In the fourth quarter of 2014, bitcoin’s volatile price generally fluctuated between $300 and $400, about one-third of its all-time peak of around $1,200 from one year before. Despite this price drop during 2014, startup companies and financial products focused on bitcoin continue to burgeon, and, in turn, various regulators have recently proposed regulations, made pronouncements, and taken enforcement actions related to bitcoin. Section I below outlines significant companies and products in the bitcoin space, and Section II summarizes the state of bitcoin regulation.
1. The Bitcoin Marketplace
A number of companies currently offer bitcoin derivatives. However, TeraExchange has launched the first CFTC-regulated swap execution facility (“SEF”) for bitcoin swaps. Specifically, TeraExchange allows users to trade “TeraExchange bitcoin forwards,” U.S. dollar-denominated bitcoin currency forwards. A proprietary bitcoin price index developed by TeraExchange, the “Tera Bitcoin Price Index,” underlays these swaps. Parties to a swap calculate the U.S. dollar-denominated settlement payment on the settlement date based on the difference between the contracted rate agreed to on the trade date and the prevailing Tera Bitcoin Price Index at the time of settlement on an agreed notional amount. The swap is not centrally cleared.
TeraExchange self-certified the swap with the CFTC pursuant to CFTC regulation 40.2(a). The contract qualifies as a “swap,” as defined under the Commodity Exchange Act, as amended (“CEA”) and, therefore, is available only to “eligible contract participants” (i.e., a financial institution, an insurance company, commodity pool, or other entity based upon its regulated status or the amount it invests on a discretionary basis) that are permitted to enter into swaps off-exchange. Additionally, LedgerX, a startup backed by Google Ventures, has applied for registration with the CFTC as both a “swap execution facility” and a “derivatives clearing organization” (i.e., a clearinghouse) that will list physically-settled bitcoin (and other digital currency) option contracts. The CFTC recently opened a public comment period for that application.
Several other companies currently offer bitcoin derivatives. For example, ICBIT facilitates the trading of bitcoin options and futures, providing margin with upper and lower limits similar to a traditional futures exchange. Although labeled as “futures,” such contracts physically settle in bitcoins. OKCoin offers bitcoin futures for U.S. dollars. BTC Oracle and Trade Rush each offer bitcoin binary options as a broker. Bitfinix offers total return swaps in which one party exchanges an interest rate to obtain synthetic exposure to the return of bitcoin. BTC.sx offers bitcoin-denominated margin trading.
Separately, the Winklevoss Bitcoin Trust ETF remains under review by the SEC. Notably, in early 2014 the Winklevoss entrepreneurs also launched a bitcoin price index, Winklevoss Index (also known as WinkDex), on which the ETF will be based. The Winklevoss Index is calculated by blending the trading prices in U.S. dollars for the top three (by volume) qualified bitcoin exchanges through a proprietary formula. Tyler Winklevoss, one of the entrepreneurs behind the ETF, recently suggested that the launch remains on-track.
Other bitcoin companies
Bitcoin startups are operating in many areas in addition to bitcoin derivatives. For example, significant bitcoin payment processors (i.e., generally, companies that process bitcoin payments to enable merchants to accept bitcoin), include, among others, BitPay, Coinbase and GoCoin, each of which has been integrated into PayPal. Bitcoin startups also include: bitcoin exchanges; bitcoin mining operations; companies offering bitcoin wallet, payment, and exchange services; bitcoin business incubators; messaging applications that allow users to send bitcoins; bitcoin debit cards; and others.
Large, major retailers and other companies currently accepting bitcoin in some capacity include Dell, Dish Network, EBay, Expedia.com, Microsoft, Overstock, and Zynga.
Other virtual currencies
Many other virtual currencies exist, which eventually may compete to overtake bitcoin for market dominance. For example, “ripple,” which has substantially appreciated over 2014, currently has a market capitalization of around 15% of that of bitcoin. “Litecoin,” which, like bitcoin, has substantially depreciated during the past year, currently has a market capitalization of about 2% of that of bitcoin. Many of the regulations and pronouncements discussed in Section II below would apply not only to bitcoin but also to other virtual currencies.
