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Bitcoins: Have You Started Thinking About the Concept?

6/10/14

By: John Goselin & Stephanie Stewart 

Bitcoins.  Have you heard of them?  If not, you probably will.  Are you starting to think about how bitcoins will impact your business?  If not, you probably should.

The media describes bitcoins as a “virtual” or “crypto-“ or “cyber-currency”.  It is a peer-to-peer payment system in which digital bitcoins can be exchanged for money, goods, services, or newly created bitcoins.  Bitcoins are a relatively new development within the last five years.  Governments worldwide are struggling to determine how to classify them, how to regulate them, and what to do about them and with them.
Defining bitcoins as a currency is the subject of some dispute because bitcoins operate without a central authority, have no single administrator, and are not backed by any government.  For example, both Finland and Russia currently treat bitcoins as a commodity as opposed to a currency.  Yet, they seem to be gaining wide acceptance.  Apple recently announced that it will permit apps within the ios Apple Store that process bitcoin transactions.  The first bitcoin ATM has made its debut in a Las Vegas casino and a manufacturer is marketing the new bitcoin ATMs for wider use.  A Malaysian online electronics retailer has added a bitcoin payment option to its website.
Because bitcoins are still in their infancy, there is little clarity regarding the legal rules relating to their use. It is not even clear whether it will be a federal or state issue or a combination thereof.  We do know that the IRS has issued guidance in which the IRS stated that bitcoins are treated as property for federal tax purposes.  That would seem to suggest that if people lose their bitcoins, that can constitute economic damages although nothing is certain.  For a discussion regarding bitcoin depositor protection and developments, click here.
The anonymity and lack of regulation associated with bitcoins has caused some regulatory agencies to note the high potential for fraud and abuse.  Investor alerts have been issued by both the SEC and FINRA  related to bitcoins.  In 2013, the SEC charged a Texas man with operating a bitcoin Ponzi scheme.  And earlier this month, the SEC announced a settlement with two bitcoin ventures for failure to register the offerings with the SEC.  How long before broker-dealers and investment advisors are trying to grapple with the question of whether bitcoins should be part of an investor’s portfolio?  It seems likely that other federal and state regulators will start looking at bitcoins too.  If history holds true, we will see a period of time with few if any rules followed by a period of contradictory regulations before someday in the future, the business community will enjoy certainty regarding how bitcoins work and should be handled.
At present, however, no one really knows how people might decide to use bitcoins as they continue to grow in popularity and acceptance.  In an attempt to study a bitcoin ecosystem, MIT is providing each of its undergraduate students with $100 in bitcoins this fall.  The experiment is designed to encourage research into the technology behind how bitcoins are exchanged and the economics of how people use bitcoins.  It will be interesting to see how the study will turn out.  Nevertheless, real world businesses may find themselves dealing with bitcoins sooner rather than later, and before they really understand how they work.

It appears that bitcoins are here to stay and it is time for the business, legal, and insurance community to start thinking seriously about what bitcoins means for businesses.  Legal disputes involving bitcoins seem to be inevitable.
We will be following the evolution and potential issues regarding bitcoins.  Stay tuned for more information, analysis, and updates.