed the powers of the sovereign and noted that the Court would have to reverse course for its growing body of canons of statutory construction if it did not uphold Congress’s acts concerning legal tender.
A government’s interests are no less when one considers the authority to tax transactions and profits189 and to impose duties on foreign transactions. Thus, following its announcement that it would not require Bitcoin exchanges to register as a “money service” or “money transmitter” in the United Kingdom, Her Majesty’s representatives still warned Bitcoin users about paying attention to the tax implications of their Bitcoin transactions. Those representatives, however, predicted that regulation “will definitely come into play” and “so it is in the best interests of businesses that think they are transacting as a money services business to still keep anti-money laundering and know-your-customer practices in play so they’re prepared for when HMRC does come knocking.” Soon afterwards, Her Majesty’s representatives did an about-face and, following a meeting with Bitcoin U.K. representatives, announced their intention to issue regulations.
Considering the different possible regulatory paradigms and the questions we raised in Part VII of this article, we find ample evidence of governments’ interests in regulating cryptocurrencies in one fashion or another and of several possible ways to determine which of the competing federal-versus-state and payments-versus-securities- versus-commodities paradigms should be considered. 
Even among the paradigms that apply to different payments systems, options abound. The participants in transactions of this type have long had regulations governing their rights and have had, in greater and lesser degrees, government regulation of depositories and exchange/payment systems rules. Some of these regulations grew out of informal self-regulation, at least as the subjects suitable for resolution by private law or system rules—as opposed to public law—are concerned.
The federal government’s action against e-gold and its 2013 regulatory guidance and law enforcement actions against Liberty Reserve and Mt. Gox persuade us that the government will exercise regulatory authority over cryptocurrencies and other virtual currencies to some extent.
Despite the tendency of new Internet-based entrants to imagine themselves to be entitled to exist and operate without regulations, a kind of unregulated Wild West attitude, the oldfashioned notions of why we regulate payments and value-storage media that we discuss in this article suggest to us that regulation will happen, and that its challenges will be similar to those faced since kings and princes first issued coins and then issued other indicia of stored value such as paper “money” that qualified for use as “legal tender.”
The idea that governments issue “money” and declare what qualifies as “legal tender” is an ancient notion. The history of regulating money and legal tender suggests that it is not likely that governments will surrender their privileges to regulate cryptocurrency issuers, exchanges, administrators, or users. The real questions are which paradigm(s) governments will use, how much enforcement energy they will spend on regulating cryptocurrencies, and whether and how they will compete with each other to offer regulatory schemes that do not send cryptocurrency entrepreneurs, investors, and users running offshore.
On 25 March the US Internal Revenue Service in its Notice 2014-21 (Virtual Currency Guidance) indicated [PDF] that indicated that
In some environments, virtual currency operates like “real” currency - i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance -- but it does not have legal tender status in any jurisdiction. 
The notice provides that virtual currency is treated as property for U.S. federal tax purposes. General tax principles that apply to property transactions apply to transactions using virtual currency.
  • Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes. 
  • Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099. 
  • The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer. 
  • A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.