The rapidly rising public and regulatory awareness of the potential risks—and opportunities—surrounding bitcoin ("BTC") raises a diverse set of fundamental legal questions regarding the appropriate characterization, regulation and taxation of such a 'virtual currency'; essentially, how can and should a non-fiat currency that is derived from an open source algorithm (as opposed to a central bank) be regulated—or left unregulated? InsightLegal Asia Consulting (www.insightlegalasia.com) specializes in 'clarifying complexity' and below we analyze (i) fundamental legal issues surrounding BTC, (ii) how states worldwide have reacted thus far, including (iii) an emphasis on jurisdictions within APAC. We then broaden our analysis to consider (iv) what opportunities arise with the advent of BTC, with a particular focus on how bilateral counterparties may conceive of and put to use certain OTC and securitized derivatives linked to BTC as the underlying asset, including structured products with embedded derivatives linked to BTC.
PART 1: Introduction
Many states and individuals initially react with a mixture of fear and confusion upon first learning of BTC1. Is it a currency, a commodity, a security, or something entirely sui generis? To say that conventional regulatory authorities are being intellectually challenged by virtual currencies would be an understatement of galactic proportions. Five years after regulators at the G-20 (or global) level were required to step-up their game and try to get their minds around the myriad of derivatives that had become staples within most sophisticated financial institutions, an even more complex set of issues with vast potential for rapid financial innovation now presents itself in the form of BTC. At least BTC does not appear to pose systemic risk—yet, and in the final analysis we ultimately contend that:
"...for the foreseeable future, OTC and securitized derivatives linked to BTC will remain outside the regulatory ambit of G-20 and individual state initiatives (including those in APAC)."
Structure of Analysis
Herein, we examine and attempt to provide a taxonomy of how different regulators have approached this 'brave new world' so far, which varies from: (A) the hysterical (e.g., Russia, much of Africa and certain states with the least developed financial infrastructure); to (B) the 'Tax Mobsters', ever-eager to extract maximum revenue sources from this new brand of economic activity (e.g., the EU, Australia and Canada); to (C) potentially empowering individuals, markets and states by enabling financial transactions and innovation via BTC (e.g., segments of the U.S. and APAC). We consider categories (A) through (C) in turn below. Following our taxonomy of the genus of regulators (A through C), we then hone our analysis onto how BTC is being treated in APAC by looking at China, Hong Kong and Singapore. Finally, we shift our analysis onto an even greater set of challenging questions for the world's regulators that are set to emerge alongside financing schemes and derivatives linked to BTC (and its competitors in the virtual currency space).
Let us open up such analyses and attempt to make some educated predictions as to what the road ahead might look like for retail end-users, counterparties, investors, market-makers, providers of complex financial products, and--of course—regulators themselves.
PART 2: Legal Issues: The Challenges of Characterization
(i) Characterization, Integration and Regulation
BTC is particularly interesting because of the fundamental questions it raises, for example:
- What exactly is an algorithmic-based virtual currency, as opposed to a fiat2 currency, which is not backed by or issued by a central government authority?
- Is an open-source algorithm that issues units/coins via the process of 'mining3' a 'currency', a 'commodity', a 'security' or something else?
There are many ways that regulators may attempt to characterize BTC for one purpose or another, but the playing field for lawyers is wide open at this stage when it comes to challenging and litigating any such characterizations. What is certain is that BTC presents some very intellectually and practically challenging legal issues that are for the most part open for sustained debate and will undoubtedly form the basis of many legal cases in the years to come.
If one considers the extent to which there has been already been legislation or litigation surrounding BTC, there are a few clues from which one can attempt to draw inferences or analogies; however, most of the fundamental questions remain unresolved and will remain so in the absence of specific legislation or litigation.
At one level, local unregulated currencies are not new and existed long before the digital age. Historically, such currency systems have contributed in a beneficial manner to financial innovation and can provide additional payment alternatives to consumers and traders. Moreover, competition of this type usually reduces transaction costs over time, although it may also present new risks for end-users due to the lack of consumer-protection regulation. In the digital age, this is very much the world of caveat emptor writ large.
