Is Bitcoin legal?

Could the next revolution in payment systems be already here? Bitcoin is a non-fiat cryptographic electronic payment system that purports to be the world’s first cryptocurrency. In other words, it is a peer-to-peer, client-based, completely distributed currency that does not depend on centralised issuing bodies to operate, the value is created by the users, and the operation is distributed using an open source client that can be installed in any computer running Windows, Mac or Linux (see a good article about the new currency here). So, is Bitcoin legal? To answer that, we must first know a little bit about currencies in general, and electronic currencies specifically.

Currency basics

Payment systems in general, and currency specifically, depend on value. What is value? When you think about it, value is simply the desirability that someone allocates to something. Under normal circumstances, we value material things according to our needs, such as food and shelter, or according to their scarcity, such as gold. We also give value to energy in the shape of labour. Finally, we value intangibles, such as experience, knowledge, creativity and know-how.

Currencies were invented as a means to transfer value. Initially, this was done through barter, then we used coins in metals that were considered valuable for their scarcity. At some point we invented paper money to make transactions easier, as carrying gold and silver around was insecure and expensive. The first paper notes used to be a promise to give the bearer the equivalent value in metal. Money therefore relied on the idea that the issuer had metal reserves that could be redeemed at any time, hence giving value to the currency. The problem with this system, called the gold standard, is that it placed a limit on the amount of money that could be issued to that which could be allocated to metal reserves. There would be situations when a country would need to issue more money, such an during time of war, but this would result in heavy devaluation, as people would not trust that there were reserves that supported the money. During the 20th century, the gold standard was abandoned, and a new monetary system was put in place. This is what is known by some as fiat money.

Modern fiat currencies have value based on the economic strength of the issuer. In some libertarian and anarchist circles, it is said that fiat money does not have any inherent value, but this fails to recognise that neither does the gold standard. Gold does not have intrinsic value, under the right circumstances gold could be valueless. In fact, there is no such thing as inherent value, all value is dependent on circumstances. Having said that, the value in fiat money arises from the law, the currency has the backing of the government behind it, and therefore, it is supported by the economy of the territory where it is accepted.

Bitcoin as currency

Bitcoin is advertised as a non-fiat currency, in other words, its proponents claim that it has “real” value. The value arises from computing power, that is, the only way to create new bitcoins is by allocating distributed CPU power through computer programs named “miners”; the miners create a block after a period of time that is worth 50 bitcoins. The idea is that the computing power and electricity used to create the currency are what give each bitcoin its value. I have a huge problem with this from both a practical and conceptual point, as what the Bitcoin proponents are doing is simply allocating value arbitrarily to a little program that performs the mathematical equations necessary to support the creation of a bitcoin. It’s self-referential and circular currency, and its only value is that which is given by the people who buy into the idea… just like fiat money. Under this theory, many other online currencies, particularly in-game currencies, would be non-fiat money. Heck, I think I may have 25,000 gold resting in several World of Warcraft servers, maybe I could try to see if I can exchange it into BTCs, after all, that gold was mined by killing monsters using electricity, time and computing power.

Another problem that I have with Bitcoin is that mining for coins becomes more difficult as time goes by and the market grows. The algorithms that produce new coins increase the amount of processing power necessary to create each new block, so producing new money is more difficult as time goes by, and this difficulty is built into the system to try to keep the total amount of Bitcoins at a maximum of 21 million. So, the first block “mined” by BTC creator Satoshi Nakamoto (probably a pseudonym) was done at difficulty 1, at the time of writing there were 131301 blocks, making a total BTC of 6.56 million, and a difficulty of 877,227. That means, making a new block will be more than 800 thousand times more difficult than it was for the initial block. This difficulty will only go up, so an individual cannot hope to have the processing power to develop new coins, and this can only be done currently through pool mining CPU resources. This model is trying to replicate scarcity in the market, but it acts as a punishing disadvantage for late adopters, and means that early adopters have too much power if they hoarded coins early. More than anything else, this would lead me to be very sceptical of Bitcoin, the whole scheme screams Ponzi, but I am willing to be proven wrong.

Another practical concern is that while I found it easy to install the client, once it is open it is not very clear what to do with it. Bitcoin has reached a point where it is very difficult to create new coins, so their value has gone up considerably. I found the mining instructions difficult to follow, but was able to get a miner registered and working, although this was not easy to achieve. I would like to think of myself as a person with above-average technical skills, so I do not see the scheme catching on, particularly to a wider audience. It is possible to buy BTCs with real money in exchanges, but this didn’t strike me as straightforward either, and I did not feel inclined to invest in this currency (maybe I will regret it in the future, who knows?) The fact that the mining business seems to be a very closed niche would mean that newcomers would have to part with their hard-earned cash to acquire a virtual currency. At the time of writing, the exchange rate of $19 USD per 1 BTC seems ludicrously inflated.

