Preface:Though I have limited experience in Business Law, I am by no means an expert in the subject, including areas such as Securities Law, Finance Law, and Corporate Law, nor am I a lawyer.
That said, I contacted both a Business Attorney at LegalZoom.com (which I use for all legal needs regarding my business) and a local law firm that specializes in the various financial laws and regulations.
The intent of this document is to disclose information I received from them regarding the legality of Bitcoin for use in trading, funds and securities, and “real world” transactions. I did NOT discuss the implications of operating a Security Exchange, though we touched on it briefly.
This document contains not only both their statements, but also my own research to help clarify and provide a pretext to the information that was presented to me.
Notes:The information contained here may
NOT be 100% accurate as it was just a briefing by both lawyers. If anyone wants to help me cover the $250 an hour to pay for these guys to do some solid research, I’d be more than happy to get more information out of them. The result here is from me “picking their brain” on the subject based on the offhand securities knowledge they had, as well as in depth research I worked on during personal time.
This information is solely based on United States Federal and Vermont State laws (where I live). The information provided may not be applicable to your country.
SECTION 1:Bitcoins: Where They Stand with the Law There has been a fair amount of speculation as to where Bitcoin falls under when talking about currency and regulation. Some speculate it can qualify as a fully regulated currency under the government, others note that it can never be regulated. The truth of the matter is that it falls under both categories depending on the coin’s use (implied or otherwise).
So what is Bitcoin? To us in the community, Bitcoin is a ‘cryptocurrency’. To my securities lawyer, it most aptly describes what is known as a “Community Currency” (which cryptocurrency falls under). This form of currency is used within a certain group of people with a common bond, which serves a different purpose than conventional currency.
The good news is that Community Currencies are not federally regulated, though local State laws may prohibit them. An example of this would be under the Illinois Department of Financial & Professional Regulation Administrative Code (Title 38, Chapter 1, Part 120) which explicitly prohibits the use of this form of currency. Thankfully there are no other States that currently have these laws in place.
Another aspect of Bitcoin, and the most important, is that it has
no intrinsic value. Meaning that Bitcoins only have value because we say it has value, unlike typical government backed currencies. This means that as long as the Bitcoin economy is contained, Bitcoins can be traded without issue just as Monopoly money can be traded.
As a result of the above statements, Bitcoin does not meet the definition requirements of “Money” according the SEC, which I was told is defined as “an officially issued currency adopted by a domestic or foreign government”. Backed by the United States’ Constitution, this gives the government full power over the regulation of money, including under the common law version, which notes that money is a “generally accepted object or item used for payment”. The good news is, this definition and regulation only covers public currency, which Bitcoin is not (it’s private, created by private individuals and/or enterprises). Based on this information, it would
appear that Bitcoin is in the clear. This, however, is solely the legality of Bitcoin. As talked for a bit longer, things got a little fuzzy when you bring in security and currency exchanges, specifically those operating for profit.
The Securities and Exchange Commission and Bitcoin The primary purposes of the Securities and Exchange Commission (SEC) are to a) protect investors and b) provide market stability through law and regulation enforcement. As a result, there are a vast number of regulations that a typical investment firm would need to abide by in order to issue, create, purchase, sell, or otherwise work with securities.
By the Securities Act of 1933, the SEC defines ‘Security’ as
“any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘‘security’’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.”And although this sounds quite vague for purposes of covering every security aspect, the definition is actually referring to any financial instrument that is publicly traded, such as stocks, bonds (or other debt), and options, specifically targeting corporations and institutional investors.
As a result, Bitcoin trading is possible as long as it isn’t publicly traded on an open market. Privately trading Bitcoins, as a security or for goods and services, is legally allowed. This is the same definition that can be applied to Investment Clubs, online games with virtual economies, etc.
Exemptions To that end, the Securities Act of 1933 (specifically Section 3[a]) also goes on to specify what does
not qualify as a Security to be regulated. The crux of the Act focuses on the defining of the term “Investment Contracts”, of which the majority of exemptions are based upon. If a currency or other object for exchange can qualify under the definition, then it is not exempt and under the jurisdiction of the SEC.
The definition for the previously undefined “Investment Contracts” clause was proposed during the
Securities and Exchange Commission v. W. J. Howey Co. Supreme Court case of 1946. As a result of the case, Investment Contracts became defined as:
1. investment of money due to
2. an expectation of profits arising from
3. a common enterprise
4. which depends solely on the efforts of a promoter or third party
Based on this set of rules, we need to narrow down whether or not Securities based on Bitcoin apply.
Investment of Money Proponents of Bitcoin can argue that the coin doesn’t fall under the definition of Money, not only based on what I’ve noted previously, but also because a user is not required to invest their conventional [fait] currencies and instead invest computational time.
Opponents, on the other hand, can make the argument that most Bitcoin enthusiasts
do make a purchase on exchanges to acquire Bitcoins rather than mining them, which would mean their initial ‘real-world’ currency investment would transfer into the coin.
Another test is proving whether or not Bitcoins are considered more of a commodity than a security. Owning a Bitcoin gives a user the right to use the coin in any way they see fit, including sales or contracts involving the coins. Not only that, but commodities are considered tangible and have inherent value. Bitcoins are indicative of a commodity because of this, and their inherent value is as a result of an economic limit in place to prevent any more than 21 million coins. Securities, on the other hand, confer a claim on another entity, meaning their value is generated based on a third party.
Expectation of Profits Supporters of Bitcoin can argue that there is no expectation of profits assuming that their coins are held or exchanged for goods and services, compared to individuals that solely speculate on the Bitcoin exchange rate and trade regularly. Therefore, investing in a Bitcoin fund can be done as long as there is a written statement expressing the investor’s understanding that there isn’t an expectation of a gain, but instead to receive what they put in. That
does not mean the gain won’t happen (you can still profit from the investment), but instead you must
expect that it won’t.
Common Enterprise Defined as “the tying of each individual investor’s fortunes to the fortunes of other investors”, Bitcoin supports can argue that individuals who choose to promote Bitcoin are more than likely independent of each other, essentially meaning there is no one business or person seeking to raise Bitcoins. As a result, the argument for a common enterprise is invalid.
Depends Solely on the Efforts of a Promoter or Third Party Bitcoin investors have no active part in the management of the coin, but they are dependent on the ongoing efforts of miners and developers. The case could also be made that due to the limited supply of Bitcoins overall, developers won’t necessarily be needed, just the large number of miners.
Based on the definitions above, Bitcoins themselves are arguably exempt from being classified as an “Investment Contract”. As a direct result, a Fund
solely dedicated to raising Bitcoins for capital could not be considered an Investment Contract because the capital being raised isn’t recognized by the United States Government or the Securities and Exchange Commission.
