Let's Talk Bitcoin Episode 31 Transcription

Let’s Talk Bitcoin Episode 31 – “The Regulatory Question”

Participants:
Adam B. Levine (AL) - Host
David Landsman (DL) – Executive Director of the National Money Transmitters Association (NMTA) – Guest Interview

Inside Bitcoins Conference participants:
Ryan Singer (RS) – President and Co-Founder of Tradehill
Jerry Brito (JB) – Director of Technology Policy at the Mercatus Center at George Mason University
Jacob Farber (JF) – Senior Counsel, Perkins Coie
Patrick Griffin (PG) – EVP of Business Development, Ripple Labs
Greg Schvey (GS) – Head of Research at the Genesis Block
James White (JW) – Director, Tax Issues at the U.S. Government Accountability Office (GAO)
Music was provided by Jared Rubens


[Music playing] (0:09)

AL: Hi folks, Adam B. Levine here. We’re back from New York with exclusive talks, panels and interviews to share with you. Regulation and compliance are some of the most common buzzwords in the Bitcoin entrepreneurial space right now, but how do you comply with rules that don’t yet exist? Today’s release is a double-feature that starts with my 12 minute talk with David Landsman, Executive Director of the National Money Transmitters Association. After that we dive right in to the 50 minute panel entitled, “Legal and Regulatory Issues Facing Virtual Currency Businesses” from the main stage at Inside Bitcoins. Moderated by Tradehill’s Ryan Singer, that panel features Jerry Brito of George Mason University,  Jacob Farber of the legal firm Perkins Coie, Patrick Griffin of OpenCoin, Greg Schvey of the Genesis Block, and James White, a director at the U.S. Government Accountability Office. Our release schedule for the next few weeks might be a little more crowded than normal, so stay tuned for Episode 30 to be released sometime before Friday. If you have comments, questions or topics for the show please visit letstalkbitcoin.com/reddit to be directed to our new listener interactions Subreddit. We’ve had a lot of activity here so far and I’m excited to hear what you have to say. If you enjoy the content from the conference (it will be releasing over the next few weeks), please donate Bitcoins or Litecoins at letstalkbitcoin.com. This trip was out-of-pocket and your support allows us to cover future conferences in this same fashion. We have three or four more scheduled before the end of the year. Also, thanks to Mediabistro for putting on such a great event with Inside Bitcoins. David Landsman is the director of the National Money Transmitters Association. He joins us this morning to talk about some of the complexities of compliance in a world where there aren’t many set rules.  David, thanks for joining us on Let’s Talk Bitcoin. (1:54)

DL: Good morning Adam, thanks for having me. (1:56)

AL: Like I said this is a polarizing space. You come at this from a compliance viewpoint rather than cryptocurrency viewpoint. Now that you’ve been in the space for a little bit of time and you’ve looked around, can you give us an overview of where you think the cryptocurrency fits as it relates to regulatory compliance? (2:13)

DL: The NMTA, the National Money Transmitters Association, our core membership is the State licensed money transmitters of the United States. That’s the population that we’re trying to uphold and protect and we’re looking forward to welcoming a whole bunch of new licensees into that field of membership, but the impression that I get is that the vast majority of people that have been working in virtual currencies and in Bitcoin up until now, were not totally aware of the fact that they were going to be entering this space. On the other hand, you have FinCEN who just made this March 18th ruling, which is great for what it is, but it’s just trying to fit a brand new technology in the same old categories which is not going to work. (2:58)

AL: Are Bitcoin businesses money transmitters? (3:01)

DL:  Well, unfortunately, the closest analogy I can come to is a traveler’s check. If you look at it that way, you could say that virtual currencies are like traveler’s checks, but on steroids. Every state in the country regulates the sale of traveler’s checks, except maybe two. The sale of traveler’s checks is considered a money transmission activity. The problem is there is going to be a huge population of people trading Bitcoin for their own account. Up until now, in the definition that was put forward by FinCEN, I can’t see any difference between an active Bitcoin trader and a financial institution. When I say financial institution, I’m talking money service business that’s subject to a full array of requirements: the Bank Secrecy Act, the Patriot Act, compliance programs, everything. (3:46)

AL: The guidance that came out, the broad interpretation that I hold and I think a lot of other people within the community held was that it specifically sets aside and says if you’re not doing this as a business then you’re not a money transmitter. Is that different than your understanding of the guidance? (4:05)

