Digital Money and Cryptocurrencies - a Regulatory Gordian Knot

LAWSG099 Constantine Nikolaidis
1
Digital money and cryptocurrencies: a regulatory Gordian knot
1. Introduction
“If we are to contemplate abolishing the exclusive use within each national
territory of a single national currency issued by the government, and to admit on
equal footing the currencies issued by other governments, the question at once
arises whether it would not be equally desirable to do away altogether with the
monopoly of government supplying money and to allow private enterprise to supply
the public with other media of exchange it may prefer.”1 – F. A. Hayek, 1976
It has been argued that the conceptual foundations of digital money and
cryptocurrencies, which started developing during the early 1990s and have since
then experienced a rapid growth in use and reputation, can be traced to political and
economic advocates of the free market, especially the Austrian School of
economics.2
Great figures of economic and political thought such as Ludwig von Mises and
Friedrich A. Hayek have criticised the current money system based on fiat currencies
and have strongly opposed the monetary interventions by governments and central
banks which, according to their school of thought, are to be held responsible for
aggravated business cycles and artificially high levels of inflation.3 Hence, digital
currencies have been held to fill the gap of ‘private currencies’ which directly
1
FA Hayek, Denationalisation of Money: The Argument Refined (3rd edn, The Institute of Economic
Affairs 1990) 26, emphasis added.
2 N Wenker, 'Online Currencies, Real-World Chaos: The Struggle to Regulate the Rise of Bitcoin'
[2014] 19(1) Texas Review of Law & Politics 160
3 European Central Bank (ECB), Virtual Currency Schemes (Oct. 2012) 22, online at:
https://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemes201210en.pdf (visited June 16,
2015)

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compete with the state’s monopoly of issuing and acknowledging a legal tender.4 A
stronger view advocated by Hayek suggests that private enterprises should have the
right to issue currencies bearing no interest and let market forces alone determine
which currency provides the most stability and strong purchasing power, thus
eliminating other weaker currencies.5
Given their initial relatively restrictive use and low reputation, digital currencies
were not always a concern for regulators, legislators, and policy makers. However,
as of 2015 there are more than five hundred digital currencies in circulation, a trend
that began in 2009 with the revolutionary introduction of Bitcoin, the world’s first
decentralised digital cryptocurrency.6 Further, given the ever increasing number of
daily transactions being completed by users of digital cryptocurrencies7, it is now apt
to discuss the emerging legal issues that surface through the continuous use and
development of this new financial technology and to examine existing and proposed
regulatory responses.
This essay seeks to describe, analyze and assess the adequacy of the current
regulatory and legislative framework which surrounds digital money and
cryptocurrencies. Most of the discussion will revolve around the laws and regulations
as they are applying or could potentially apply to Bitcoin, as it is the most commonly
used digital cryptocurrency in circulation. Using Bitcoin as a point of reference will
help create clarity and avoid confusion, as the area of digital cryptocurrencies is
characterised by its highly complex technical background which legal practitioners
4 Wenker (n 2) 160
5 ECB 2012 (n 3) 22.
6 European Central Bank (ECB), Virtual Currency Schemes – A Further Analysis, (Feb. 2015) 4,
online at: https://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemesen.pdf (visited July 1 2015)
7 Ibid, 4

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and academics have found extremely challenging.8 Accordingly, any legal or
otherwise discussion referring to Bitcoin should be considered as applying invariably
to other digital cryptocurrencies sharing the same characteristics and technical
aspects as Bitcoin.
The second part of this essay will set the background and provide the necessary
information, definitions, and clarifications regarding digital cryptocurrencies.
The third part will examine certain virtues and vices of Bitcoin which make it
prone to illicit use by criminals and some of Bitcoins’ inherent attributes, all of which
highlight the need for action by regulators in order to counter its dangers and
undesirable effects.
The fourth part of the essay will host the majority of the legal discussion and
analysis focusing on the regulatory and legislative responses towards digital
currencies and Bitcoin by the U.S., European Union, and other jurisdictions.
The fifth part will comment on the recommendations and possible future paths
that have been put forward on how to adequately approach the regulation of Bitcoin.
Finally, the concluding remarks will summarize the main findings and arguments
of this essay that regulators worldwide have adopted divergent regulatory
approaches thus leading to a general confusion as to the legal status of digital
money and cryptocurrencies.
8
Wenker (n 2) 146

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2. Background information and definitions
Given the complexity and technical nature of digital money and cryptocurrencies,
it is not surprising to read that every academic article published in a law journal
which addresses these issues makes a dedicated effort to clarify and define some
essential elements.9 This part will explain the nature of digital currencies,
cryptocurrencies, and, finally, it will give an overview of the workings of Bitcoin.
2.1 The emergence of digital currencies
The concept of money has changed considerably over the centuries but can be
broadly categorized in three forms of existence. Firstly, in ancient times, money was
‘commodity money’ meaning that it was an object with intrinsic value (e.g. copper or
cows).10 Secondly, ‘commodity-backed’ money was introduced around the late
1700s, where pieces of paper which had no intrinsic value represented an underlying
commodity, thus fostering greater amounts of money being transferred.11 Thirdly,
modern economies are now based in what is commonly known as ‘fiat money’ which
tend to resemble ‘commodity-backed’ money, but, according to the European Central
Bank (ECB), they are “radically different”, and have been defined as “any legal
tender designated and issued by a central authority.”12 Notwithstanding its form or
tangibility, money has been associated with serving three functions; it is a medium of
exchange, a unit of account, and a store of value.13
Digital money (or currency), on the other hand, has been defined as “a store of
value that is issued by a private entity and is fungible via an established system of
9 PC Tucker, 'The Digital Currency Doppelganger: Regulatory Challenge or Harbinger of the New
Economy?' [2009] 17:589 Cardozo Journal of International and Comparative Law 593
10 ECB 2012 (n 3) 9
11 Ibid
12 Ibid
13
Ibid, 10

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exchange on the Internet.”14 Subsequently, comparing this definition with the
definition of fiat money given by the ECB, we can discern that the main difference
between digital money and fiat money is that the former is issued by a private entity,
while the latter by a trusted central authority. As Tucker notes, a typical structure of a
modern digital currency system is comprised of three functions; firstly the issuing and
storing of the currency, secondly the ability to convert the digital currency to and from
fiats, and thirdly the capacity to transfer the currency between end-users.15 In its
2015 report on digital currency schemes, the ECB defined digital currency as a
“digital representation of value, not issued by a central bank or credit institution,
which, in some circumstances, can be used as an alternative to money”.16 The report
later clarifies that digital currencies, such as Bitcoin, are not considered to be “full
forms of money” from an economic and legal perspective.17
A crucial distinction is made by the ECB between digital currencies and electronic
money. The ‘Electronic Money Directive’18 provides a definition for ‘electronic money’
and the substantial difference with digital currencies is that the former preserves a
link between the electronically stored value and the traditional money and has a legal
foundation while the latter changes the unit of account into a virtual one.19 This, in
turn, has severe legal implications which are going to be examined in the next part of
the essay.
Furthermore, digital currencies can be divided into three types; i) closed digital
currencies typically found in an online game which can only be used within the
boundaries of this virtual game, ii) digital currencies with a unidirectional flow
14 Tucker (n 9) 593
15 Ibid, 595
16 ECB 2015 (n 6) 25
17 Ibid, 4
18 2009/110/EC
19 ECB 2012 (n 3) 16

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meaning that they can be purchased using fiat currency but cannot be exchanged
back to fiat currency once they are purchased, and, iii) digital currencies with
bidirectional flows, i.e. their performance corresponds to that of any other convertible
fiat currency, can be used to purchase real goods and services, and may also be
exchanged back to fiat currencies based on the typical function of floating exchange
rates (buy and sell).20 Bitcoin falls under the third category of digital currencies with
bidirectional flows and this category is the main issue under examination in this
essay.
The Financial Action Task Force (FATF), which was established with the purpose
of setting standards and promoting effective implementation of laws aimed at
maintaining the integrity of the international financial system, has also clarified that
digital currencies may be either centralised or decentralised. Centralised digital
currencies are those who have a single administrating authority, where the
administrator issues the currency, establishes rules of conduct, and has the authority
to redeem the currency. Decentralised digital currencies do not have any central
administrating authority which monitors and oversights the payments system. They
are usually “open source math-based peer to peer” digital currencies and are
typically maintained by a community of digital currency users.21
The emergence of digital currencies can be seen as directly proportional to the
appearance of e-commerce.22 The rise of e-commerce brought along a demand for
an online, instantaneously convertible, medium of exchange which could facilitate
online transactions. Digital currencies are particularly appealing to online retailers
20 Ibid, 5
21 Financial Action Task Force (FATF), 'Virtual Currencies: Key Definitions and Potential AML/CTF
Risks', [2014] 5, online <http://www.fatf-gafi.org/media/fatf/documents/reports/virtual-currency-key-
definitions-and-potential-aml-cft-risks.pdf>
22 LH White & DJ Bordeaux , 'Is Nonprice Competition in Currency Inefficient?' [1998] 30(1) Money,
Credit & Banking 255

