Now that Bitcoin recently crossed the $1,000.00 threshold for the first time in its short life, a discussion on the regulatory status of Bitcoin in the United States (“U.S.”) is in order. Stories of online drug purchases, hitmen, and other unsavory activity initially marred Bitcoin’s reputation by associating it with black market transactions. However, for every story involving a drug transaction using Bitcoin, there have been positive Bitcoin related stories including the availability of the first Bitcoin ATM and the first law firm to begin accepting Bitcoin for retainer payments.

In August of this year, Federal District Court Judge Amos Mazzant established in a Securities and Exchange Commission (“SEC”) lawsuit that, “Bitcoin can be used as money. It can be used to purchase goods or services and … pay for individual living expenses. The only limitation of Bitcoin is that it is limited to those places that accept it as currency.” Earlier this November, the U.S. Senate convened a hearing on Bitcoin and assessed the risks and benefits of wider adoption. Although the U.S. is moving toward adoption of Bitcoin by mandating that exchanges follow federal regulations, it recognizes potential in Bitcoin’s growth over time. Mythili Raman, an acting assistant attorney general at the U.S. Department of Justice (“DOJ”) stated at the hearing, “The Department of Justice recognizes that many virtual currency systems offer legitimate financial services and have the potential to promote more efficient global commerce.” Even Federal Reserve Chairman Ben Bernanke wrote in a letter to the Senate Banking Committee that Bitcoin “may hold long-term promise.” Finally, the Chicago Federal Reserve Bank issued a letter from a senior economist in December of 2013, offering a detailed primer on Bitcoin as an investment.

In response to negative criticisms that Bitcoin has been used primarily for money laundering and criminal activities, Ms. Raman responded that law enforcement has “been able to keep pace with that, and we’ve been able to develop protocols and strategies to address it.” The U.S. Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”) has begun accepting applications from Bitcoin exchanges as money services businesses (“MSBs”) seeking to legitimize themselves under U.S. laws. FinCEN suggested at the very least that Bitcoin miners would likely have to register as a MSB because they are creating units of virtual currency and selling them. FinCEN’s report also distinguished Bitcoin exchanges from traditional currency exchanges because to fall under FinCEN’s regulations, an exchange must trade in the currency of two countries, which Bitcoin is not associated with a specific country. Similar to other registered money exchanges, Bitcoin exchanges must also comply with both the Bank Secrecy Act of 1970 as well as the PATRIOT Act of 2001. Compliance with these laws involve implementation of anti-money laundering processes, maintenance of ongoing customer records, and reporting of suspicious transactions. The U.S. also requires strict state-by-state compliance for registered currency exchanges, so all U.S. based exchanges must register federally and must also register and comply each individual state it intends to conduct business in. By having to comply with both federal and multiple state laws, the present U.S. regulatory environment for Bitcoin based startups is cumbersome when compared to countries that have taken a wait-and-see or laissez-faire approach toward regulating Bitcoin.

For traders and speculators in the U.S., the big question is how Bitcoin transactions will be taxed. While the General Accounting Office (“GAO”) has requested that the Internal Revenue Service (“IRS”) provide guidance as to how to treat gains from the sale of Bitcoin(s), it has not yet. The IRS and Treasury Department have not determined yet whether holdings in Bitcoin constitutes a commodity or a currency. The IRS has also not yet determined whether gains from the sale of Bitcoin constitutes a capital gain or ordinary income for tax purposes. The IRS has reported that they are currently working on issuing guidance to taxpayers for how Bitcoin based gains should be treated, so this question will be answered soon.

As legislators plan how to integrate Bitcoin into the economy, the U.S. must be careful not to impose too many regulations, or it may lose the head start that it has against other countries interested in Bitcoin, such as China, the UK, and Canada. China is already home to the world’s largest Bitcoin Exchange, and Bitcoin provides an efficient way for Chinese citizens to avoid strict capital controls imposed by the government. Although the U.S. currently hosts the Bitcoin Foundation and a number of larger third-party Bitcoin payment brokers, there have been reports that the Bitcoin Foundation and others have contemplated relocating abroad given the state of the U.S. regulatory environment. Because countries such as the UK and China have taken a hands off approach to regulating Bitcoin and Bitcoin transactions, the U.S. may lose its competitive advantage as the leader of the Bitcoin economy if it continues to impose regulations which deter Bitcoin investment and innovation.