DL: Well, what they tried to say was if you’re using it for an underlying transaction, if you’re using Bitcoin to pay for a good or a service, they consider you to be a user. They completely ignore the process you have to go through in order to get the Bitcoin. You have to buy them. Well, are you a financial institution just for buying it? Let’s suspend our disbelief for a moment and say, “No.” OK, you’re still just a user and the people that you buy them from are just exchangers if we can tell the difference, but what happens when there’s an active market from person-to-person? The whole point of Bitcoin in particular is that it’s a de-centralized system. First of all, there is no liability of the issuer from a consumer protection standpoint. It doesn’t fit any paradigm we have from before, but from a regulatory point of view, the first thing a regulation has to do is define the population of people that it applies to. I think FinCEN is going to have a big problem defining the population of financial institutions based on what they do. People who buy and sell Bitcoin in huge quantities for a lot of people—how are you going to tell the difference between someone who is doing it for himself versus someone who is doing it as a business? Does he hang a shingle out? Does he advertise to the public? Well, that’s great. If you have somebody who advertises to the public, then you can pretty much be sure he is a financial institution and treat him as such. What about people who just get a reputation and they start doing huge business? Where [are] we going to draw the line? I don’t think FinCEN really has the answer for those questions. (5:37)

AL: We’ve had guidance, but no really clarity on the rules in the long-term. You’ve been in this space for a while, how long can a situation like this continue? Is there a historical precedence here that we can look to for some sort of guidance? (5:51)

DL: I’ve been talking to a lot of people in particular the Bitcoin Foundation, because they are already so active on this. They have three separate committees. They’re wonderful. One of them on education. One of them for governmental affairs which is interfacing with regulators. Another committee called Law and Policy which is going to talk about what kinds of changes we can make to the law. I think that’s necessary, but in the meantime, it’s a very practical matter. If you happen to be an entrepreneur who’s been planning on starting a Bitcoin business, in the near future, you really have to check this out and you have to take it seriously. You have to look at your operation (through the eyes of FinCEN actually) and find out if you are going to be considered subject to these rules. Chances are you will be (6:37)

AL: Earlier in this conversation, we talked about how there's a need to register. There's a need to comply with different state-by-state rules. Licensing generally is done on a state-by-state level. I read an article this morning about a gentlemen named Aaron Greenberg [Greenspan], who’s a Fintech entrepreneur from California. He basically was driven out of business before he ever got started with an innovative financial service because the cost of coming to market in financial services right now is quite great. He estimated that in order to comply with the 48 states that have such requirements, it would cost about $7.8 million in surety bonds and $71,000 in application fees alone. Regulators say this isn’t a barrier to entry, but rather that its consumer protection. Where do you think this falls on that spectrum? (7:26)

DL: I’m afraid that Aaron Greenspan got off on the wrong foot with the California authorities. I’m not sure what kind of a business plan he submitted, but basically there going to ask for a surety bond that’s going to be commensurate with the size of your business plan. So if you’re talking about selling large numbers of volume or large volume numbers, they’re going to ask for a high bond without even bothering to look at the fact that your outstanding liabilities are going to be zero because  everything’s extinguished immediately. There’s a few misconceptions in those figures that were given. If it were $7 million worth of surety bonds that would be required for many, many states in total, your premium that you would pay [would be] perhaps 1 or 2% of that amount. So it would be like $14,000 a year. That would be your commission to the broker who’s providing the surety bonds for you. Surety bonds are going to be issued to you based on your personal credit and the riskiness that’s assessed by the surety broker. The fees for applying for state licenses, I guess, are going to be a lot more than $7,000 if you’re going for all the states. There’s a lot of misconceptions and misinformation out there. It’s really best to talk to the professionals and to come to our compliance conference on August 14 in New York City. Nmta.us is our website, so please check out all the information there. Really, it’s a process of education and getting very specific, looking at each state. You cannot make any assumptions about any given state, because if you don’t have to get a license, you sure don’t want to. Some states may or may not decide that you’re regulatable based on your physical location. Even if you’re doing business with their residents, although most states will require a license, some states won’t. Some states still haven’t gotten up to the point where they even want to regulate anything to do with Bitcoin, regardless of what location you’re in. It really pays to be specific. (9:19)