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who wish to avoid the higher transaction costs of credit cards which are imposed by
financial services companies and merchants banks.23 Secondly, individuals who are
not granted a credit card from a financial institution given their bad credit history also
benefit by the use of digital currencies as an alternative form of online payment.24
Thirdly, users of websites of dubious character, such as online gambling, are
typically required by the website operator to make payments using methods other
than credit cards in order to avoid ‘charge-backs’ and increase profit margins.25 Last
but not least, increased anonymity in transactions using digital currencies provides
another important drawing factor to those who value privacy.26
2.2 Cryptocurrency: a definition
A cryptocurrency has been defined as a type of digital currency which “is
encrypted using cryptography to give it an increased level of security.”27
Cryptocurrencies are “math-based, decentralised convertible digital currencies”28,
with a unique technological innovation, that of a public ledger that functions as a
decentralised system that records ownership of the digital currency and value
transfers.29
The basic premise behind cryptocurrencies is that they are essentially ‘protocols’
that facilitate the validation of a transaction without the need for a trusted third party
such as a merchant bank.30 Thus, cryptocurrencies have been praised for reducing
transaction costs associated with value transfers, and for avoiding the usual
23 Tucker (n 9) 604
24 Ibid
25 Ibid
26 Ibid
27 P Vigna and M Casey, The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging
the Global Economic Order (1st edn, St Martin's Press 2015) 18
28 FATF Report (n 21) 5
29 O Marian, 'A Conceptual Framework for the Regulation of Cryptocurrencies' [2015] 82(53) The
University of Chicago Law Review 55
30 Ibid

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shortcomings of a centralised monetary system.31 A closer examination of Bitcoin
may provide a useful elucidation of how digital money and cryptocurrencies operate,
and may put into perspective the aforementioned theoretical background.
2.3 Bitcoin: a decentralised digital cryptocurrency
Bitcoin is the world’s first decentralised peer-to-peer digital currency.32 It was
introduced in a paper published online by an individual or individuals called Satoshi
Nakamoto33. Nakamoto argues that the inherent weaknesses of the trust based
model which is currently in place to facilitate online transactions fettered the need for
the development of Bitcoin.34 Such weaknesses include the increased cost of
mediation faced by the financial institutions which in turn increase transaction costs,
thus reducing the profitability of small electronic transactions. According to
Nakamoto, another weakness of the current trust based model is that the ability of
the users to make non-reversible payments for non-reversible services is not
possible.35 The mere possibility of a reversal of payment is enough to make
merchants wary. As these increased costs and hindrances may be avoided by face-
to-face cash payments, Bitcoin seeks to serve exactly this role, albeit in the realm of
online payments.36
Bitcoin does not have a central authority, for example a central bank, in charge of
the money supply, there is no clearing house responsible for clearing transactions,
31 Ibid
32 J Brito & A Castillo, 'BITCOIN: A Primer for Policymakers' [2013] Mercatus Center - George Mason
University 1
33 The creator’s true identity remains unknown. See Adrianne Jeffries, 'The New Yorker's Joshua
Davis Attempts to Identify Bitcoin Creator Satoshi Nakamoto' (Observer, 4 October 2011)
<http://observer.com/2011/10/did-the-new-yorkers-joshua-davis-nail-the-identity-of-bitcoin-creator-
satoshi-nakamoto/> accessed 4 July 2015
34 S Nakamoto, 'Bitcoin: A Peer-to-Peer Electronic Cash System' [2009] BITCOIN 1, available online
at: https://bitcoin.org/bitcoin.pdf, accessed 13 June 2015
35 Ibid
36 Ibid

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and none of the traditional financial institutions are involved.37 Bitcoin’s framework is
supported solely by its users who voluntarily operate specific software and run all the
tasks themselves.38 As Farmer puts it, Bitcoin may very well be visualized as similar
to a computer file or as a coin on a desktop which can be sent to another user in the
same way that someone sends a document to another person through an email.39
In its simplest form, for example, when A wishes to make an online payment in
Bitcoins to B for the purchase of an online service they start by creating an online
‘wallet’. A digital wallet is the equivalent of a physical wallet on the Bitcoin network.40
A transfers a number of Bitcoins to B’s wallet and the transaction is immediately
broadcasted to the Bitcoin network. By providing her own private digital ‘signature’, A
is able to prove that the Bitcoin transfer has been made by the true owner.41 Every
few minutes a multiple of these transactions are ‘tied’ together and form what is
known as a ‘block’.42 This ‘block’ of transactions is then processed by a number of
users called ‘miners’ who use their computing power and technical skills to verify and
settle these transactions.43 If they are successful in verifying the transaction then the
‘miners’ are rewarded newly created Bitcoins by the Bitcoin network. Afterwards, the
transaction is published on a public ledger which is available online44 without
revealing the true identities of the parties, and B’s ‘wallet’ is credited the Bitcoins and
A’s ‘wallet’ is deducted by the same amount.
37 ECB 2012 (n 3) 6
38 Ibid
39 PH Farmer, 'Speculative Tech: The Bitcoin Legal Quagmire and the Need for Legal Innovation'
[2014] 9(1) Journal of Business and Technology Law 87
40 Izabella Kaminska, ‘Scandals and Price Volatility Leave Bitcoin Looking Spent’ Financial Times
(London, 4 February 2015) 17
41 Ibid
42 Ibid
43 Ibid
44 See https://blockchain.info/

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There are three ways through which an individual may acquire Bitcoins. Firstly, by
‘mining’ them; As described above, ‘miners’ use their CPU power to verify
transactions, and a good analogy would be that they are performing the back-office
work of a financial institution. However, ‘mining’ is extremely costly and requires high
level of computer science expertise.45 Secondly, a Bitcoin may be purchased through
an exchange by trading traditional currencies (euro, dollar, etc.) at an exchange rate
which is determined purely by supply and demand.46 Thirdly, Bitcoins may be
acquired if someone sells something and gets remunerated in Bitcoin.47
Overall, the qualities of Bitcoin that make them appealing and useful, including
anonymous transactions, transactions are carried out faster, and lower transaction
fees than other conventional methods of online transfer, have played a major role in
the ever increasing number of daily Bitcoin transactions. As Annex 1 evidences, it is
quite probable that by the end of 2016 the 300,000 transactions per day threshold
may be reached. Although this number is significantly smaller compared to those of
well-established financial institutions such as Visa which average 200 million
transactions per day48, the overall market capitalization of Bitcoin which reaches $3.6
billion cannot easily be ignored.49
The Bitcoin network is also programmed in such a way that the creation of new
Bitcoins will cease when the total number of Bitcoins in circulation reaches 21
million.50 The fact that the creation and the increase of Bitcoins is predetermined by
45 J Turpin, 'Bitcoin: The Economic Case for A global, Virtual Currency Operating in an Unexplored
Legal Framework' [2014] 21(1) Indiana Journal of Global Legal Studies 340
46 Ibid
47 Ibid
48 ECB (2015), (n 6) 16
49 Ibid, 15
50 N Kaplanov, 'Nerdy Money: Bitcoin, The Private Digital Currency, and the Case Against Its
Regulation' [2013] 25(1) Loyola Consumer Law Review 2011

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the system itself implies that there is no need for a central authority to oversee the
process, leaving the market forces of supply and demand free to set the value.51
Notwithstanding the vast number of benefits arising from the operation of the
Bitcoin system, regulators have become increasingly worried as Bitcoin operates in a
“legal gray area”52 and its inherent characteristics may lead to other undesirable and
potentially dangerous results.
3. Bitcoin, its risks, and the Regulators’ Concerns
3.1 Risks Affecting Consumers
The European Banking Authority (EBA) is one of the several regulating bodies
worldwide that has warned users of digital currencies and Bitcoin about their
potentially dangerous effects. Specifically, the EBA warns that because Bitcoin is not
addressed by regulatory protections, consumers might, quite simply, “lose their
money”53. This may occur for several reasons.
Exchange platforms that trade in Bitcoins tend to be unregulated. They are prone
to fraud, hacking attacks by third parties, and since these platforms are not banks,
there is no legal mechanism such as deposit guarantee scheme to protect
consumers.54
Additionally, there is a very high possibility that money may be stolen from a
consumer’s ‘digital wallet’. According to the EBA, consumers have lost from their
digital wallets more than $1 million due to thefts carried out mainly by hackers.55
51 Ibid
52 J Brito & A Castillo (n 32) 22
53 European Banking Authority ‘Warning to Consumers on Virtual Currencies’ (Dec 2013) 2, online at:
https://www.eba.europa.eu/-/eba-warns-consumers-on-virtual-currencies, accessed 20 June 2015
54 Ibid
55 Ibid

