are created by using a mathematical formula, using computer algorithms. Bitcoin is a “decentralized peer-to-peer (digital) payment network” where there is neither central issuing authority nor third party intermediary. Therefore, no monetary policy is possible. Bitcoin is also not a sovereign currency, as there is no government support. Bitcoin wouldn’t exist without a whole network and little thing called cryptography. It is described as world’s first cryptocurrency. Bitcoin being a fully virtual currency, one can exchange Bitcoins between computers in a worldwide peer-to-peer network and no third-party intermediary is required to validate the transactions. Each transaction is publicly recorded on a decentralized public ledger called a ‘blockchain’, which is visible on the Bitcoin network. Verification of each transaction is performed by independent businesses and individuals in exchange for a small amount of virtual currency. Consumers can acquire Bitcoin directly in exchange for real or fiat currency or with other users, store them in virtual wallets or can be used to purchase goods and services.
Bitcoin as a ‘private’ currency being decentralized, it turns out that what different regulators believes a Bitcoin to be is crucial since factors like businesses, taxes, and lawsuits need to be taken into consideration. Since there is mass confusion amongst all regulators, Bitcoin is going through an identity crisis over the last few years.
Bitcoin as Security:
The Securities Exchange Commission (SEC) treat Bitcoin as a security. Bitcoin is fungible i.e. a negotiable financial tool that has a monetary value. Bitcoin can be used as stock such as in case of Initial Coin Offerings (ICOs) where the business organization sell their underlying crypto tokens in exchange for Bitcoins. ICOs are considered as securities if they constitute an investment contract. Bitcoin does provide a sense of ownership of an asset of a financial promise that can be used to recover a financial value in future. The SEC Chairman said that, “the Bitcoin is not a security as it is not secured by third party intermediary but unlike stocks, it does not provide promise to pay in future as per the market value, and that is a kind of security for Bitcoin enthusiasts”. Although a bank or third part intermediary does not back the security, the value of Bitcoin will be available, transparent and exchangeable depending on the crypto market position based on demand. However, if the totality of the offering and arrangement is considered, regulators will consider substances over forms.
Cryptocurrencies which are used as replacement for sovereign currencies like the dollar, the euro, with Bitcoin, then such type of currency is not security. For example, if virtual currency is used to purchase sports equipment or video games, then it is not a security. But the virtual currency whose value is tied to speculative future profits, then it is a security.
Bitcoin as Currency:
The Financial Crime Enforcement Network treat Bitcoin as currency. They consider Bitcoin as a medium of exchange that operates like a currency in some environment. Bitcoin is a type of digital currency i.e. only exists electronically. Unlike common fiat currency, Bitcoin, neither have centralized governing authority nor tied to any jurisdiction or geography as fiat money. The cryptocurrency is also not generated as and when required, but in fact, a complex mathematical cryptographic technique is required to unlock or ‘mine’ Bitcoin, the total units of which is limited to 21 million. It has been steadily gaining acceptance as a form of payment, but lacks relative stability unlike most fiat currency.
If the Bitcoin is used as currency, it takes the form of currency. For example, In Japan, Bitcoin had accepted as a form of payment for consumers bill, KFC Canada had rolled out the Bitcoin Bucket, which offers payment by using Bitcoin. Even at some point, it had gained acceptance as a form of payments by Subway, Microsoft. But if the consumer protection standpoint is taken into consideration, Bitcoin as a currency lacks the relative stability as compared with fiat currency.
Bitcoin as Property:
The Internal Revenue Service (IRS) treat Bitcoin as property. In 2014, IRS issued guidelines stating that they will treat virtual currencies, such as Bitcoin, as property for federal tax purposes. Bitcoin being treated as property, it is taxed as ordinary income or assets subject to capital gains taxes, depending on the circumstances. According to the IRS, Bitcoin is one example of a convertible virtual currency which can be traded to pay for goods or services in real-world economy transactions that may result in a tax liability. For federal tax purposes, virtual currency is treated as property.
Bitcoin as Commodity:
According to Investopedia, “a commodity is a basic good used in commerce that is interchangeable with other commodities of the same type.” A commodity is an economic good or service that has full or substantial fungibility. The Commodity Futures Trading Commission (CFTC) treats Bitcoin as a commodity. The head of CFTC qualifies Bitcoin as commodity, because it does not have any liability. Bitcoin is compared with a gold, where the price is decided by market and not by any regulating authority. Bitcoin functions similarly to gold, which is a commodity. But doesn't have the same amount of liquidity as gold though, which is the primary difference between the two. Bitcoin is considered as a digital commodity, where it is used in the Crypto-economy and is fungible. Bitcoin exchange offers derivative contracts or options on the value of cryptocurrency. It is interchangeable with other digital or fiat currencies. Bitcoins possess the same properties wherever it is mined, and therefore, it can be used as commodity with the same properties and value just like a gold.
Group Opinion:
Bitcoin has been described as decentralized, peer-to-peer version of digital currency which allows online transactions from one party to another party without going through a financial institution.
According to our understanding, Bitcoin is versatile concept. There are different attributes that defines Bitcoin as per its usage by consumer. While it is clear from the above review of different definitions that Bitcoin can act as a security, a currency, a property or a commodity depending upon the usage of Bitcoin by consumers.
Adoption of Bitcoin and other virtual currencies as a medium of exchange is quite low amongst the consumers as Bitcoin is highly volatile in its store value. For example, if Ben purchased a video game for 3 BTS (assume 1 BTS= CAD 20) today and the value of BTS decreases after the purchase to 7 CAD per BTS, in this case the business owner would not prefer to accept Bitcoin as a mode of payment. Virtual currencies do not appeal enough to obtain, hold and use them as a medium of exchange by many consumers. One key exception is that consumers who expect virtual currencies to appreciate in value are much more likely to demand them. This result may suggest that consumers demand virtual currencies primarily as a speculative investment rather than as a payment instrument. Even though the main purpose of Bitcoin was for it, to function as a payment instrument through the advanced block chain technology. Today, However Bitcoin is a speculative instrument. Traditional security hold intrinsic value as they are attached to business profits or underlying assets. Bitcoin on the other hand does not hold any intrinsic value, the value of Bitcoin fluctuates purely on the basis of demand and supply. For example, Bitcoin can be compared to a precious metal in functionality it can act as a commodity. However precious metals have an intrinsic value in it, the Bitcoin does not possess the same. The value of Bitcoin is a store of information in blockchain. Therefore, it doesn’t act as a commodity. Considering the above analysis and consumer protection standpoint, it is our opinion that Bitcoin can be treated as a speculative security over currency or commodity.
[VANDIT PART]
Should Bitcoin be regulated?
Bitcoin is a largely an unsupervised area, there are no protections applicable to consumers and users of virtual currency. Bitcoins are controversial because there is a possibility that they can be used to anonymously transfer illicit funds, hide unreported income and evade taxes. Illegal businesses use Bitcoins because they are not currently regulated or under government scrutiny.
Some of the keys reasons why Bitcoin needs to be regulated is because of the anonymity in trade of virtual currencies, anonymity in transactions and the lack of geographical boundaries. i.e. anyone can purchase a Bitcoin online from any jurisdiction or any country and use it to purchase/ trade anonymously on the network.
1. Bitcoin needs to be regulated in order to tackle the lack of clarity regarding the responsibility for Anti Money Laundering or Counter Terrorist Financing, compliance, supervision and issues with regards to enforcement for these transactions because they are segmented across several countries.
2. Lack of a central oversight body.
3. Possible threat to the global banking and economic landscape.
4. Lack of consumer protection.
Concerns associated with Bitcoins include:
1. Volatility
2. Transparency
3. Valuation
4. Custody and liquidity
5. Decentralization and unregulated exchange
6. Customer protection and complaint handling
How should Bitcoin be regulated
Scope and suggestions for regulations of crypto currencies: –
Regulations related to customer protection:
1. Customer protection regulations must be at the forefront they must include clear product disclosure in marketing and distribution, proper and adequate disclosure of risks and communication regarding available redressal mechanisms to investors. Regulations must be made for investment protection and disclosure. Currently consumers have limited options for legal recourse when using digital currencies and therefore additional recourse bodies need to be put into place.
2. Regulations must be put into place for business conduct and selling practices of Crypto currencies so that customers are not misled by the media coverage, where there is lack of consumer protection provisions for digital currency users. E.g.: news reports often refer to Bitcoin kiosks as Bitcoin ATMs, which could mislead consumers to expect the same level of protection they are afforded when using the ATMs of federally or provincially regulated financial institutions.
3. Educational resources should be created to make consumers more fully aware of the unique precautions they should undertake if they decide to use digital currencies. Cautions must be given to consumers about the privacy concerns that stem from the public ledgers used to record and verify digital currency transactions. Consumers need to be aware that digital currency transactions are not private and should be considered, at best, pseudo-anonymous. Consumers also need to be made aware that transaction confirmation can take upwards of 10 minutes and that their funds are particularly vulnerable to unauthorized access during the relatively lengthy process of verification.
4. Risks associated with digital currencies as a very volatile store of funds and liquidity issues which may expose consumers to significant financial risk. It is important for consumers to be aware that losses within digital currency wallets (or accounts) are not covered by deposit insurance.
5. Financial implications of Bitcoin transactions each have separate legal responsibilities Digital currencies are considered Property under the barter rules of the Income Tax Act. Purchases made with digital currencies are considered the same as buying or selling a commodity, which means that consumers need to maintain a record of losses and gains for tax purposes. GST/HST also applies to the fair market value of any units of digital currency used to make a purchase.
Regulations related to crypto business in order to maintain integrity of the financial system:
1. Regulations must be made by keeping in mind the threat of digital currencies to monetary policy and any threats to global monetary stability by analyzing and studying the effects of the Bitcoin phenomenon as use Bitcoin official money is going out of the financial system on which the central government and central banks will have no control, therefore affecting economic situations in a country. Regulations must be put into place where cryptocurrency can be made accountable to the exchequer due to the concern related to the intractability of virtual currency transactions.
2. Regulations must be put in place to regulate virtual currency exchanges, coins and securitized tokens. Regulation should include the activities of firms, that use Distributed Ledger Technologies (DLT) to store or transmit value.
3. Regulations with primary focus on anti-money laundering policies. FATF is the global money laundering watchdog, and so instead of creating fragmented regulation on cryptocurrency related to anti-money laundering, FATF will release a guideline so as to unify regulation on cryptocurrency. This regulation will help in setting a uniform standard for crypto technology companies. This guideline is expected to release in June 2019.
4. Regulations complying with existing legislation and securities law: Virtual currency exchange platforms and custodian wallet providers must be brought under the purview of existing legislation of anti-money laundering directive. Regulations must be in place where certain uses of Bitcoin must require a license or permit. Regulations should also be put in place to include virtual currency businesses in financial services providers, they must also be asked to receive authorization from the Minister of Finance similar to what is done in Luxemberg. Securities Act: the Canadian Securities Administrators (CSA) sent out a regulatory notice on August 24, 2017, confirming “the potential applicability of Canadian securities laws to cryptocurrencies and related trading and marketplace operations and to provide market participants with guidance on analyzing these requirements. It should be noted that as part of the North American Securities Administrators Association (NASAA), Canada joined an association-wide “cautionary directive” on the risks of cryptocurrencies, with all representatives from every province in the country believing there is a “high risk of fraud.”
5. Regulations to limit the amount that can be invested in ICO’s and other controls: The Russian Ministry of Finance prepared a bill to be submitted to Deputy Finance Minister Alexei Moiseev said the bill, as reported by Tass, includes a limit of 1 billion rubles [~ USD$17.3 million] that can be raised through an ICO, and a limit of 50,000 rubles [~$864] that each unqualified investor will be able to invest. Other questions to address may include ICO or IPO, that might be the next big question for a lot of firms that utilizes the blockchain technology and questions like what kind of companies can raise ICOs? And the impact on traditional stock exchanges if companies start raising capital over the counter?
Canadian Parliament approved Bill C-31 on June 19, 2014, the world’s first national law on digital currencies. The Canadian government has been transparent and communicative in its regulatory stances on cryptocurrency.
5. Regulations with regard to the use of Blockchain technology: Release guidance on the use of distributed ledger technology (including blockchain) in financial services and financial markets and how they can be made compatible to existing financial infrastructure. OSC Launchpad and Regulatory Sandbox should be used to give relief to Fintech companies in the crypto space and regulations must be put into place by analyzing through simulation the potential risks associated to the crypto ecosystem. In Nov. 2017, the Bank of Canada has issued a discussion paper addressing whether a central bank should issue digital currency (CBDC) that could be used by the general public. In Nov. 2, 2017, the Ontario Securities Commission granted regulatory relief to Toronto-based Funder, Inc. to allow Ontario’s first regulated ICO/ITO. On May 25, 2017, the Bank of Canada stated that its experiment with blockchain, or distributed ledger technology, showed it is currently not compatible with operating the country’s centralized interbank payment systems.
Regulations related to Bitcoin used in speculative trade/investments:
1. Regulations to control high volatility: Provisions for stop loss and circuit breakers must be put into place as used in the case of highly speculative investments such as Derivatives, so that the market risk and volatility of Bitcoin can be controlled. Regulation should be put in place impose additional measures to regulate speculation in cryptocurrency trading and trading of Bitcoin futures, within the country.
2. Registration of investment advisors who are selling the virtual currency. Adequate disclosure and risk communication to the client, registration of online platforms, client identification etc. Bitcoin exchange Coincheck was robbed of $530 million in January, 2018 which drew the scrutiny of Japan’s regulators therefore such exchanges should be registered by the governing financial bodies.
3. Online monitoring: Bitcoins are purchased online. Auditors should be appointed and must be given access to online software to consider sample monitoring.
4. Identification and verification: are a major problem, who is sitting behind the computer and buying the Bitcoin? There is no restriction on boundaries, flows freely within countries and therefore sanctions and special lists need to be created.
5. Cyber security standards on exchanges and online platforms: Japan has suffered multiple Bitcoin exchange thefts, including the high-profile Mt. Gox, which lost most of its Bitcoin to theft in 2014 and had to file for bankruptcy. Investors lost money and customers are still waiting for their money as a result of the bankruptcy therefore global cyber security experts have to work in unison with regulators to set system security standards which crypto companies have to comply to.
6. The Canada Revenue Agency (CRA) and Securities act: “has characterized cryptocurrency as a property and not a government-issued currency. Accordingly, the use of cryptocurrency to pay for goods or services is treated as a barter transaction gain or loss generated from the disposition of cryptocurrency should be treated as on account of capital. However, where a taxpayer engages in the business of trading or investing in cryptocurrency, gains or losses therefrom should be treated as being on account of income.
Regulations related to accepting Bitcoin as currency:
1. Customer Identity verification rules: Where Bitcoin is a means of payment and the cryptocurrency is being used as a medium of exchange or operating as a service provider certain implementation with respect to customer identity verification rules for virtual currency platforms must be put into place. Bitcoin regulations should require transactions that involve traditional, government-backed currencies to be attached to an identity. For example, When Bitcoin is purchased the government must be able to attach an identity to the person transacting.
2. The source of the money used to buy Bitcoin must be legitimate: Bitcoin purchases must follow the same due diligence and customer identification that is used for other financial instruments.
3. Information law, electronic transaction laws and currency laws must be put into place and the Bitcoin companies have to comply to them and alter the product where required.
4. Point of sale/ Online payment gateway: The scope of regulation should include the purchase and sale of virtual currencies and other innovations used in domestic money transfers and merchant transactions via point-of-sale or online payment gateways as is suggested by officials in Singapore.
5. Money service business: Crypto companies involved in Bitcoin exchange for fiat money must be registered under money service business and must require a license to act as a money transmitter.
6. Tax regulations on using Bitcoin as currency, Eg: KFC Canada: A bucket of chicken purchased with Bitcoin also triggers a taxable event that Canada Revenue Agency expects to keep track of.
7. Regulations in accounting/ Indirect taxes: need to be put into place where business accepts Bitcoin in consideration of a service or a product there is a risk that such a Business owner may not record the sale and evade income tax and GST/HST. For example, paying for movies with virtual currency is a barter transaction. The value of the movies purchased using virtual currency must be included in the seller’s income for tax purposes.