AL: There haven't been many specific actions actually taken against Bitcoin companies or exchanges, but there have been lots of bank accounts closed. It's the sort of thing that looks odd to me because it feels like if these are issues of compliance, then it should be a regulator that is saying this, but more often than not, the action is coming just from individual other financial institutions that are just withdrawing support. That seems like a situation that is dangerous for everybody involved because there's no set standards. Can something like that continue for very long? (9:52)

DL: Well, unfortunately it can and it has and it’s disastrous, but it’s a quiet disaster and nobody really speaks about it, because there’s no constituency that has a voice, unfortunately. This is the reason that the NMTA was founded, because of the banking problem. They’ve been closing money transmitter accounts for a long time. If anybody in the government ever tells you that they do not expect the banks to be the de facto regulator of our industry, you have to call them out on that because it’s just not true. The government absolutely wants the banks to be the chokepoint. From the very beginning of the Bank Secrecy Act, they looked upon financial institutions, specifically depository financial institutions, as the chokepoint with which they’re going to control the movement of currency among the entire population. If you’re going to go through a financial institution and of course, with special attention paid transactions in cash, which now we see that Bitcoins are like cash on steroids. It's really the perfect regulatory storm and unless we change the laws, nothing is going to happen. You’re going to have to have huge deposits to leave for the bank in order to make it worthwhile for them to even bother looking at your account, unfortunately. (11:03)

AL: This is a complicated problem and as you mentioned, you’re putting on a conference in Manhattan on the 14th of the month, is that right? (11:10)

DL: That's correct, Wednesday. (11:11)

AL: If an entrepreneur who's interested in having a compliant Bitcoin business wanted to attend that, what would they see at your conference? What's the focus, broadly speaking, besides the regulatory part? (11:22)

DL: There is nothing besides the regulatory part and that’s why it’s unique. It’s an entire day devoted to discussing this issue in all its complexities. The people who come there are going to get a sense of the history of this problem. A lot of the questions that you’re asking now, they really have to be understood only in context. That’s what they're going to get. Connie Fenchel, our program director, is a former deputy director of FinCEN. Kicking off our conference is Jim Freis. He was until recently, the director of FinCEN and he’s going to take us through the history of the regulation of money transmitters in general, which now Bitcoin and virtual currencies are specific case of. The person who comes there is going to get a chance to ask their questions. They’re going to get a chance to hear the way regulators think and that’s the most important thing. If you’re going to be dealing with regulators, you have to understand how they think. (12:17)

AL: If someone wants to investigate that further, you gave the website before, can you give it one more time? (12:22)

DL: Sure, it’s www.nmta.us (as in National Money Transmitter Association). We have the registration link right up on our website and if you use the secret discount code, “Bitcoin,” you'll get $100 off. Right now its $445 minus $100, your price is $345 now, up until Sunday night when it goes up. So please buy your tickets now. (12:48)

AL: David Landsman. Thank you very much for your time. (12:50)

DL: Thank you. (12:51)

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[The Conference]
The moderator for this next panel is Ryan Singer, who is the president and COO of Tradehill. He is a passionate leader in open source software and was a co-founder of the OpenDocument foundation. Prior to Tradehill, Ryan spent two years leading projects for the Stanford Peace Innovation Lab. Let’s give him a big round of applause, he’s going to introduce the panelists. (14:10)

[Clapping] (14:15)

RS: There's two interesting pieces of news today related to what we do on this panel. One of them is that a bunch of companies in this space, including mine and Patrick's and a bunch of my clients got together and announced that we’d like to be a part of an organization that wants to synchronize our views on know your customer [KYC] and MLA [Money Laundering Activities] policies and things like that with the goal of eventually becoming a part of a regulatory organization in this space. It’s called DATA (Digital Asset Transfer Authority) and there was an article about it in the Wall Street Journal, in American Banker, and in the Huffington Post. That's an interesting thing to look into. The other piece of interesting news was Thailand’s central bank just told a company in that space that in Thailand, they think the purchase, sale and international transfer of Bitcoin is illegal. That's an interesting first move too. Thailand’s famous for doing moves like that. It’s illegal to compete with the Thailand banks to do micro finance, for example. Interesting trends happening. Anyway, I’m going to let the panel introduce themselves. We’re going to kind of go in order. Everybody’s going to talk about their little thing for five minutes or so. Some of them are experts in different aspects of regulation [and] legal compliance. Then we’ll open it up for questions and then we’ll have a panel discussion and we’ll see what’s interesting. (15:41)