2. Bitcoin Regulation
New York’s “BitLicense” proposal
The New York Department of Financial Services (“NYDFS”) published proposed “BitLicense” regulations in July 2014. The comment period has concluded but the proposed regulations have not yet been finalized. Under the proposed regulations, licensing is required of businesses engaging in (i) bitcoin (or other virtual currency) activities, such a performing retail conversion services or holding bitcoin on behalf of others (but excluding merchants or consumers using bitcoin solely for the purchase or sale of goods or services), (ii) with New York customers or otherwise operating in New York. Requirements under the proposed BitLicense regulations span the following areas: BitLicense application and revocation, consumer protections, safeguarding assets, cyber-security programs, anti-money laundering, and exams, reports and oversight.
Based on the comments received and industry feedback, NYDFS Superintendent Benjamin Lawsky recently suggested that the NYDFS may offer a “transitional” BitLicense, with lighter regulatory requirements for startup companies. He also indicated that the regulations might be finalized by early 2015.
Commodity Futures Trading Commission (the “CFTC”)
The CFTC has regulatory responsibility over bitcoin derivatives to the extent that bitcoin constitutes a “commodity” under the CEA. The CFTC has not yet made a formal determination in this regard, but, among other statements by CFTC officials, Chairman Timothy Massad recently stated the following in testimony before the U.S. Senate Committee on Agriculture, Nutrition & Forestry: “The CFTC’s jurisdiction with respect to virtual currencies will depend on the facts and circumstances pertaining to any particular activity in question. . . . [However,] the agency’s authority extends to futures and swaps contracts in any commodity. . . . Derivative contracts based on a virtual currency represent one area within our responsibility.” He then cited the CFTC’s recent approval of the TeraExchange SEF, discussed above.
Bitcoin appears very likely to constitute a commodity, and so, the CFTC should have regulation over bitcoin derivatives just as it does over other kinds of commodity derivatives. Accordingly, bitcoin swaps would be subject to the various requirements under Title VII of the Dodd-Frank Act, including, among others, reporting and recordkeeping, business conduct standards, margin requirements, and, if eventually mandated by the CFTC, central clearing and exchange trading requirements. Additionally, bitcoin swap trading generally would only be available to eligible contract participants, and exchanges and clearinghouses involved in bitcoin swaps would be subject to applicable CFTC regulations.
Significantly, the CFTC also generally has authority over price manipulation of futures, swaps and cash commodities. Certain individuals are believed to hold large portions of the entire existing supply of bitcoins, leading to concern that they could manipulate or otherwise cause extreme, sudden movements in the bitcoin price. Depending on the extent to which such individuals dominate the bitcoin supply and whether such power has caused, and was intended to cause, an artificial price, the CFTC could potentially regulate this market risk. In this regard, Commissioner Mark Wetjen has stated that bitcoin’s apparent status as a commodity “gives [the CFTC] authority to bring enforcement against any type of manipulation.”
Financial Crimes Enforcement Network (“FinCEN”)
FinCEN, a bureau of the U.S. Treasury Department, has issued guidance providing that virtual currency “exchangers” and “administrators” may be subject to its regulations governing money services businesses (“MSBs”). Such regulations impose registration, know-your-customer, risk mitigation, recordkeeping, transactional monitoring, reporting, and other requirements. The same guidance confirmed that virtual currency users are not MSBs.
Securities and Exchange Commission (the “SEC”)
The SEC’s authority over securities offerings and public companies includes virtual currency-related securities. For example, as discussed above, the SEC is currently reviewing the Winklevoss Bitcoin ETF. Additionally, the SEC’s enforcement authority likely extends to fraud involving virtual currency-related securities transactions. The SEC also may regulate registered broker-dealers accepting or holding virtual currencies, as well as investment advisers recommending virtual currencies or virtual-currency-related securities.
Internal Revenue Service (the “IRS”)
In March 2014, the IRS released guidance stating that bitcoin (and other virtual currencies) should be treated as property, rather than currency. As a result, the long-term capital gains rate would apply to bitcoins held for more than a year. Moreover, technically, purchases of goods or services with bitcoin would constitute a taxable disposition of the bitcoins. If the IRS had, instead, treated bitcoin as currency, then the ordinary income rate would have applied to any foreign currency gains. With respect to bitcoin mining, the fair market value of bitcoins on the date of their receipt is generally includible in gross income.
Consumer Financial Protection Bureau (the “CFPB”)
The CFPB, which has broad consumer protection responsibilities over various consumer financial products and services, including taking deposits and transferring money, issued in August 2014 a consumer advisory warning of risks to consumers posed by virtual currencies.
Prudential banking regulators
The prudential banking regulators (i.e., the Federal Deposit Insurance Corporation, the Federal Reserve, the National Credit Union Administration and the Office of the Comptroller of the Currency) are responsible for providing guidance and oversight ensuring that depository institutions with accounts for virtual currency exchanges or other MSBs have adequate anti-money-laundering controls for those accounts.