The absence of a clear legal basis for virtual currencies highlights the overall lack of understanding regarding virtual economies and how they impact the real economy. The global scope of virtual communities means that the location of participants and the owners are difficult to establish. By extension, states and central banks face serious challenges when attempting to control or ban a virtual currency. States are limited by the means in which they can obtain information, which is further confounded by unclear political and legal mandates, insufficient practical tools, and other barriers to effectively regulating such currencies. From an extraterritorial stand-point, what specific legal authority does one state rely upon to impose its own regulatory system onto the high seas of the financial world?
Currently, there is no legal framework that specifically addresses the unique features and functionality of BTC. Nonetheless, regulators from certain jurisdictions are taking active steps to provide individuals and businesses with rules on how to integrate this new technology into the formally regulated financial system.
To complicate matters further, since BTC displays certain features that enable it to function as a 'commodity' (such as the algorithm's self-imposed supply limitation of 21 million BTCs and its rampant implied volatility rate) and, alternatively, as a 'security' (e.g., its use as an object of investment), regulators have expressed concerns over its proper legal status and regulation.
Market mavericks like Robocoin4 have launched the world's first BTC ATMs. Curiously, even Baidu (China's heavily censored version of "Google5") began accepting BTC. These companies conduct international business through a stateless currency. Although many skeptics have doubted the stability or longevity of this virtual currency, BTC continues to grow and move from strength to strength (despite some major road-bumps discussed below), which regulators worldwide are finding very hard to ignore.
At a comparatively more pedestrian level, the taxation of individual or business income (to say nothing of capital gains) earned through virtual currency transactions has become an obvious target—especially in the case of the Tax Mobsters (see Part 3(B)). Furthermore, the definition, security and protection of virtual properties remain unclear (as we consider in more detail in relation to the Mt. Gox fiasco).
(ii) Early Crises
Regulation is typically crafted in the wake of crises and initial media focus on--and ignorance of--BTC has been generally skeptical, negative or outright hostile. This is in part due to the features that make BTC ideal for certain illegal activities. For example:
- BTC is not regulated, backed, guaranteed or protected by any central bank or state;
- BTC is based on a decentralized peer-to-peer network, which means that there is no central authority;
- BTC transactions are virtually anonymous as parties' identities are not disclosed (especially if proxy server or 'deep web' tactics are employed); and
- BTC has no intrinsic value, so its value is determined by the market's confidence in, and perception of, the virtual currency.
Since BTC is not a fiat currency, a key factor in its current value is the ability to convert BTC into legal tender. Businesses currently accepting BTC do so on the assumption that they will be able to exchange their BTC for 'hard currency' (or even 'soft currency' that is at least legal tender), which in turn allows them to pay third parties down the chain in legal tender. At their essence, BTC exchanges are companies focused on converting BTC into USD, EUR, RMB and many other forms of legal tender and charge service fees for such intermediation. In the process of intermediation, exchanges enable the BTC world to expand by providing a mechanism through which real value exists for an intangible object that otherwise lacks intrinsic worth.
However, the risks of unregulated BTC exchanges were on display in February 2014 when certain exchanges (most notably Mt. Gox6 in Japan) suspended withdrawals of BTC and temporarily suspended BTC transactions on the basis that the exploitation of a 'flaw' in BTC's protocol had resulted in a major cyber-heist. Mt. Gox went offline claiming this software glitch made it possible for someone to use the BTC network to alter transaction details to make it appear that BTCs sent to a BTC wallet did not occur--when in fact it did occur. In Tokyo District Court, Mt. Gox asserted that 750,000 BTCs deposited by users and approximately 100,000 BTCs of its own had disappeared, claiming that the BTCs were probably stolen due to the glitch. The U.S. Attorney for the Southern District of New York and the U.S. Federal Bureau of Investigation are also probing potential criminal activities in relation to the shutdown of Mt. Gox.,
Other major BTC exchanges, including Kraken7 (USA) and BTC China8 (China), as well as BTC wallet-makers, such as Coinbase9 (USA) and Blockchain10 (USA), all distanced themselves from Mt. Gox. and claim to be working together to improve the security of customer funds.