There is something else bothering me, and it is the fact that Bitcoin seems to be a big hit with the libertarian fringe in the United States. There is a very strong anti-government and anti-taxation slant in the forums, and there were too many mentions of Ayn Rand for my liking. Libertarians, particularly of the Tea Party ilk, think that fiat money is going to collapse any minute, and that those surviving are going to be the ones holding “real” currencies. Bitcoin seems to have been erected into that small category. So there is certainly a rabidly loyal element which lends some value to the currency.

Despite my misgivings, there is little doubt that BTCs have been gaining value. They are not accepted at any major retailer (but they can be used to purchase alpaca socks, yay!), but can be used in a growing number of websites. It seems to me that the increase in value is that it has become a supposedly good investment at the moment, and with larger press presence comes increase in value. In fact, Bitcoin has been a lot in the news recently because it is being accepted as means of payment in some of the less savoury corners of the Internet. The fact that the coins are anonymous and supposedly untraceable mean that they are allegedly being used to pay for porn and drugs.

Moreover, a big security problem has been uncovered recently, as a user had 25,000 BTC stolen from his wallet. A hacker got into his system and removed the un-encrypted file, which seems to be a major issue with Bitcoin. Because it is possible to see which wallet holds what, similar attacks may happen more and more in the future if the value continues to increase.

Legalities

But now to the real question, is Bitcoin legal? There are generally two types of currency from a legal perspective, there is legal tender and legal currency. Legal tender is simply currency that cannot be refused in the fulfilment of a debt. Legal currency is currency that is recognised by the government as a legitimate manner to pay for goods and services. In most countries legal currency and legal tender are one and the same, but there are some exceptions. For example, in the most of the UK the Bank of England notes are legal tender, but in Scotland only coins are legal tender, there are notes issued by several banks, which act as legal currency. The same applies for Northern Ireland. It is also common to see economies with a weak local currency to accept international money as legal currency.

In the United States, where most of the BTC action seems to be taking place at the moment, only the US Dollar is legal tender (31 U.S.C. § 5103). Similarly, only the Mint and the Federal Reserve can produce coins and currency, which are the only means of legal tender. Title 31 of the US Code does not seem to make the distinction between legal currency and legal tender, so to me both are one and the same (please comment if this is not the case). This is corroborated by several official documents that indicate clearly that only the USD is allowed as the official currency of the United States. According to the FBI “it is a violation of federal law for individuals, […] or organizations,[…] to create private coin or currency systems to compete with the official coinage and currency of the United States.” I am no securities expert, but it would seem that Bitcoin would not fall under definitions of securities and commodities either(see here for a discussion on these). So in my humble opinion Bitcoin is not legal currency in the United States.

The picture is clearer in the European Union. Unlike the United States, the EU has implemented a legal framework for the regulation of electronic money. The Electronic Money Institutions Directive 2009/110/EC defines electronic money thus (paraphrased for clarity):

  1. electronically, including magnetically, stored monetary value;
  2. as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions;
  3. the transaction is an act, initiated by the payer or by the payee, of placing, transferring or withdrawing funds, irrespective of any underlying obligations between the payer and the payee;
  4. which is accepted by a natural or legal person other than the electronic money issuer.

If a payment system fulfils these requirements, then it is considered electronic money, and only electronic money institutions can issue electronic value. There is a high threshold for an electronic money institution, as the EMI would have to fulfil quite a lot of requirements. The idea behind this stringent regulation is evident, as what is taking place is the issuing of value into the economy. In my opinion, Bitcoin would definitely meet the legal definition, which would mean that in order to work in Europe it would need to be declared an electronic money institution, otherwise it is operating outside of the regulatory framework.

It seems like it is only a matter of time before regulators come knocking on the doors of Bitcoin. However, part of the appeal of the system is that it is completely decentralised. Just as it happens with P2P file-sharing, you could shut down the entire Bitcoin operation tomorrow and the network would still run because it does not depend on a central system. So, while Bitcoin may very well be illegal, it may also be almost impossible to shut down in any efficient manner, that is the beauty of distributed networks.

However, this point may be moot. Regulators only need to be involved if Bitcoin becomes a large source of value in a national economy. At the moment, there are 6.5 million BTCs in circulation, with a value of almost $130 million USD at today’s prices. This is no small change, and would seem to prompt some form of involvement from governments. However, I think that the value of Bitcoins may be a bubble as a result of hoarding from early adopters. Once newcomers realise that it is very expensive to enter the market, prices may drop. However, investors only invest if they see room for growth, it is perfectly possible that speculation will continue to drive prices up, therefore prompting regulation by the government. Catch 22 in my opinion, Bitcoin is better off remaining small.

