Virtual Currency and the Blockchain

Cause for Caution: Virtual Currency-Related Enforcement Actions

On January 19 the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) issued a joint statement warning about potential enforcement actions involving the offering of digital instruments: “When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws.”[1] In conjunction with this warning, the CFTC brought a number of virtual currency enforcement actions in January, three of which are discussed below. READ MORE

Recent Blockchain Regulatory Developments


Blockchain and distributed ledger technology (“DLT”) applications outside of the bitcoin context are attracting the attention of financial entities, prompting regulators to become increasingly focused on these possible applications.[1]  Recently, for example: (i) potential financial and securities applications of DLT were discussed in depth at a “FinTech Forum” held at the Securities and Exchange Commission (“SEC”); (ii) the Federal Reserve Board published a paper titled “Distributed Ledger Technology in Payments, Clearing, and Settlement”; and (iii) the Financial Industry Regulatory Authority (“FINRA”) published a paper titled “Distributed Ledger Technology: Implications of Blockchain for the Securities Industry.”[2]  Each of these recent developments is discussed in turn below. READ MORE

CFTC Considers Blockchain Technology

The disruptive effects of blockchain technology on the financial system may take several years to materialize. Nevertheless, in preparation, regulators are increasingly focused on understanding potential uses of blockchain technology and considering related legal issues.  Many regulators are already familiar with bitcoin, the popular virtual currency underpinned by blockchain technology.[1]  As discussed below, the bitcoin blockchain, which records and makes publicly available every transaction ever made in that virtual currency, is a “distributed ledger” created by a “consensus algorithm” that ensures that each local copy of the distributed ledger is identical to every other local copy.  It is widely expected that such distributed ledger technology (“DLT”) will be used in the future to track the ownership of financial, legal, physical, electronic, and other types of assets and, as discussed below, to automate the performance of certain contracts.

The CFTC has begun to consider the implications of DLT with respect to the derivatives markets. For example, a meeting of the CFTC Technology Advisory Committee (the “TAC”) on February 23, 2016 featured a panel presentation, titled “Blockchain and the Potential Application of Distributed Ledger Technology to the Derivatives Markets.”[2]  In addition, CFTC Commissioner J. Christopher Giancarlo has recently given numerous speeches on the topic to various groups, including Markit Group and the Depository Trust & Clearing Corporation.[3]  An overview of DLT is provided below, followed by a summary of certain points, including legal considerations, from the TAC meeting and Commissioner Giancarlo’s speeches. READ MORE

Responses to ESMA Call for Evidence on Investment Using Virtual Currency or Distributed Ledger Technology Published

Earlier this year, the European Securities and Markets Authority (“ESMA”) published a “call for evidence [on] investment using virtual currency or distributed ledger technology.”[1]  ESMA established July 21, 2015 as the deadline for market participants and other stakeholders to respond to the call for evidence and to submit feedback and any additional information on the following topics:

  1. virtual currency investment products, i.e., collective investment schemes or derivatives such as options and contracts for differences that have virtual currencies as an underlying or invest in virtual currency related businesses and infrastructure;
  2. virtual currency based assets/securities and asset transfers, i.e., financial assets such as shares, funds, etc. that are exclusively traded using virtual currency distributed ledgers (also known as blockchains); and
  3. the application of the distributed ledger technology to securities/investments, whether inside or outside a virtual currency environment.

Respondents to the call for evidence included various major financial institutions and significant participants in the bitcoin and virtual currency markets.[2] Among other topics, many responses discussed how distributed ledger technology may be used to record ownership of essentially any type of financial asset. Such a distributed ledger could facilitate nearly immediate transactions and settlement. Several responses also addressed “smart contracts,” in which multiple stages of a transaction could be initially encoded and subsequently triggered by external factors. For example, a smart contract could be designed to transfer from one account to another, at a future date, an amount of money determined by the price of a particular security on that date. A trusted data provider could relay that price, when known, to the smart contract, which then would automatically perform the appropriate transfer of money and terminally settle the transaction. More complex contractual mechanisms, including various legal requirements and ISDA standards, could be encoded into a smart contract as well.

[1] The call for evidence (and related responses) is available at:

[2] Respondents included, among others, ABN AMRO Clearing Bank N.V., CFA Institute, CME Group, DBT Labs, Deutsche Bank, Digital Asset Transfer Authority, ECSDA (European Central Securities Depositories Association), Euroclear SA/NV, Intesa Sanpaolo S.p.A., Krypto FIN ry, LedgerX LLC, Lykke Corp, Modular FX Services Limited,, PAYMIUM, SWIFT, and Tradernet Limited.