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Many of those thefts have occurred in Bitcoin marketplaces. The most prominent
theft took place in February 2014 when the largest Bitcoin exchange, Mt. Gox,
declared bankruptcy after it was discovered that 850,000 of customers’ Bitcoins were
missing.56 By the end of 2014, it is reported that $500 million worth of Bitcoins have
been stolen or lost.57 Thus, it is evident that recovery procedures of stolen Bitcoins is
an area where regulators need to catch up.58
Another area of risk facing consumers is that Bitcoin transactions are irreversible.
This means that consumers are not protected by any refund rights and it is up to the
merchant’s discretion to accept Bitcoin as a method of payment, and thus much will
depend on their contractual agreements which may change at any point.59 Thus,
owing to the lack of specific regulation and the unclear legal status, the users of
Bitcoins may also find themselves liable to tax regimes which are not clearly defined,
as is the case in several jurisdictions.60
3.2 Risks of a Larger Scale
One major issue that might affect not only those who engage in Bitcoin
transactions, but the public in general, is the cryptocurrency’s extreme volatility, as
the price for a single Bitcoin has fluctuated from $13 in January 2013 to almost
$1300 on November 2013.61 This volatility is attributed to Bitcoin’s lack of maturity,
legal uncertainty, and the lack of confidence on the part of the users towards the
56 N Swartz, 'Bursting the Bitcoin Bubble: The Case to Regulate Digital Currency as a Security or
Commodity' [2014] 17(1) Tulane Journal of Technology and Intellectual Property 323
57 Ibid
58 Ibid
59 EBA 2014 (n 53) 2
60 ECB 2015 (n 6) 21
61 S Middlebrook and S Hughes, 'Regulating Cryptocurrencies in the United States: Current Issues
and Future Directions' [2014] 40(2) William Mitchell Law Review 817

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cryptocurrency’s framework.62 Although the low volume traded in digital
cryptocurrencies in general and their lack of significant connection to the real
economy means that the stability of the financial system cannot be adversely
affected, this might change in the future if digital cryptocurrencies become a
substitute for fiat currencies.63 This event might introduce the inherent instability of
digital currencies to the financial system in general with the potential to distort the
price of real goods and services.64 Annex 2 illustrates Bitcoin’s price instability and
the potentially disruptive effect it might have if it is completely encompassed within
the financial system.
Central banks around the globe also face substantial risks which, although they
have not yet materialised, their prospect highlights the urgency of proper regulation.
For example, Bitcoin has the dynamic to distort the effectiveness of monetary policy
and its implementation in the event that they interfere with the control of money
supply to the market, with the consequence of affecting interest rate manipulations
by central authorities.65 Furthermore, central banks may face reputational risks as
the general public might believe that the regulation of Bitcoin and other digital
currencies falls under the realm of the central bank and is thus responsible for any
disruptive effects.66
More importantly, however, policymakers and regulators have become
increasingly wary about the use of Bitcoins and cryptocurrencies in general for
criminal and other illicit activities, especially due to the fact that Bitcoin is reputable
62 ECB 2012 (n 3) 33
63 Ibid
64 Ibid
65 Ibid 33
66 Ibid 45

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for facilitating anonymous transactions.67 Moreover, as the financial system relies
heavily on regulating intermediaries which are capable of preventing illicit activities
by imposing ‘know your customer rules’, in the case of Bitcoin the use of
intermediaries is eliminated.68 Consequently, regulatory authorities are not able to
use intermediaries to monitor criminal and illicit conduct facilitated through the use of
cryptocurrencies.
Marian makes a very important analysis which explains why Bitcoins may be
appealing to fraudsters and criminals. By implementing the classic model of criminal
behavior, he argues that a rational individual who seeks to realize profits will engage
in criminal activity if “the utility of doing so is greater than zero”.69 Thus, an individual
will consider the expected gain from his or her criminal behavior, the probability of
being sanctioned, and the harshness of punitive measures that may be enforced
against him. Marian argues that if an individual would not have engaged in criminal
activity using fiat currencies due to negative utility, the newly introduced option of
cryptocurrencies to facilitate his contemplated criminal activity greatly reduces the
probability of being sanctioned due to the anonymity associated with
cryptocurrencies.70 Consequently, individuals might calculate a greater utility from
engaging in a criminal activity by using cryptocurrencies rather than fiat currencies.
Marian concludes that given the absence of a regulatory regime specifically
addressed to combat the negative effects of digital money and cryptocurrencies, it
follows naturally that there will be an increase in the level of criminal activity.71
67 J Brito & A Castillo (n 32) 20
68 O. Marian (n 29) 56
69 Ibid 59
70 Ibid
71 Ibid

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Marian’s predictions are not unfounded. It has been noted that digital money and
cryptocurrencies have been used, inter alia, for nefarious activities such as drug
trafficking, money laundering, terrorist financing, and illegal gambling.72 The Federal
Bureau of Investigation (FBI) has issued a warning about the potential criminal use
of cryptocurrencies which are increasingly used on the ‘dark web’.73 The FBI
highlights the difficulty to prosecute criminal activities in the realm of Bitcoins as
there is no centralised authority to detect suspicious activity and identify users.
An example of the use of Bitcoins for the aforementioned illegal activities is the
now defunct online marketplace ‘Silk Road’. Silk Road facilitated the online trade of
drugs and other illegal materials and its basis of operation was user anonymity.74
The website was not available through traditional internet search engines, and in
order to avoid the eyes of law enforcement, Silk Road users were required to
transact only in Bitcoins.75 Eventually, in 2013 the FBI shut down the website, and
charged its founder, Ross Ulbricht, with a heavy sentence.76
Money laundering through the use of Bitcoins is another criminal activity which
has troubled regulators. Money laundering is “a process by which the illicit source of
assets obtained by criminal activity is concealed to obscure the link between the
funds and the original criminal activity.”77 Money laundering typically entails a three
72 S Middlebrook and S Hughes (n 61) 816
73 Federal Bureau of Investigation, 'Bitcoin Virtual Currency: Unique Features Present Distinct
Challenges for Deterring Illicit Activity' [2012] FBI Directorate of Intelligence 2
74 J Turpin (n 45) 357
75 D Dion, 'I'll Gladly Trade You Two Bits on Tuesday for a Byte Today: Bitcoin, Regulating Fraud in
the E-conomy of Hacker Cash' [2013] 2013(1) Journal of Law, Technology & Policy 166
76 N Hong, 'Silk Road Founder Ross Ulbricht Sentenced to Life in Prison' [29 May 2015] 1(1) The Wall
Street Journal <http://www.wsj.com/articles/silk-road-founder-ross-ulbricht-sentenced-to-life-in-prison-
1432929957> accessed 5 July 2015
77 International Monetary Fund, 'Factsheet: The IMF and the Fight Against Money Laundering and the
Financing of Terrorism’ <http://www.imf.org/external/np/exr/facts/aml.htm> accessed 5 July 2015

16
step process – placement, layering, and integration.78 Bitcoin now offers another
alternative route for prospective money launderers to launder their illicit profits. This
is mainly because Bitcoin users can transfer financial instruments with value without
the intervention of a third party such as a bank which can enforce enhanced due
diligence operations.79 Secondly, user anonymity in completing transactions makes it
very difficult for law enforcement to investigate money laundering violations.80
Thirdly, money laundering risk relates to the relative speed and ease with which
Bitcoin transnational transactions are facilitated, about ten minutes for each
transaction.81
Although the aforementioned description and analysis of potential risks arising
from the use of Bitcoins is non-exhaustive,82 it illustrates the main concerns of the
regulators when they approach legal issues stemming from the exploitation of digital
money and cryptocurrencies for criminal and other illicit purposes.
4. Regulatory Approaches on Digital Money and Cryptocurrencies: a Legal
Analysis
Bitcoin, and other digital cryptocurrencies, operate in a so called ‘legal grey area’.
This means that the legislatures and regulators have not been able to catch up with
the ever developing technology of Bitcoin. Consequently, an analysis of the legal
status of Bitcoin must be performed through the lenses of existing laws which are
currently in place and might apply to the case of Bitcoin, thus rendering any
78 N Ajello, 'Fitting a Square Peg in a Round Hole: Bitcoin, Money Laundering and the Fifth
Amendment Privilege Against Self-Incrimination' [2015] 80(2) Brooklyn Law Review 444
79 Ibid 446
80 Ibid 447
81 Ibid
82 For a comprehensive description and analysis of Bitcoin risks see: European Banking Authority,
'EBA Opinion on ‘Virtual Currencies’ [2014] EBA Opinion, online at:
<https://www.eba.europa.eu/documents/10180/657547/EBA-Op-2014-
08+Opinion+on+Virtual+Currencies> accessed 30 June 2015

