The Federalization of Bitcoins

The Bitcoin System

A bitcoin is a convertible virtual currency, a currency that has an equivalent in, or acts as, a substitute for 'real' currency, i.e., coin and paper money that is legal tender in its country of origin.

The bitcoin system uses peer-to-peer technology to operate with no central authority. Transactions are carried out collectively by the network in that they are recorded only in an electronic log of transactions called the blockchain. See, http://bitcoin.org/en/how-it-works. Nodes, or individual computing centers, compete to create the blockchain. This 'mining' process is a distributed consensus system that is used to confirm waiting transactions by including them in the blockchain. 'Miners' create units of convertible virtual currency because they are rewarded for a successful validation of the blockchain by being issued 25 bitcoins.

Bitcoin transactions are anonymous, decentralized, and resistant to forensic exploration. A particular transaction traces bitcoins identified with digital signatures, verified by miners and authenticated by the blockchain. See, 'Bitcoin: A Peer-to-Peer Electronic Cash System.' Thus, there is a serious question as to whether any one person involved in a bitcoin transaction has uttered, i.e., sent the bitcoin into circulation. See, http://legal-dictionary.thefreedictionary.com/utter. A bitcoin has no inherent value, does not have a physical existence, and is utilized by persons who are intimately aware of its nature. Arguably, the use of a bitcoin is the trading of a commodity or token rather than the use of money.

Regulating Bitcoins

FinCEN's guidance on virtual currency is remarkably succinct and direct. A bitcoin is a decentralized convertible virtual currency because it has no central repository and no single administrator. See, 'Application of FinCEN's Regulations,' supra, p. 5. It is obtained through individual computing or manufacturing efforts.

Because the bitcoin is not legal tender and providers of prepaid access and dealers in foreign exchange are money services businesses only if they deal in legal tender, bitcoin exchanges by such businesses are not regulated by FinCEN.

It goes without saying that the appearance of the bitcoin presented federal enforcers of the Bank Secrecy Act with an unprecedented challenge. (The Bank Secrecy Act and its application to FinCEN is explained at www.fincen.gov/statutes_regs/bsa.) The bitcoin's principal differentiation from regulated currency, as pointed out above, is that it is decentralized and not legal tender. FinCEN cannot hold a single issuer or regulator responsible for the virtual currency and thus has no leverage to regulate the currency one-on-one. Rather, the situation is FinCEN versus the Web. In addition, the fact that the bitcoin is not legal tender implies that market forces govern its ebb and flow and there is no public authority with any interest in any given value for the bitcoin.

FinCEN has accepted the fact that bitcoins are cleverly created to avoid federal regulation. The old, 19th-century model for national watchdogs was based on Article I, section 8, clause 5 of the U.S. Constitution: Congress has the power to 'coin Money, regulate the Value thereof, and of foreign Coin.' Beyond this, 'broad and comprehensive national authority over the subjects of revenue, finance, and currency is derived from the aggregate of the powers granted to the Congress' concerning money, finance, and taxation and the 'necessary and proper' clause. See, Norman v. B & O R. Co., 294 U.S. 240 (1934).

Alternative Money Systems

In response to the Supreme Court's ruling that '[w]hatever power there is over the currency is vested in Congress,' Congress has enacted a sea of counterfeiting statutes. Inserted among them is a law against 'uttering coins of gold, silver or other metal.' This singular statute forbids the promulgation of a 'coin[] of gold or silver or other metal, or alloys of metals, intended for use as current money.' The producer of such a coin faces five years in federal prison. See, 18 U.S.C. section 486; U.S. v. Falvey, 676 F.2d 871 (1st Cir. 1982) [section 486 predecessor intended to be 'the prohibition of private systems of coinage created for us in competition with the official [U.S.] coinage]'.

An example of old-style currency policing under section 486 is the prosecution of Bernard von NotHaus, the founder of an organization called the National Organization for the Repeal of the Federal Reserve and Internal Revenue Code. Von NotHaus manufactured 1998 Liberty coins to include markings such as the dollar sign and the words 'dollar,' 'USA,' 'Liberty,' 'Trust in God,' features associated with legitimate U.S. coinage. Because of its resemblance to U.S. silver coins, including the use of terms copied from legitimate coins, Von NotHaus was eventually convicted of counterfeiting under section 485, which states: 'Whoever falsely makes, forges, or counterfeits any coin or bar in resemblance or similitude of any coin of a denomination higher than 5 cents or any gold or silver bar coined or stamped at any mint or assay office of the United States, or in resemblance or similitude of any foreign gold or silver coin current in the United States or in actual use and circulation as money within the United States ' [s]hall be fined under this title or imprisoned not more than fifteen years, or both.'