NYDFS Finalizes BitLicense Regulations

On June 3, 2015, the New York Department of Financial Services (“NYDFS”) released its final BitLicense regulations, which Superintendent Benjamin Lawsky described as “the first comprehensive framework for regulating digital currency firms.”[1]  As previously reported, the NYDFS originally released proposed BitLicense regulations on July 17, 2014.[2]  After receiving thousands of public comments, primarily voicing concern over the possible scope of regulation, the NYDFS made major revisions and released re-proposed BitLicense regulations on February 4, 2015.[3]

The final BitLicense regulations contain relatively few changes to the February 2015 re-proposed version, which we previously summarized.[4]  Such changes include, for example: (i) with respect to the requirement that a licensee obtain the NYDFS’s written approval before offering any materially new product, service, or activity involving New York or New York residents, the final BitLicense regulations added language clarifying the meaning of “materially new product, service, or activity”; (ii) with respect to the requirement that a person seeking to acquire control of a licensee must obtain approval from the NYDFS Superintendent, the final BitLicense regulations added that a person will not be deemed a “control person” solely by reason of being an officer or director; and (iii) with respect to the requirement that a licensee must report to the NYDFS virtual currency transactions exceeding $10,000 in an single day, the final BitLicense regulations clarified that such reporting is required only for virtual currency to virtual currency transactions that are not subject to reporting requirements under federal law.

Generally, the BitLicense regime applies various requirements to persons engaged in specified “Virtual Currency Business Activities.”[5]  These requirements include, but are not limited to: paying a $5,000 application fee and obtaining a license; maintaining capital in an amount and form as the Superintendent determines is sufficient to ensure the financial integrity of the licensee and its ongoing operations based on an assessment of the specific risks applicable to a licensee; protecting customer assets, including maintaining a surety bond or trust account in U.S. dollars for the benefit of licensee customers in such form and amount as is acceptable to the Superintendent; submitting certain periodic reports to the Superintendent; being subject to examination by the Superintendent at least once every two years of the licensee’s financial condition, safety and soundness of its business conduct, management policies, and other matters; and establishing and maintaining written, board-approved compliance policies addressing anti-fraud, anti-money laundering, cyber security, privacy and information security.

Superintendent Lawsky made the following points in announcing the release of the final BitLicense regulations “in order to allay various concerns [the NYDFS] heard during the public comment period”:[6]

  • Companies will not need prior approval for standard software or app updates, but only for material changes to their products or business models. An example of a material change would be if a firm that was licensed as a wallet service decided to begin offering exchange services.
  • The NYDFS intends to regulate only financial intermediaries, not software developers. For example, software developers that do hold customer funds will not be required to apply for a BitLicense.
  • Firms will be able to “cross-satisfy” many of the licensing requirements under BitLicense and the federal money transmitter regulations.
  • Companies that file suspicious activity reports with federal regulators such as the United States Department of the Treasury Financial Crimes Enforcement Network (FinCEN) will not be required to file duplicate reports with the NYDFS.
  • Companies will not need prior approval from the NYDFS for every new round of venture capital funding. Generally, a company will need prior approval only if an investor would become a “control person,” i.e., would direct the management and policies of the company.

The final BitLicense regulations will not take effect until published in the New York State Register. Upon such publication, a person conducting Virtual Currency Business Activity will have a 45-day transitional period to apply for a license, at which point it will be deemed to be in compliance with the BitLicense requirements until notified by the Superintendent that its application has been denied. If a person is so notified by the Superintendent, then it must immediately cease operating in New York and doing business with any New York State Resident.

Various other U.S. states have followed New York’s lead in pursuing virtual currency regulation. Significant state proposals are highlighted below.

In June 2015, the California State Assembly approved a bill that would impose on virtual currency businesses operating in California licensing requirements similar to those under the BitLicense regime. The bill is currently under review by the California Senate. Features of the bill include, among others, a $5,000 licensing fee and capital standards for virtual currency businesses. Similar to BitLicense, the California proposal would not subject firms that use virtual currencies only to buy or sell goods or services to its various requirements.

