Bitcoin miners and the Financial Crimes Enforcement Network (FinCEN)

FinCEN recently issued a letter in which they clarified some of the requirements for Bitcoin miners. The full text of the administrative ruling is available at and concerns the activity of Atlantic City Bitcoin LLC. The Twitterverse has been very active but much of the pronouncements have been of the form “FinCEN says miners don’t need to register.” This is not what they said.

To be sure the ruling is clear as mud, as these things usually are. From the letter:

“The guidance makes clear that an administrator or exchanger of convertible virtual currencies that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency in exchange for currency of legal tender or another convertible virtual currency for any reason [Emphasis added] (including when intermediating between a user and a seller of goods or services the user is purchasing on the user’s behalf) is a money transmitter under FinCEN’s regulations, unless a limitation to or exemption from the definition applies to the person.”

In response to the letter, FinCEN said that it was okay to exchange convertible virtual currency (aka #bitcoin) into legal tender currency (aka USD) “so long as the user is undertaking the transaction solely for the user’s own purposes and not as a business service performed for the benefit of another.”

In other words, if you mine bitcoin and then sell it on an exchange to buy a Ferrari (because you can only buy a Lamborghini with bitcoin), then you’re golden. So, at what point are you performing a business service and not selling the bitcoin for your “own purpose?” After all, any business has expenses to pay and dividends to distribute to the owners of the business. Would selling all your bitcoin and then paying all your vendors and owners in USD mean your performing a business service or mean your doing it for your own purposes?”  I would take this to mean that if you mine bitcoin and turn around and regularly sell those bitcoin to a third party or parties for legal tender currency, you’re probably operating it as a business service. Clear right?

Again from the guidance it says “By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter.”

The bottom line is the hobbyist miner who spends his bitcoin for goods or services is probably in the clear, whereas a large enterprise (as most mining operations are moving towards) that is earning so much bitcoin every day that it has to sell them wholesale is probably an MSB.

Interestingly enough, FinCEN has NOT addressed the other function of miners and something that will be prevalent after 2140 when the last bitcoin is mine and that is signing transactions on the blockchain. In essence they are vouching that the transaction from address 1 to address 2 is a valid transaction and should be acknowledge in the collective bitcoin blockchain. They are (potentially) facilitating the transfer of value from one person (or location) to another. I don’t think this falls within the letter of the regulatory structure, but it is certainly something that will receive closer scrutiny and could be addressed in future changes to the laws and regulations.






Why bitcoin would benefit from the shutting down of every exchange…..

Bitcoin has had a meteoric rise in the last few weeks following intensive press coverage and activity from investors and startups in the Bitcoin space. However, most of this activity is fueled by speculative actions on the value of Bitcoin. Practically none of it is by virtue of the actual use of Bitcoin as a medium of exchange. As I’ve written before, the primary beneficial use of Bitcoin is as a medium of exchange, not a store of value. The recent activity is reminiscent of the Dutch tulip mania of the early to mid 1600’s.

The easy of exchanging Bitcoin for fiat currency is the cause of this. As long as people can transfer in and out of the currency with ease, the tendency will be for people to hoard it because it’s value against other currencies will be more than it’s value as a medium of exchange. If the exchanges were shut down (voluntarily or by government action) then Bitcoin will shine and people will actually spend it and use it as it is meant to be used. Then it’s true “value” will be determined, not by some mythical exchange rate but by what people are actually willing to accept it for in exchange for the goods and services they produce.

Casascius coins and the FinCen Letter reported today that the owner of Casascius received a letter from the FinCen (the United States Financial Crimes Enforcement Network) that essentially stated that the service he operated was a Money Services Business (MSB), specifically a money transmitter,  and he had failed to register as required of MSBs. Images of Casascius’s coins have become to the visual representation of Bitcoin, owing to the otherwise difficult situation in visualizing the virtual currency. Casascius’s decision to shutdown the service in light of the letter represents a high profile shuttering of a Bitcoin based business.

Title 31 Section 1010.0100(ff)(5) defines a money transmitter as:

(5) Money transmitter—(i) In general. (A) A person that provides money transmission services. The term “money transmission services” means the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means. “Any means” includes, but is not limited to, through a financial agency or institution; a Federal Reserve Bank or other facility of one or more Federal Reserve Banks, the Board of Governors of the Federal Reserve System, or both; an electronic funds transfer network; or an informal value transfer system; or

(B) Any other person engaged in the transfer of funds.

