United States: Bitcoin Basics For Corporate Counsel

Last Updated: May 27 2015
Article by Steve Gold

Bitcoin, the online "cryptocurrency," is not just for anti-government doomsday fanatics and drug dealers. Seen everywhere from SEC filings, to state legislature hearings, to an episode of The Good Wife, it is both an influential new Internet technology and a new financial medium that will have a growing impact on corporate enterprises across the economy.

Corporate counsel who support technology transactions are likely to face a variety of legal issues of first impression as corporate planners, strategists, investors and consumers find new applications and run into old problems with this technology. This article will catalog eight of the most salient aspects of Bitcoin that corporate counsel should understand.

What is Bitcoin?

Touted as a new currency and as a disruptive technology, Bitcoin is both. At its most basic Bitcoin is little more than a shared online ledger, called the "blockchain," that lists every bitcoin transaction that has ever occurred. Users interact with the blockchain through software referred to as a bitcoin "wallet." It is the complex cryptography that secures the blockchain and the clever incentive structure for volunteers to maintain the blockchain and earn new bitcoins that makes Bitcoin sophisticated, practical and disruptive.

Bitcoin was created in 2009, based on a paper posted to the Internet in late 2008 under the (most likely pseudonymous) name Satoshi Nakamoto. Nakamoto's paper outlined the underlying technical details: Ownership of an entry in the blockchain is demonstrated by possession of a cryptographic private key (in a Bitcoin wallet) that is mathematically tied to the numerical designator (a Bitcoin address) of that entry. The blockchain is also protected against tampering by a process called "mining," which rewards new bitcoins to the first computer on the Bitcoin1 network that successfully solves a mathematical calculation associated with validating additional blockchain entries. The costs and incentives of mining are designed to make it unfeasibly difficult to introduce nonexistent transactions into the blockchain (i.e., to "double spend" a bitcoin).

Online reports indicate that as of spring 2015 there may be as many as 5 million Bitcoin wallets holding the more than 14 million bitcoins now in existence. The value of a bitcoin has fluctuated from about $14 at the beginning of 2013, to a high of $979 late that year. In May 2015, the price fluctuated between approximately $225 and approximately $250.

Eight Things Corporate Counsel Should Know

1. Bitcoin is a Decentralized System

Bitcoin does not rely on a government as the issuer of currency or on a software company that controls its existence – anyone can join the network and the core software is open source. It is, however, dependent on the volunteer software developers that maintain and modify the core network and mining software and on the many "miners" who maintain the blockchain. If, for example, too few miners were validating transactions, the entire system would be open to manipulation.

2. Bitcoin is Not Anonymous

Bitcoin has been called anonymous, but that is not entirely accurate. It is anonymous in the limited sense that no personally identifying information is required to be stored as part of the blockchain. Every transaction, however, is publicly traceable. If it becomes known who controls a particular Bitcoin address it is an easy matter to see the Bitcoin addresses that sent or received those bitcoins. Although a lot of Bitcoin's publicity has associated it with online anonymous drug markets, its public traceability has proven to be an Achilles' heel, or at least a significant burden, for law evaders, so Bitcoin has far more utility for law-abiding transactions.

3. Bitcoin is Currently in Use

Bitcoin is becoming more widely used, with approximately 100,000 transactions per day being added to the blockchain. Many well-known businesses have begun to accept bitcoin as payment, and bitcoin can be spent many more places through third-party relationships with bitcoin payment processors and gift cards. Bitcoin also has two very attractive features for its use for funds transfer: essentially no transfer fee and quick processing. Although a future change to this structure is built into the Bitcoin protocol, at present all transfer fees are essentially paid out of the Bitcoin network as a whole through mining rewards, so any amount of bitcoin can be transferred (anywhere) without the payment of a transaction fee. The protocol also is designed so the time to make a transfer is short: Assuming that sufficient miners are working on updating the blockchain, new transactions will be added approximately every 30 minutes, though additional cycles of mining are required in order to assure security. The handling of transaction fees, and the fact that payments are accounted for to eight decimal places, also makes Bitcoin attractive for micro payment applications.

4. Thefts Have Resulted from Failures Outside the Bitcoin Protocol Itself

There have been many press reports about collapsed bitcoin exchanges and millions of dollars of lost or stolen bitcoins. Those losses, so far as has been reported, do not arise out of insecurities in Bitcoin's software, the cryptography on which it is based, or the Bitcoin network. Indeed, the nature of a Bitcoin transaction is theoretically more secure than a credit card transaction because a buyer paying with bitcoin need not give any sensitive information about his bitcoins to the seller, while a buyer paying with a credit card generally has to give the seller her credit card number. From the seller's perspective, a Bitcoin transaction may be more secure than a credit card payment because there is no intermediary that might reverse or charge back the transaction. Once bitcoins are transferred and recorded on the blockchain, they are fully controlled by the recipient.

The publicly reported losses have resulted from thefts or failures outside the blockchain itself. There are many reasons for this, but one of the most significant is that current Bitcoin wallet software is at an early stage of usability development and remains complex for many users. So, rather than operate the software themselves, users have their bitcoins held online by third parties. In quite a few cases, those third parties have not proven trustworthy.

5. Bitcoin Isn't the Only Game in Town

Bitcoin is only the most well-known and most widely adopted of many similar crypto-currencies that have emerged over the last few years. At least 25 different crypto-currencies each had total market capitalizations over $1 million in May 2015, according to online sources. Bitcoin, however, is the most significant one, with a total value over $3.5 trillion, nearly 15 times the total value of Ripple, the next largest entry.

