What is Bitcoin?

Bitcoin is a decentralized electronic payment system, created in 2009 by Satoshi Nakamoto.[1] Not backed by any governmental entity, Bitcoin is completely electronically created and stored.[2] It is a form of “cryptocurrency”, which is currency that uses encryption and is stored on peer-to-peer technology.[3] Transactions are recorded using blockchain, which is an open, public ledger that requires no central authority to validate transactions.[4] Creating new Bitcoins is a process called “mining.”[5] Each time a valid transaction is made, it is recorded in a “block,” and is added to the blockchain and broadcast to the network of users.[6]

Due to its decentralized and encrypted nature, it is difficult to trace Bitcoin transactions, which allows for its users to be almost completely anonymous.[7] By eliminating the need for a third party clearinghouse to mediate transactions, Bitcoin lowers transaction costs and increases the speed and ease of transfers.[8] In addition, because a Bitcoin user is not required to enter personal information, there is lowered risk for identity theft or fraud.[9] Merchants are also protected from fraud because Bitcoin transactions are non-reversible.[10]

An increasing amount of retailers are accepting Bitcoin as a form of payment, including Overstock.com, Dell, Expedia, and Dish Network.[11] Although not widely accepted as legal tender, Bitcoin has the potential to become more mainstream.[12]

Investing in Bitcoin and Cryptocurrencies

Despite the apparent benefits of Bitcoin and other cryptocurrencies, there are risks.[13] In addition to enabling criminal activities, its exchange rate is extremely volatile.[14] When Bitcoin was first created in 2009, while writing a thesis on encryption, Kristoffer Koch bought 5,000 Bitcoins for about $27.[15] Four years later, his investment was worth $886,000.[16] Earlier in 2017, the value of one Bitcoin surpassed the $5,000 mark.[17] Although a tempting investment, Bitcoin or other cryptocurrencies is extremely risky and volatile. In December 2013, its value dropped from $1,200 to $600 within two days.[18] This was not an isolated shift: similar extreme price fluctuations (both positive and negative) continue to occur since its inception in 2009.[19] But with any investment, there is potential for large gains and great losses. Because Bitcoin is still in its early stages, as with any new currency, its value is volatile; but, there is potential for it to have a stable price in the future.[20]

Bitcoin as Securities

There have been some questions about whether Bitcoin or other cryptocurrencies are securities. However, the Securities Exchange Commission (SEC) is making it increasingly clear that it views Bitcoin, cryptocurrencies, as well as coins and tokens offered for fundraising purposes via initial coin offerings (“ICO”), as meeting the definition of a “security.”

In 2017, the average price gains for the 10 top-performing cryptocurrencies were 14,000%, versus 20% for the stock market.[21] However, few taxpayers are reporting their gains from cryptocurrency transactions.[22] In response, the IRS is turning its attention to cryptocurrency investors and plans on pursuing claims against taxpayers who failed to report their cryptocurrency earnings. Coinbase, a cryptocurrency exchange, will be releasing information on approximately 13,000 of its users to the IRS as a result of a court order.[23] It is expected that the IRS will pursue criminal tax liability based on this information and high-profile cases will follow.

If you are considering fundraising through an ICO or offering of investments in cryptocurrencies, be sure to comply with applicable federal securities laws, including either federal securities registration or a proper Regulation D private securities offering.

Doug McCullough and Kimberly Dang | McCullough Sudan

photo credit: yourg – www.123rf.com

Footnotes:

[1] Tara Mandjee, Bitcoin, Its Legal Classification and Its Regulatory Framework, 15 J. Bus. & Sec. L. 157, 158 (2015).

[2] Kevin V. Tu & Michael W. Meredith, Rethinking Virtual Currency Regulation in the Bitcoin Age, 90 Wash. L. Rev. 271, 275 (2015). 

[3] Id. at 279.

[4] Portia Crowe, There is a ‘Game Changer’ Technology on Wall Street and People Keep Confusing It with Bitcoin, Bus. Insider (Mar. 6, 2016, 8:39 AM), http://www.businessinsider.com/what-is-blockchain-2016-3/#blockchains-are-ledgers-like-excel-spreadsheets-but-they-accept-inputs-from-lots-of-different-parties-the-ledger-can-only-be-changed-when-there-is-a-consensus-among-the-group-that-makes-them-more-secure-and-it-means-theres-no-need-for-a-central-authority-to-approve-transactions-1.

[5] Tu, supra note 2, at 283.

[6] Id. at 282-84.

[7] Eric Engle, Is Bitcoin Rat Poison? Cryptocurrency, Crime, and Counterfeiting (CCC), 17 J. High Tech. L. 340, 341-43 (2016).

[8] Tu, supra note 2, at 282.

[9] Id. at 283.

[10] Id.

[11] Id. at 287-88.

[12] See id. at 284-86.

[13] See Engle, supra note 7, at 341-57 (describing the use Bitcoin for criminal activities, such as “arms sales, drug dealing, human trafficking, murder-for-hire, money laundering, . . . and sanctions busting.”).

[14] Michael Hiltzik, Bitcoin’s Price Hit $5,000 Last Week. It’s Still a Dumb Investment, LA Times (Sept. 5, 2017, 10:45 AM), http://www.latimes.com/business/hiltzik/la-fi-hiltzik-bitcoin-price-20170905-story.html.

[15] Saumya Vaishampayan, Guy Named Koch Bought 5,000 Bitcoins in 2009 for $27, Now Worth $886,000, MarketWatch Blog (Oct. 29, 2013, 1:16 PM), http://blogs.marketwatch.com/thetell/2013/10/29/guy-named-koch-bought-5000-bitcoins-in-2009-for-27-now-worth-886000/.

[16] Id.

[17] Hiltznik, supra note 12.

[18] Id.

[19] See Tu, supra note 2, at 232-33.

[20] See Mandjee, supra note 1, at 156; see also Timothy B. Lee, These Four Charts Suggest that Bitcoin Will Stabilize in the Future, Wash. Post (Feb. 3, 2014), http://www.washingtonpost.com/blogs/the-switch/wp/2014/02/03/these-four-charts-suggest-that-bitcoin-will-stabilize-in-the-future/ (suggesting that Bitcoin will stabilize in the future based on four charts).

[21] Ryan Derousseau, The IRS Is Cracking Down On Cryptocurrency Transactions. Here’s What That Means For You, N.Y. Times (Mar. 5, 2018), http://time.com/money/5178950/the-irs-is-cracking-down-on-cryptocurrency-transactions-heres-what-that-means-for-you/. 

[22] Id.

[23] Id.

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