17
discussion on this issue highly speculative.83 Generally, responses from regulators
range from warnings about potential risks, issuing clarifications and statements on
the legal status of digital currencies, and licensing and supervision of digital currency
related activities.84
4.1. The United State’s Approach
4.1.1 Legal Precedent
Although the words ‘digital currency’ or any related phrase do not appear in the
federal code85, precedent can be found in the 2007 indictment of E-Gold by the
United States Department of Justice86. E-Gold was a form of digital currency
claiming to back its digital currency with actual gold bullions, and had similar
characteristics with Bitcoin as E-Gold accounts were anonymous and online
transfers were irrevocable, making it a suitable instrument for those who wished to
launder money, engage in pyramid schemes, and pump-and-dump-schemes.87 The
owners of E-Gold were indicted for “conspiracy to launder money, and conspiracy to
operate an unlicensed money transmitting business under federal and state law.”88
Stemming from the E-Gold indictment, there are a number of laws and
regulations which could potentially apply to Bitcoin exchanges and other modern age
digital cryptocurrencies.
83 J Turpin (n 45) 352
84 ECB 2015 (n 6) 32
85 Tucker (n 9) 608
86 United States v e-Gold Ltd., No. 07-109 (D.D.C. 2007)
87 Ibid, at 14
88 Dep’t of Justice, Digital Currency Business E-Gold Indicted for Money Laundering and Illegal
Money Transmitting, http://www.usdoj.gov/opa/pr/2007/April/07_crm_301.html

18
Under the United States Code (U.S.C.) § 196089, which was enacted to tackle the
ever increasing use of money transmitting businesses to transfer monetary proceeds
of unlawful activities90, it is a federal crime to operate an unlicensed ‘money
transmitting business’. The act of ‘money transmitting’ is defined as “transferring
funds on behalf of the public by any and all means including but not limited to
transfers within the country […]”91. Although it is not clear from Section 1960 whether
‘transferring’ may involve the transfer of digital currencies without fiat changing
hands, or whether digital cryptocurrencies such as Bitcoins qualify as ‘funds’, this
Section is directly related to the Bank Secrecy Act (BSA) which in turn requires
unregulated financial institutions to register with a governmental body and implement
and follow certain procedures.92 Thus, assuming that digital currency issuers or
digital currency exchangers meet the definition of ‘money transmitter’, they are
required to register with the Financial Crimes Enforcement Network (FinCEN) and
are subject to the provisions of the BSA.93
The BSA is a compilation of statutory provisions enacted to counter money
laundering through the use of banks and other financial institutions.94 Under the
BSA, financial institutions are required to disclose the identities of parties involved in
transactions in excess of $10,00095, and transactions over $2,000 that “they know,
suspect, or have reason to suspect […] involve funds derived from illegal activity”96.
Moreover, financial institutions are required to file Suspicious Activity Reports
89 18 U.S.C. § 1960 (2010)
90 United States v. Velastegui, 199 F.3d 590, 593
91 18 U.S.C. § 1960(b) (2008)
92 R Grinberg, 'Bitcoin: An Innovative Alternative Digital Currency' [2012] 4(1) Hastings Sci & Tech L.J.
204
93 Tucker (n 9) 611
94 K Singh, 'The New Wild West: Preventing Money Laundering in the Bitcoin Network' [2015] 13(1)
Northwestern Journal of Technology and Intellectual Property 45
95 31 U.S.C. §5313(a) (2012); 31 C.F.R. §1010.311 (2011)
96 31 C.F.R. §103.20(a)(2) (2006)

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(SARs) for any suspected illegal transactions, have in place adequate anti-money-
laundering programs97, and responding to requests by the law enforcement.98 Taking
into account The PATRIOT Act which extends the definition of ‘financial institution’ to
include any “licensed sender of money or any other person who engages as a
business in the transmission of funds”99 it can be assumed that the BSA, and the
Money Laundering Control Act 1986 (MLCA) which makes money laundering a
federal crime100, may apply to transactions involving Bitcoins and to exchanges
which facilitate those transactions.
The MLCA applies to individuals who engage in financial transactions involving
‘dirty money’ with knowledge of the fact that they are ‘dirty’ and with the intention to
promote certain kinds of illegal activities, or concealing or avoiding to report these
transactions101. Applying the MLCA in the context of Bitcoins is extremely
challenging as it requires knowledge of unlawful activity. Accordingly, someone
dealing in Bitcoins could deny any knowledge of the initial flow of the proceeds which
are suspected to relate to illicit activity.102 Law enforcement would have to satisfy a
two level procedure; firstly to locate the person behind the anonymous Bitcoin
transaction, and secondly to prove that the individuals engaged in the transaction
knowingly used their Bitcoins to finance an unlawful activity.103 It has also been
argued that compelling an individual to provide his passwords and private keys to his
‘digital wallet’ raises self-incrimination issues as the Fifth Amendment of the U.S.
Constitution provides that “no person […] shall be compelled in any criminal case to
97 31 U.S.C. §5318(g)(1),(h) (2012)
98 31 C.F.R. § 103.125(d)(2)-(4) (2006)
99 31 U.S.C. § 5312(a)(2) (2000)
100 18 U.S.C. § 1956(a)
101 Grinberg (n 92) 204
102 Kirby P. ‘Virtually Possible: How to Strengthen Bitcoin Regulation Within the Current Regulatory
Framework’ [2014] 93(1) North Carolina Law Review 202
103 Ibid

20
be a witness against himself”104 and this hinders the prosecution of suspected
criminals using Bitcoins.
As these laws and regulations were specifically addressed by the prosecutors
against E-Gold, it is uncertain whether how and if they can apply to the Bitcoin
network and to other cryptocurrencies. The crucial issue to note here is that E-Gold
was a centralised digital currency while Bitcoin and its recent counterparts are based
on a decentralised model.105 It is relatively more straightforward to apply the
aforementioned statutes to a centralised authority which is the sole manager and
issuer of a digital currency than to apply them to each Bitcoin user individually.
FinCEN took notice of these difficulties and in 2013 it issued an interpretive
guidance clarifying the application of the BSA to digital currencies and to those
obtaining, creating, distributing, exchanging, transmitting or accepting digital
currencies106. FinCEN thus sought to address the issue of if and when a participant
in a digital currency scheme might be engaged in ‘money transmission’ which would
require that entity to register with FinCEN, file reports, and maintain transaction
records. Under the amended regulations regarding money services businesses
(MSBs), the legislation now encompasses currency exchanges and money
transmitters.107 FinCEN’s guidance made clear that mere ‘users’ of digital currencies
such as Bitcoin are not subject to FinCEN registration and reporting because they
are not encompassed by the definition of a MSB.108 On the other hand, the MSB
provisions and requirements do apply to ‘administrators’ or ‘exchangers’ who are
104 Ajello N. (n 78) 453
105 See Section 2.1 for the difference between centralised and decentralised digital currencies.
106 Fin. Crimes Enforcement Network, U.S. Dep’t of the Treasury, FIN-2013-G001, ‘Application of
FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies’ (2013),
available at http://www.fincen.gov/statutes_regs/guidance/pdf/FIN-2013-G001.pdf
107 S Middlebrook and S Hughes (n 61) 828
108 FinCEN Guidance (n 106) 2

21
‘money transmitters’.109 A person who “engages in the transfer of funds” is a money
transmitter and “the acceptance of currency, funds, or other value that substitutes for
currency from one person and the transmission of currency, funds, or other value
that substitutes for currency to another location by any means” is a money
transmission service.110 A ‘user’ is defined as someone “who obtains convertible
virtual currency and uses it to purchase real or virtual goods or services”.111
The interpretative guidance issued by FinCEN was received with mixed emotions
by the academic and Bitcoin communities. Immediately after its publication, Bitcoin
companies based in the US qualified as money transmitters under 18 U.S.C. § 1960
and the BSA, and had to undergo the very expensive procedure of obtaining forty-
seven state licenses and registering with FinCEN.112 It has also been suggested that
many AML and money transmitter statutes are “ill prepared” to deal with such a
disruptive financial technology as is Bitcoin as it is insensible to regulate entities that
engage in Bitcoin transactions other than Bitcoin currency exchanges given the peer-
to-peer decentralised nature of the Bitcoin network.113 Another academic has
emphasized the fact that the definition of ‘user’ from FinCEN’s guidance creates
“uncertainty among Bitcoin participants who do not clearly fit the definition”114. Singh
also criticized FinCEN’s initiative to mail warning letters indiscriminately to all
businesses that engaged in Bitcoin transactions which sought to mobilize them to
follow the registration procedures, even if they did not qualify as ‘exchangers’.115
Apparently, this action had a “chilling effect” on Bitcoin businesses.116 Although the
109 Ibid
110 Ibid
111 Ibid
112 Wenker (n 2) 168
113 Bryans D., ‘Bitcoin and Money Laundering: Mining for an Effective Solution’ [2014] 89 Ind. L.J. 472
114 Singh (n 94) 50
115 Ibid
116 Ibid