6. Blockchain Technology is the Real Breakthrough

According to many observers, the importance of Bitcoin goes well beyond bitcoin itself as a currency. The Bitcoin blockchain is said to represent both an important advance in computer science and a disruptive innovation that has a wide variety of applications. Some well-known blockchain advocates claim that the technology, though at an early stage today, will be as important as, for example, the development of the TCP/IP protocol that was the foundation of the Internet, the worldwide web and all of the online world built around those.

In this view, blockchain technology is a way to keep a reliable electronic record of things and transactions, not just bitcoins, without the need for a central authority. Possible applications, some of which are already under development, include using something like the blockchain to manage other technological assets (such as data storage locations); records of ownership of other financial assets, such as securities; or even physical assets.

Blockchain transactions themselves are also programmable, which opens even more possible applications. It is theoretically possible, for example, for a blockchain-based financial instrument to automatically make payments over time, or for a blockchain-based escrow to respond to external inputs in order to settle a transaction.

7. People (and Governmental Agencies) are Taking Notice

Because of these many possible future applications, as well as the current financial uses of Bitcoin (and the other similar systems), Bitcoin has received a considerable amount of attention. Highlights include the following:

  • The IRS has, in early 2014, issued guidance on the treatment of bitcoins for United States federal income tax purposes. The IRS notice and "frequently asked questions" took the position that bitcoins should be treated as property for tax purposes, that transactions in bitcoins (including mining) are subject to tax, tax withholding and tax reporting to the same extent as transactions involving other forms of property.
  • The New York State Department of Financial Services is preparing to implement financial regulation over certain economic participants in the Bitcoin financial systems, with other states likely to follow suit. The regulation is going to impose money laundering and capital requirements on businesses that exchange bitcoin into other currencies for consumers. Without the state-level regulations in place, federal officials are already taking notice of Bitcoin and, in fact, fined Ripple (one of the largest currencies other than Bitcoin) for violating anti-money laundering requirements.
  • At least two state legislatures have initiated studies into whether facilities could be established for taxpayers in their states to pay taxes in bitcoin.
  • In March 2015, the UK Treasury issued a report in which it acknowledged the potential of innovation of digital currencies and undertook further investigation and regulation. Several other countries with strict currency controls have taken steps to ban or restrict bitcoin.
  • One of the leading Silicon Valley venture capital firms is actively promoting the significance of Bitcoin and investing in several startup ventures that are seeking to capitalize on Bitcoin.
  • Finally, as an indication of the penetration of Bitcoin into popular culture, the mystery surrounding Bitcoin's creation (recently renewed in the business section of The New York Times) has appeared in a highly rated network TV show. Popular CBS drama The Good Wife devoted an episode to a fictionalized Satoshi Nakamoto-like character seeking legal advice related to an investigation by the secret service.

8. Legal Issues Will Abound

Bitcoin and blockchain technology will raise a wide variety of legal issues that may cross corporate counsel's desk. Some of these could arise right now, as businesses seek to take advantage of the existing capabilities of Bitcoin, while others will be relevant to strategy and planning for the wide variety of possible future applications.

  • Licensing and regulatory compliance. For any entity already in, or seeking to enter, a business that directly involves providing exchange or other financial services around Bitcoin, advice on licensing and regulatory compliance is a "must," along with constant monitoring and adjustment as regulation expands and matures. Those issues will be heavily influenced by geography, with many countries around the world taking very different approaches to bitcoin regulation.
  • Data security. Similarly, any business lawyer in a business that receives funds from consumers also should be monitoring developments with a particular focus on the contractual and data security aspects of receiving and handling consumer funds, whether in bitcoin or other media. The payments industry as a whole is under disruption – Bitcoin, Square, smartphone-based payments and other new competitors in that area are likely to be expanding dramatically over the coming months and years. Because of the decentralized, irrevocable nature of bitcoin transfers, any payment application for bitcoin will require close attention to legal developments affecting data security and encryption.
  • Third-party contractual arrangements. For businesses that outsource the handling of bitcoin transactions, close attention will be required regarding the contractual arrangements with third-party processors. In Bitcoin, the usual centralized infrastructure of the banks and payment card industry does not exist. Indeed, eliminating fees to those entities is part of the attraction of Bitcoin. But without those intermediaries and without standards yet in existence, every relationship will be unique and require attention to such things as chargebacks, transaction documentation, equipment, security, effect of errors, and all the other aspects of a payment system's rules.
  • Liability. As Bitcoin and blockchain technology are applied outside of the payments environment, lawyers will have wide latitude (and few fixed direct precedents) to establish the basic parameters of accountability and trust. Contractual, industry or legislative steps will be needed to establish appropriate allocation of liability for transactions that go wrong, particularly if circumstances arise in which the distributed blockchain itself is at fault (or is alleged to be at fault) for a party's losses. Beyond that, difficult questions of attribution can arise if automated transaction steps (repetitive withdrawals of consideration over time, for example) were carried out without human intervention and without even a single human-owned computer being responsible, but rather distributed responsibility occurring over the blockchain.
  • Jurisdiction. As with any online legal issue, there will be the question of which jurisdiction's laws will apply and which courts will decide the issues. These questions have long been an academic concern for Internet-mediated transactions, even if they turned out to be of very little practical concern. Blockchain transactions will raise these issues to a much greater degree. An Internet transaction can be problematic because it might not be clear which of many physical locations' laws apply; in a blockchain transaction, by contrast, it is almost a certainty that a great many geographically scattered physical locations will be implicated simultaneously.

Footnote

1. By convention, "Bitcoin" − capitalized – refers to the software, protocol and entire network, while "bitcoin" – not capitalized – refers to the unit of account.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions