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Regulations on Virtual Currencies

Why to regulate Virtual Currencies

The Bitcoin structure (and its peers) holds natural tension with traditional regulatory and government controls. However, there are a few aspects of Bitcoins that do lend themselves to regulatory oversight, and such intervention could be very useful.

Regulatory scrutiny of criminal activity is necessary within the Bitcoin universe in three core areas: Bitcoin-specific crimes, money laundering, and Bitcoin-facilitated crimes.

  • Bitcoin specific crimes are attacks on either the infrastructure of Bitcoin transfers or the currency itself. This could include Bitcoin theft, attacks on mining pools, or denial-of-service attacks on exchanges. Law enforcement has struggled with these crimes due to the inherent technical complexities and limited cyber resources. Money laundering is a big potential
  • Money laundering is a big potential issue with Bitcoins. This involves using the Bitcoin protocol to conceal proceeds of illegal activities. Law enforcement’s only weapon in this war is to attempt to map transactions through the blockchain record. The use of mixers can further cloud this area that requires more regulatory oversight. Bitcoin-facilitated crimes occur when account owners use
  • Bitcoin-facilitated crimes occur when account owners use Bitcoins to conduct illegal transactions for goods or services or for payment of bribes and
    extortion. These three factors are all reasons why the Bitcoin infrastructure needs to have some measure of regulation.

These three factors are all reasons why the Bitcoin infrastructure needs to have some measure of regulation.

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Key challenges to imposing regulation

There are some key challenges to imposing regulation on the Bitcoin universe.

  • One such challenge is that Bitcoins are an international virtual currency. If all national jurisdictions do not impose the same constraints, then account owners will domicile their holdings in a game of regulatory arbitrage, seeking the country with the lowest regulatory hurdles.
  • Regulators are traditionally drawn to financial intermediaries as targets to deploy regulation. One challenge is that many intermediaries in the Bitcoin structure have very little leverage with which to enact national regulations. This is why the Silk Road was able to conduct illegal transactions in controlled substances, hacking services, and money laundering using Bitcoins as a cover. Ross Ulbricht, the founder of the Silk Road, was only caught because early in his career, he advertised the Silk Road online using a Gmail account, which could be linked to his encrypted transactions in the blockchain.

One potential point of regulation is in the currency exchanges. In December 2013, China enacted a “know-your-customer” standard for all accounts under their scope of influence. This imposed certain registration and record-keeping responsibilities on Bitcoin currency exchanges.

Taxation issue

Another legal issue is taxation of Bitcoin profits. How will profits be taxed when the users are supposed to be anonymous? The IRS has been wrestling with this issue and whether to classify Bitcoin currency gains as ordinary income or capital gains income. If taxation is imposed, then users would need to keep track of all Bitcoin currency transactions, and transactions would be formally linked to Bitcoin accounts. If taxation is not imposed in all jurisdictions, then it would leave room for abuse.

Fraud Tracking System

One good feature about the Bitcoin structure is that theft can be tracked. Since all transactions are recorded in the blockchain, the account number that stole Bitcoins can be easily isolated. The tricky part is identifying who the account belongs to. That might take an extended period of time to wait for the account owner to make a mistake and either convert assets at a currency exchange or use their account to ship product to a physical address. In theory, they could use the anonymous account to buy online services that require no physical delivery and remain anonymous indefinitely.