JW: I'm Jim White from the Government Accountability Office. For those of you who don't know what the Government Accountability Office is, it's GAO. We’re part of the legislative branch. We do tax policy analysis for Congress and also oversight of the Internal Revenue Service. I’m a director at GAO. We just issued a report on virtual economies and virtual currencies. That report was requested by the Senate finance committee, both the chairman and the ranking minority member requested the report. They were interested in learning more about the tax compliance risks associated with virtual economies and virtual currencies. I want to thank you for the invitation to be part of the panel today. It’s traditional for government types like myself and academics to start out with a disclaimer at these things. I have two disclaimers not one. First of all, the report that we issued speaks for GAO, not me and second of all, I’m not a tax advisor. If you need tax advice, you need to talk to a tax advisor. Our report covered three topics essentially. One was what’s known about the volume of Bitcoin transactions potentially subject to US tax, the types of transactions that might be subject US tax, and finally what IRS is doing to provide guidance on this. First topic on the volume of transactions. There is little known about the volume of transactions that might be subject to US tax. There’s some data about Bitcoin transactions and the volume of Bitcoins in circulation, the volume of transactions, but that information’s global. It’s worldwide. It doesn’t break out US information, furthermore the US information isn’t broken out by what might subject to US tax. Based on that there’s virtually no reliable information about the size of any tax compliance problem right now and I’ll come back to this when I talk about the recommendation that we made to IRS. The second topic is on the types of potentially taxable transactions. Basically, there are two types of tax obligations under the US tax code for people. One is paying the tax on the income that you earn and the other (and this applies mainly to businesses) is a third-party reporting requirement. A lot of businesses have requirements to report income [and] people they deal with as a third-party. For example, employers have to report wages they pay and they report that on a W-2 and IRS gets a copy of that W-2. Similarly, settlement organizations such as credit card companies have to report the receipts that the merchants they deal with are making. There are reporting requirements for barter exchanges. In the course of our work, we dealt with IRS on some of these reporting requirements. They hadn’t thought a lot about this, but we had some conversations with them about what might taxable and so on. The general rule is if it would be a taxable transaction or a reportable transaction if it was carried out in Dollars or Yen or some currency like that, then it's very likely that it's also a taxable transaction or a reportable transaction if it is carried out using Bitcoin. That’s a general rule, again the specifics to a particular case depend on the facts of that particular case. The bottom line is that a Bitcoin miner, therefore, might earn taxable income mining Bitcoins. A merchant who accepts Bitcoin in a payment for a service or a good that’s sold may be earning taxable income. The report also highlighted some of the risks. These are really uncertainties associated with the tax consequences of Bitcoins. Some of those risks… One is there’s just a lot of uncertainty out there about what is taxable income. Is it if you receive payment for services? Is that considered wage income or is that barter income? When is an asset that goes up in value a taxable capital gain? How’s the basis calculated for estimating the capital gain? When do third parties have reporting requirements if transactions involve Bitcoins? All of this is uncertain and that led us to the final part of the report, [which] was our recommendation to the IRS. Based on what I've said so far, both the fact that this uncertainty exists about what's taxable income, what the reporting requirements are and combined with the fact that we really don't know much about the size of the problem, we made a recommendation that IRS put some informal guidance on its website as opposed to more formal guidance. The advantage of this is that it’s cheaper and easier for IRS to do it. IRS agreed with our recommendation. They’ve told us they’re in the process of developing some informal guidance. I don't know when that will go on their website and with that I’ll stop. (21:28)

RS: Thanks, Jim. That’s actually really exciting that they’ve agreed and that that’s coming. I hadn’t heard that yet. Next up, Jacob works for Perkins Coie. Perkins Coie represents us and many of my clients. Most of the companies in this space have retained them to try to figure out how does virtual currency apply to existing laws. I’d say they’re the law firm that has probably done the most research in the area. (21:53)

