You are on page 1of 5

The Past and Future of Bitcoins in Worldwide Commerce

Author(s): Denis T. Rice


Source: Business Law Today, (November 2013), pp. 1-4
Published by: American Bar Association
Stable URL: http://www.jstor.org/stable/businesslawtoday.2013.11.06
Accessed: 26-02-2018 11:45 UTC

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide
range of content in a trusted digital archive. We use information technology and tools to increase productivity and
facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
http://about.jstor.org/terms

American Bar Association is collaborating with JSTOR to digitize, preserve and extend access
to Business Law Today

This content downloaded from 147.230.153.235 on Mon, 26 Feb 2018 11:45:50 UTC
All use subject to http://about.jstor.org/terms
Click to view the latest
NOVEMBER 2013
Business Law TODAY

BUSINESS LAW TODAY


The Past and Future of Bitcoins
in Worldwide Commerce
By Denis T. Rice

Virtual currency is not new. It has been and mediate disputes. To that end, the bit- nodes participating in the bitcoin system.
around since the early 2000s in virtual coin system is based on open source com- The full block chain contains every trans-
world websites like Second Life and online puting. Bitcoin users cooperate to validate action ever executed in bitcoin, starting
role-playing game sites like World of War- transactions either by running a program with the very first one which is called the
craft, where virtual currency is “earned” implementing the bitcoin protocol on an in- “genesis block.” This allows determination
by completing virtual quests. But neither dividual’s own computer or by creating an of the value belonging to each address at
Linden Dollars earned in Second Life account on a bitcoin website to run the pro- any point in time. Miners who succeed in
nor Facebook credits earned on Farmville tocol. Although creators of bitcoins origi- adding a block to the block chain automati-
could be spent outside of their restricted nally used them for Internet-related tasks, cally receive a fixed number of bitcoins as
virtual worlds, even though some could be like trading bitcoin for programming help, a reward for their effort.
exchanged for dollars (or other real world the currency has gained increasing accep- Space does not permit a detailed descrip-
currencies) on third-party websites. The tance in broader contexts. tion of the mining process, but in essence
bitcoin is changing this landscape. Some The early use of bitcoin in online drug a miner maps an input data set (i.e., the
hail it as “the next great step in Internet markets and casinos gave it a somewhat block chain plus a block of the most recent
and global currency.” (Although “bitcoin” tarnished reputation. But bitcoin increas- Bitcoin Network transactions and an arbi-
is capitalized by some writers; the author ingly is used in legitimate commerce. trary number called a “nonce”) to a desired
elects to treat the word generically and use Thus, early this year, Coinbase, a bitcoin output data set of predetermined length
the lower case throughout.) payment processor, reported selling $1 mil- (the “hash value”), using Nakamoto’s al-
Bitcoin started in 2008 with a self-pub- lion in bitcoins in one month at more than gorithm. The miner then “solves” a new
lished white paper by a group of computer $22 each. Later, venture capitalists began block by repeating this computation with
geeks using the fictitious name “Satoshi pouring millions into startups that focus a different nonce until hash of a block’s
Nakamoto.” A bitcoin is essentially just a on bitcoins. In July 2013, the Winklevoss header having a value not more than the
snippet of code, based on an algorithm first twins (of Facebook fame), having formed current target set by the Bitcoin Network is
identified in the Nakamoto white paper. In an electronically traded fund called the generated. Because each unique block can
2009, the Bitcoin Network was established “Winklevoss Bitcoin Trust,” filed with the only be solved and added to the block chain
and actual bitcoins were first issued and its U.S. Securities and Exchange Commission from one source, all individual miners and
evolution since has been swift. Practitio- (SEC) to sell shares in the trust to the pub- mining pools in the Bitcoin Network are
ners in cyberspace or commercial finance lic. competing. Such competition spurs them to
law need at least a working knowledge of constantly increase their computing power
this digital currency which has no borders Creating Bitcoins in order to improve their ability to solve for
and is unregulated by any governmental au- Bitcoins are created by “mining.” Bitcoin new blocks. A miner can only build onto
thority or central bank. miners engage in a set of prescribed com- a block (referencing it in blocks the miner
A central purpose of bitcoin according to plex mathematical calculations in order to creates) if it is the latest block in the lon-
Nakamoto was to reduce transaction costs add “blocks” to the “block chain,” which gest “valid” chain. A chain is valid if (1) it
incurred when parties validate transactions is a transactional database shared by all starts with the genesis block and (2) all of

Published in Business Law Today, November 2013. © 2013 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any 1
portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written
consent of the American Bar Association.