22
FinCEN guidance is definitely not a “model of clarity”117, it made a significant step in
recognizing that individuals who merely use Bitcoin or other digital currencies to
purchase goods or services are not going to be caught in the net of the definition of
‘money transmitters’ and are not required to register as an MSB.
It appears that the US Government has adopted a ‘wait and see’ approach to the
emergence of digital money and cryptocurrencies while seeking to utilize existing
statutes such as the MLCA, the BSA, and various know-your-customer rules
implemented by FinCEN to combat financial crime and other nefarious activities on a
federal level. However, the US regulators, legislators, prosecutors, and law
enforcement agencies may, theoretically, follow alternative routes.
4.1.2 Alternative regulatory approaches in the US
In 2013, a US District Court ruled that Bitcoin may be considered as “a currency
or form of money”.118 This is an important step towards legitimizing Bitcoin and other
cryptocurrencies, however, its categorization as a currency has other legal
implications and has to be examined through the lenses of the U.S. Constitution, the
rules against counterfeiting, and the securities legislation.
Firstly, the U.S. Constitution provides that the Congress “shall have the power to
coin money” and “regulate the value thereof”119 and prohibits other States from doing
the same.120 Prima facie these provisions completely delegitimize Bitcoin, given that
it has assumed the definition of ‘currency’ and it is not issued by the U.S. Congress.
However, as Doguet notes, the Framers’ definition of ‘money’ was limited to coins
117 Middlebrook and S Hughes (n 61) 830
118 Sec. & Exch. Comm’n v. Shavers, No. 4:13-CV-416 (E.D. Tex. 2013), available at
http://www.lawfareblog.com/wp-content/uploads/2013/10/SEC-v.-Bitcoin-Savings-and-Trust.pdf
119 U.S. Const. art. I, § 8, cl. 5
120 U.S. Const. art. I, § 10

23
and the Constitution goes no further “than establishing Congress’s authority over the
money of the United States to the exclusion of the States”121. Thus, private issuance
of currency is not prohibited by the Constitution as it makes no mention of the
subject altogether.122 Dion builds on that argument and draws a distinction between
what is considered to be a ‘legal tender’ and ‘legal currency’. The former is currency
as the law authorizes a debtor to render and requires a creditor to receive in
payment of money obligations, while the latter is simply a legitimate ‘medium of
exchange’.123 This distinction is crucial as a creditor could not refuse payment
offered in legal tender (e.g. US Dollars) for a debt, but a service provider may be
specific as to which currency they will accept (e.g. Bitcoin).124
Secondly, having established Bitcoin’s legitimacy as a private currency under the
U.S. Constitution, many commentators address the issue of whether Bitcoin may be
deemed a counterfeit and thus rendered illegal. The Stamp Payments Act 1862
(SPA) was enacted to ensure that no other domestic currency competes with the US
Dollar.125 The SPA makes it a criminal offence for an individual to “issue, circulate, or
pay out any note […] for a less sum than $1, intended to circulate as money or to be
received or used in lieu of lawful money of the United States […]”126 Given that
Bitcoin was designed to be “economically superior” to government-backed
currencies, and because Bitcoin reduces online transaction costs so as to enable
micropayments it can easily be argued that it will be used to facilitate transactions
below the SPA’s one-dollar threshold.127 Notwithstanding the fact that the time period
121 J Doguet, 'The Nature of the Form: Legal and Regulatory Issues Surrounding the Bitcoin Digital
Currency System' [2013] 73(1) Louisiana Law Review 1132
122 Ibid
123 Dion (n 75) 171
124 Ibid
125 Farmer (n 39) 94
126 18 U.S.C. § 336 (2006)
127 Doguet (n 121) 1134

24
of the act and the physical nature of the enumerated list of financial instruments
make it unlikely to apply to Bitcoins, there is still potential for prohibiting competing
currencies such as Bitcoin and this may be considered as a detriment to the
legitimacy of Bitcoin.128 It is indeed difficult to prove that Bitcoins were not intended
to directly compete with the US Dollar, and the SPA is a very useful tool in the hands
of the US government to aggressively regulate or even prohibit the use and
circulation of Bitcoins.
Thirdly, under the Securities Act of 1933 a security is defined through an
enumeration of various financial instruments129 and jurisprudence has provided for a
very broad scope for the applicability of the securities laws. The financial instruments
that might closely relate to Bitcoin are notes and investment contracts.130 Farmer
argues that although Bitcoins do not meet the traditional definition of a note, i.e. a
written promise by one party to pay money to another party131, the ‘family
resemblance test’132 makes Bitcoin more apt to be securities that are not notes.133
Farmer believes that although the intention of individual users is to use Bitcoin as a
medium of exchange, the actual uses and expectations of the investing population
leads to the conclusion that Bitcoins are used speculatively given the wild
fluctuations of its price, thus prompting investors to buy low and sell high134.
Nevertheless, it is doubtful whether Bitcoin could meet the fourth limb of the test, that
is whether some other regulatory scheme reduces the risk of the instrument, and
128 Farmer (n 39) 95
129 15 U.S.C. § 77(b) (2006) “The term ‘security’ means any note, stock, treasury stock, security
future, security based swap […], or in general, any interest commonly known as ‘security’ […]”
130 Grinberg (n 92) 195-97
131 Black's Law Dictionary 9th ed. (West Group, 2009), edited by Bryan A. Garner 732
132 Reves v. Ernst & Young, 494 U.S 56, 60 (1990)
133 Farmer (n 39) 100
134 Ibid

25
there is a very high probability of such a regulatory scheme to apply to Bitcoin, for
example the aforementioned regulations concerning counterfeiting.135
Regulating Bitcoin as an investment contract under the Securities Act 1933
appears to be potentially feasible. An investment contract is defined as “a contract,
transaction or scheme whereby one person invests his money in a common
enterprise and is led to expect profits solely from the effort of the promoter or third
party”136. Farmer advocates that the Bitcoin network meets the conditions of the
Howey test that make an investment contract, meaning that that there is an
investment of money, a common enterprise, expectation of profits, arising
substantially from the effort of others.137 This is mainly because Bitcoins are created
through the investment in computer equipment and electricity by ‘miners’138, there is
a common enterprise when Bitcoins are bought and sold through an exchange,
Bitcoins are used mainly to be sold later at a higher price with an expectation of
profit, and finally those who develop the Bicoin network and promote its use are the
ones who add value while the average user once he has purchased his Bitcoins
places no further effort into them.139
Through this analysis, Bitcoin may be defined as a ‘security’ given the broad
scope of the US securities regulations, and this may be beneficial for the Bitcoin
network which will escape the absolute definition of Bticoin being solely defined as a
‘currency’. On the other hand, because of the relative loose interpretation governing
135 Ibid
136 SEC v. W.J. Howey Co., 328 U.S. 293, 298-99
137 Farmer (n 39) 100
138 See section 2.3
139 Farmer (n 39) 102

26
the area of securities, one may argue with the same ease that Bitcoin is not a
security under federal securities law.140
4.1.3 The First Digital-Currency-Specific Regulation in the US
In June 2014, B. Lawsky, the superintended of the New York State Department of
Financial Services (NYDFS), announced that his office will be working towards a
comprehensive regulatory approach aimed at companies operating within the realm
of digital currencies and within the boundaries of New York.141 Lawsky stated that
current money transmitting laws142 are antiquated and do not offer the desirable level
of protection and regulation regarding digital currencies which are “unlike anything
we had ever seen before”143. In June 2015 the final version of the ‘BitLicense’ was
released, a new regulatory regime which explicitly requires digital-currency
businesses to obtain a license by registering with the NYDFS and complying with the
BitLicense’s requirements. BitLicense is now the world’s first regulatory scheme
which addresses specifically the regulation of digital currencies.
The BitLicense addresses those companies and individuals who engage in
‘Virtual Currency Business Activity’.144 A ‘Virtual Currency Business Activity’ is
defined expansively covering actions such as receiving digital currencies for
transmission, storing, holding, or maintaining custody or control on behalf of others,
buying and selling digital currencies as a customer business, performing exchange
140 J Nelson. ‘Why Bitcoin Isn’t a Security Under Federal Securities Law’ [2011] Lex Technologiae,
www.lextechnologiae.com/2011/06/26/why-bitcoin-isnt-a-security-under-federal-securities-law
141 R Abrams, ‘Virtual Exchange Plans Are Sought in New York’, N.Y. TIMES DEALBOOK, Mar. 11,
2014, nyti.ms/1dNocO3, accessed 10 July 2015
142 See part 4.1.1.
143 MJ Casey, 'NY Financial Regulator Lawsky Releases Final BitLicense Rules for Bitcoin Firms' [3
June 2015] The Wall Street Journal <http://www.wsj.com/articles/ny-financial-regulator-lawsky-
releases-final-bitlicense-rules-for-bitcoin-firms-1433345396> accessed 14 July 2015
144 Regulations of the Superintendent of Financial Services Part 200, Virtual Currencies. Hereafter
‘BitLicense’ , Section 200.3(a).