More interesting is how Von NotHaus violated section 486. Since 1998, NORFED placed into circulation his version of the Liberty Dollar in all its forms throughout the United States. NORFED's purpose was to mix Liberty Dollars into the current money of the United States and for the Liberty Dollar to be used as current money in order to limit reliance on, and to compete with, United States currency. In a somewhat baroque post-conviction statement, the U.S. Attorney announced: 'Attempts to undermine the legitimate currency of this country are simply a unique form of domestic terrorism' aimed at challenging 'the legitimacy of our democratic form of government.'

In other words, the placement of a precious-metal, non-government coin into the stream of commerce causes uncertainty in the minds of those utilizing the specie as to the value of the coin and, by implication, the government which supposedly honored it. Congress was bound 'to prevent the debasement and expulsion, and the destruction of the general confidence and convenience, by the influx and substitution of a spurious coin in lieu of the constitutional currency.' U.S. v. Marigold, 50 U.S. 560 (1850).

It would seem that placing a virtual coin in the stream of commerce would have the same deleterious result as a precious non-specie coin, but there is no specific statute covering the virtual coin. It has no physical existence, let alone precious-metal content or resemblance to any specie and obviously could not come within the terms of section 486.
Furthermore, no one, or everyone, 'utters' the currency for section 486-style statutory regulation. In sum, it is clear that although the principal goal of the bitcoin creator was to provide currency immune to governmental interference by de-nationalizing it. See, 'Bitcoin: A Peer-to-Peer Electronic Cash System,' supra. In doing so, the bitcoin creator also prevented the total regulation of bitcoms as currency by the Federal government.

Conclusion

FinCEN's approach in exonerating the users of bitcoins from any suspicion under the Bank Secrecy Act is immensely practical. Although the blockchain appears to be no more than a simple debit-credit system, the encoded designations of the individual bitcoins are the only identifiers in the blockchain. The users are scattered through the Internet, protected by multiple and diverse encryption.

The possibility of the use of bit coins for criminal Internet transactions is obvious, but the inclusion of miners and third-party dealers as regulated entities, coupled with money laundering and contraband prohibitions, imply that FinCEN's limited regulation of the bitcoin will probably be a practical success.

[Editor's Note: On May 15, U.S. Authorities seized two accounts linked to Tokyo-based Mt. Gox, a major operator in the Bitcoin market, according to Reuters. A seizure warrant obtained by the Department of Homeland Security froze an account that an Iowa-based online payment processor, Dwolla Inc, held at Veridian Credit Union in the name of Mutum Sigillum LLC, according to the wire service. An affidavit in support of the warrant states that Mutum Sigillum, a Mt. Gox subsidiary incorporated in Delaware, was operating as an unlicensed money transmitter, in violation of federal law. Neither Mt. Gox nor Mutum Sigillum had registered with FinCEN, which the affidavit cited Mutum Sigillum's as sufficient grounds to seize its accounts, Reuters reported. Mt. Gox says it handles 80% of Bitcoin trading. See the full story at http://reut.rs/194pLDY.]

James Ching is a former Supervising Deputy Attorney General, California Department of Justice and Chief Counsel, California Board of Prison Terms. He has argued over 200 appellate cases in the California Courts of Appeals and Supreme Court, many cases in the federal appellate system, and three cases in the U.S. Supreme Court. He specializes in criminal, constitutional and labor law and is the author of numerous published articles on these subjects.

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On March 18, the Financial Crimes Enforcement Network of the Treasury Department (FinCEN) issued guidance on the application of its regulations: 'Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies.' Much of its attention is focused on the bitcoin, a virtual currency introduced in 2009, although this currency is not mentioned by name.'