Part 3: Taxonomy of Global Regulatory Reactions
(A) The Hysterical
Perhaps unsurprisingly, Russia presents itself as the archetype knee-jerk reactionary state with regards to BTC. Rather than attempting to understand the basic facts or potential benefits of such an innovation, Russia has simply attempted to shut down the operation via diktat (i.e., the Prosecutor General's Office)11. Of course, there is in fact very little that they--or any state acting unilaterally--can actually accomplish by taking this type of shortsighted or stubborn approach except perhaps limit BTC access for only the least tech-savvy users within their borders. (For example, it is hard to see how an offshore OTC NDF using a BTC-RUB currency pair could ever be captured or shut down by even the most zealous Russian apparatchik.)
In short, the ability of clever individuals to operate through proxies, 'deep web'12 or other forms of anonymous on-line tactics to by-pass the 'Mr. No' states are well beyond the resources and technological capacity of any single state. Further, it is fairly safe to contend that political priorities and resources in states emerged in warfare and similar demonstrations of 'high politics' are otherwise occupied. BTC, and most of its variations and technological options for exchange, speculation and hedging, will remain several steps ahead of any single 'bare-chested' state (Putin's Russia of course being the archetype here). (Perhaps, in a twist of irony, punters will be able to buy and sell CDS protection on the very sovereigns that seek to block BTC--settled in BTC (i.e., with an in-built quanto into 'hard currency' to hedge BTC volatility during the tenor of the swap).)
Ultimately, the world does not expect or look to these states to act as innovators in the financial world and it is—by extension—fairly safe to contend that these states will not be where the bulk of BTC activity, innovation, ideas or new wealth will be generated at any point in the foreseeable future. There is probably not much value in discussing or expecting anything further from the hysterical state genus, or any of its constituent species, in the short-term.
(B) The Tax Mobsters
Perhaps unsurprisingly, the most common reaction among EU regulators (and to an extent the Australian and Canadian approaches) has been to frame BTC into the age-old paradigm of: how do we tax this form of activity to fill our state coffers?
While it may be fair game to attempt to capture all forms of commerce, exchange, services and barter, these states are perhaps taking too pedestrian of an approach to such a potentially innovative financial tool. The disadvantage of focusing exclusively on how much the state can extract from BTC is that the more dynamic and voluminous activities will be located in more amenable jurisdictions, which imposes potentially adverse opportunity costs and long-term revenue losses at the macro-economic (i.e., GDP) level. However, it is not likely that specimen-states within the Tax Mobster genus will change their racket(s) anytime soon in the face of BTC or any other form of innovative economic activity.
(i) EU Regulatory Treatment of BTC
Given its historical reliance upon statist solutions, current fiscal inadequacies and the omnipresent usage of taxation as a front-line solution to most issues, there is nothing surprising about the EU's initial regulatory reactions to BTC. The EU is scrambling for ways to finance its outsized—hence unaffordable—bureaucracies; for these states, BTC is essentially just another euro in the state's coffers. While this may be a somewhat uninspiring outlook, the taxation of BTC transactions is unavoidable to the extent one must characterize any transaction as having occurred within the EU. Most notably, the German government has categorized BTC as a "unit of account", thus officially recognizing it as money taxable under capital gains. It is fairly safe to speculate that other countries in the EU will follow suit and treat BTC primarily as a source of much needed state revenue.
There have been several initial attempts in the EU to define the legal status of BTC. For example, French courts dealt with this issue after local banks shut down the currency exchange facility for accounts handling the currency, on the presumption that BTC should conform to electronic money regulations. The French Prudential Supervisory Authority cautioned the public that transactions are not protected13. The issue of BTC's legal framework was also raised in the European Commission's Payments Committee. In response to instances of hacking and taking a consumer protection approach, the European Banking Authority warned that virtual currency users should be fully aware of and understand specific characteristics of such currencies14; basically, advising users to not spend "real" money to buy virtual currencies that they cannot afford to lose.
(ii) Australian Regulatory Treatment of BTC
The Australian Taxation Office ("ATO") considers transactions made in BTC in the same manner as it would any other transaction. Paying for goods and services with BTC will not relieve the seller to account for GST or include the income in their business tax return. The ATO is due to release a draft determination on the question of whether BTC is a "foreign currency", which would trigger special rules regarding how it may be treated for taxation purposes.
