Digital currencies have grown in spite of (or perhaps because of?) some uncertainty about the regulatory framework in which they operate. As they become more visible, regulatory authorities in different parts of the world recognise these currencies’ emerging role within the financial landscape and are reacting differently to their increased use. This difference in approach was recently illustrated by regulatory developments in the US and China towards the end of 2013. Those developments indicate policy-makers in the world’s biggest trading nations are taking different approaches towards the use of virtual currencies.
Over the past few years’ time.lex has analysed digital currency developments including the US government’s announcement in early 2013 that Bitcoin would be subject to US money-laundering rules. While Bitcoin is not the only digital currency, it is currently the one with the highest-visibility and has been gaining the most regulatory and public attention as a result. Some of this assessment of digital currency regulatory developments will consider what has been happening with Bitcoin.
November 2013: the US’ regulatory approach
In the US in mid-November 2013, the first-ever US congressional hearings on virtual currencies took place. The US Senate’s Homeland Security and Governmental Affairs Committee and then its Banking Committee heard testimony on consecutive days on the subject. A number of US federal agencies, such as the Treasury department, Justice department and Secret Service, and US state banking agencies spoke (sometimes at both hearings).
The hearings were significant as many of the federal authorities signalled a general willingness to accept legitimate virtual payment alternatives, such as Bitcoin. Senior US law-enforcement and regulatory officials saw the benefits in the use of digital forms of money and announced they were making progress in tackling its risks (such as money-laundering and other illegal activities).
While the US federal authorities indicated support for “smart” regulation of digital currencies, certain issues remained unanswered.
One was the classification of digital currencies themselves. A US Treasury department official said a number of basic questions remain unsettled including whether a digital currency could actually be categorised as a currency or should be classified instead as either a commodity, a security, an internet portal or a value storage device. That particular distinction is significant as classifying a digital currency as anything other than a currency might impose significant restrictions on how it is created and traded. That classification would also determine which federal agencies would regulate such virtual networks.
Another issue raised was the treatment of digital currencies under tax law. Digital currency taxation was an unresolved issue as, while the US Internal Revenue Service was “actively working” on its own rules for Bitcoin, the timing of such guidance remained uncertain.
December 2013: China’s regulatory approach
China is a country where Bitcoin is traded heavily (perhaps even the most in the world) and, at the start of December 2013, the Chinese government announced Chinese banks were banned from handling transactions in Bitcoins. The reason given was because Bitcoins were a "virtual good", had no legal status and should not be used as a currency. The ban did not prevent individual Chinese citizens from buying, owning or trading Bitcoins.
Then in mid-December there was another development moving in a similar regulatory direction. The Chinese authorities informed ten clearing houses they would have until the end of January 2014 to sever links to the country's Bitcoin digital currency exchanges. This restriction was significant as Chinese digital currency exchanges are not licensed by the country's central bank to accept or pay out Yuan to their customers, making the digital currency exchanges reliant on intermediary independent clearing houses. This development did not affect the legality of the Bitcoin exchanges themselves; it just now makes it more difficult to use Bitcoin.
The US’s tentative openness towards virtual currencies and China’s suspicions about Bitcoin indicate a current divergence between these international jurisdictions on the subject of digital currencies; the former appears to be heading towards some form of regulatory approval, while the latter is moving in the opposite direction.
Such divergences reflect different policy priorities: the US authorities’ appear to emphasise the innovative aspects of digital currencies and the consequent benefits; and China, within the context of its fixed exchange rate policy, treats them with more suspicion.
The Bitcoin “rollercoaster”
As mentioned earlier, while Bitcoin is not the only digital currency, it has been gaining most of the general media attention on the subject in recent months. These regulatory developments have been reflected in its price “rollercoaster” (and the subsequent attention-grabbing media headlines). So the immediate impact of the US hearings was to increase Bitcoin’s price as the US authorities’ push for a regulatory framework was seen as strengthening Bitcoin’s legitimacy and stability. That price increase prompted one former US financial regulator to describe Bitcoin as a “bubble”. Yet the wider impact of US regulation, in terms of the further development and usage of digital currencies around the world, was always likely to be quite limited. As one US commentator noted, in Bitcoin’s case, it has developed to its current status - as a small, growing, globally-used digital currency - largely through its development and use outside the US. That was confirmed when the regulatory developments in China caused a huge correction in Bitcoin’s price.
Regardless of the price volatility around one particular digital currency, financial regulators around the world are edging towards setting up regulatory frameworks indicating their legality within particular jurisdictions. One thing that may have to happen before Bitcoin is more widely used by businesses in Europe is clarification of its legal status and some sort of regulation. A key question that needs to be answered is whether it has the legal status of a currency or an investment. If it is a currency then it should be treated as such by the Payment Services Directive. This provides the basis of refund rights for unauthorised transactions.
This publication does not necessarily deal with every important topic or cover every aspect of the topics with which it deals and is not designed to provide legal or other advice.