This content downloaded from 147.230.153.235 on Mon, 26 Feb 2018 11:45:50 UTC
All use subject to http://about.jstor.org/terms
Click to view the latest
november 2013
Business Law TODAY

the blocks and transactions within the chain mine bitcoins successfully. Mining “pools” sistant to central control. The private key,
are valid. have formed, in which multiple miners used to authorize bitcoin transactions, has
A proposed block is added to the block combine their processing power. When no information about the user, although the
chain once a majority of the nodes on the pool members solve a new block, they al- transactions are traceable by means of the
Bitcoin Network confirms the miner’s locate the reward according to the process- public key. The result is that the address
work. In addition to new bitcoins, the suc- ing power each contributed to the solu- of a bitcoin is traceable on an individual’s
cessful miner receives any transaction fees tion. Such pools give participants access own computer, but ownership of each ad-
paid by transferors whose transactions are to smaller, but steadier and more frequent, dress remains anonymous.
recorded in the block. This process has bitcoin payouts. The Wall Street Journal re- One way to buy bitcoins is to identify
been described as a “mathematical lot- ported on November 6, 2013, that the speed someone willing to sell bitcoins, then of-
tery,” where miners with greater process- of bitcoin mining was now 40 times faster fer to buy them with conventional currency.
ing power (i.e., ability to make more hash than in January 2013. It was estimated in Once a price is set, the seller transfers the
calculations per second) are more likely to August 2013 that about 11.5 million bit- bitcoins to the buyer’s wallet. Another and
succeed. Because the method for creating coins were in existence, with the amount more organized way is to use a bitcoin ex-
new bitcoins is mathematically controlled, steadily increasing. Estimates are that 90 change. As with conventional currency ex-
the total bitcoin supply grows at a pre-set, percent of the 21 million bitcoin limit will changes, price is usually not individually
limited rate. The fixed reward for solving have been produced by 2020. negotiated, but instead based on the aggre-
a new block is currently 25 bitcoins per The Bitcoin Network is designed so gate supply of and demand for bitcoins in
block, but will decrease to 12.5 bitcoins per as to decrease the reward for adding new the system. While using an exchange adds
block around the year 2017. The number of blocks to the block chain over time. Ul- to the transaction cost, it is both more ef-
bitcoins in existence will never exceed 21 timately, miners will need to be compen- ficient and better monitored.
million, and bitcoins cannot be devalued sated in transaction fees in order to provide There are estimated to be approximately
through excessive production unless the adequate incentives for miners. (However, 12 currency exchanges around the world
Bitcoin Network’s source code and the un- as of publication of this article, transac- where consumers and businesses can trade
derlying protocol for bitcoin issuance are tion fees still accounted for but 1 percent of bitcoins for local currency. Because the
changed. miners’ total revenues.) technology is open source, new services
The targets established by the Bitcoin are created almost every week. Among the
Network constantly increase in difficulty, Trading For Bitcoins more active are Mt. Gox in Japan, BitBox
meaning that miners constantly need more To buy or sell bitcoins, one must have and Bitstamp in the United States, and Bit-
expensive processing power to compete. Internet access to the Bitcoin Network, curex in Poland. Banks like Morgan Stanley
Early on, a bitcoin could be bought for 25 where such transactions are consummated and Goldman Sachs reportedly visit bitcoin
cents on an exchange, and a miner with within seconds. Double-spending of any exchanges up to 30 times a day. Bitcoin
just a laptop’s CPU could make a handful single bitcoin is avoided by having the user exchanges are not problem-free: Mt. Gox
of new bitcoins a day. Computers now are give information on the transaction to the in Tokyo, the largest exchange, reported in
specially designed solely for bitcoin min- Bitcoin Network of the transaction, which 2013 that its services had been disabled for
ing, and the newest rigs use an application- uses the block chain to memorialize every hours by an Internet “denial-of-service” at-
specific integrated circuit (ASIC) built bitcoin transaction. tack. Mt. Gox said attackers wait until the
specifically to execute the hash operation. A bitcoin trader first installs on a com- price of bitcoins reaches a certain value,
This bitcoin “arms race” led to a 2013 ven- puter (or mobile device) a software pro- then sell, destabilize the exchange, wait for
ture funding of $200 million in the maker gram allowing the trader to generate a digi- panic-selling to cause the bitcoin price to
of high-end servers designed specifically tal “wallet” for storing bitcoins. The wallet drop to a certain amount, then stop the at-
for producing bitcoins, with the deal also can either be stored in the trader’s own tack and start buying as much as they can.
including the maker of state-of-the-art mi- computer or hosted on a third-party web- Such volatility caused bitcoin to rise from
crochips to power the hardware. site. The trader then connects to the Bitcoin roughly $5 in June 2012 to a high of $266
The current mining protocol makes it in- Network and engages in the purchase, sale, in April 2013, before dropping to $108 in
creasingly difficult to solve for new blocks and receipt of bitcoins. A trader can have May 2013.
as computer processing power dedicated an unlimited number of digital wallets,
to mining increases (in order to maintain a each with a unique address and verification Using Bitcoin in Day-to-Day Commerce
10-minute per block average). Because the system consisting of both a “public key” A retail customer can pay in bitcoin by
difficulty in finding valid hash values has and a “private key.” Because the system using a smartphone to scan a barcode pro-
grown exponentially since the first block relies upon peer-to-peer networking and vided by the retailer. Retailers see an ad-
was mined, one individual can no longer cryptography, it is a distributed model re- vantage in avoiding credit card fees that

