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Some basic rules for using ‘bitcoin’ as virtual money

Techies know that “bitcoin” is a virtual currency generated by predetermined computers and recognized on traditional currency exchanges as BTCs. Of interest to investors and business owners, bitcoins have skyrocketed into mainstream popularity, as has their price.

No government is involved in creating bitcoins, and they are insulated from Cyprus-style bank lockouts. But before joining the BTC revolution, here are seven fundamentals to consider.

1.) Rules apply. Recent virtual currencies guidelines from the Financial Crimes Enforcement Network acknowledge the uses, while detailing the watchdog’s expectations.

“No new rules, no new regulations. We issued the guidelines to say how we see virtual currencies within the Bank Secrecy Act and record-keeping [and] reporting responsibilities,” says the director of FinCEN, Jennifer Shasky Calvery. “Virtual currencies are subject to the same rules as other currencies. … Basic money-services business rules apply here.”

FinCEN’s guidelines safeguard bitcoins from being used by money launderers. For example, an Austin, Texas, man selling a Porsche for bitcoins on Craigslist or a Houston lawyer announcing he’d accept bitcoin payments would not be “money transmitters” for the money-services business rules. Conversely, a trading exchange website could be subject to registering as a “money transmitter,” and to filing FinCEN anti-money-laundering reports and following its record-keeping requirements.

In contrast, Japanese-based bitcoin exchange Mt. Gox set up a U.S.-based bank account registered under the name of Mutum Sigillum in 2011. Last May, the Department of Homeland Security effectively shut down Mt. Gox’s operations for not registering itself as a money services business in accordance with FinCEN guidelines. Specifically, DHS got a court order restricting payments to the Mutum Sigillum/Mt. Gox account because it was involved with currency exchanges but failed to register as a money services business.

2.) They can be a quick and cheap alternative payment method. “When I was in private practice, I accepted bitcoin from clients,” says Patrick Murck, general counsel for the Bitcoin Foundation. “If I sent an invoice for $5,000, I had to wait for that client to mail me a check. … If I accepted credit cards, I got hit with a processing fee. … With bitcoins, I was paid within minutes in an irreversible manner without fees.”

Aside from instant payment, “you can lock in the exchange rate every single time a payment is made to you,” says Fred Ehrsam, co-founder of Coinbase, a bitcoin electronic wallet and merchant host website. “At the end of the day we send a lump sum amount over to your account. Users can hold a balance in the account if they want to have exposure in the bitcoin investment market, or convert to cash. Once you have bitcoin, all bitcoin-to-bitcoin transactions are free.”

Otherwise, Coinbase charges 1 percent when dollars are exchanged into, or out of, bitcoins.

Bitcoinstore.com and other merchant-processing-services sites also allow bitcoin purchases. Per anti-money-laundering rules, personal information is required to exchange bitcoins into cash.

3.) Lost or stolen bitcoins are gone forever. Hackers exist in the bitcoin world. When paid by, or buying, bitcoin, it’s transmitted by code.

“There’s something called a private key,” says Murck. “That’s what you are storing in your bitcoin e-wallet when you receive or buy bitcoins. Lose that private key, you’ve lost your ability to spend bitcoins. There’s no central bank or person to reclaim a password.”

Ehrsam’s tip: “If you are going to store your e-wallet on your own server, don’t keep your e-wallet on your desktop, and make sure you use encryption. If you lose your computer, your bitcoins are lost forever.”

4.) Expect volatility. Whether bitcoins are the currency wave of the future or a mere bubble, historical pricing shows volatile fluctuations.

To illustrate, in January its high was $15.68. On April 3, the price swung from $106 to $147 to $125.

“It’s a very new technology and asset market. The vast increase in value may be due to speculation, but it is hard to argue that it isn’t warranted,” says Ehrsam, who began his career at Goldman Sachs. “Cutting 2-3 percent off of fees on all payments made globally with bitcoins, that’s significant.”

“Cyprus also had an impact,” Murck says. “Hoarding by speculators occurs, but the problem in quantifying circulation—there’s a 21.4 million limit—is that it’s unknown how many bitcoins go lost” by owner error.

5.) Glitches exist. Traffic overload causes temporary shutdowns.

“There are transitions that some sites are going through,” says Murck.

6.) There is a limited market. From an adoption perspective, “the merchant side is where things are lagging,” says Ehrsam, whose firm’s users include Reddit. Whether retailer adoption of bitcoins catches up to the investment chatter is uncertain.

“It’s not there yet,” Murck says. “There are online sites [where] you can buy televisions and things. … It’s peer to peer.”

7.) Conduct a trial run. “It’s experimental currency,” Murck says. “Don’t invest any more of your time or money than you can afford to lose.”

Still interested? Murck says, “If you have a client that wants to pay in bitcoin, as long as the remittance is something you don’t need to operate your practice, and you can afford to run an experiment on, then try what I did: Set up a wallet. I used Blockchain.info. Experiment. See what you can do.”