JF: Thank you, Ryan. I have been given the unenviable task of going through the regulation of virtual currency in the United States in five minutes.  [Laughter] For somebody who knows a lot, this will be ridiculously basic. To somebody who’s new to the community, all you’re going to hear is a list of topics, because that's basically all I have time for. I figure even just doing that, issue spotting for people, if you’re not familiar with it,  will at least get you the vocabulary and then you can start asking questions and follow-up with people in the community. I know it’s going to be rapid fire and unfortunately devoid of deep content, because we don’t have time for it. This was in a Bitcoin primer that circulated a year or so ago. The legal classification of Bitcoin is still unclear. It could be considered a commodity, a currency, a financial product or legally equivalent to World of Warcraft gold. The answer is it's all of those and I’ll talk about why that is. We also know that it isn't pre-paid access federally, except that maybe it is sometimes. It’s stored value which really is pre-paid access according to some states. It’s probably not a security, but except it can be made into one. What does all that mean? I’m going to divide the talk into federal law and then the states. I’m not even touching outside of America. It's not because I’m America-centric, it’s literally in five minutes I can’t even do justice to that much less international regulation. The landscape began to crystallize the regulation of virtual currency in Bitcoin in March of this year when FinCEN, which is the Financial Crimes Enforcement Network, issued its guidance on virtual currency. It’s the arm of Treasury responsible for anti-money laundering policies. The guidance defined virtual currency and then basically said it was going to regulate virtual currency under the existing definitional scheme for a money transmitter, under the Bank Secrecy Act, which is the anti-money laundering law in the US. There is a class of financial institutions and money services businesses that have to follow anti-money laundering policies. One of those categories is money transmitter and that’s what FinCEN decided virtual currency was. It went on to define a whole bunch of terms that literally have no basis anywhere in the statute or the regs that it then used to talk about virtual currency exchangers and administrators. There's been a fair amount of uncertainty created by some of those terms. I don’t have time to go into it now. You see the bullet up on the screen. [I’m] happy to answer questions. One of the big ones is that while the guidance more or less clarified how exchanges and gateways are going to be regulated, it left some big unanswered questions about users and miners, suggesting the possibility that they might be money transmitters too. One thing to keep in mind, there’s a lot of emphasis when people talk about the guidance about these terms that FinCEN created and whether they made new law or not. It almost doesn't matter because nothing in the guidance changed the definition of money transmitter in the Bank Secrecy Act regulations and that’s what you have to come back to whenever you’re faced with a question about whether you’re regulated under the guidance. I want to point out one key here, basically money transmission is when you take value from a person and you send it to another person or, and this is key, another location and I’ve emphasized it and bolded it, because that’s how FinCEN gets at an awful lot of what happens in the virtual currency space. You take dollars from somebody, you send value back to that same person, say Bitcoins, but since you sent it to their Bitcoin address and not the bank account that they sent you dollars from, you’ve sent it back to another location. Ding, money transmission. If you are a money transmitter, you have to register with FinCEN, you have to have an anti-money laundering policy. Most of the major exchanges and gateways are or are coming into compliance with this. It’s not that hard compared to (and I’ll talk about this in a second) what you have to do if you fall under state money transmission regulation. I’m just going to tick off a couple topics really quickly. Right now there's no regulation of virtual currency by the CFTC, the Commodities Future Trades Commission. They’ve signaled they very well may in the future. It's clear that virtual currency is a commodity, because basically under the act that governs the CFTC everything is a commodity. I’ll simplify. It doesn't matter. If you're not engaged in things that the CFTC have jurisdiction over, like options, contracts and futures and derivatives, it’s not going to matter. If you’re doing those things, it’s likely at some point the CFTC will come calling. There is also the SEC, continuing the federal alphabet soup. Right now, I think the general consensus is that virtual currency is not a security. You can package it in a way that you turn it into a security, but if you’re just buying and selling Bitcoins, you’re probably not trading in a security although I’d say that’s only something that the industry is only reasonably comfortable with being true. There are a whole bunch of other federal regimes. There’s consumer lending laws. There’s the FTC which will get involved if there’s consumer fraud, which of course there will be. At some point I think we can expect them to pop up. That’s it for federal regulation of virtual currency, it was like 3 minutes. States. Most States regulate money transmission. Their perspective, unlike the federal perspective, is consumer protection, not anti-money laundering. They do it under a whole bunch of different frameworks. Some refer to money transmission, some talk payment instruments, some talk about stored value. It matters, because (and I have a slide on each of the three and I’ll just tick through them), basically you have to look the language of the statutes to see if they apply to virtual currency. For example, sometimes the statute defines the  subject of money transmission laws being money and make's clear that by that they mean real currency legal tender, and since FinCEN’s guidance told us that virtual currency is not legal tender, in those states (at least under the letter of the law), you’re probably not engaged in money transmission. The details matter. We've gone through [and] we’ve analyzed the 50 states and the District of Columbia and you can put them into groups. There are some states we think you’re probably safe to operate in, some where there’s a question mark, and some that are no go, unless you go and get money transmitter license. As a lot you know by now that’s an expensive and time-consuming process to go and get 50 state money transition licenses. People say $1 million in a year, that’s a little rough, but it’s not off by more than an order of magnitude. Two quick points on the States. At least two have said, it’s not just if you're operating in our state, but if you’re sending currency to somebody in our state. So from outside of our state, we view ourselves as having jurisdiction. It’s very possible that others might take that position as well. Back up a slide to note the second point. There are at least three states (let’s see if I can get there, yes), New Mexico, South Carolina, and Montana, no money transmission regulation. What does all of this mean? You’ve got to look carefully at the regulation in the State you want to operate in and do the parsing of the regs of the statute. Where you think you need a license, you'd better go get it. Businesses have gotten cease and desist letters. It's pretty clear that if you're operating virtual currency business in a state that views itself as having regulatory authority over it, they will come to you and get you to stop until you come into compliance. One thing to keep in mind, a lot of the more established gateways and other businesses are figuring this out. There are options. You don’t necessarily have to go and get your licenses in every state. There are ways of partnering with licensed money transmitters and with banks which are exempt from the money transition laws to structure your offering so that you technically have the money transmitter or the bank doing the money transmission piece of it and you’re functioning legally as their agent even though it’s really your offering. Those are complicated structures to put in place, but they’re doable. It does mean more. This is a common misconception. You don’t have a bank partner for this purpose if you just talked a bank into giving you an account. Even that’s a hurdle for some companies in the space. That's not enough. That really doesn't get you out of the money transmission kettle. Last two slides.