Published in Business Law Today, November 2013. © 2013 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any 2
portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written
consent of the American Bar Association.

This content downloaded from 147.230.153.235 on Mon, 26 Feb 2018 11:45:50 UTC
All use subject to http://about.jstor.org/terms
Click to view the latest
november 2013
Business Law TODAY

can run as high as 3 percent, compared to years as a granular, niche fund – more like violating such laws. Indeed, the California
less than 1 percent for bitcoins. Moreover, one specializing in Bulgarian stocks than Department of Financial Institution already
bitcoin transactions are final, whereas cred- with mainstream applications.” has in its files a detailed letter from a law
it card charges can be disputed. This kind firm on behalf of the Bitcoin Foundation,
of advantage helped BitPay, Inc., of Atlan- Regulatory Issues arguing that California’s law, the Money
ta in 2012 sign up more than 8,000 mer- Bitcoin faces a number of unresolved Transmission Act, has no application to
chants worldwide to accept bitcoins and to regulatory issues. They involve FinCEN, bitcoins.
set what was then a new record for bitcoin the U.S. Department of Justice, the SEC, Turning to securities laws, in July 2013,
payment processing, with orders and pay- and state regulators of money service the SEC filed a civil action in federal court
ments from 17 different countries such as businesses (MSBs). As mentioned earlier, in Texas, charging an individual and his
Belgium, Russia, and Poland. Since bitcoin FinCEN this year issued regulatory guid- company with using a bitcoin-based Ponzi
is a currency run by those who use it, a ance classifying digital payment systems scheme to defraud investors. The SEC al-
bitcoin’s value is determined by the mar- like bitcoin as “virtual currencies,” on the leged that the founder and operator of Bit-
ketplace; in other words, a bitcoin is worth basis they are not legal tender under any coin Savings and Trust had offered and sold
whatever someone will take for it. sovereign jurisdiction. While opining that a bitcoin-denominated investments through
user of virtual currency is not an MSB and the Internet using the monikers “Pirate”
Venture Capital and Bitcoin hence not subject to federal MSB regula- and “pirateat40.” The company allegedly
Startups focused on marketing bitcoin tion, FinCEN went on to state that U.S. en- received 700,000 bitcoins from investors
services have attracted increasing inter- tities that generate “virtual currency” (in- valued at more than $4.5 million, based on
est from venture capitalists. For example, cluding bitcoins) could be deemed MSBs the average price of bitcoin when the in-
in 2013, venture firms invested more than if the virtual currency were sold for “real vestments were sold.
$2 million in OpenCoin, Inc., and $5 mil- currency or its equivalent.” Thus, miners of The SEC claims the company was a
lion in Coinbase, which operates an online bitcoin within the United States may need “sham” where bitcoins from new investors
service allowing users to buy and store bit- to register and comply with federal MSB were used to pay interest of up to 7 percent
coin in a digital wallet and pay merchants regulations if they sell bitcoins for dollars. per week to existing investors and also to
for goods and services. Coinbase claimed American Banker online has asserted that cover investor withdrawals. The SEC fur-
some 116,000 members who had converted at least three U.S. bitcoin exchanges elect- ther alleges that the founder diverted inves-
$15 million of real money into bitcoin, and ed to shut down as a result of FinCEN’s tors’ bitcoins to trade for his own account
dollar conversions increasing by about 15 guidance. FinCEN’s director stated that its on a bitcoin exchange and to trade for dol-
percent a week. The San Francisco ven- guidance aims to protect digital currency lars in order to pay personal expenses. Such
ture firm Kleiner Perkins Caufield & Byers systems from abuse and ensure that infor- acts are alleged to violate the anti-fraud and
reports that it is exploring bitcoin-related mation is available to prosecute “criminal registration provisions of Sections 5(a),
investments and has reviewed over two actions,” and is not aimed at everyday bit- 5(c), and 17(a) of the Securities Act of
dozen companies. coin users. 1933, Section 10(b) of the Securities Ex-
In May 2013, the Department of Home- change Act of 1934, and SEC Rule 10b 5.
Electronically-Traded Funds land Security seized an account controlled
As noted earlier, the Winklevoss twins by Mt. Gox on the theory that the Japanese Criminal Issues
filed a registration statement with the SEC exchange was operating as an unlicensed Two federal criminal indictments in
in 2013 for their “Winklevoss Bitcoin MSB. Mt. Gox subsequently registered 2013 have somewhat tarnished the bitcoin
Trust,” an ETF. The filing, which contains with the U.S. Treasury as an MSB. The var- image. An indictment of Liberty Reserve,
over 17 pages of “Risk Factors,” observes ious regulatory issues surrounding bitcoin S.A., a Costa Rican currency exchange,
that (1) the value of bitcoins is determined has prompted bitcoin enterprises to form and seven of its executives by a grand jury,
by the supply of and demand for bitcoins a self-regulatory group called the “Com- alleged that operators of the exchange used
in the bitcoin exchange market, as well as mittee for the Establishment of the Digital bitcoin to run a $6 billion money-launder-
the number of merchants that accept them, Asset Transfer Authority,” which intends to ing operation in violation of Section 311
and (2) bitcoins have little use in real-world set technical standards aimed at preventing of the USA PATRIOT Act and provided a
retail and commercial markets compared money-laundering and insuring compli- central hub for criminals trafficking in ev-
with their “relatively large use by specula- ance with laws. erything from stolen identities to child por-
tors.” Columnist Chuck Jaffe opined that Fifty states also have laws regulating nography. Prosecutors asserted that Liberty
the twins face a long, uphill battle just MSBs. Several, including California and Reserve’s trading in bitcoin provided the
to get their fund to market, adding that New York, have reportedly warned compa- kind of anonymous and accessible banking
“chances are good it will still be viewed for nies involved in bitcoin that they may be infrastructure increasingly sought by crimi-