(ii) Facts and circumstances; Limitations. Whether a person is a money transmitter as described in this section is a matter of facts and circumstances. The term “money transmitter” shall not include a person that only:

(A) Provides the delivery, communication, or network access services used by a money transmitter to support money transmission services;

(B) Acts as a payment processor to facilitate the purchase of, or payment of a bill for, a good or service through a clearance and settlement system by agreement with the creditor or seller;

(C) Operates a clearance and settlement system or otherwise acts as an intermediary solely between BSA regulated institutions. This includes but is not limited to the Fedwire system, electronic funds transfer networks, certain registered clearing agencies regulated by the Securities and Exchange Commission (“SEC”), and derivatives clearing organizations, or other clearinghouse arrangements established by a financial agency or institution;

(D) Physically transports currency, other monetary instruments, other commercial paper, or other value that substitutes for currency as a person primarily engaged in such business, such as an armored car, from one person to the same person at another location or to an account belonging to the same person at a financial institution, provided that the person engaged in physical transportation has no more than a custodial interest in the currency, other monetary instruments, other commercial paper, or other value at any point during the transportation;

(E) Provides prepaid access; or

(F) Accepts and transmits funds only integral to the sale of goods or the provision of services, other than money transmission services, by the person who is accepting and transmitting the funds.

The key provision is in bold. The way I understand Casascius to have worked was the you would send a unit of Bitcoin (plus a fee) to Casascius and they would generate a new public/private key pair. Your unit of Bitcoin value would be transferred into the public address of the key pair. The private key would then be placed on a newly minted physical coin and a tamper resistant hologram would be place over the privacy key. Therefore any attempt to remove the hologram and defund the address of it’s value would be visible on the physical coin. Users were encouraged not to accept tampered with coins.

The governments argument appears to be (from the article) that the sender who originated the transaction could induce Casascius to create a new Bitcoin address and have that address (via the physical coin) be sent to another person. Casascius’s action as an intermediary in the transaction places it squarely in the ambit of the money services business regulation. In order to avoid such a position, Casascius would need to very that they sender of the original Bitcoin is in fact the recipient of the physical coin.

[As an aside, I’ve never been too fond of a physical representation of the virtual currency. As noted in the Wired article, someone seems to have produced counterfeit holograms which would allow a thief to retrieve the value in the hidden private key and replace the hologram, allowing future purchasers to think they are getting something with stored value when they are not. Also, the system requires that you trust Casascius to not have kept backups of the private keys which either puts holders of the coins at risk that Casascius absconds with them or that they private keys aren’t stolen by a third party which does the same. Finally, the benefits of virtual currency (ease of transmission, etc) are destroyed by embodying them in a physical representation.]

Many Bitcoin adherents may be scratching their heads. After all, if I wanted to send someone some Bitcoin value, I could just initiate a transfer from my address to the recipient address. Why should Casascius’s position as an intermediary require a lot of regulatory compliance issues on their part? The FinCen regulations (and the laws they implement) were written in a day when it was impossible/difficult to transfer large sums of money around from one person to another. You needed an intermediary. Look at the continuing brisk business done by Western Union or any of its contemporaries who facilitate the transfer of some store of value from one person to another. Now, can one person give another cash without having to jump through regulatory hoops? Sure. But other than cash, which most people are smart enough not to mail, all the other methods require an intermediary, some financial or quasi-financial institution. And while you can ship cash, most carriers prohibit it. The laws were written for this situation, where transmitting money over a distance required a company to facilitate the transfer. Bitcoin obviates the need for those intermediaries. Unfortunately, even though it seems “obvious” that transfers between individuals can happen without an intermediary, those companies that find themselves offering services that do just that will have to contend with laws written in a world before Bitcoin was conceived.

Good faith purchaser for value

Disclaimer: This post is not meant as legal advice and I’m thinking about working up a full legal brief/article on the subject. This post is meant to point out a potential concern over Bitcoin and it’s fungibility.

Many of the legal discussions around Bitcoin concern the potential impact that regulation may have on the emerging digital currency. There are, though, other legal issues afoot. I’d like to address one that recently came to my attention. Two of the appealing characteristics of Bitcoin are the irreversibility of the transactions and the fungible nature of the currency.This makes Bitcoin much more cash-like. It also makes it more susceptible to theft and the continuing problem of stolen addresses plagues Bitcoin. Proposals to blacklist wallets identified as holding Bitcoins stolen or otherwise the result of criminal proceeds has caused division in the Bitcoin community. The concern is that by blacklisting Bitcoin wallets from the blockchain could cause forking and introduce additional regulatory oversight of the currency. Seeing as how many of the early adopters of Bitcoin did so because they wanted a monetary system free from government manipulation, such a proposal runs counter to the original raison d^etre for Bitcoin.