FinCEN's jurisdiction is, in part, the regulation of money services businesses. Such businesses, including those deemed money transmitters, are subject to reporting requirements, such as reports on currency transactions, including suspicious activities related to such transactions. See, 31 C.F.R. section 103.20. Criminal and civil penalties apply to the non-registered and non-reporting money services businesses. See, 31 C.F.R. section 103.41(e).

FinCEN relies on the facts and circumstances of the provided services to determine whether the broker or dealer is acting as a money services business. Therefore, the creation and transmission of bitcoins is germane to FinCEN's decision to deem certain bitcoin transactions as performed by money services businesses.

The Bitcoin System

A bitcoin is a convertible virtual currency, a currency that has an equivalent in, or acts as, a substitute for 'real' currency, i.e., coin and paper money that is legal tender in its country of origin.

The bitcoin system uses peer-to-peer technology to operate with no central authority. Transactions are carried out collectively by the network in that they are recorded only in an electronic log of transactions called the blockchain. See, http://bitcoin.org/en/how-it-works. Nodes, or individual computing centers, compete to create the blockchain. This 'mining' process is a distributed consensus system that is used to confirm waiting transactions by including them in the blockchain. 'Miners' create units of convertible virtual currency because they are rewarded for a successful validation of the blockchain by being issued 25 bitcoins.

Bitcoin transactions are anonymous, decentralized, and resistant to forensic exploration. A particular transaction traces bitcoins identified with digital signatures, verified by miners and authenticated by the blockchain. See, 'Bitcoin: A Peer-to-Peer Electronic Cash System.' Thus, there is a serious question as to whether any one person involved in a bitcoin transaction has uttered, i.e., sent the bitcoin into circulation. See, http://legal-dictionary.thefreedictionary.com/utter. A bitcoin has no inherent value, does not have a physical existence, and is utilized by persons who are intimately aware of its nature. Arguably, the use of a bitcoin is the trading of a commodity or token rather than the use of money.

Regulating Bitcoins

FinCEN's guidance on virtual currency is remarkably succinct and direct. A bitcoin is a decentralized convertible virtual currency because it has no central repository and no single administrator. See, 'Application of FinCEN's Regulations,' supra, p. 5. It is obtained through individual computing or manufacturing efforts.

Because the bitcoin is not legal tender and providers of prepaid access and dealers in foreign exchange are money services businesses only if they deal in legal tender, bitcoin exchanges by such businesses are not regulated by FinCEN.

It goes without saying that the appearance of the bitcoin presented federal enforcers of the Bank Secrecy Act with an unprecedented challenge. (The Bank Secrecy Act and its application to FinCEN is explained at www.fincen.gov/statutes_regs/bsa.) The bitcoin's principal differentiation from regulated currency, as pointed out above, is that it is decentralized and not legal tender. FinCEN cannot hold a single issuer or regulator responsible for the virtual currency and thus has no leverage to regulate the currency one-on-one. Rather, the situation is FinCEN versus the Web. In addition, the fact that the bitcoin is not legal tender implies that market forces govern its ebb and flow and there is no public authority with any interest in any given value for the bitcoin.

FinCEN has accepted the fact that bitcoins are cleverly created to avoid federal regulation. The old, 19th-century model for national watchdogs was based on Article I, section 8, clause 5 of the U.S. Constitution: Congress has the power to 'coin Money, regulate the Value thereof, and of foreign Coin.' Beyond this, 'broad and comprehensive national authority over the subjects of revenue, finance, and currency is derived from the aggregate of the powers granted to the Congress' concerning money, finance, and taxation and the 'necessary and proper' clause. See , Norman v. B & O R. Co. , 294 U.S. 240 (1934).

Alternative Money Systems

In response to the Supreme Court's ruling that '[w]hatever power there is over the currency is vested in Congress,' Congress has enacted a sea of counterfeiting statutes. Inserted among them is a law against 'uttering coins of gold, silver or other metal.' This singular statute forbids the promulgation of a 'coin[] of gold or silver or other metal, or alloys of metals, intended for use as current money.' The producer of such a coin faces five years in federal prison. See , 18 U.S.C. section 486; U.S. v. Falvey , 676 F.2d 871 (1st Cir. 1982) [section 486 predecessor intended to be 'the prohibition of private systems of coinage created for us in competition with the official [U.S.] coinage]'.

