Mar
20

An Introduction to Bitcoin

            Hey, brother, can you spare a Bitcoin? We may not yet be at a point where panhandlers request cryptocurrency, but increasingly, Bitcoin and other alternative currencies,[1] are on the mind of regulators, investors, and merchants. Lawyers are free to accept Bitcoin as payment for legal fees, and some, including the author, do. But this shadowy world of electronic currency raises important questions about transparency, legitimacy of existing institutions, and, alas, money laundering.

            Most lawyers aren’t paying attention to Bitcoin. It is a wave breaking all around them, yet all they hear is a distant roar. Isn’t it time you learned to ride the waves you’re hearing?

            Is Bitcoin Money? What Is Money, Anyhow?

            Aside from work done without a fee, pro bono work, lawyers work for a fee; indeed, the world moves and gyrates in response of the pressure of supply and demand. Every exchange requires recognition of things of value. What helps make the modern world spin at such dizzying speed is the fact that we no longer barter one thing for another. We use artificial measures of value to grease the skids of commerce.

            We use these measures daily, without thought. Our lives, our prosperity, our collective security depend on the use of these interchangeable things. In the United     States we call the units dollars; the Germans have marks, the Chinese use renminbis. These currencies are bought, sold, exchanged and created in tightly regulated markets.

            Welcome to the world of money.

            Pink Floyd had a thing or two to say about money:

 “Money, it's a crime

Share it fairly but don't take a slice of my pie

Money, so they say

Is the root of all evil today”[2]

            Money, Nobel Prize laureate and New York Time columnist Paul Krugman tells us, is “any asset that can easily be used to purchase goods and services.”[3] Of course, things are more complicated than that: money, in so far as the law is concerned, has three characteristics. It is a legally enforceable means of exchange, a store of value and a unit of accounts.[4]

            To the degree that participants in a market are prepared to use Bitcoin as a means of exchange, a store of value or a unit of account, it functions as money. This is a troubling development for the world’s governments, which create, regulate and monitor the creation of state-recognized currencies. Indeed, the entire point of calling a currency legal tender is that a person to whom a debt is owing and due must accept payment of legal tender as satisfaction of the debt. This lends stability to economic markets and to society as a whole.

            Bitcoin disrupts that stability.

            Bitcoin and the Silk Road

            Although initially created by cyber enthusiasts in first decade of the twenty-first century,[5]Bitcoin burst into broader public view as a result of the federal government’s prosecution of Ross Ulbricht, the architect of a dark web emporium permitting anonymous purchasers to buy drugs, even to contract for the killing of others, and to pay for these items in Bitcoin. Ulbricht was sentenced to life in prison, although his sentence is currently on appeal in the United States Court of Appeals for the Second Circuit.[6] The taint of Bitcoin’s use as part of a broader criminal enterprise has chilled many from exploring further the use of the cryptocurrencies for law-abiding means.

            Bitcoin is far more radical than a mere instrument of criminal enterprise. Its founders wanted an anonymous, decentralized, means of exchange operated not through centralized institutions, but based on peer-to-peer communications by anyone with a computer or a smart phone. Bitcoin in particular, and cryptocurrencies in general, seek nothing less than a transformation of domestic and international economies.[7]  Indeed, some regard the development of cryptocurrencies as little more than right-wing propaganda, steeped in irrational distrust of central banks.[8]

            Bitcoin clearly has roots in anarchistic fantasies of a world without states. Its origins are rooted the same sort of hopes that brought us Wikileaks, the Arab Spring and the hope that lateral communication will replace the hierarchies that organize the world. But it is no mere ideology. It is rooted in the Internet of Things, what some regard the next revolution in communications set to rock the world off centuries-old foundations.

            What, Exactly Is Bitcoin?

            The governments of the world can’t tell you. They can’t agree. Some define it as property. Some call it currency. Sometimes, it is regarded as both currency and property. There are millions of Bitcoin in the world, but you’ll never see one. Bitcoin, you see, are digital events, pulses of electricity harnessed and displayed as units on a computer screen.

            It works something like this. Two individuals communicate directly with one another via a computer network in what computer-literate folks call a peer-to-peer exchange. Each has a code. They exchange a good or service and the transaction’s value is paid for in Bitcoin. The transaction is electronically recorded. Buyer and seller determine, in a sort of digital state of nature, how many Bitcoin to accept in exchange for, let’s say, a cup of coffee, or, in terms of legal services, representation in a criminal case.

            The next time one of the parties engages in an exchange and uses Bitcoin, they use their code to link to another party, who, in turn, uses his or her code to complete the link. That transaction, too, is recorded as part of a chain of communications.

            A blockchain defining these unique exchanges is encoded and encrypted on line. These chains are unique to each unit, and are transparent, open to viewing by anyone with the inclination and skill to do so.[9]

            What no one ever sees is the identity of the parties who are trucking, bartering and trading in Bitcoin. (At least that is the theory – Big Brother always finds a way to watch what it cannot control.)

            In simplified terms, this is Bitcoin, a medium of exchange not created by the government, and, in the United States, largely unregulated. Individuals are free to use Bitcoin as a means of purchasing goods and services, so long as they are able to find a seller willing to accept it.

            So is it money?

            That is a question easier to pose than to answer.      

            Bitcoin is not legal tender — a medium of exchange authorized by, and created by, the federal government. The Constitution gives to the federal government the power to mint money; legal tender is always valid to meet a financial obligation. If you owe a creditor $10, he or she must accept legal tender to satisfy the debt. The acceptance of Bitcon, on the other hand, is optional.