27
services, and controlling, administering, or issuing a digital currency.145 In the event
that a corporate entity or individual meets these definitions they will have to meet
certain capital requirements as determined sufficient by the NYDFS taking into
account aspects such as the amount of leverage employed by the licensee and their
liquidity position146, maintain detailed records of transactions, bank statements and
records demonstrating compliance with applicable state and federal laws and
regulations147, and be subject to examinations by the NYDFS148.
More importantly, however, the BitLicense requires entities holding digital funds
on behalf of another person to hold the same type and amount of digital currency
that the entity owes the person who deposited the funds.149 Thus, if a Bitcoin
exchange holds $500 in Bitcoins for a client it will have to hold an additional $500 in
Bitcoins to meet this requirement.
Further, the BitLicense imposes anti-money laundering programs to licensees
and is considered to be more prescriptive than risk-based than the pre-existing US
anti-money-laundering laws which give entities more latitude to assess their own
risks and determine methods to counter illicit transactions.150 The BitLicense scheme
requires the licensee to identify its customers’ identification information and physical
location, and file ‘suspicious activity reports’ (SAR) with the NYDFS within twenty-
four hours which is an extra burden to that of FinCEN’s regulations.151
145 BitLicense s. 200.2(q)
146 Ibid, s. 200.8
147 Ibid, s. 200.12
148 Ibid, s. 200.13
149 Ibid, s. 200.9
150 S Hughes, 'Did New York State Just Anoint Virtual Currencies by Proposing to Regulate Them, or
Will Regulation Spoil Them for Some?' [2014] 71(1) Washington & Lee Law Review Online 62
151 BitLicense, s. 200.15

28
Consumer disclosure requirements under the BitLicense are also prescriptive and
exceed those imposed under regulations for analogous products152. The licensee
has to inform the customer of ‘material risks’ associated with digital currencies153
such as those referred to in section 3 of this essay. One important innovation of this
consumer disclosure requirement is that a licensee must ensure that all disclosures
are “acknowledged and received by customers”154, an unprecedented requirement in
US regulation of financial services.155
This innovative and specialized regulatory scheme has come under severe
criticism by the Bitcoin community and commentators. This ‘one size fits all’
approach means that an individual digital currency hobbyist who helps his friends
and family buy and sell Bitcoins could face the same compliance and registration
burdens as a large Bitcoin exchange.156 Another criticism has been raised against
the overly broad definitions provided in the regulations. For example, ‘Virtual
Currency’ and ‘Virtual Business Activity’ are overbearing and may lead to some
unintended consequences or may be impossible to enforce.157 Additionally, it has
been noted that BitLicense creates an unprecedented new anti-money laundering
requirement for licensees, something which is not applicable to money transmitters
or banks in the State of New York and is thus considered to be discriminatory.158 On
the other hand, it may be argued that BitLicense adds credibility, legitimacy, and
confidence to this new technology of Bitcoin and other digital cryptocurrencies.159
152 S Hughes (n 150) 64
153 BitLicense s. 200.19
154 Ibid
155 S Hughes (n 150) 64
156 T Vays, ‘Top 5 Issues with the NYDFS BitLicense Proporsal’, COINTELEGRAPH (July 24, 2014),
http://cointelegraph.com/news/112141/top-5-issues-with-the-nydfs-bitlicense-proposal , accessed 15
July 2015
157 Wenker (n 2) 183
158 MJ Casey (n 143)
159 Ibid

29
Finally, the BitLicense itself is silent on how non-compliant businesses will be
penalized or cited and it is unclear how enforcement actions will be taken.160
BitLicense is a bold move forward in regulating the emerging market of digital
currencies, and although there are still many issues left to be addressed, it can be
used as a template for future, more efficient, regulations.
4.2 European Union’s Approach
As is the case in the US, with the exception of BitLicense in the State of New
York, the EU has not yet developed a comprehensive regulatory scheme addressing
digital money and cryptocurrencies. Member States can only look at the guidance,
opinions, and recommendations of EU institutions such as the European Banking
Authority (EBA) and the European Central Bank (ECB) in order to determine the
methods which they may use in order to address Bitcoins. Hence, any discussion
about the legal aspects of the regulation of digital cryptocurrencies in the EU remains
speculative.
4.2.1 Digital cryptocurrencies and the existing EU regulatory framework
The ECB has recognized that digital currencies fall under the central bank’s
responsibility to oversee and regulate due to their characteristics which resemble
payment systems.161
On a European level, the Eurosystem central banks do not consider digital
currencies such as Bitcoin to belong to the sphere of money or currency from an
economic and legal perspective.162
160 S Higgins, 'NY Bitcoin Businesses Now Have 45 Days to Apply for BitLicense' [24 June 2015]
COINDESK <http://www.coindesk.com/ny-bitcoin-business-45-days-bitlicense accessed 16 July 2015
161 ECB 2012 (n 3) 47

30
From an economic perspective the ECB maintains that digital currencies do not
fulfill the functions of money, i.e. medium of exchange, unit of account, and store of
value, because of their very low level of acceptance among merchants and the
general public, and due to their high exchange rate volatility.163 From a legal
perspective, it is argued that since digital currencies are not widely used to exchange
value in transactions, they are not money or currency.164 This adopted stance by the
ECB can be contrasted with the aforementioned 2013 decision of the US District
Court which declared Bitcoin to be “a currency or form of money”165, and this
contrast is evidence of the regulatory conundrum introduced by the evolving
technology of digital money and cryptocurrencies.
The insistence of the ECB to disregard the legitimacy of digital currencies as legal
tender is based on Council Regulation (EC) No 974/98 on the introduction of the
euro which clearly states that only euro banknotes and coins are legal tender166
within the Eurozone countries, and should, by law, be accepted as payment for a
debt.167
The ECB has also considered the possibility of Bitcoin falling under the Electronic
Money Directive (2009/110/EC) (EMD) which regulates the issuance of electronic
money.168 Electronic money is defined as money stored electronically or
magnetically, issued on receipt of funds of an amount not less than the monetary
value issued, and is accepted by a natural or legal person other than the electronic
162 ECB 2015 (n 6) 23
163 Ibid
164 Ibid 24
165 Sec. & Exch. Comm’n v. Shavers, No. 4:13-CV-416 (E.D. Tex. 2013) 416
166 Art. 10 Council Regulation (EC) No 974/98 of 3 May 1998 on the introduction of the euro.
167 ECB (2015) (n 6) 24
168 ECB (2012) (n 3) 43

31
money issuer169. Although Bitcoin seems to satisfy the first and third criteria, it is
difficult to envisage Bitcoin satisfying the second criterion. Taking into account Art.
11 EMD which states that “Member States shall ensure that, upon request […]
electronic money issuers redeem […] the monetary value of the electronic money
held”, it becomes evident that this operation cannot be ensured with digital
currencies such as Bitcoin. Furthermore, as Bitcoins are issued through a process
called ‘mining’ which leads to money creation without the receipt of funds,170
applying the protections afforded by the EMD to Bitcoin would be like trying to fit a
square peg into a round hole.
On a similar note, the Payment Services Directive (2007/64/EC) (PSD) which
regulates the execution of payment transactions of funds in an electronic form
encounters several difficulties in its applicability to Bitcoin and digital currencies. As
the PSD applies to transactions of funds, with ‘funds’ being defined as “banknotes
and coins, scriptural money and electronic money”171 there is clearly no room to fit
Bitcoin and other digital currencies within this narrow definition, an issue which is
also highlighted by the ECB which does not regard digital currencies to be funds.172
Having examined these possible regulatory routes, the ECB concludes in its
report on digital currencies that enacting ‘tailor made’ legislation, or amending and
extending its current legislative framework is not desirable at this moment in time
since such an action would give legitimacy to digital currencies, something which is
not warranted given their low level of usage.173
169 Electronic Money Directive (2009/110/EC) Art. 2 ‘Definitions’
170 ECB (2012) (n 3) 43
171 Payment Services Directive (2007/64/EC) Art. 4.15 ‘Definitions’
172 ECB (2015) (n 6) 24
173 Ibid 25

32
In June 2014 the EBA produced a substantial report titled ‘Opinion on Virtual
Currencies’174 which provides a more specific and clearly articulated guidance and
recommendations in regulating digital currencies within the EU. By directly
addressing EU legislators and national supervisory authorities, the EBA maintains
that the risks of digital currency systems outweigh their benefits and calls for
domestic supervisory authorities to discourage payment and other financial
institutions from engaging in digital currency transactions.175 Therefore, the aim of
the EBA in the short term is to “shield” the financial services industry from digital
currencies and mitigate the risk of contamination.176
Since there is no substantial body of regulation in place, and taking into account
the fact that the EMD and the PSD cannot be implemented to address digital
currencies, the EBA suggests that EU legislators declare market participants, such
as digital currency exchanges, to become ‘obliged entities’ under the newly enacted
Fourth Anti-Money Laundering Directive (AMLD4). Under the AMLD4, obliged
entities such as credit and financial institutions are prohibited, inter alia, from keeping
anonymous accounts or passbooks177, should apply customer due diligence
measures when carrying out transaction of €7,500 or more in cash,178 whilst also
being subject to perform simplified and enhanced customer due diligence.179
However, EU legislators did not follow EBA’s recommendation that digital currency
exchanges become ‘obliged entities’.180
174 EBA Opinion (n 82)
175 Ibid, 6
176 Ibid
177 Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on the
prevention of the use of the financial system for the purpose of money laundering and terrorist
financing COM/2013/045 Art. 9
178 Ibid, Art. 10
179 Ibid, Arts. 38 - 45
180 ECB 2015 (n 6) 29