An example of old-style currency policing under section 486 is the prosecution of Bernard von NotHaus, the founder of an organization called the National Organization for the Repeal of the Federal Reserve and Internal Revenue Code. Von NotHaus manufactured 1998 Liberty coins to include markings such as the dollar sign and the words 'dollar,' 'USA,' 'Liberty,' 'Trust in God,' features associated with legitimate U.S. coinage. Because of its resemblance to U.S. silver coins, including the use of terms copied from legitimate coins, Von NotHaus was eventually convicted of counterfeiting under section 485, which states: 'Whoever falsely makes, forges, or counterfeits any coin or bar in resemblance or similitude of any coin of a denomination higher than 5 cents or any gold or silver bar coined or stamped at any mint or assay office of the United States, or in resemblance or similitude of any foreign gold or silver coin current in the United States or in actual use and circulation as money within the United States ' [s]hall be fined under this title or imprisoned not more than fifteen years, or both.'

More interesting is how Von NotHaus violated section 486. Since 1998, NORFED placed into circulation his version of the Liberty Dollar in all its forms throughout the United States. NORFED's purpose was to mix Liberty Dollars into the current money of the United States and for the Liberty Dollar to be used as current money in order to limit reliance on, and to compete with, United States currency. In a somewhat baroque post-conviction statement, the U.S. Attorney announced: 'Attempts to undermine the legitimate currency of this country are simply a unique form of domestic terrorism' aimed at challenging 'the legitimacy of our democratic form of government.'

In other words, the placement of a precious-metal, non-government coin into the stream of commerce causes uncertainty in the minds of those utilizing the specie as to the value of the coin and, by implication, the government which supposedly honored it. Congress was bound 'to prevent the debasement and expulsion, and the destruction of the general confidence and convenience, by the influx and substitution of a spurious coin in lieu of the constitutional currency.' U.S. v. Marigold , 50 U.S. 560 (1850).

It would seem that placing a virtual coin in the stream of commerce would have the same deleterious result as a precious non-specie coin, but there is no specific statute covering the virtual coin. It has no physical existence, let alone precious-metal content or resemblance to any specie and obviously could not come within the terms of section 486.
Furthermore, no one, or everyone, 'utters' the currency for section 486-style statutory regulation. In sum, it is clear that although the principal goal of the bitcoin creator was to provide currency immune to governmental interference by de-nationalizing it. See, 'Bitcoin: A Peer-to-Peer Electronic Cash System,' supra. In doing so, the bitcoin creator also prevented the total regulation of bitcoms as currency by the Federal government.

Conclusion

FinCEN's approach in exonerating the users of bitcoins from any suspicion under the Bank Secrecy Act is immensely practical. Although the blockchain appears to be no more than a simple debit-credit system, the encoded designations of the individual bitcoins are the only identifiers in the blockchain. The users are scattered through the Internet, protected by multiple and diverse encryption.

The possibility of the use of bit coins for criminal Internet transactions is obvious, but the inclusion of miners and third-party dealers as regulated entities, coupled with money laundering and contraband prohibitions, imply that FinCEN's limited regulation of the bitcoin will probably be a practical success.

[Editor's Note: On May 15, U.S. Authorities seized two accounts linked to Tokyo-based Mt. Gox, a major operator in the Bitcoin market, according to Reuters. A seizure warrant obtained by the Department of Homeland Security froze an account that an Iowa-based online payment processor, Dwolla Inc, held at Veridian Credit Union in the name of Mutum Sigillum LLC, according to the wire service. An affidavit in support of the warrant states that Mutum Sigillum, a Mt. Gox subsidiary incorporated in Delaware, was operating as an unlicensed money transmitter, in violation of federal law. Neither Mt. Gox nor Mutum Sigillum had registered with FinCEN, which the affidavit cited Mutum Sigillum's as sufficient grounds to seize its accounts, Reuters reported. Mt. Gox says it handles 80% of Bitcoin trading. See the full story at http://reut.rs/194pLDY.]

James Ching is a former Supervising Deputy Attorney General, California Department of Justice and Chief Counsel, California Board of Prison Terms. He has argued over 200 appellate cases in the California Courts of Appeals and Supreme Court, many cases in the federal appellate system, and three cases in the U.S. Supreme Court. He specializes in criminal, constitutional and labor law and is the author of numerous published articles on these subjects.

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