In May 2015, the Connecticut House of Representatives passed a bill that would allow the Connecticut Banking Department to deny a money transmission license to an otherwise-qualified applicant that has a virtual currency business model, based on potential consumer risks. This bill also includes surety bond requirements for money transmitters in virtual currency that differ from those that ordinarily apply to money transmitters. The bill is now before the Connecticut Senate.

In June 2015, the “Digital Currency Jobs Creation Act” was introduced in the New Jersey Legislature. In addition to imposing requirements relating to cybersecurity, risk disclosure, and recordkeeping, the bill would provide certain tax breaks to digital currency companies in New Jersey. For example, the bill would exempt from New Jersey’s sale and use tax the sale of energy to virtual currency miners. The bill also would allow New Jersey to accept tax payments in bitcoin.

In March 2015, the North Carolina House of Representatives approved a bill that would clarify that virtual currency transmission–except for certain “business-to-business” transmission activity–would require licensing and regulation under the existing North Carolina Money Transmitters Act. The bill is now under review by the North Carolina Senate.

In March 2015, a bill was introduced in the General Assembly of Pennsylvania that would, among other changes, add virtual currencies to the definition of “money” in Pennsylvania’s statute providing for the licensing and regulation of money transmission businesses.

[1] NYDFS Announces Final Bitlicense Framework for Regulating Digital Currency Firms (June 3, 2015) (available at:; New York State Department of Financial Services, New York Codes, Rules and Regulations, Title 23, Chapter 1, Part 200 (June 3, 2015) (available at:

[2] New York State Department of Financial Services, Proposed New York Codes, Rules and Regulations, Title 23, Chapter 1, Part 200 (July 17, 2014) (available at:; previous postings of Derivatives in Review (available here) also reported on Bitcoin developments.

[3]; New York State Department of Financial Services, Proposed New York Codes, Rules and Regulations, Title 23, Chapter 1, Part 200 (February 4, 2015) (available at:

[4] This summary may be found here:

[5] “Virtual Currency Business Activity” is defined as an activity that falls under the BitLicense requirements if it involves New York or a New York Resident.  “New York Resident” means, generally, an individual or entity, however organized, that resides, is located, has a place of business, or is conducting business in New York.

[6] NYDFS Announces Final Bitlicense Framework for Regulating Digital Currency Firms (June 3, 2015) (available at:

NYDFS Releases Revised BitLicense Proposal

On February 4, 2015, the New York State Department of Financial Services (“NYDFS”) released a revised version of its proposed virtual currency regulations (commonly referred to as “BitLicense”), originally released in July 2014. Nearly 4,000 formal comment letters were submitted by advocacy groups, financial service providers, law firms, individuals and others on the original proposal.  A 30-day public comment period began upon publication of the revised proposal in the New York State Register on February 25, 2015.  Section I below summarizes significant changes that the revised version of the BitLicense proposal made to the original, and Section II provides an outline of the overall proposed BitLicense regime, as amended.

  1. Revisions to the Original BitLicense Proposal

The revised BitLicense proposal includes several significant changes to the original.  As expected, several of these revisions are designed to accommodate startups or other small companies operating, or wishing to operate, in the virtual currency space.  Specifically, the NYDFS superintendent (the “Superintendent”) may grant a conditional license to an applicant that is not in full compliance with the BitLicense requirements.  In issuing a conditional license, the Superintendent may impose upon an applicant any reasonable conditions that the Superintendent determines.  A conditional license will expire two years after issuance, unless the Superintendent either removes its conditional status or renews it.  In determining whether to issue, renew or remove the conditional status of, or impose or remove any specific conditions on, a conditional license, the Superintendent may consider any relevant factors, including without limitation:  the nature, scope and anticipated volume of the applicant’s or licensee’s business, and the nature and scope of the risks that the applicant’s or licensee’s business presents to consumers, virtual currency markets, financial markets and the general public; registration of the applicant or licensee with the United States Department of the Treasury Financial Crimes Enforcement Network (FinCEN); licensing, registration, or other authorization of the applicant or licensee by any governmental or self-regulatory authority to engage in financial services or other business activities; the applicant’s or licensee’s financial services or other business experience; and the licensee’s history as a holder of a conditional license.

