Bitcoin technology leaves regulators falling behind

Bitcoin technology
Bitcoin technology

Since the inception of bitcoin in January 2009, it has appreciated exponentially in value. In 2009, it would have cost €24 for 5,000 bitcoins. At the time of writing, those same 5,000 bitcoin would cost €10,868,309.

Some view this as a ‘bubble’ or ‘Ponzi scheme’ that will eventually burst. In terms of ease of use, bitcoin can work at any time and anywhere with an internet connection. It does not take holidays and allows for the effortless transfer of payments to anywhere in the world.

The transfer fees are significantly cheaper than bank-transfer fees.

One of the significant risks associated with bitcoin is the extremely large fluctuations in value that it appears to go through.

The Russian government recently confirmed that a draft bill would create the legal framework for trading in bitcoin and other digital currencies. This comes a year after the same Russian institutions said people trading in these currencies could be jailed.

Ethereum, the second biggest cryptocurrency in the world after bitcoin, also continues to skyrocket in value. Ethereum was released in 2015 by a then 21-year-old Vitalik Buterin. Born in Moscow, he now lives in Canada.

Ethereum raised $18m (€15.75m) during its initial coin offering, a process used by start-ups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks.

Its currency is now trading at $256 – 18 times more than at this time last year. Russia and the rest of the world share similar concerns regarding the pseudo-anonymity of cryptocurrencies.

There is no need to fill out any paperwork or personal details and it is possible for cash to be converted to bitcoin in approximately 15 seconds.

Users do not disclose any personal details and while transactions are recorded in this public ledger, information concerning the transacting parties is not recorded, which signals the greatest threat to the combating of money-laundering, fraud and theft.

The inability to link an individual user to an identifiable bitcoin address means that the ability of law enforcers to track the actual injection, layering and re-entry of laundered funds into an economy has become a virtually impossible task.

Bitcoin’s website contains a disclaimer, which includes the following: “The website does not store, send or receive bitcoins.

“This is because bitcoins exists only by virtue of the ownership record maintained in the bitcoin network.

“Any transfer of title in bitcoins occurs within a decentralised bitcoin network and not on the website.”

The complete lack of a controlling authority has resulted in many concerns with regard to anti-money-laundering (AML) governance.

All solicitors (when working on matters that fall within the regulated area) must comply with the requirement to ensure that funds are not laundered or procured illegally.

This inevitably involves an inquiry into the source of funds. With bitcoin, this is practically impossible. There is no mechanism to even identify suspicious transactions in the first place.

Similarly, it is virtually impossible to identify account holders or their locations, meaning that the original source of funds cannot be identified.

Even in an ideal scenario, where a bitcoin wallet address is known, obtaining a freezing order over that wallet would not be an easy task.

Wallets are solely controlled by the person who has the private key. Secondly, the pseudo-anonymity of the wallet address means that there is no formal name attached to that specific wallet address.

This creates obvious issues in terms of ensuring that the assets can be frozen, as this is usually done by a third party, such as a bank.

Moreover, there is also the issue that if it is not known to whom the wallet belongs, then the court will not grant a freezing order over that particular wallet.

Coinbase is the largest bitcoin exchange and was one of the first well-designed bitcoin wallets to enter the scene.

A recent US government request to trawl through the personal data of millions of users of the Coinbase signals the start of an effort to pull digital currencies like bitcoin into the mainstream.

In the United States, cryptocurrencies are classified as “property” for the purposes of tax law, while in Europe, the European Court of Justice concluded that they are neither “property” nor a “currency” in relation to a question of whether they were subject to VAT.

A lot of people value their pseudonymity and the compliance with existing AML and KYC (know your customer) guidelines force Coinbase to ask for identity documents, which are then stored on behalf of the government.

However, the extent to which bitcoin users with US tax liabilities have been declaring such assets is unclear.

Bitcoin and cryptocurrencies are making daily headlines, whether it relates to the volatile exchange rate, the regulatory issues concerned or its criminal potential.

In terms of how to regulate bitcoin in protecting against the inherent risks that exist, there does appear to be a clear-cut solution. Bitcoin is speckled with legal uncertainty and has the potential to become something of a scammer’s paradise. Technology is advancing at a pace which regulators simply cannot match.

Any attempts to regulate the initial bitcoin sender or receiver appears to be impractical as a result of the pseudonymous and dispersed nature of each user’s identity.

The best solution may be to follow the proposed US model of regulation and introduce the mandatory disclosure of one’s digital currency holdings.

The question remains: how do we ensure that cryptocurrencies do not become even more of a conduit for criminal activity?

Reliance upon the good faith of whistleblowers to reveal the wrongdoings of others is simply not an effective solution and with no central authority to sue or an effective technique for revealing the identity of the parties to a bitcoin transaction, it is difficult to see how this question can be solved.

Regardless of how the regulatory approach is dealt with, the solution needs to be addressed at an international level if measures are to be effective in the modern, increasingly globalised economy.

Gregory Glynn is a partner in the Litigation and Dispute Resolution Group at Arthur Cox. Philip Munnery is a solicitor at the firm.

The views expressed here are solely those of the authors in their private capacity and do not in any way represent the views of Arthur Cox.

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