I’m off to see if I can produce some more WoW gold, it makes more sense to me to kill monsters and get gold in return.

ETA: Just in case, here is my purse address if anyone feels like proving me wrong 1F9arzFyYFXTEd2FEjiRxHuyTSGNxehwEt

ETA2: There are lots of other interesting considerations, such as money laundering and the use of the currency in black markets. I will touch on those subjects in the next couple of weeks.

ETA3: Mt.gox, the largest Bitcoin exchange, has been hacked exposing usernames, emails and encrypted passwords. I’m looking at the list of 61,020 accounts right now. I would say that this could be a fatal flow for BTC, and no regulators had to get involved.

Final Edit: EFF has removed Bitcoin donation support fearing negative legal repercussions.

25 thoughts on “Is Bitcoin legal?

  1. Bitcoin's proponents does not claim that it's value arises from computing power. "Bitcoins have value because they are accepted as payment by many" is the usual claim.

    How does the value in fiat money arise from the law? How is it backed by the government behind it?

    • Hi,

      I have been reading a lot of forum posts in the last week while preparing this short article, and I have seen a lot of talk that the advantage of BitCoin is that it has real value, as opposed to fiat currencies. Nakamoto's paper also hints heavily that processing power is used to create value, as opposed to just creating value "out of thin air" (p.6), as would happen if a rival wanted to attack the system by creating new bitcoins. This is a big selling point amongst some circles.

      As to the second question, fiat money is by definition created by law, fiat means "let it be done" in Latin. The government is the one that guarantees its value, but this value is not set by law, it is precisely the value given to it by the markets. However, fiat currencies are supported by the strength of the economy in which they operate. The government supports the currency, but the value is given by the market.

  2. Further to Mikael Engdahl's comment, regular users don't need to worry about mining bitcoins – they'll mostly end up spending more making them than they'd get for the bitcoins. You'd get started either by buying bitcoins for dollars or by charging for a service you provide in bitcoins.

    Currency speculation aside, the impetus for doing this is likely to be that you want to buy something online. Changing dollars into bitcoins and paying with those seems like a more attractive option than sharing your credit card number with everyone you do business with, or paying charges to the rapacious PayPal.

    Legality is the main issue here, IMHO.

    • I completely understand that the system is built in a way that mining becomes more difficult, but as a normal punter who just installed the software, I have to say that I did not find it appealing as a late adopter. Unless I can mine and create wealth, I do not see any encouragement for transferring money into BTC at the current rates, particularly because I fear the price may be seriously inflated by current speculation.

      Do not get me wrong, I can see the advantages of electronic payment systems, particularly of cheap payment systems, but I am a bit sceptical of BitCoin as of now. Perhaps I will change my mind in the future.

      The legal analysis is the important part as you say, but to me an analysis of the validity of the system as a viable currency is very important, as it might determine whether or not regulators will try to get involved.

      • "Money" does not ever have intrinsic value once it has been monetized. There are very useful things that can be done with gold that can also be done with aluminum, copper, chromium steel, wood and water. Making pretty jewelry, conducting heat and electricity, resisting weathering, portability, ease of machining, et cet. Do not mistake the map for the territory. The only real value that these monetary symbols are maps of is energy, food, shelter, health, power. The point of anonymous coinage is not whether or not it has intrinsic value. It is ungovernable.

        Like WOW gold, obviously its a little unreal. Most maps are. If you, yourself, cannot produce something that you and others require to live well, in excess of what you need, you will NEVER understand what money is a map of. Most of the world's immediate financial difficulties arose because a few people knew the difference between a symbol of value and real worth, and most other people could not tell the difference. So they fall in love with money again and again.

  3. On legality in the EU, would Bitcoin really satisfy:

    # as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions;

    ?

    Maybe you could explain what that sentence means, and how it applies here?

    • Sure. This phrase means that electronic money is not to be confused with the provision of credit, because credit tokens have an entirely different legal regulatory framework, including the existence of consumer credit agreements, which make the provision of credit more expensive (it creates a legal debt relationship between the parties).

      The paragraph means simply that the value must be issued on receipt of pre-existing funds, which exists so that no new value is generated into the economy. This will not apply in all cases to BitCoin, particularly for miners, as they would be creating value. However, this paragraph would be met in most other circumstances, such as through exchanges (you pay some EUR and receive some BTC). I have paraphrased the Directive, and services can also meet the requirement of "receipt of funds".