Virtual currency exchange platforms are currently not regulated by the Australian Securities and Investments Commission ("ASIC"). Since it is not clear at this stage whether BTC constitutes a 'financial product' that could be the subject of a financial services business, financial services businesses using BTC for non-standard transactions (e.g., OTC trades) would by any logical inference be exempt in the absence of any future specific legislation.
Under Australia's Anti-Money Laundering and Counter-Terrorism Financing Act 2006, reporting obligations to the Australian Transaction Reports and Analysis Centre ("AUSTRAC") apply to financial institutions and other persons who provide specific designated services. BTC reporting is not specifically captured under the current laws, except for perhaps a large deposit of AUD into a bank account in return for BTC, which may trigger notifications to AUSTRAC.
(iii) Canadian Regulatory Treatment of BTC
Canada's initial reaction to all the possibilities that BTC presents can be broadly summarized as falling within this genus: how can we tax BTC in a way that captures every pocket of economic activity (exchange, service, barter or otherwise)?
Canadian tax regulators (i.e., pursuant to the Canadian Revenue Act ("CRA")) have thus far stuck to the mantra that BTC is a virtual currency used to buy and sell goods and services on the Internet--therefore, it is a simple commodity. When BTC is used to purchase goods or services, the transaction is treated as a barter transaction and the value of what is received is considered to be equal the value of the thing given up in exchange. These values must be translated into CAD, which determines the Canadian tax liability of the parties15. This analysis would seem to apply equally to capital gains taxation.
Although not a particularly visionary approach to BTC, it is one that seems theoretically sound under the legal characterizations used in Canadian tax law.
The Canadian Deposit Insurance Corporation, like its equivalent in most developed jurisdictions16, does not cover transactions made in BTC. This feature could open up a market for more nimble market players that are willing to extend counterparty credit and/or settlement protection to transactors using BTC for a fee, similar to the way that traditional credit enhancers (e.g., mono-line insurers) have conducted such businesses in the past. However, such a discussion is beyond the scope of our current analysis.
(C) The Enablers
In contrast to the regulatory regimes described in subsections (A) and (B), there is a third category of states that are relatively forward-looking with regards to BTC and its potential uses as a means of exchange, money transfers, transactions and investments. Rather than employing a knee-jerk or how can we maximize our tax haul approach, states in this category are taking a more holistic approach and considering BTC as a potentially innovative part of the new financial landscape. Let us consider this genus of states in more detail below.
(i) US Regulatory Treatment of BTC
The US has a mix of protractors and detractors with regards to BTC in general; however, the more sophisticated actors in the financial establishment17 appear to understand the nuances and potential of BTC in a more visionary light than what appears to be the case in the states described above in subsections (A) and (B).
Political background of BTC in the US
The U.S. Senate Committee on Homeland Security and Governmental Affairs held its first hearing on virtual currencies on November 18, 2013, followed by the U.S. Senate Committee on Banking, Housing and Urban Affairs on November 19, 2013. These hearings were spurred by the FBI shut down Silk Road after (a) more than a one billion USD of illegal drugs and illicit services had been purchased via BTC and (b) the dominance of BTC China18, a China-based BTC exchange. Essentially, there is broader and more balanced debate in the U.S. between security concerns on the one hand, and huge market potential on the other. U.S. lawmakers seem partially concerned that overzealous legislative actions could drive innovation in financial services to other countries with fewer constraints.
However, the more basic issues surrounding the legal definition of virtual currencies, including their classification as 'commodities' or 'securities', remain unanswered. Answers to these fundamental issues will determine the regulatory agencies that will regulate such currencies and their treatment under the law.
US regulators, most notably the SEC and CFTC, have not yet determined the appropriate treatment of BTC and the vast array of investments, products and schemes that can be conceived of (or linked to) using such a virtual currency. The simplest example is a BTC exchange, which falls clearly under the Treasuries' Financial Crimes Enforcement Network and requires registration of the exchange as a money services business.