NYDFS clarified or provided additional guidance on several additional points in the revised BitLicense proposal, including the following:

  • Software development and dissemination, in and of itself, does not constitute “Virtual Currency Business Activity,” i.e., an activity that falls under the BitLicense requirements if it involves New York or a New York Resident;[1]
  • Transmission of virtual currency for non-financial purposes that involves only nominal amounts also does not constitute Virtual Currency Business Activity;
  • Merchants and consumers utilizing virtual currency solely for investment purposes were included in the exemption from the BitLicense requirements originally available only to merchants and consumers utilizing virtual currency solely for the purchase or sale of goods or services;
  • A licensee may seek clarification from NYDFS regarding the materiality of any proposed change to an existing product, service, or activity involving New York or New York residents prior to making that change;
  • $5,000 is specified as the BitLicense application fee;
  • The books and records of licensees must be preserved in their original form or native file format for seven years, rather than ten years;
  • The capital requirements have been somewhat relaxed such that a licensee may hold required capital “in the form of cash, virtual currency, or high-quality, highly liquid, investment-grade assets, in such proportions as are acceptable to the [NYDFS] superintendent;”[2] and
  • Background reports are required only for employees of an applicant who have access to customer funds, rather than for all employees.

II. Outline of the BitLicense Regime

The BitLicense regime, as currently proposed, would apply various requirements to persons engaged in any of the following Virtual Currency Business Activities: (i) receiving virtual currency for transmission or transmitting virtual currency (except where the transaction is undertaken for non-financial purposes and does not involve the transfer of more than a nominal amount of virtual currency), (ii) storing, holding or maintaining custody or control of virtual currency on behalf of others; (iii) buying and selling virtual currency as a customer business; (iv) converting or exchanging virtual currency as a service; or (v) controlling, administering or issuing a virtual currency. Merchants and consumers utilizing virtual currency solely for the purchase or sale of goods or services or for investment purposes are specifically excluded. Requirements applicable to persons conducting Virtual Currency Business Activities include the following:

  • obtaining a license from NYDFS;
  • payment of a $5,000 BitLicense application fee;
  • submission to NYDFS of voluminous information related to the applicant, such as biographical information and background reports for the applicant’s principal officers, principal stockholders, principal beneficiaries, and employees with access to customer funds; organizational charts and financial statements; details of banking arrangements; and other items;
  • designating a qualified individual (or individuals) as a compliance officer;
  • maintaining written, board-approved compliance policies addressing anti-fraud, anti-money laundering, cyber security, privacy and information security, and other requirements;
  • capital requirements in an amount and form as the Superintendent determines is sufficient to ensure the financial integrity of the licensee and its ongoing operations based on an assessment of the specific risks applicable to a licensee;
  • protecting customer assets, including maintaining a surety bond or trust account in U.S. dollars for the benefit of licensee customers in such form and amount as is acceptable to the Superintendent;
  • obtaining prior written approval from the Superintendent before introducing or offering a new, or making a material change in an existing, product, service, or activity involving New York or New York residents;
  • obtaining prior written approval from the Superintendent before taking any action that may result in a merger or acquisition of all or substantially all or a substantial part of the assets of a licensee;
  • maintaining certain books and records, including but not limited to a general ledger meeting certain specifications and records of the names and addresses of the parties to each transaction that are customers or accountholders of the licensee and, “to the extent practicable,”[3] those that are not customers or accountholders;
  • examination by the Superintendent at least once every two years of the licensee’s financial condition, safety and soundness of its business conduct, management policies, and other matters;
  • periodic submission to the Superintendent of certain reports and financial disclosures, including quarterly and audited annual financial statements;
  • establishing and maintaining the following programs, in each case satisfying various specifications: (i) anti-money laundering based on the legal, compliance, financial, and reputational risks associated with the licensee’s activities, services, customers and counterparties, and geographic location; (ii) cyber-security to ensure the availability and functionality of the licensee’s electronic systems and to protect those systems and any sensitive data stored on those systems from unauthorized access, use, or tampering; and (iii) business continuity and disaster recovery to ensure the availability and functionality of the licensee’s services in the event of an emergency or other disruption to its normal business activities;
  • certain restrictions relating to advertising and marketing, including that advertisements must include a legend that the licensee is “Licensed to engage in Virtual Currency Business Activity by the New York State Department of Financial Services”;
  • disclosure to customers of various virtual currency-related material risks and terms and conditions; and
  • establishing and maintaining written policies and procedures to fairly and timely resolve complaints. 