Conference of State Bank Supervisors (the “CSBS”)
On December 16, 2014, the CSBS issued a “Draft Model Regulatory Framework” for state virtual currency regulatory regimes and requested public comment. The CSBS stated that the model framework is intended to promote consumer protection, anti-money laundering protections and data security among virtual currency companies.
Law enforcement agencies
Law enforcement agencies, including the Department of Homeland Security and the Department of Justice, have taken enforcement actions in numerous cases involving bitcoin. Most notably, in 2013 and 2014, U.S. and foreign agencies took actions against “Silk Road,” a black market website that accepted bitcoin. Also, in May 2013, U.S. agencies seized the accounts of a U.S.-based subsidiary of Mt. Gox, a former virtual currency exchange based in Tokyo, for operating an unlicensed money services business. Moreover, in April 2013, U.S. agencies filed a civil asset forfeiture complaint against Tcash Ads Inc., an online payment processor that enabled users to make purchases anonymously from virtual currency exchanges, for operating an unlicensed money services business.
Various foreign regulators, including those in Europe, Canada and Australia, have made pronouncements regarding bitcoin. Additionally, a number of foreign countries appear to have substantially restricted—or outright banned—bitcoin transactions. These include, among others, Bangladesh, Bolivia, Ecuador, Kyrgyzstan and Ukraine. Moreover, financial institutions in China are prohibited from handling bitcoin transactions, and Russia is considering fining bitcoin users.
 A previous posting in Derivatives in Review (available here) also reported on bitcoin developments.
 Winklevoss Twins: Bitcoin Trust Is Alive and Well, Bloomberg TV, November 4, 2014 (available at: http://www.bloomberg.com/video/winklevoss-twins-bitcoin-trust-is-alive-and-well-SracRWQuQ~GqLdGsFEU84w.html).
 New York State Department of Financial Services, Proposed New York Codes, Rules and Regulations, Title 23 Department of Financial Services, Chapter I Regulations of the Superintendent of Financial Services, Part 200 Virtual Currencies (available at: http://www.dfs.ny.gov/about/press2014/pr1407171-vc.pdf).
 Testimony of Chairman Timothy Massad before the U.S. Senate Committee on Agriculture, Nutrition & Forestry, December 10, 2014 (available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-6) (emphasis added).
 Michael J. Casey, CFTC Commissioner Says Agency Has Authority Over Bitcoin Price Manipulation, Wall Street Journal, November 17, 2014 (available at: http://www.wsj.com/articles/cftc-commissioner-says-agency-has-authority-over-bitcoin-price-manipulation-1416265016?mobile=y).
 FinCEN, Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies, FIN-2013-G001, March 18, 2013. An “exchanger” is defined as a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency. Id. An “administrator” is defined as a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency. Id. An administrator or exchanger that (1) accepts and transmits a convertible virtual currency, or (2) buys or sells convertible virtual currency for any reason is a “money transmitter” potentially subject to FinCEN’s regulations for MSBs. Id. “Convertible” virtual currency means a type either having an equivalent value in real currency or that acts as a substitute for real currency.
 See, e.g., Securities and Exchange Commission v. Shaver et al., No. 4:13 CV 416 (E.D. Tx. 2014) (holding that bitcoin is “money” and that a scheme involving bitcoin investment can be considered to be a security under the Securities Act of 1933).
 Internal Revenue Service, Notice 2014-21 (available at: http://www.irs.gov/pub/irs-drop/n-14-21.pdf).
 Consumer Financial Protection Bureau, Consumer Advisory, Risks to Consumers Posed by Virtual Currencies, August 2014 (available at: http://files.consumerfinance.gov/f/201408_cfpb_consumer-advisory_virtual-currencies.pdf).
 Conference of State Bank Supervisors, State Regulatory Requirements for Virtual Currency Activities, CSBS Draft Model Regulatory Framework and Request for Public Comment, December 16, 2014 (available at: http://www.csbs.org/regulatory/ep/Documents/CSBS%20Draft%20Model%20Regulatory%20Framework%20for%20Virtual%20Currency%20Proposal%20–%20Dec.%2016%202014.pdf).
 Mt. Gox was a Tokyo-based bitcoin exchange that in 2013 was handling about 70% of all bitcoin trading. The company filed for bankruptcy in early 2014 and announced that 850,000 bitcoins, valued at almost $500 million, had gone missing.