Crypto-Currency: Do Bankers Dream of Electric Money?

Crypto-currencies.  Bitcoin.  Litecoin. Dogecoin.  All Crypto-currencies.  Compelling.  Disruptive.  Confusing.  Safe?  Legal?  There are lots of questions about crypto-currencies—especially Bitcoin, which is in the headlines a lot lately.  I am going to explore crypto-currencies in a series of posts.  Hopefully, we can all gain a little understanding of the mysterious meta-money!

Today, crypto-currencies are not directly regulated in the U.S.  As reported by The Wall Street Journal, Federal Reserve Board chair Janet Yellen informed the Senate Banking Committee that the Fed doesn’t have any authority over Bitcoin at this point.  In 2013, FinCEN published guidelines articulating how FinCEN is applying certain aspects of the Bank Secrecy Act to virtual currencies and those trading and mining virtual currencies.^[1]  The conclusion:  crypto-currencies aren’t “real currency” and, hence, aren’t regulated like real currency.  But the landscape is tumultuous and changing.  Senator Joe Manchin recently called for regulation of Bitcoin.  It’s possible the regulatory environment for crypto-currencies could be vastly different in a year.  Despite this uncertainty, Bitcoin and other crypto-currencies remain compelling due to their incredible potential.  Bitcoin continues to trade at phenomenal values and investments in startups in the Bitcoin industry are escalating.

Digital currencies, whether it is Bitcoin or something else, are on the precipice of going mainstream.  A recent article in the American Banker describes the case for digital currencies well.  The message:  a modern, digital payment system is inevitable.  It has vast potential to make financial transactions more efficient and to eliminate many of the challenges of doing business in a global economy.  The legal and financial communities need to understand how digital currency works.  We need to start asking:  How will this new payment system impact the work we do?

Where to start the discussion?  To understand a crypto-currency, you need to understand the money you use every day.  I am talking about cash, greenbacks, dollar bills, etc.  In the U.S., those bills are Federal Reserve notes.  Federal Reserve notes (and coins) are legal tender.  As legal tender payment by Federal Reserve note extinguishes a debt.^[2]

Bitcoins are not legal tender—not in the U.S. and not anywhere else.  Legal tender status affects how the currency will be treated under the law.  For now, those effects are beyond our discussion.  It’s enough to understand that Bitcoin (and all crypto-currencies except one^[3]) relies on its users each agreeing to opt into Bitcoin as a form of payment.  Unlike the greenback, Bitcoin is not a fiat currency.  A Bitcoin has no value except the value the free market assigns to it.

So how does a crypto-currency work?  There are lots of great technical explanations on the web.  So, I’ll keep my explanation short.  A crypto-currency is a digital medium of exchange.  It’s intended to be digital cash.  Compare this to actual cash.  Cash is a physical medium of exchange.  I physically hand you a dollar and that extinguishes one dollar of debt.  A Federal Reserve note is a piece of paper.  I know what you are thinking…. I use credit cards.  I pay my bills online.  I don’t even use those musty paper bills anymore.  My money is digital.

Those digits in your bank account represent actual paper dollar bills that exist in a vault somewhere.  Those credit cards…credit (obviously) not cash.  There is a complicated body of commercial and banking law that makes a physical payment system work in an e-commerce world.  Complication creates friction.  Friction creates a drag on efficiency.

Bitcoins are not tied to a physical bill or coin.  They are a digital payment system.  Features like near real-time settlement and world-wide transactions are intrinsic.  Processing fees are also less than processing fees for traditional money transfers.  The system is designed for a digital economy.  It reduces the drag on efficiency.

So, what legal dilemmas are on the horizon?  I’d like to hear what questions you have about crypto-currencies.  But, I will get the ball rolling with one dilemma that is on my mind.  Assume you are a bank.  You make a commercial loan to a borrower that accepts Bitcoins as payment for its services.  That borrower will have a lot of value tied up in Bitcoins.  How do you, as a bank, underwrite that value when making your loan?  Are there covenants necessary to limit the Bitcoin exposure?  How do you perfect a security interest in a Bitcoin?  More importantly, can you be certain that you can enforce your security interest in a practical way?

In upcoming posts, I will explore these legal questions and others impacting crypto-currencies.  Remember, I want your help!  Please contact me with your dilemmas, questions, and experiences with Bitcoins or other crypto-currencies.

You can contact me by email at jfleming@bdlaw.us.  Follow me on Twitter @JFWFleming.