Will Legal Reform Kill the Bitcoin?

by McManis Faulkner

For two decades, during the 1620s and 1630s, Europe fell into the grip of “tulip mania.”  At its peak in 1637, tulip bulbs were sold for more than 10 times the average worker’s annual income—enough to buy a house.  Within weeks of its peak, the market crashed.  A “priceless” tulip purchased at the height of the market became worth barely more than the dirt in the garden.  Economists consider this the first market bubble, a phenomenon in which the market price of an item is significantly different from its actual value.

Some believe the Bitcoin, virtual currency which has skyrocketed in value over the past few years, represents a modern version of the tulip craze.  This view, combined with the highly publicized use of virtual currency in the black market, has spurred national governments to take a close look at the Bitcoin and other virtual currencies—and consider intervention that could shock or crash their market values. 

Created in 2009, Bitcoins sold for $0.14 each in 2010.  By 2011, they were worth $0.87 each.  Today, one Bitcoin can be sold for about $850.  (Unfortunately for some early investors, not everyone who purchased the currency held on long enough to enjoy this price surge—one man reportedly purchased a pizza for 10,000 Bitcoins—now worth about one million dollars per slice.)

Bitcoin enthusiasts espouse the Bitcoin as a natural extension of technology, transnationalism, and deregulation in the currency market.  Considered a “crypto-currency,” Bitcoins move freely and stealthily, based on encrypted algorithms not easily subjected to government regulation or taxes.  A purchase with Bitcoins is theoretically private and untraceable.

Skeptics of the Bitcoin question its exponential, and largely inexplicable, increase in price, a telltale indication of a speculative bubble.  Skeptics also question the soundness of the Bitcoin market—which was created by an anonymous programmer, lacks institutional support (e.g., a central bank), and exists only in the virtual world.  Skeptics also contend there is nothing fundamentally different about Bitcoins compared to other, rising cryto-currencies, such as “Ripples,” “Litecoin,” “Peercoin,” “DogeCoin,” and “Nxt.” 

Ironically, although these cryto-currencies are prized for their international and decentralized qualities, the laws of national governments will likely affect their value in the coming years.  On the one hand, if the Bitcoin and its brethren receive governments’ official acceptance, then highly-valued virtual currencies may be here to stay.  On the other hand, harsh governmental intervention could put a ceiling on their potential use, cap their growth, and possibly burst any Bitcoin bubble.

It is not clear which path national governments will choose.  Officially, Bitcoins are only illegal in Thailand and Iceland.  Indonesia has said they may be illegal.  China recently shut down its domestic Bitcoin market—but then reopened it weeks later

Bitcoins are generally—but not universally—considered legal in the United States.  The U.S. government barely regulates virtual currency at this point.  However, further regulation appears to be imminent. 

The Department of Treasury, through its Financial Crimes Enforcement Network, “FinCEN,” has imposed some guidelines.  Neither the U.S. Commodity Futures Trading Commission nor the U.S. Securities and Exchange Commission have issued formal regulations—but have reserved the right to do so. 

Although contributing to the Bitcoin’s early success, the prominent use of Bitcoins in the black market is one of its biggest impediments to official sanction.  Last year, the FBI seized 144,000 Bitcoins with its raid on the “Silk Road,” an online emporium for guns and drugs.  In January, 2014, prominent Bitcoin investor Charlie Shrem was indicted for helping launder drug money through the Bitcoin market. 

These and other high-profile abuses of virtual currency have triggered mounting governmental scrutiny.  Members of Congress, the Department of Homeland Security, and law enforcement have expressed concern about the Bitcoin market, and legislators have conducted extensive hearings over the past few months.   The amount of U.S. intervention into the virtual currency market is thus likely a question of degree. 

In addition to the United States, other major governments may intervene in the virtual currency market, if they calculate that the benefits of additional free trade are outweighed by the perceived risks, e.g., illegal trade and tax evasion.  The European Banking Authority recently warned that virtual currencies, including the Bitcoin, risk consumer abuse.  According to a report published in December, 2013, the European Union is considering whether such currencies could and should be regulated.  According to the E.U. report: “[M]isuse could lead law enforcement agencies to close exchange platforms at short notice and prevent consumers from accessing or retrieving any funds that the platforms may be holding for them.”

Even if the market value of the Bitcoin reflects its present actual value, which is hotly disputed, legal intervention could significantly undermine the major appeal of the currency, i.e. its status as a fluid, transnational form of payment.  Given the large amount of speculative investment in the Bitcoin, the market reaction to even moderate government regulation—which appears highly possible in the present political atmosphere—may be enough to kill the Bitcoin.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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