Beyond the more straightforward BTC exchange example, the U.S. Commodities Futures Trading Commission ("CFTC") would seem to be the more logical authority with regards to BTC regulation, to the extent one presupposes BTC should be characterized as a commodity (or more broadly under the CFTC's authority over any swap transactions that are not security-based swaps). The CFTC has authority over Forex pools and trusts, which would logically capture a number of BTC-related investment structures. Furthermore, futures, swaps (that are not security-based swaps) and rolling spot transactions all fall under the CFTC's jurisdiction and it is likely that most BTC transactions will ultimately be deemed to fall under this head of regulatory authority.
However, the U.S. Securities and Exchange Commission ("SEC") has not yet been relegated to the sidelines in the BTC legal analysis. Interestingly, the Winkelvoss twins (a.k.a. the 'Winkelvi' as per Facebook's Mark Zuckerberg's humorous nomenclature) have re-emerged and re-engineered themselves as the first to register an exchange traded fund ("ETF") using a trust whose value to unit holders is linked to the performance of a BTC basket19, which is currently proceeding under the SEC's bailiwick. The SEC has also taken enforcement action in at least one instance against a BTC trust Ponzi scheme20. Nonetheless, in most instances it is quite an analytical stretch to categorize BTC transactions as a "security" or "security-based swap" for U.S. Securities Law purposes.
There have already been M&A transactions paid for entirely in BTC, most notably the sale of ZeroBlock21, which publishes a BTC-related mobile app of the same name, to Blockchain22. This transaction was unique in that it was entirely settled in BTC and was made practicable largely due to the fact that the BTC transfer took only 20 seconds to settle, thereby avoiding the volatility issue that currently plagues most transactions that are not instantaneously settled. In theory, any number of derivatives could be used to hedge against the volatility of BTC and it is reasonable to expect more aggressive players will begin providing BTC hedges and managing BTC risk on a global booking basis (as is currently done with most other asset classes at major financial institutions). The short term potential for BTC in M&A in the private equity space would seem fairly strong, especially where rapid settlement or a volatility hedge (i.e., by way of an OTC derivative) is made available to the contracting parties.
PART 4: BTC in the Asia-Pacific Context
Exchange controls have long been a part of the financial and 'real economy' landscape of APAC. This has long fueled a large scale non-deliverable forward ("NDF") and interest rate swap ("IRS") market, which constitutes the lion's share of derivative transactions regionally. However, traders and investors in APAC are also familiar with many 'market access' products in the equity derivatives space (such as low exercise price options ("LEPOs"), zero exercise price options ("ZEPOs") and other delta-one structures). By contrast, the corporate bond market (and by extension credit protection in the form of credit default swap ("CDS") or other credit derivatives) remains relatively undeveloped compared to the US or EU. In the context of exchange controls, convertibility issues and foreign ownership regulations preventing direct market participation in equity by foreign parties, many opportunities exist for using BTC as a means of exchange (for real economy transactions); alternatively, BTC could be used to hedge certain market distortions imposed by existing regulatory controls. Let us consider the regulatory reactions thus far in two core APAC jurisdictions; namely, China, Hong Kong and Singapore.
(i) Regulatory Treatment of BTC in the PRC
In China, in addition to being used to pay for goods and services, BTC is also viewed as an alternative method to invest or save (similar to stocks, gold and property). In the absence of regulation, BTC could be an enormous avenue to remit money out of China. BTC also has huge potential as a means of speculating on currencies outside regulatory controls. BTC could also be used to circumvent investment limits in the domestic property market. It can be used to convert RMB to invest in offshore equities and properties, and for tax evasion.
The PRC set of a big scare when the People's Bank of China ("PBOC") issued a notice on BTC, barring financial and payment institutions from trading in BTC and constituted the PRC's first step toward regulating BTC. The PBOC's notice specified that financial and payment institutions may not:
- employ BTC as a unit of payment for goods or services;
- accept BTC as a method of payment;
- purchase, sell, or deal in BTC;
- engage in RMB-BTC exchange services;
- engage in saving, trust or mortgage services involving BTC;
- undertake insurance activities related to BTC;
- issue any financial instrument related to BTC; or
- directly or indirectly provide any services related to BTC.
