Bitcoin seems to be everywhere these days. What was once an esoteric topic discussed only by mathematicians, cryptographers, end-of-the-world doomsday predictors, and the occasional conspiracy theorist has grabbed front-page headlines around the world and become a leading topic presented at financial services industry events. Regulators, journalists, bankers, consultants, and venture capitalists have poured time, money, and energy into understanding what a bitcoin is and trying to determine how the virtual currency fits into the global payments landscape.
The bitcoin payment mechanism emerged in 2008 under extremely mysterious circumstances. The term “bitcoin” was supposedly coined by someone named Satoshi Nakamoto, who wrote a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.” As of this writing, no known individual, organization, agency, or government has ever maintained that it created the bitcoin infrastructure or technology platform. Various theories have been floated, and a few mainstream publications—including The New York Times and Fast Company—have launched serious investigations, but so far no one really knows how bitcoin payments got their start.
The bitcoin currency is entirely digital. Although publications sometimes use photo montages of gold-embossed coins to accompany articles about bitcoins, these are purely mock-ups. Bitcoins do not exist in the physical world; the best way to think of a bitcoin is as a long sequence of data. Individuals who want to make bitcoin-denominated purchases can buy the currency through one of several exchanges, including Bitstamp; Kraken; CampBX; and Mt. Gox, which is the most prominent and popular. Bitcoins’ value fluctuates vis-à-vis the U.S. dollar and other traditional currencies. Users can track exchange rates at sites such as bitcoinexchangerate.org and preev.com. Through most of 2013, the price of a bitcoin has hovered in the $100 to $140 range, but it fluctuated from a low of US$20 in January to around US$220 in April, and it's back up to just over US$240 today.
Owners of bitcoins transact using an open-source, peer-to-peer file-sharing technology that is similar in many ways to the music-sharing Napster technology from the late 1990s. Each bitcoin transaction utilizes cryptography—the mathematical science that goes into keeping communications secure from unwanted third parties—to protect the identity of its owners while ensuring the transaction’s integrity. Each transaction is time-stamped and is permanently recorded in a public ledger called the “blockchain.”
A secondary market for bitcoins is beginning to appear, but it does not yet represent a strong and viable platform for speculation. For people who are technologically challenged, two options for bitcoin investments are the SecondMarket Bitcoin Investment Trust and the Winklevoss Bitcoin Trust—launched this summer by the famous Winklevoss twins, who were involved in the lawsuit against Mark Zuckerberg enshrined in the 2010 film “The Social Network.” These vehicles enable investors to put money into bitcoins without actually directly trading in the currency, in much the same way that an investor might elect to fund a REIT mutual fund rather than buy a piece of real estate directly.
Bitcoins Gain Purchase in the Public Eye
Payments experts tend to think that bitcoin-denominated payments appeal primarily to three groups of people. First are people who believe the virtual currency is a good mechanism for speculation, and that the bitcoin will soon be a highly valuable commodity. Second are people who inherently distrust authority. These individuals find the notion of anonymity appealing and consider bitcoin transactions to be less traceable than deals made in traditional currencies, since bitcoin has no central bank or central banker. Finally, the bitcoin platform appeals to criminals who are trying to cover their tracks—money launderers, terrorists, and the like. In theory, they can avoid scrutiny by any government if they use bitcoin payments to move funds, compensate employees, and initiate other types of transactions. ZDNet has referred to the bitcoin platform as “the world’s largest floating black market.”
In early 2012, the mainstream media and investors began paying a great deal of attention to the potential inherent in bitcoin-based businesses. Venture capital funds in California started funding startups that manage, trade, track, and process bitcoin-denominated payments. With names like Coinbase, Vaurum, Coinsetter, Tradehill, CoinLab, BitInstant, Gliph, Alydian, BitPay, and TruCoin, these various startups remain at the vanguard of the emerging payments mechanism.
At the same time that funding began flowing into the community of bitcoin-related startups, the platform was involved in a number of very public incidents that demonstrated its ability to capture the attention of the mainstream media and the public. Several high-profile renegades began accepting donations from their supporters via bitcoin exchanges. Julian Assange’s WikiLeaks organization has reportedly received nearly $500,000 in bitcoin donations since the late-2010 blockage of donations to WikiLeaks by Bank of America, Visa, MasterCard, PayPal, and Western Union. More recently, the legal fund for Edward Snowden, the alleged U.S. National Security Agency (NSA) leaker, supposedly received $13,000 in bitcoin-based contributions within the first two weeks of its launch.
Then, in September 2013, the U.S. FBI shut down the drug market website called “Silk Road.” In doing so, the agency specified the volume of bitcoin currency that it had seized. This was one of the first investigations to mention bitcoin so explicitly, and the idea of bitcoins as a viable currency for legitimate businesses suffered a bit as a result of the publicity.