            Bitcoin as property has a value. It can be purchased. As of the time of this writing, one Bitcoin was selling for about $1030, according to www.coindesk.com, a reliable source of information about Bitcoin. Bitcoin can be purchased in small fractions of a coin. They are stored in electronic wallets.

            Bitcoin, and other virtual currencies, pose a challenge to the government. A secret, unregulated quasi-currency can be used to do all sorts things. One fear is that it can used as a means of money laundering.   

            Most of us don’t give a second thought to the provenance of the dollars we spend. But state and federal law are strict when it comes to the proceeds of unlawful gain: assets can be forfeited to the government if they are used to commit of facilitate a crime, or if they have their origin in unlawful activity. Money can be “clawed back” in civil and criminal proceedings from the hands of those who knew, or should have known, that the funds were “dirty.”

            Lawmen monitor the flow of cash to deter the funding of terrorism and to frustrate those intent on making a living by illegal means. That slows commerce considerably as banks try to verify the provenance of large sums in order to comply with a wide variety of laws. This drives up the cost of exchanges, as bankers take not just their broker’s fee, but also recoup the expenses of the various compliance reviews required by governments.

            By eliminating the middlemen, Bitcoin promises to speed exchanges and to reduce transaction costs on transfers large and small.

            Can Lawyers Accept Fees in Bitcoin?

            Lawyers, in particular criminal defense lawyers, walk a tightrope. Unless you are a public defender, you are working for fees. A smart lawyer gets the fee up front.

            Suppose your client wants to pay you in cash? What then?

I           f the sum is less than $10,000, it’s not big deal. But if a client pays $10,000 or more in cash, things get awkward. The law requires the lawyer to review a form of the client’s identification and to report the transaction, and the client’s identity, on a federal form. Failure to do so is a felony.

            Can clients avoid these reporting requirements by paying in Bitcoin?

            I thought the answer was no. That would make sense, right? If Bitcoin can operate as currency, and it can be used to pay for services, then a client paying $50,000 worth of Bitcoin surely can’t be permitted to do so privately?

            Yet, the Internal Revenue Service requires only the reporting of cash. The form is silent about Bitcoin. A separate IRS publication calls Bitcoin property. You needn’t report the identity of a person who gives you property, although you must report the value of the property as income.

            This conclusion made no sense to me. None. I didn’t trust my reasoning. How could the law spend so much time trying to deter money laundering but ignore this obvious way to step outside its boundaries?

            So I called a federal prosecutor who represents the IRS in criminal prosecutions. He, too, assumed I was wrong.

            Two days later, he called back: Bitcoin payments needn’t be reported, he told me.        

            I was surprised by the answer. It’s reassuring, candidly, that there are ways to exchange goods and services that aren’t on the government’s lawful radar. (I’ll leave it the likes of Edward Snowden to tell me the government is watching Bitcoin, too.)

            Next:  Regulators Respond – A Confusing Set of Signals

 



[1] As of July 2106, there were 710 crytpocurrencies traded on currency exchanges. An additional 30 more were not actively traded. Bitcoin is the most popular and well-known, currency. https://en.wikipedia.org/wiki/List_of_cryptocurrencies. (accessed on March 20, 2017)

[3] Economics, 4th ed., Paul Krugman, Robin Wells,  Glossary, G-9.

[4] Following, Mann on the Legal Aspects of Money, 7th Ed., Charles Proctor, pp. 40-41.

[5] The currency was first discussed in a paper by Satoshi Nakamoto, in 2008, entitled, with simple elegance, Bitcoin: A Peer-to-Peer Electronic Cash System. https://bitcoin.org/bitcoin.pdf (accessed March 20, 2017). The actual identity of  Mr. Nakamoto, assuming the author is a he, remains a topic of debate.

[6]United States of America v. Ross William Ulbricht, also known as Dread Pirate Roberts, also known as Silk Road, also known as Sealed Defendant 1, also known as DPR, 15-1815, United States Court of Appeals for the Second Circuit.

[7] Plenty has been written about the origin on Bitcoin and the dark net. Two useful introductions are: Nathaniel Popper, Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money (2015), and, Jamie Bartlett, The Dark Net: Inside the Digital Underworld (2015).

[8] A quirky, but informative, read is David Golumbia’s The Politics of Bitcoin: Software as Right-Wing Extremism (2016).

 

[9] Indeed, at its root, Bitcoin is but the most popular and accessible form of blockchain software, and it the blockchain, rather than Bitcoin itself that stands poised to change the world of computing and offers the hope of a world of self-regulating behavior in which governments and accountants play little role in verifyin transcations. See, Don and Alex Tapscott, Block Chain Revolution (2016). Financial institutions, government and investors worldwide are racing the find ways to use blockchain software in transactions of all sorts.

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About Norm Pattis

Norm Pattis is a Connecticut based trial lawyer focused on high stakes criminal cases and civil right violations. He is a veteran of more than 100 jury trials, many resulting in acquittals for people charged with serious crimes, multi-million dollar civil rights and discrimination verdicts, and scores of cases favorably settled.

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I believe that the state is a necessary fiction and that failing to combat it is the first step toward tyranny.
– Norm Pattis

Disclaimer:

Nothing in this blog should be considered legal advice about your case. You need a lawyer who understands the context of your life and situation. What are offered here are merely suggested lines of inquiry you may explore with your lawyer.

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