Published in Business Law Today, November 2013. © 2013 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any 3
portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written
consent of the American Bar Association.

This content downloaded from 147.230.153.235 on Mon, 26 Feb 2018 11:45:50 UTC
All use subject to http://about.jstor.org/terms
Click to view the latest
november 2013
Business Law TODAY

nal networks, which they said “heralds the Denis T. Rice is senior counsel at
arrival of the cyber age of money launder- Arnold & Porter LLP in San Fran-
ing.” cisco. The author offers his thanks to
Finally, October 2013 saw the federal partner Robert L. Taylor of Arnold &
government indict and shut down the “Silk Porter for a review of patents possibly
Road,” an online marketplace where mil- bearing on bitcoin.
lions of bitcoins allegedly were swapped
for drugs and black market products. As
news of the shutdown spread, bitcoin val-
ues tumbled, initially dropping by about 20
percent (or close to $500 million) before
turning around. On the Bitstamp exchange,
bitcoins dropped from about $125 to $90
before climbing back to $115. Values on
the Mt. Gox exchange dropped from $140
to $109 before returning to $128. The gov-
ernment simultaneously arrested Ross Wil-
liam Ulbricht, who allegedly operated the
Silk Road website using the alias “Dread
Pirate Roberts,” and who now faces drug
trafficking, money laundering, and hacking
charges. The FBI filed an affidavit in the
case which asserts that digital currency is
not just used in the black market, but can
serve criminal purposes because of the ease
of moving money anonymously.

The Future . . .?
The economist Paul Krugman stated ear-
lier this year that, unlike gold or paper fiat
currencies, bitcoin derives its value solely
from a self-fulfilling expectation that others
will accept it as payment. Herb Jaffe cited
a Morningstar analyst as having called the
Winklevoss ETF “a total gimmick,” that
bitcoins are very illiquid, and that the cur-
rent trading infrastructure “is riddled with
security/efficiency problems.” Others see
bitcoin as a major development in virtual
currency. Robin Harris on ZDNet asserts
that bitcoin or something like it is not going
away, observing that dollar/gold convert-
ibility ended in 1971 and floating exchange
rates have prevailed since. There are many
areas where the future of bitcoin is yet to
be developed: Is it an investment? How will
transactions be taxed? What will be the ef-
fect of China’s recent entry into the bitcoin
market? In 2014, we can expect some an-
swers, but also many new questions.

Published in Business Law Today, November 2013. © 2013 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any 4
portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written
consent of the American Bar Association.

This content downloaded from 147.230.153.235 on Mon, 26 Feb 2018 11:45:50 UTC
All use subject to http://about.jstor.org/terms

You might also like