The PBOC urged government agencies to educate the public on such topics as currency, investment, and financial safety and indicated that it will closely monitor BTC and similar virtual commodities in the light of AML risks. The press noted that BTC exchanges may soon be required to inform government authorities about sizeable or suspicious transactions and that internet companies serving as BTC trading platforms may be required to request their clients to register with certain information such as name and identity card number. After the PBOC's notice was published, divisions of Baidu (China's 'Google') and China Telecom removed references to BTC payments from their services, and announced that they will no longer accept BTC.
The initial reaction to the PBOC's notice was that BTC prices slumped to below US$1,000 on major BTC trading platforms23. BTC prices, however, soon bounced back and partially recovered to CN¥5,765 (US$943) as of December 10, 2013. The majority of BTC trading currently still occurs in RMB. As of December 10, 2013, approximately 59% of BTC global trading occurred on exchanges that traded in RMB. Meanwhile, BTC trading in USD accounted for roughly 35% of the global trading. BTC trading in EUR accounted for slightly less than 2%. No other currency accounted for more than 1% of the global trading.
In the beginning of February 2014, BTC China announced that customers were once again able to purchase BTC in China by depositing RMB directly into BTC China's corporate bank account. BTC China also launched RMB-based reward programs to encourage trading in BTC and boost its liquidity. BTC China's decision came after the exchange stopped accepting RMB deposits, in response to the notices given by the PBOC in December 2013 banning national financial institutions from trading in BTC. BTC-China determined that it was legally permitted to accept deposits into its corporate bank account and transfer funds into customer accounts, even though banks per se were barred from engaging in BTC businesses and transactions. The PBOC's statement that exchanges should register with the Chinese Ministry of Industry and Information Technology was viewed by some as implicit recognition of BTC exchanges as a business category and BTC China as a legitimate business.
BTC China continues to operate and a healthy network of sellers and resellers are still in business. Competitors to BTC such as OKCoin24 have begun to emerge, so alternative virtual currencies are catching on inside the country despite restrictive measures.
The instantaneous and low cost nature of BTC transactions could facilitate global seed funding (and crowd-funding) so there are many potential benefits to using it. Chinese regulators will no doubt continue to monitor the benefits of (lower transaction costs and flexibility) and at some point in the future the benefits may outweigh the risks25.
(ii) Hong Kong's Regulatory Approach to BTC
Essentially, Hong Kong is a prime example of the Enabler genus, even if has not expressly stated its intent in this regard.
BTC Payment Systems and ATMs
Following the PBOC's unofficial order, the Hong Kong government reiterated its opposition to virtual currencies as issued a general caution. Despite these generalized public 'concerns', BTC has not lost any popularity amongst investors and users in Asia. To avoid risks associated with BTC, some investors choose to invest in companies providing BTC-related services instead of investing directly in BTC. For example, even Li Ka-shing (a.k.a. 'Superman'), Asia's richest man, through his venture capital company, Horizons Ventures, recently invested in BitPay26, a BTC payment system roughly equivalent to PayPal.
First-time buyers of BTC would find it easier to invest and transact in BTC using an ATM. Registration processes for online BTC exchanges are slow and customers often wait for several days before making their first purchase of BTCs. In hyper-speed Hong Kong, that simply will not do! When using a BTC ATM, registration is expected to take just several minutes. The ATMs combine biometric authentication, government-issued HKID scanning, as well as verified facial matching to make them secure.BTC ATMs from other providers are now being installed at the International Finance Centre, Wanchai Computer Centre and Mong Kok.
Laissez-faire in Action
The Hong Kong Government previously stated that BTC is not a real currency and businesses should have proper safeguards in place to prevent money laundering and financing of terrorism. A source from Hong Kong Customs and Excise department said that the officials are considering which government department would be responsible for regulating BTC-related activity in Hong Kong. John Tsang, the Hong Kong Financial Secretary and the Chairman of a number of the Committees within the Hong Kong Monetary Authority, warned that:
"People and businesses should be extremely careful when it comes to investing in or accepting BTC. It is important to understand the associated risks. Whether the BTC is a bubble which would burst or whether it will become an independent cross-national electronic payment system is difficult to tell".
Anyone who has lived in Hong Kong long enough knows exactly what people are going to do following that statement. These are all very big words from a very 'light touch' government.
