15 May 2015
‘Bitcoin’, ‘crypto-currencies’, ‘mining’ and ‘blockchains’ seem to be drawing a huge amount of comment with some convinced it is a fad and others sure it is the future
Reporters have called Bitcoin a ‘shady online currency’ while others believe Bitcoin start-ups could be ‘the Google and Facebook of the financial sector’. Time will tell who is right but in light of the number of investment products and projects involving so called crypto-currencies, it is vital people understand them and their risks before jumping into the pool.
With any kind of new technological breakthrough, mixed in with the early adopters and visionaries seeking ‘first mover advantage’ will be those with less pure aims. Usually the criminal fraternity will seek to take advantage of a lack of understanding to hide an unlawful activity (or the proceeds thereof) in amongst what appears to the uneducated to be a proper activity.
Bitcoin and other web-based crypto-currencies are user controlled currencies. Rather than being centrally controlled by a national bank, the Bitcoin network is operated by members of an online community by way of a public shared record of all Bitcoin transactions known as the block-chain. The block-chain is maintained and updated by members of the Bitcoin community who dedicated their processors to the task and are rewarded for this with transaction fees (in newly issued Bitcoin - thereby helping maintain the integrity of the currency and helping it grow).
This public register has made some say that Bitcoin is a poor vehicle for money-laundering but this may not prove ultimately to be the case. In April, a piece of software called ‘Dark Wallet’ was released, with the specific intent of subverting attempts to tie Bitcoins to specific owners.
‘I want a private means for black market transactions whether they are for non-prescribed medical inhalers, MDMA for drug enthusiasts, or weapons’ said one of Dark Wallet's creators. The fact that technology bible Wired Magazine titled its coverage of the launch ‘‘Dark Wallet’ Is About to Make Bitcoin Money Laundering Easier Than Ever’ is not exactly reassuring those of us in regulatory and compliance roles either. Dark Wallet is not alone either – others are looking to achieve similar goals.
In many ways, those private black market transactions are what has fuelled the take-off of Bitcoin, at least initially. One expert has speculated that in 2012 as much as 9% of all Bitcoin exchanges were undertaken in relation to drug trades on the now-defunct online black market Silk Road. Silk Road was famously shut down by the FBI and, for anyone wondering whether or not Bitcoin truly is ‘money’, Silk Road's founder's claims that he couldn't be laundering money as Bitcoins aren't money were rejected by a US court. Last month, February 2015, founder of Silk Road Ross Ulbricht was found guilty of seven charges including drug trafficking, criminal enterprise, aiding and abetting the distribution of drugs over the internet, computer hacking and money laundering.
While Bitcoin is now accepted by many legitimate online retailers including Expedia and Overstock.com, it would be foolish to believe it has fully escaped the dark days of 2012. As a result, in any Bitcoin related transaction, financial services companies may wish to be doubly certain regarding the source of wealth of any individual.
A lack of clarity amongst consumers regarding how Bitcoin works can also make it an ideal vehicle of a Ponzi scheme (much like other new investment opportunities) and some have suggested the currency itself may be a Ponzi scheme. The SEC has already closed down one scheme offering exorbitant returns based on an ‘investment’ into Bitcoin: ‘The Bitcoin Savings and Trust’.
In the Channel Islands, two very different approaches have been taken by the islands' financial services regulators and governments. Jersey has embraced Bitcoin. A local campaign group bit.coin.je is pursuing local acceptance of the currency and a ‘digital island’ rebrand for Jersey.
Senator Philip Ozouf, the Treasury Minister for Jersey, noted ‘Our infrastructure of world-class financial services and digital expertise gives us the tools to be an early leader in the field. Innovation will be central to Jersey’s future prosperity. We are keen to support local businesses by helping to create a well-regulated and responsive environment for investment in the sector’. Additionally the Jersey Financial Services Commission has recently approved the world's first regulated Bitcoin fund tying Jersey's colours very publicly to the Bitcoin mast.
By contrast in Guernsey, an island not known for turning down new investment opportunities, the position is slightly different. The Guernsey Financial Services Commission (GFSC) has released a statement noting that it has a policy of encouraging innovation and ‘continues to monitor closely [virtual currencies] while recognising that there are currently significant risks associated with them.’
The GFSC go on to note that ‘In the light of those risks, the Commission will adopt a cautious approach and may well refuse applications to register financial services business where the use of virtual currency is involved. However, this approach will be regularly reviewed in the light of international developments.’
While seeming rather regressive compared to Jersey's forward thinking stance, a cautious approach may yet make sense given that only in 2014, the European Banking Authority advised European banks not to deal in virtual currencies such as Bitcoin until a regulatory regime was in place.
Notwithstanding this approach from the regulator, Guernsey's financial services businesses are still seeing the impacts of Bitcoin on business. A local precious metal dealer's vault holds the bullion for a London-based Gold-Bitcoin exchange and plans were briefly mooted for the island of Alderney to mint a Bitcoin coin in recognition of the currency.
These spin-off activities are illustrative of some of the challenges and opportunities of the current ‘Bitcoin boom’ - Bitcoin ATMs and Bitcoin payment mechanisms for online retailers will both raise interesting compliance issues for those concerned about AML. There is also the issue that Bitcoin is effectively a volatile investment with its exchange rate against other currencies changing with some regularity. Less sophisticated retail clients attempting to pay for items with Bitcoin may therefore find themselves getting less bang for their buck than expected.
All of the above raises interesting issues for those in compliance regarding Bitcoin. But in many ways these are issues which we have had to address previously in relation to cash, PayPal and all other payment methodologies in between. Beyond its reliance on technology and its unregulated global status there is nothing inherently risky about Bitcoin and Bitcoin related structures other than their newness.
Understanding how Bitcoin and the related technologies work is key to minimising the compliance risk relating thereto. Ultimately service providers will still need to identify clients and their sources of wealth, understand the commercial rationale for transactions and the methodologies by which they are affected. We cannot simply rely on ‘Bitcoin’, ‘blockchains’ or ‘miners’ to explain how something can become profitable like some sort of digital deus ex machina. If something sounds too good to be true it probably is, whether digital or analogue.
Bitcoin is a far from perfect new system. It is poorly understood and explained, unregulated and therefore more open to abuse than other currencies.
That does not however mean we should throw out the baby with the bathwater. Whatever its faults, Bitcoin can clearly be used for any number of legitimate purposes. It may also further open up the realm of e-commerce and, if its embrace by the likes of Expedia are anything to go by, it is here to stay. The market will continue to change. Our job, as always, is to keep up.
Wayne Atkinson is a Senior Associate at Collas Crill