      The good news for BitCoin may be that European regulators have usually been quite lax in applying the electronic money directives. There are lots of services that in my opinion have met the requirements but were seldom required to be declared EMIs (e.g. mobile payment systems).

  4. So it seems like the situation is that the authorities could kill Bitcoin for legal purposes without legislation, but they don't have to if they don't want to.

    If it's being used mainly for illegal drugs and gambling, it's going to be banned one way or another if it gets wide enough adoption. But if it can get enough people using it for legal commerce, governments will be wary of damaging their economies.

  5. Re the legality of Bitcoin, I dont care if its legal or not. Fiat currencies under the control of the central banks are losing their value on a daily basis, with the full knowledge, consent and approval of the legislature. They are literally stealing your money from you on a daily basis, by design. If I earn money, what I earn belongs to me. If I choose to accept gold or silver or bitcoins, that is a matter for me and the person I work for or who I am trading with.

    There must come a point where people are not willing to put up with being stolen from any more, they do something about it, the old and bad ways die and the new good ways supersede them. That time is now.

    Look at PayPal and how they have stopped all their users in India from purchasing goods with their own money. Why should anyone put up with that? Why should PayPal restrict their users at the behest of the State? Its wrong, and we shouldn't put up with it.

    I hope Bitcoin takes over the internet as a payment system. When that happens, if they try and shut it down, they will also have to shut down e-commerce as well. Thats why its so important that it spread quickly, which is exactly what is happening.

    • Bitcoin will not take over as a currency, at least as far as it remains a speculative market. You must be seeing something I am not, because I do not see this quick spread you speak of. The list of sites accepting BTCs is far from impressive to be honest, lots of donation sites, some few bands, and some few products offered. This is because nobody wants to accept a coin that is very speculative at the moment.

      Bitcoin will only become a currency if value stabilises at some point.

  6. Legality of bitcoin is a relative term, certainly across jurisdictions. Furthermore, the arbitrary enforcement of the law by certain governments permits politically-motivated actions when the political winds change (i.e., e-gold, LibertyDollar).

    Therefore, the primary consideration with the global bitcoin ecosystem is whether or not it can gain critical mass for transactions to stay within the bitcoin network. The total available market at that point becomes the portion of economies (white/grey/black) that rely on paper cash today, which is significant indeed. People will only migrate to futuristic digital currency if they don't lose the features that paper cash gives them today. And, those features are user-determined anonymity, traceability, and irreversibility.

  7. Bitcoin's value does not come from the fact that mining requires electricity. It only has value because people have decided that it is valuable. I would guess that people believe it is valuable because

    1. it is scarce

    2. it is uncounterfeitable

    3. it is easily transferred from one user to another

    these qualities among others make it a desirable medium for trade

  8. Script has a long history and is legal in the US and so are things such as Ithica dollars and wooden nickles. Hard to see anything different that would not allow bitcoins to also be legal. Also bitcoin has no claims represented by the issued so would seen to not fall under the eu regs you mention.

  9. Interesting take on the legality of Bitcoin. There are a few inaccuracies in your piece but they aren't major:

    – "Under this theory, many other online currencies, particularly in-game currencies, would be non-fiat money": this is incorrect, since the owners of the game (Blizzard in the case of WoW) can arbitrarily increase the amount of gold in the system, just like the US government can arbitrarily increase the amount of dollars in existence. With BTC or gold this is not possible. That doesn't mean those last two somehow have more intrinsic value, as you correctly explained.

    – "Because it is possible to see which wallet holds what, similar attacks may happen more and more in the future if the value continues to increase.": You'r confusing the wallet file with the bitcoin addresses that it can generate. The amount of BTC in any given address can easily be discovered because all the transactions are known in the entire network. But which wallet file holds the keys to those addresses is in general not known, so it is not simple to target an attack against computers with 'large' bitcoin wallets. The current approach of using Trojans to look for wallet files regardless of the amount of BTC in them is similar to using Trojans to look for credit card and bank account information, which criminals have been doing for years. People will need to learn to take good care of their wallet files, just as they do with their CC information, bank info and physical cash. There could be a market for 'bitcoin banks', who will be able to securely store your wallet and require strong authentication before allowing you to do transactions.

    My main questions about Bitcoin legality haven't really been answered in your piece. It is not whether Bitcoin is legal (can a piece of software in itself be legal or illegal? Most software can be put to both legal and illegal use), but it is whether individuals and companies using/accepting Bitcoins are committing an illegal act.