As the world's freest economy, with an advanced level of readily available technological applications, laissez-faire enforcement of existing AML controls (essentially no on-going monitoring beyond proof of address and ID) and the limited types of goods and services subject to any kind of sales or capital gains tax, one can safely predict that the use of BTC (and other virtual currencies) in Hong Kong will skyrocket off the charts.
(iii) Singapore's Regulatory Approach to BTC
Singapore is another prime example of the Enabler genus and much innovation within the BTC space can be expected.
In February 2014, Singapore became the home to two of Asia's first BTC automated ATMs, following the set ups of similar machines in Canada and the United States. More BTC ATMs are planned for this year, including in Japan, Hong Kong, Australia and the United Kingdom. The announcement of BTC ATMs in Singapore came several days after Singapore's Deputy Prime Minister and Minister for Finance, said that the Singapore Central Bank did not recognize BTC as a legal tender and cautioned individuals about the use of virtual currencies.
Singapore, like other countries, does not have specific regulations for virtual currencies, as they are not considered legal tender.
The Monetary Authority of Singapore ("MAS") does not regulate BTC and has "...been advising individuals and businesses to think twice and be cautious about accepting or dealing in virtual currencies..."
The MAS recently announced that it would regulate virtual currency intermediaries to address potential money laundering and terrorist financing risks. New regulations will require intermediaries that buy, sell or facilitate the exchange of virtual currencies for real currencies, such as operators of BTC exchanges and BTC ATMs, to verify the identities of their customers and report suspicious transactions. Such regulations are similar to those currently imposed on moneychangers and remittance businesses that undertake cash transactions. However, in so doing, the MAS also made it clear that its regulation of virtual currency intermediaries, which include vending machines, would be limited specifically to the money laundering and terrorism financing risks they posed. It added that its regulation did not extend to the safety and soundness of those virtual currency intermediaries, nor the proper functioning of currency transactions. "Consumers and businesses should take note of the broader risks that dealing in virtual currencies entails and should exercise the necessary caution," said the MAS's deputy managing director.
In Singapore, we can expect a great deal of activity in the BTC space going forward.
PART 5: Speculative, Hedging and Other Uses of OTC Derivatives
Beyond BTC Exchanges
Due to the efficiency and lower transaction costs, there is little reason to doubt that the use of BTC (and other virtual currencies) as a means of exchange will continue to grow at both the retail and institutional level. Beyond BTC exchanges, the potential for OTC derivatives structured around BTC are quite limitless in the absence of major legislative and regulatory initiatives.
BTC's Regulatory Terra Nova
Currently, regulators worldwide are focused on bringing OTC derivatives into a transparent trading, clearing, settlement and reporting framework with the primary objective of reducing systemic risk and counterparty risk. However, regulatory initiatives (such as Dodd-Frank, EMIR and Basel III) can only push transactions onto exchanges or via central counterparty ("CCP") clearing to the extent that such exchanges or CCPs exist. For BTC, the only logical legal analysis is that no such current mandatory obligations exist, since there is no basic architecture in place for such purposes. Perhaps after regulators have digested the more conventional asset classes (FX, rates, equity, credit and commodities) and brought those broadly within the centralized trading, clearing, settlement and reporting universe, they will attempt to take a bite at BTC.
However, for the foreseeable future, OTC and securitized derivatives linked to BTC will remain outside the regulatory ambit of G-20 and individual state initiatives (including those in APAC).
BTC's Brave New World
The potential for higher spreads and profit margins for those structuring OTC and other derivative products linked to BTC will attract market makers, speculators and counterparties with specific BTC hedging requirements.
Many complex legal and regulatory issues remain entirely unresolved and fundamental questions need to be addressed--hopefully sooner rather than later--given the exponential growth trends in BTC and other virtual currencies.
- How should regulators approach OTC derivatives between bilateral counterparties (such as private equity funds, hedge funds or venture capitalists) linked to BTC as the underlying asset27?
- How about a securitized derivative linked to the value of BTC relative to a 'hard currency28' (or a basket of hard currencies, or basket of baskets)?
- Why not devise structured products targeted at the exempt professional investor segments of investors, with periodic payouts determined by the performance of BTC against any number of measurable benchmarks or indices?