33
The EBA concludes its report by emphasizing that in the long term there needs to
be a substantial body of regulation relating to, inter alia, governance requirements for
market participants, separation of client accounts, the creation of central managing
authorities, and capital requirements. Notwithstanding the numerous regulatory
recommendations and opinions, the EBA refrains from providing whether regulation
should take place through a modification or amendment of existing EU Directives, or
through a separate and specific regulatory initiative.181
4.2.2 An alternative approach in regulating Bitcoin within the EU
It is well established that this emerging electronic financial technology is difficult
to become adequately regulated since Bitcoins are not issued by a single issuer, but
are created through a decentralized system and the use of the peer-to-peer network.
Professor R. Houben makes this remark and indicates that the issue of Bitcoins, and
other similar decentralized digital cryptocurrencies, falls outside the ambit of legal
instruments such as the prospectus regulations which have as a prerequisite an
initial public offering by an issuer.182
Prof Houben indicates that the secondary public offering and commercialization of
Bitcoins or derivatives of Bitcoins can be subjected to financial regulation. The MiFID
regulation Art. 4(1) provides an exhaustive list of what can be considered as a
financial instrument and Houben argues that although Bitcoin itself cannot be
considered as a financial instrument, derivatives of Bitcoin are more likely to be
qualified as financial instruments as Art. 4(1) explicitly mentions derivatives.183
Hence, qualifying derivatives of Bitcoin as a financial instrument would bring into play
181 EBA Opinion (n 82) 39
182 R Houben, 'Bitcoin: there are two sides to every coin' [2015] 26(5) International Company and
Commercial Law Review 163; Directive 2003/71 on the prospectus to be published when securities
are offered to the public or admitted to trading (Prospectus Directive).
183 R Houben (n 182) 162

34
the MiFID rules resulting in licensing requirements and application of rules of
conduct for the provider of the investment service.184
Moreover, Prof Houben considers the possibility of derivatives and secondary
offerings of Bitcoin falling under the scope of the Prospectus Directive. In order for
the Prospectus Directive to apply, the ‘connecting factor’ must be satisfied meaning
that derivatives of Bitcoin, or Bitcoins themselves, have to fall within the definition of
‘securities’.185 A ‘security’ is defined in Art. 1(4) of Directive 93/22 as shares in
companies, negotiable bonds, other forms of securitized debt, and any other
securities normally dealt in giving the right to acquire any such transferable
securities.186 Houben dismisses the notion of Bitcoin itself being considered as a
security, although he remains cautious as to whether derivatives of Bitcoin are
securities. If the latter is legally viable, then prospectus requirements would apply to
a public offering of derivatives of Bitcoins at a European level.187
Overall, where an entity can be identified which is responsible for the distribution,
secondary public offering, and commercialization of Bitcoins or derivatives of Bitcoin,
this entity can be subjected to regulation within the EU. These entities may be
managing Bitcoin systems, exchange platforms, trade platforms, or custodians of
Bitcoins.188
184 Ibid 164
185 Ibid
186 Council Directive 93/22/EEC of 10 May 1993 on investment services in the securities field
187 R Houben (n 182) 164
188 Ibid

35
4.3 The legal status of Bitcoin in other jurisdictions
Having examined the existing and potential regulatory approaches towards digital
currencies and Bitcoin in the US and EU, this section will provide a brief description
of how various jurisdictions have attempted to address the emergence of this
innovative online payments technology.
In Singapore, the Monetary Authority of Singapore (MAS) has issued a statement
clarifying that it is not regulating digital currencies such as Bitcoin as it does not
consider these to be legal tender or securities.189 The MAS has decided to take this
approach because under s. 13 of the Currency Act (CA) ‘currency’ is defined as
“currency notes and coins which are legal tender in Singapore” and only currency
issued by the MAS is legal tender in Singapore.190 Additionally, as Bitcoin is not a
debt nor does it give its holder an interest in the share capital of any corporation, but
it is simply a medium of exchange, it does not fall under the scope of Singapore’s
Securities and Futures Act.191 Instead, the MAS will seek to regulate digital currency
intermediaries in Singapore in order to counter potential money laundering and
terrorist financing by introducing regulations obliging intermediaries to verify the
identities of their customers, reporting suspicious transactions, and, most
importantly, Bitcoin transactions should be undertaken with face-to-face contact with
the customer unless the prior approval of MAS has been obtained.192
In the UK, government agencies have initiated an effort to understand and
properly regulate Bitcoin and digital currencies. In a briefing paper setting out its
thoughts the HM Revenue & Customs states that VAT treatment for cryptocurrencies
189 E Chan, 'The Regulation of Bitcoin in Singapore' [2014] 29(6) Butterworths Journal of International
Banking and Financial Law 399
190 Ibid
191 Ibid
192 Ibid 400

36
in the UK should be consistent with any potential treatment implemented across the
EU.193Generally, VAT will not be charged on digital currency transactions, however,
corporation tax will apply and will be determined on case by case basis.194
In August 2014, the Chancellor of the Exchequer announced a major program of
work called 'Innovate Finance’ which would, inter alia, seek to collect information
about digital currencies and Bitcoin with the aim of determining their risks, benefits,
and whether and how they should be regulated.195 Almost a year later, in March
2015, the HM Treasury published a report196 setting out its findings based on a call
of information which invited various government agencies and market participants to
express their views about Bitcoin and other digital cryptocurrencies.
One of the main proposals of the Treasury was that UK anti-money laundering
regulation should apply to digital currency exchanges in order to support innovation
and prevent criminal use.197 Consequently, under the Proceeds of Crime Act 2002
exchanges in the UK will be under an obligation to perform stricter background
checks and customers may no longer be able to transact with Bitcoins anonymously.
The Treasury’s report has received mixed reactions from market participants who
argue that if the proposals are implemented they will force the UK’s Bitcoin firms to
move to other jurisdictions198; others have welcomed the proposals arguing that best
practice standards would benefit the industry as long as they remain reasonable and
193 HM Revenue & Customs, ‘Policy paper: Revenue and Customs Brief 9 (2014): Bitcoin and other
cryptocurrencies’, <https://www.gov.uk/government/publications/revenue-and-customs-brief-9-2014-
bitcoin-and-other-cryptocurrencies/revenue-and-customs-brief-9-2014-bitcoin-and-other-
cryptocurrencies> accessed 21 July 2015
194 Ibid
195 G Osborne MP, ‘Speech: Chancellor on developing FinTech’,
<https://www.gov.uk/government/speeches/chancellor-on-developing-fintech> accessed 21 July 2015
196 HM Treasury, 'Digital currencies: response to the call for information' [18 March 2015]
<https://www.gov.uk/government/consultations/digital-currencies-call-for-information> accessed 21
July 2015
197 Ibid 19
198 G Caffyn ‘Treasury Report: UK’s Bitcoin Startups React’ [20 March 2015] COINDESK
<http://www.coindesk.com/treasury-report-uks-bitcoin-startups-react/> accessed 13 July 2015

37
do not unduly burden UK-based companies.199 It remains to be seen whether the
newly elected Conservative government will proceed on the basis of the Treasury’s
proposals.
In China, payment institutions and banks are prohibited from dealing in Bitcoins
as of December 2014, and the government has undertaken an aggressive regulatory
approach in order to address money laundering risks by closely monitoring Bitcoin
related websites.200
The German Ministry of Finance has recognized Bitcoin as a unit of account,
which is not legal tender, but can be considered as a financial instrument.201 The
German Federal Financial Supervisory Authority has stated that sophisticated Bitcoin
transaction services may be subject to authorization, and the financial regulators of
Sweden and France have followed the same attitude by imposing licensing
requirements to Bitcoin exchanges.202
As it becomes evident from the ECB’s recent comprehensive report on digital
currencies, regulatory responses worldwide are inconsistent, ranging from simple
warnings and clarifications to more strict licensing requirements, and, in some
circumstances, issuing bans.203 Hence, multiple recommendations have been put
forward by academics, commentators and governmental authorities as to what would
be the most preferable method to address the risks and potentially harmful effects of
digital cryptocurrencies whilst maintaining their numerous benefits.
199 Ibid
200J Turpin (n 45) 363
201 A Charles, 'Bitcoin now 'unit of account' in Germany ' [19 August 2013] 1(1) The Guardian
<http://www.theguardian.com/technology/2013/aug/19/bitcoin-unit-of-account-germany> accessed 2
July 2015
202 ECB 2015 (n 6) 31
203 Ibid 30