A person conducting Virtual Currency Business Activities at the time the BitLicense requirements take effect would have a 45-day transitional period to apply for a license, at which point it will be deemed to be in compliance with the BitLicense requirements until notified by the Superintendent that its application has been denied. If a person is so notified by the Superintendent, then it must immediately cease operating in New York and doing business with New York State Residents.[4]

[1] “New York Resident” is defined to mean, generally, an individual or entity (however organized) that resides, is located, has a place of business, or is conducting business in New York.

[2] In the original BitLicense proposal, each licensee was “permitted to invest its retained earnings and profits in only the following high-quality, highly liquid, investment-grade permissible investments with maturities of up to one year and denominated in United States dollars: certificates of deposit issued by financial institutions that are regulated by a United States federal or state regulatory agency, money market funds, state or municipal bonds, United States government securities, or United States government agency securities.”  New York State Department of Financial Services, Proposed New York Codes, Rules and Regulations, Title 23, Chapter 1, Part 200, Section 200.8(b) (July 17, 2014) (available at:

[3] New York State Department of Financial Services, Proposed New York Codes, Rules and Regulations, Title 23, Chapter 1, Part 200, Section 200.12(a) (February 4, 2015) (available at:

[4] New York State Department of Financial Services, Proposed New York Codes, Rules and Regulations, Title 23, Chapter 1, Part 200, Section 200.21 (February 4, 2015) (available at:

The Bitcoin Marketplace and Regulatory Environment: An Overview


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]

       1.  The Bitcoin Marketplace

Bitcoin derivatives

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. 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.[2]

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,, 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.[3] 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.”[4] 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.”[5]

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”).[6] 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.[7] 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.[8] 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.[9]

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.[10] 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.[11] 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.

Foreign jurisdictions

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.

[1] A previous posting in Derivatives in Review (available here) also reported on bitcoin developments.

[2] Winklevoss Twins: Bitcoin Trust Is Alive and Well, Bloomberg TV, November 4, 2014 (available at:

[3] 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:

[4] Testimony of Chairman Timothy Massad before the U.S. Senate Committee on Agriculture, Nutrition & Forestry, December 10, 2014 (available at: (emphasis added).

[5] Michael J. Casey, CFTC Commissioner Says Agency Has Authority Over Bitcoin Price Manipulation, Wall Street Journal, November 17, 2014 (available at:

[6] 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.

[7] 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).

[8] Internal Revenue Service, Notice 2014-21 (available at:

[9] Consumer Financial Protection Bureau, Consumer Advisory, Risks to Consumers Posed by Virtual Currencies, August 2014 (available at:

[10] 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:–%20Dec.%2016%202014.pdf).

[11] 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.

Bitcoin: The Virtual Currency Market Emerges


Bitcoin is a “virtual” currency that was developed in 2008 and has gained increased acceptance as a form of payment and as a recognized asset in currency exchange markets, as reflected by the granting in 2013 of “XBT” as its ISO currency code.  Alternative virtual currencies also have been established, but none has approached the popularity of bitcoin.

The founder (or, perhaps, founders) of bitcoin used the pseudonym of “Satoshi Nakamoto” and remains unknown, although certain news sources recently claimed to have identified him.  However, this founder was present on bitcoin blogs for some time, where he articulated that bitcoin was intended to be immune from the possibility of corruption by governments, central banks and other third parties because such entities would not be empowered to directly affect the issuance or exchange of the currency.  Instead, as further described below, bitcoin is a decentralized, peer-to-peer digital-payments system.  The Bitcoin Foundation, an advocacy group, “standardizes, protects and promotes” the use of bitcoin.  It has been primarily funded by grants from for-profit companies that depend on bitcoin, such as CoinLab (an investor in new technologies and business in the bitcoin marketplace), Mt. Gox (formerly a bitcoin exchange based in Tokyo) and BitInstant (formerly a means to rapidly pay traditional funds to bitcoin exchanges).  The latter two companies are now defunct.

Similar to traditional currencies, bitcoin is accepted by an increasing number of merchants and others.  For example, began accepting bitcoin on January 9, 2014 and expects bitcoin sales to reach between $10 million and $15 million this year.  Also, similar to traditional currencies, bitcoin may be traded in the currency markets; the current USD/XBT exchange rate is approximately 0.0017.  Significantly, spikes in that exchange rate sometimes have coincided with insecurity about traditional currencies.  For example, when the Cypriot government announced in March 2013 that citizens would be assessed a 6.75% tax on bank deposits in response to the banking crisis, the value of bitcoin rose abruptly and substantially; it has been suggested that this spike was caused, at least in part, by citizens of other struggling nations desperate for safekeeping of their savings.