So what happens when the owner of a Bitcoin address follows the blockchain and finally identifies a wallet containing the stolen balance? In other words, the proceeds of theft are transferred to a known merchant dealing in Bitcoin. [What follows is applicable to US law, clearly Bitcoin is international so such analysis may be limited] Under common law, a seller can not convey more ownership in property than they possess. Since a thief has no rights to property his conveyance of possession conveys no rights to the purchaser and thus the purchaser has no rights to convey to future purchasers (“nemo dat quod non habe”). There are some exceptions:

 Under the law of good faith purchase as it is embodied in the Uniform Commercial Code (U.C.C.), the nemo dat rule is subject to only two exceptions. First, under the “voidable title” rule, if the original owner is induced-say, by fraud or deceit-to transfer goods under a transaction of purchase, the transferee acquires the power to transfer a good title to a good faith purchaser for value. Second, under the “entrustment” rule, if the original owner entrusts goods to a merchant who deals in goods of the kind, the merchant has the power to transfer the owner’s title to a buyer in the ordinary course of business.

The other common limitation on replevin actions against purchasers is a statute of limitations and requirement that the original owner demand and the purchaser refuse to return the goods within a certain period of time.

The current common law rule places the burden of proof on the receiver of goods, because ultimately they are going to be the one losing the value if the original owner comes to them. The thief is probably long gone. The put the recipient in the awkward position of wanting to know if the good they receive have been stolen and investigating to see if the title is clean. If the original owner is actively publishing that these goods are stolen in a way that the purchaser is on notice, it behooves them not to take possession of the goods. What does this all mean for Bitcoin?

Characteristics when support original owners of Bitcoin coming after recipients

  1. Traceability – The public nature of the ledger puts all Bitcoin transactions in the public sphere. This means that the original owner can potentially follow their Bitcoin balance as it is transferred from thief to future recipients.
  2. Publicity – Related to the traceability, an original owner could publicize the address from which a balance was stolen and because of the searchable nature and traceability of the blockchain, any future recipient from that address or subsequent recipient address would be on notice that they are receiving stolen goods.
  3. Identifiability – While Bitcoin is touted as an anonymous system, the anonymity characteristic is tied to the non-identifiability of addresses owners. However, many address owners are real world merchants and businesses and publicize their Bitcoin address in order to receive payments for goods and services. This makes the likelihood of some downstream recipient of Bitcoin balance being identifiable very high. Even if the thief were to transfer the Bitcoin to an exchange, the transfer out to the regulated fiat currency market and the scrutiny of exchanges to know their customers increases the identifiability of the thief.
  4. Value – When Bitcoin was only worth a few USD, the effort necessary to recover stolen balances was probably not worth it. However, with balances in the millions of dollars being stolen, the time and effort to track down and bring legal action against recipients is now cost effective.

Characteristics which may make it hard for original owners to recover

  1. Fungibility- Money is not generally subject to a replevin action unless it is marked or packaged in such as way as to make it distinguishable. It’s unclear how courts might view Bitcoin addresses as a Bitcoins are not discrete objects but a balance collectively agreed to by the blockchain. There may be actions in trover, dentinue, conversion,  or even trespass to chattels. More research into these needs to be done. The problem exists that if a Bitcoin address that receives both “good” and “bad” balances and proceeds to transfer partial balances to different recipients, how then to distinguish the “good” and “bad” balances.
  2. Statute of Limitations – At least with replevin, it is governed by statutes of limitations. This may allow a thief to put the Bitcoins in cold storage long enough to defeat the statutes and then bring the balance out to recover the value at that time.
  3. Proof of ownership – Ownership of a Bitcoin address is proven by possession of the private key. Theft of Bitcoins is generally accomplished by accessing the private key and using that private key to then transfer the balance to another Bitcoin address. How then does the original owner prove that, in fact, the private key was stolen and they are not the ones who initiated the transfer. A Bitcoin owner could transfer the balance, receive goods or services and then sue the recipient or future recipient resulting in a double benefit to the original owner for their fraudulent actions.