38
5. Recommendations and proposals for future regulatory actions
The most simple and decisive solution towards the risks and problems that arise
through the use of Bitcoin would be for governments to completely outlaw digital
cryptocurrencies. This hostile approach, however, is dismissed by commentators
who maintain that such an aggressive attitude to the Bitcoin system is not preferable
mainly because Bitcoin is not presently illegal under current legal frameworks in
almost every country, Bitcoin offers some significant advantages over fiat currencies
and traditional payment methods, and governments do not presently possess the
technical know-how to target the Bitcoin network appropriately204. Notwithstanding
the reasons against Bitcoin’s prohibition, these should not justify a lenient or a non-
existent approach by regulators.
A possible solution to address the threat that Bitcoin poses to the stability of the
foreign currency exchange market and international commerce in general is provided
by N. Plassaras. Plassaras notes that bringing Bitcoin under the scope of the IMF,
whose primary purpose is to ensure the stability of the international monetary
system, regulate international economic transactions, and promote the growth of
world trade205, will provide a solution in the event that Bitcoin is used for a
‘speculative attack’ on another currency.206
A ‘speculative attack’ occurs when an investor takes advantage of a depreciated
currency by borrowing a sum of the weak currency and selling it for a stronger
currency with the intention of buying the weak currency back for less than the
204 J Turpin (n 45) 366
205 N Plassaras, 'Regulating Digital Currencies: Bringing Bitcoin Within the Reach of the IMF' [2013]
14(1) Chicago Journal of International Law 393; Articles of Agreement of the International Monetary
Fund (1945) Art. 1
206 Plassaras (n 205) 397

39
investor sold it for.207 A speculative attack on a currency by Bitcoin investors may
pose problems for central banks as they will not be able to absorb any maturity
mismatches given that they do not hold any Bitcoin reserves. Plassaras states that
the IMF is in a position to properly coordinate a global response to the threat posed
by Bitcoin. Two alternatives are put forward; firstly, the IMF could obtain indirect
control over Bitcoin by expanding the meaning of Art. IV, Section 5 of its Articles of
Agreement in order to include digital currencies within the definition of ‘separate
currencies’ under which member states would be required to pay part of their
subscription to the IMF in Bitcoins. This will arguably provide the IMF with sufficient
Bitcoin reserves to counter the above mentioned threats.208 Secondly, the IMF could
exercise more direct control over Bitcoin by granting quasi-membership status for
digital currencies, allowing users to sell these currencies to the IMF for an equivalent
value of other fiat currencies. Although Plassaras recognizes the fact that these
alternatives would require a substantial amendment of the IMF’s Articles of
Agreement, he concludes that the IMF is the most suitable international authority to
counter the “Bitcoin threat” given that it was set up to protect the global economic
stability.209
Plassaras’s suggested IMF regulation has been criticised by Ed Howden who
believes that because the cryptocurrency industry is in its early stages of
development and likely to undergo changes, the proposed IMF regulation will only
prove viable if the industry stagnates and Bitcoin becomes the de facto global digital
cryptocurrency.210 If Plassaras’s suggestion is adopted then the IMF will essentially
207 Ibid
208 Ibid 403
209 Ibid 407
210 E Howden , 'The Cryptocurrency Conundrum: Regulating an Uncertain Future' [2015] 29(1) Emory
International Law Review 794

40
force member states to contribute reserves to an industry that is constantly evolving,
and it will turn out to be extremely inefficient if another cryptocurrency supersedes
Bitcoin. Thus, under the IMF solution to speculative attacks, countries may have to
expend more money to build up extra reserves of this new cryptocurrency and this
process will have to be repeated every time that an emerging cryptocurrency poses
a speculative attack threat.211
Instead, Howden recommends that the World Trade Organization (WTO) should
take jurisdiction over Bitcoin. In order to assert this jurisdiction, the WTO would have
to classify cryptocurrency transactions as barter transactions and cryptocurrencies
themselves as a good.212 Should this barter view be adopted, countries will be able
to protect their domestic financial integrity from a speculative attack by placing a ban
on the importation and inflow of cryptocurrencies through the implementation of
tariffs on banks or businesses that use cryptocurrencies, or on exchanges that trade
them.213 Under the WTO’s GATT Article XIX ‘Emergency Actions on Imports of
Particular Products’214 a member may enforce restrictive trade policies when the
imported products (in our case the cryptocurrencies) cause or threaten to cause
serious detriment to domestic market participants (quite possibly a speculative
attack). The WTO could enforce these restrictions if it considers the domestic
currency to be a competing ‘product’ of cryptocurrencies.
Howden concludes that the WTO will be an efficient regulator of this emerging
industry as more concrete policy could develop, businesses will be able to conduct
transactions without fear of unpredictable changes in regulation, international trade
211 Ibid
212 Ibid 783
213 Ibid 784
214General Agreement on Tariffs and Trade available at
https://www.wto.org/english/docs_e/legal_e/gatt47_e.pdf

41
will benefit from the WTO’s expertise, and, compared with the substantial
amendment of the IMF’s Articles of Agreement, a simple referral of the
cryptocurrency issue by a member state to the Ministerial Conference of the WTO
will be enough to initiate the proceedings to bring this emerging industry under the
scope of the WTO.215
Regardless of which of the regulatory alternatives is adopted on a domestic or
international level, regulation should not obstruct cryptocurrencies from achieving
their positive potential, while also preventing cryptocurrencies from becoming a
medium for criminal activity. For this reason, Marian argues that decentralization is a
positive trait which should be left intact, and regulators should instead focus on the
element of anonymity to the extent that it increases the possibility of individuals using
cryptocurrencies as part of their criminal activities.216
Since anonymity is the main trait that makes cryptocurrencies prone to illicit
activity, Marian’s regulatory proposal is to force individual users to elect between
bearing the cost of regulation and waiving the veil of anonymity. For example, the
regulatory framework would require cryptocurrency users to identify themselves to
merchants, exchanges, or clearing houses as the owner of the cryptocurrency used
in the transaction. If, on the other hand, the user wishes to maintain the anonymous
nature of the transaction he or she would be subject to an increased cryptocurrency-
based tax liability which would be collected by the merchant or clearing house. This
regulatory system would incentivize users engaged in legitimate transactions to
215 Howden (n 210) 784
216 Marian (n 29) 59

42
waive their anonymity, consequently making the entire cryptocurrency network less
anonymous and less prone to illicit behaviour. 217
Notwithstanding the numerous regulatory approaches that have been put
forward218, the majority of regulators worldwide have not directly addressed the
emerging phenomenon of digital cryptocurrencies mainly because it is still in its
primitive stages of development.
6. Conclusion
The purpose of this essay was to describe, analyze and assess the regulatory
framework surrounding digital cryptocurrencies. From the aforementioned findings it
becomes evident that policymakers and legislators worldwide have approached this
issue quite inconsistently. Regulatory responses have ranged from warnings, issuing
of guidance, licensing requirements, and governments have generally withheld from
specifically regulating Bitcoin and other cryptocurrencies leading to a general
confusion as to its legal status.
The United States has started to make bold moves forward by providing
administrative guidance, prosecuting cases involving Bitcoins, and, most importantly,
the State of New York has adopted ‘BitLicense’ which appears to be the most
comprehensive regulatory approach towards digital cryptocurrencies so far.
On the other side of the Atlantic, the examination of the legal instruments
available to address digital cryptocurrencies within the EU has shown that there is a
lack of comprehensive regulation where Member States may only consult with
217 Ibid 62
218 For an analysis of regulatory recommendations from a private law perspective see: S Bayern,
'Dynamic Common Law and Technological Change' [2014] 71(1) Washington & Lee Law Review
Online 23

43
recommendations, guidance, and opinions issued by EU institutions. In other
jurisdictions, the UK appears to be willing to embrace Bitcoin’s financial innovation
as compared with other countries such as China where the government has
toughened up its stance towards cryptocurrencies, yet specific legislation has not
been enacted.
Notwithstanding the diverse regulatory approaches and the lack of tailored made
legislation, it is inappropriate to conclude that Bitcoin remains unregulated. One has
to simply look at precedents and statutes and apply them to the circumstances
created by this new technology. Accordingly, when it is not feasible to apply existing
rules to the realm of Bitcoin, this may be an indication that new laws need to be
enacted.219
Numerous recommendations and proposals have been presented which seek to
provide solutions to this regulatory Gordian knot presented by digital money and
cryptocurrencies; however, as of 2015 none of these are realised. It can only be
envisaged that greater regulatory mobilisation on an international level is expected
as recent developments have indicated a rise in Bitcoin awareness by the general
public, and with meticulously drafted legislations the benefits of this emerging
financial technology can be maintained.
219 S Hoegner, et al., The Law of Bitcoin (1st edn, iUniverse 2015) 13

44
LAWSG099 GGJM6
7. Annexes
Annex 1
Annex 2

45
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