There are currently some 12 million bitcoins in (virtual) circulation, worth over US$7.2 billion.  Through the use of “public key cryptography,” each bitcoin user is assigned a private key and a public key (also known as a “bitcoin address”).  When a user transfers bitcoins to another user’s virtual “wallet,” a transaction message is created that contains both users’ public keys but is “signed” using the transferring user’s private key.  The transaction, including the two public keys, is recorded in a “block chain,” which is publicly viewable.  Because the public keys are not tied to anyone’s identity, however, the block chain allows for a certain degree of anonymity.  Meanwhile, the use of private keys, of course, helps protect against theft and fraud.

A process known as “mining” causes both bitcoins to be generated and transactions to be validated.  Generally, a peer-to-peer network of some twenty thousand independent nodes—i.e., very powerful and expensive computer systems—act as virtual “miners,” competing to find sequences of data (referred to as “blocks”) within a complex mathematical problem.  As noted above, all transactions in bitcoin are publicly viewable in a universal ledger called the block chain; a transaction can be added to the block chain only if a miner certifies it by including a block (again, a sequence of data that has been found in the complex mathematical problem).  Thus, every ten minutes, miners attempt to use their blocks to add recently-broadcast proposed transactions to the block chain for a reward consisting of a certain number of bitcoins as well as an additional transaction fee.  Authentication by the miners is critical to the legitimacy and integrity of the system and, among other things, prevents double-spending of the same bitcoin.

Since bitcoin’s development, computer systems with ever-increasing power have been engaged in mining, as the more powerful systems are better equipped to be the first to solve the mathematical problem and, of course, win the bitcoins reward.  As bitcoins are mined, the difficulty of the math problem is increased while the amount of the reward is reduced.

Unlike typical currencies, bitcoin is completely independent of any national or trading block central bank or system, such as the Federal Reserve System in the United States or the European Central Bank.  This means that, among other things, bitcoins are not “printed” or generated by a government or central bank and they are not directly impacted by the actions of such an entity (for example, a decision to print more currency).  As the Financial Crimes Enforcement Network of the United States Treasury Department (“FinCen”) has stated: “In contrast to real currency, ‘virtual’ currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency.  In particular, virtual currency does not have legal tender status in any jurisdiction.”[1]

Nevertheless, global financial regulators have begun implementing measures that are intended to curb the use of virtual currency for money laundering and other criminal activities and, to some extent, regulate the virtual currency market.  For example, in March 2013, FinCen issued guidance clarifying that “the definition of a money transmitter does not differentiate between real currencies and convertible virtual currencies.  Accepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under the regulations implementing the [Bank Secrecy Act].”[2]  In addition, in May 2013, the Government Accountability Office published a report to the U.S. Senate Finance Committee stating that income earned by trading virtual currencies is taxable.[3]  More recently, the CFTC announced in March 2014 that it is studying whether it should use its anti-manipulation authority to regulate virtual currencies such as bitcoin, and also whether derivatives contracts based on bitcoin should come under regulation.  In her testimony before the Senate Banking Committee on February 27, U.S. Federal Reserve Chair Janet Yellen added: “The Fed does not have authority with respect to Bitcoin . . . but certainly it would be appropriate for Congress to ask questions about what the right legal structure would be for digital currencies.”[4]  Moreover, Russian authorities recently issued warnings against using Bitcoin, stating that the virtual currency could be used for money laundering or financing terrorism and that treating it as a parallel currency is illegal.[5]  In December, the People’s Bank of China decreed that merchants may not accept bitcoin and forbade banks and payment processors from converting bitcoin into yuan.[6]  Promptly thereafter the price of bitcoin fell below US$500 per bitcoin.

Further, on January 27, the Manhattan U.S. Attorney announced charges against the CEO of a bitcoin exchange company and a co-conspirator for engaging in a scheme to sell over $1 million in bitcoins to users of “Silk Road,” an underground website that enabled users to buy and sell illegal drugs anonymously.[7]  On March 11, the New York State Department of Financial Services announced that it would begin considering proposals and applications for virtual currency exchanges based in New York and expected, by the end of the second quarter, to propose guidance on the regulation of virtual currencies.[8]

The maximum number of bitcoins is set at 21 million, with the final mining projected to occur in 2140.  After the final bitcoin is mined, it is contemplated that the transaction fees described above will continue to motivate miners to verify transactions.  The very limited supply of bitcoins is viewed by some as protection from inflation.