    In the US the government could claim Bitcoins are not legal tender and prosecute stores that accept them and perhaps people trying to spend them? Could that happen in the EU as well? If a company accepts Bitcoins as payment, how would this affect their obligations with reporting taxable income? Do Bitcoins fall under the obligations to report possible money laundering/terrorism financing by companies?

    I totally agree with you that to become widely usable the value of BTC needs to stabilise. But after that happens, the above questions become the really important ones in my opinion.

  10. I think your analysis of Bitcoin and U.S. law is misinformed. Just because something is not "legal tender" doesn't mean it can't be legally created by a private party. The "FBI" quote (which in fact comes from a US Attorney's office) is taken out of context: it's referring to Liberty Dollar coins, which were so similar to U.S. coins that individuals were mislead into believing they were official U.S. coins (and didn't realize that the metal in them was worth less than the values stamped on them).

    I covered these issues in my legal draft on bitcoin (see http://papers.ssrn.com/sol3/papers.cfm?abstract_i… which was aptly summarized by

    Corey Recvlohe in the Quora thread you linked to.

    • As I mentioned, there is a distinction between legal currency and legal tender. Only the U.S. dollar is legal tender, and my reading of U.S. law would lead me to believe that the Fed has a monopoly on issuing legal currency as well, and that no other currency can compete. This is a legal grey area, so I'm willing to wait and see. I am not a U.S. lawyer, as it is made quite clear in the blog (the .uk domain site should also give a hint). What I have read does lead me to believe that this is still an open question, and EFF's removal of BTC donation support is a very good indication that there are serious problems with Bitcoin.

      I notice that you have expressed doubts about my European analysis in Reddit, please feel free to point out where it is wrong.

      I am still very sceptical of Bitcoin, all of the events in the last week have only strengthened the negative opinion that I had. One big element of the system has become clear, and it is that regardless of the legal status of Bitcoin as a currency, the system currently relies too much on the exchanges (as it is not really operating as a currency, there is no liquidity in the market). The exchanges are clearly operating outside of the regulatory framework. Even a 2nd year law student should know that taking deposits and conducting financial operations for third parties is a regulated activity in the U.S. Brokerage firms, transfer agents, clearing agencies and exchanges need to be authorised by the SEC. In Europe, deposit-taking institutions are also covered by financial regulations. For example, in the UK exchanges are regulated by the Financial Services & Markets Act 2000 (FSMA). Any firm that takes deposits, keeps accounts, safeguards investments and administers funds is regulated and needs to be registered. As far as I can see, none of the major exchanges are registered, and therefore are illegal.

      Even MtGox in Japan would need to be regulated, and in the last week we have seen precisely why.

      Bitcoin's problems at the moment are not the system's security, and I actually no longer care if it is a currency, the clue is in the exchanges, until you can get one authorised exchange going, you will continue to see the chaos in the system.

      • I'm sure the exchanges are going to be such a problem, unless it's illegal to _use_ them, as well as illegal to run them.

        When deciding whether to conduct transactions in bitcoins, all I need to know is that an exchange somewhere in the world will be willing to do business with me.

        What was a bit unusual about the recent situation is that after one exchange got hacked, the other ones shut down in case people had used the same passwords. Regular financial organizations would never dream of doing anything that responsible, but if it's an issue in future exchanges can come up with a different way of handling login secrets that aren't vulnerable to other exchanges' passwords being stolen.

        If exchanges occasionally get shut down and I have to use one in a different country, that's not ideal, but it's not devastating. What would worry me would be if my business was going to get into trouble for accepting bitcoins from customers or spending them.

        In any case, when the bitcoin economy gets big enough, a the regulated financial firms will presumably get into the business.

  11. I'm very curious about the legal argument you make. If this is true, then Microsoft, Nintendo, and others should be guilty of issuing false currency, no?!

    Microsoft Points and Wii Shop Points are used by the companies to standardize their globally-reaching digital markets, so could you illuminate what differentiates them from Bitcoin?

    • Have a look at the European definition of electronic money for a clue: "accepted by a natural or legal person other than the electronic money issuer".

      If Wii Points are accepted by a person other than the issuer, then they should be regulated in some jurisdictions.

  12. "until you can get one authorised exchange going"

    The recently launched cryptoxchange boasts compliance with Australian law ("Fully-licensed and AML/KYC compliant", whatever that means) and might be the first regulated exchange. However a couple of months later they don't seem to be doing much trading, possibly due to high fees. But it might be one to keep an eye on. http://cryptoxchange.com/

  13. this article is strange. I mean I know someone see something is good …paint it bad, but in each 1st sentence you paint it bad but explain its not that bad . its like 20 20 trying to disturb my view and to not trust it , so that I can listen to them .

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