It remains to be seen whether virtual currencies will gain widespread acceptance among typical consumers and businesses. However, regulatory bodies in numerous countries are studying them and weighing in on their legitimacy, which indicates that many people believe virtual currencies will remain with us in some form in the future.
What’s a Corporate Treasurer to Do?
Despite the brouhaha that’s arisen when people like the Winklevoss twins have become involved in the market, bitcoins are currently an impractical means of payment for most business-to-business and business-to-consumer transactions. Of the approximately 10 million to 11 million merchants in the United States, the number of legitimate businesses accepting bitcoins for payment remains very small—although it does run the gamut from tourism agencies and restaurants to technology and other business-services firms. Sites such as spendbitcoins.com, bitcoinlocator.com, and usebitcoins.info provide visual maps that show people where they can spend their bitcoins. Qugelmatic Books, Gadgets Direct, and Alpaca Socks all accept bitcoin-denominated payments, as do WordPress, WikiLeaks, Khan Academy, and diasporafoundation.org (the Facebook competitor focused on privacy).
Only time will tell whether bitcoin payments will become ubiquitous in day-to-day transactions around the exchange of legitimate goods and services. It is reasonable to assume that most companies won’t be transacting in virtual currencies for at least another 12 to 18 months. However, as bitcoins grow in popularity (and notoriety), corporate treasury professionals need to keep an eye on the crypto-currency. Having a grasp of the technology, approach, and attitudes of the appropriate regulatory authorities will enable treasurers to perform their jobs more cogently.
Corporate treasurers who think their organization might make or receive bitcoin-denominated payments at some point in the future need, first and foremost, to track what regulators in the jurisdictions in which their company operates are saying about virtual currencies. Around the world, there appears to be very little regulatory consistency. For instance, Thailand and Germany have responded in almost opposite manners.
Thailand has issued guidance that bitcoins should not be used in Thailand, nor in exchange for the Thai baht, until the Bank of Thailand has an opportunity to consult with other relevant regulators and ministries in the Thai government. Tangibly, what this means is that Thai-based bitcoin operators who apply for licenses to serve as exchanges must discontinue their operations until final rules are confirmed. In contrast, the Finance Ministry in Germany opted to formally recognize the bitcoin as what it calls a “unit of account” appropriate for private transactions. This ruling also provides the German tax authorities with the right to tax such accounts for sales on purchases and capital gains on investments; of course, this right to tax assumes that the anonymity issues involved in owning bitcoins can be resolved, which is questionable.
In the United States, the Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a document in March 2013 titled “Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies,” which states that bitcoin operators must register as money services businesses (MSBs) and comply with traditional anti-money laundering regulations. Some states within the U.S. have developed their own bitcoin-related policies or independently undertaken enforcement actions. For example, in May 2013, California’s Department of Financial Institutions sent a cease-and-desist order to the Bitcoin Foundation. Then in August 2013, New York State’s Department of Financial Services subpoenaed 22 companies that deal in bitcoin payments in order to learn more about how that market operates.
In 2004, Eric M. Jackson wrote an excellent book titled The PayPal Wars: Battles with eBay, the Media, the Mafia, and the Rest of Planet Earth. It details the rise—and the many almost-falls—of PayPal in its early days. A few sections describe PayPal’s interactions with specific state regulators. The tales seem almost prescient when it comes to the current bitcoin debates.
Where Will Bitcoins Go From Here?
It’s reasonable to expect bitcoins to remain a fairly marginal financial services instrument for the foreseeable future.
Corporate treasurers who are asked to weigh in on whether their organization should accept virtual currencies such as bitcoins would be wise to take a wait-and-see approach. In the absence of strong market demand, it may not make sense to accept bitcoins and/or bitcoin-denominated transactions until the various legal issues are resolved by both FinCEN and the New York State Department of Financial Services. Treasurers whose organization is moving forward with making or receiving bitcoin-denominated payments need to ensure that their colleagues in risk management and compliance have put in place appropriate controls that will prevent them from getting into trouble with regulatory and law enforcement officials.
Only when regulators have become comfortable with the idea of a virtual currency, and when the public at large is ready to begin making bitcoin payments widely and proudly, will the average corporate treasury team be forced to start engaging in bitcoin-denominated transactions. By then, bitcoin may even have competition. Although bitcoins are currently the most well-known and widely used virtual currency, alternative crypto-currencies such as litecoin and Peercoin are slowly gaining a foothold as well.
Despite the uncertainty, the concept of a virtual currency is intriguing, and it will be fascinating to watch the bitcoin tale unwind over the next few years.
Joram Borenstein is vice president for NICE Actimize. He is a recognized expert in financial crime, anti-fraud, payments protection, consumer identity protection, risk management, IT audit, and compliance who has instructed regulators from the U.S. FDIC, the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), the Federal Reserve, and the National Credit Union Administration (NCUA).