Bitcoin has experienced crises and bouts of high volatility during its brief existence.  For example, in June 2011, hackers caused the price of bitcoin on Mt. Gox, then the most popular exchange, to nearly collapse within minutes.  In recent weeks, Mt. Gox filed for bankruptcy after revealing that almost $500 million in bitcoins stored by the exchange had been stolen, apparently by hackers.

The financial community continues to debate the potential of bitcoin, with some questioning its sustainability and others suggesting it could have the potential not only to compete with traditional money-transfer services for remittances, but also to compete with gold as an asset for investors to store value.  (Of course, unlike gold, the uses of which span jewelry, medicine and electronics, bitcoins are “virtual” and do not have alternative uses.)

Investments in bitcoin can be made in several ways, in addition to sourcing the bitcoins through mining.  First, an investor could purchase bitcoins outright from one of several websites located globally.  Such a purchase could have resulted in an enormous payoff for speculators in 2013, as bitcoin values began at around US$14 per bitcoin and reached a high in November 2013 of around US$980 per bitcoin.[9]  However, this wide differential also evidences the extreme volatility of bitcoin, at least at this stage of its existence.

In addition to direct purchases, in the future investors may gain exposure to the bitcoin asset class through public investment vehicles.  For example, the Winklevoss Bitcoin Trust (Trust) has filed a registration statement (not yet effective) with the Securities and Exchange Commission to issue Winklevoss Bitcoin Shares (Shares), which will represent units of fractional undivided beneficial interest in and ownership of the Trust whose purpose is to hold bitcoins.  Also, the Bitcoin Investment Trust by SecondMark is an open-ended private trust that invests only in bitcoin, but is not publicly traded.  Moreover, Fortress Investment Group, Pantera Capital and two venture capital firms together are creating a fund for investments focused on virtual currencies, which will be known as Pantera Bitcoin Partners LLC.

Besides funds and ETFs, derivatives based on bitcoin are beginning to develop.  For example, ICBIT, a bitcoin exchange based in Russia[10], has introduced a market in futures contracts on the USD/XBT rate.  Predictious, an Ireland-based prediction market, offers an option spread market in bitcoin, where users may speculate that the price of bitcoin will be above or below certain thresholds at specified future dates.  Using, a bitcoin trading platform based in Singapore and London[11], customers can short bitcoin and may use bitcoin to open leveraged positions, allowing them to profit from small market movements.

[1] Financial Crimes Enforcement Network of the United States Treasury Department, Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies, FIN-2013-G001 (March 18, 2013).

[2] Id.

[3] See Government Accountability Office, Report to the Committee on Finance, U.S. Senate, Virtual Economies and Currencies:  Additional IRS Guidance Could Reduce Tax Compliance, GAO-13-516 (May 2013).

[4] Semiannual Monetary Policy Report to the Congress: Hearing Before the S. Comm. on Banking, Housing, and Urban Affairs.

[5] For example, according to Reuters, the Russian Prosecutor General’s Office stated on February 6, 2014: “Systems for anonymous payments and cyber currencies that have gained considerable circulation – including the most well-known, Bitcoin – are money substitutes and cannot be used by individuals or legal entities.” Russian Authorities Say Bitcoin Illegal, Reuters, February 9, 2014 (available at:

[6] See, e.g., Gerry Mullany, China Restricts Banks’ Use of Bitcoin, New York Times, December 5, 2013 (available at:

[7] See Press Release, the United States District Attorney’s Office, Southern District of New York, Manhattan U.S. Attorney Announces Charges Against Bitcoin Exchangers, Including CEO of Bitcoin Exchange Company, for Scheme to Sell and Launder Over $1 Million in Bitcoins Related to Silk Road Drug Trafficking, January 27, 2014 (available at:

[8] See, e.g., Saumya Vaishampayan, New York Opens Door to Regulated Bitcoin Exchanges,, March 11, 2014 (available at:

[9] As of the date of this publication, values are around US$615 per bitcoin.

[10] This trading platform may be accessed at

[11] This trading platform may be accessed at