- Why not devise a variance swap that has a non-directional payout determined by the rate of volatility of BTC relative to any number of hard currency pairs (or baskets of hard currencies)?
- Better still, how about a structured product linked to the non-directional volatility of BTC (i.e., a structured note with an embedded BTC variance swap)?
Clearly, this is a world where possibilities quickly become very exciting; clearly, the structures being discussed here not at suitable for the faint of heart—and definitely not designed for the retail segment. To state the obvious, lawmakers and regulators have a lot of work ahead of them.
In terms of timing, the ultimate question is whether the legal and regulatory frameworks can be put in place prior to virtual currencies becoming systemically important.
PART 6: Conclusions
If regulators worldwide were not already encumbered enough trying to understand and sensibly regulate core areas of financial innovation in general--and OTC derivatives in particular--following the collapse of Lehman Brothers, BTC and similar virtual currencies throw a host of additional challenges at their beleaguered ranks.
Given the subject matter, this discussion throws open more questions that it begins to answer, but that is the inherent nature of any 'brave new world'. There will be some big winners and losers along the way, but the consensus is that BTC (and other virtual currencies to follow) is well on its way to becoming a standard and broadly accepted method of transacting efficiently.
Information, fact and understanding are always the best defenses against hysteria and erratic regulatory reactions that fail to foresee potential opportunities or benefits presented by transformative technologies and the financial innovation that may follow. If nothing else, hopefully this discussion sheds some insights into which states--and individuals and markets therein--are more likely to benefit from the opportunities presented by BTC; by contrast, it also highlights which states are likely to remain laggards in the financial and economic spheres.
1 While other virtual currencies are already in existence and new ones are being devised almost daily, BTC is by far the largest and best known. Therefore, for the purposes of this discussion we shall keep our focus upon BTC; however, readers should feel free to draw analogies to the plethora of other virtual currencies about to go into 'circulation'.
2 To the uninitiated, 'old school' currencies (i.e., those backed by a central bank, monetary authority or other government entity) are referred to as 'fiat currencies'.
3 Mining is the process by which new BTCs are released based on the protocols of the BTC algorithm on a daily basis, which eventually cuts off the supply of new BTC in 2040—therefore making BTC a finite resource.
5 As most readers are probably aware, Google itself is not accessible in China except by way of proxy servers or certain 'deep web' tactics that by-pass the PRC's 'Great Firewall'.
6 Mt. Gox is currently only available to users to check BTC balances https://www.mtgox.com
7 See https://www.kraken.com
9 See https://coinbase.com/
10 See https://blockchain.info/
12 For example the Onion browser on the TOR network, which relays IP addresses continuously amongst users, making it difficult to establish any individual behind any particular IP address. This was the most common initial method of black market sales of drugs, weapons and other contraband, which the FBI and other authorities have since shut down. This may have the undesired effect of further splintering the black market into many more providers.
15 See CRA s. 261(2)(b).
16 E.g., The US FDIC, Hong Kong's Deposit Insurance Scheme and so forth.
17 For example, a recent study conducted by the Chicago Federal Reserve concluded that "BTC protocol provides an elegant solution to the problem of creating a digital currency, i.e., how to regulate its issue, defeat counterfeiting and double-spending, and ensure that it can be conveyed safely—without relying on a single authority".
18 See Supra at footnote 8.
19 For more details see the S-1 filed with the SEC: http://www.sec.gov/Archives/edgar/data/1579346/000119312513393903/d56232...
20 To see the press release follow this link: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539730583#....
21 See http://www.zeroblock.com
22 Supra at footnote 10.
23 On BTC-China, it traded at CN¥4,785 (US$780) immediately after the publication, compared with CN¥7,050 (US$1,150) on the previous day.
24 Only in Chinese, see https://www.okcoin.com
27 In particular, since there are currently no exchanges currently accepting OTC trades with BTC underliers for clearing, settlement or reporting purposes, the mandatory provisions of Dodd-Frank, EMIR and other CCP related rules would not apply to BTC derivatives—and might not for some time to come.
28 Or even a 'soft currency' that is at least legal tender, which BTC is not?
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