What's next? In the near term future, I think the FinCEN guidance as much as it’s created consternation and confusion is going to be a fairly stable structure at least in the near term. Most of the exchanges and other business have said, “I don't like it, but I know how to get compliant. At least I have a roadmap I can follow.” There’s still these open questions for miners and users. I think the other agencies will pile on, but I don't think it's going to be that some other agency grabs jurisdiction from FinCEN. I think you’re just going to have more agencies regulating specific aspects of virtual currency. Finally, I think states are going to continue to probe at the extent of their jurisdiction. Last slide, hmmm… well… I can be done. Long-term, just a couple of observations. I think that regulators will take a wait and see approach. I don't think that necessarily there will be in the next 2, 3, 4 years a new regulatory regime put in place. I think if there’s mass adoption though of virtual currency, which is what I think most regulators are waiting to see if it happens, then you could have a relook and maybe a new scheme put into place. I think in the near term, what we know is that we’re operating under the federal level, the money service business regime. We might not like it, but at least it’s a known that we can deal with. End of talk. Sorry it was so rushed. (32:42)

[Clapping] (32:49)

RS: If you have a Bitcoin startup, your regulation and compliance strategy is one of the most important parts of your strategy and you need to hire someone like Jacob. There are five or six of them floating around the industry to help you do it. It’s required. You have to do it before you raise money. You have to do it before you start operations. A key early operational hire will be your compliance officer. This is very, very important. You’ve got to do it before you launch your business. Moving on, Jerry Brito, from the Mercatus Institute at George Mason University. This is kind of the flipside. Jacob’s all about how do you comply with existing regulation and how do you make sure your business isn’t going to jail for running it. Jerry’s going to talk more about how do you influence the direction that it’s going. (33:38)

JB: Well, thank you, Ryan. Thank you all for having me here. I thought what I’d talk briefly about is as the regulators that Jacob discussed start looking at Bitcoin, the importance of education in D.C. and in States, actually, as this moves ahead. I think that the current law and regulations aren’t really envisioning a technology like Bitcoin, so that's why it exists in a bit of a legal grey area. Bitcoin does not exactly fit into any of the existing definitions or any of the existing regulatory buckets that we have. It's difficult to make new buckets, so what regulators try to do inevitably whenever we see a new emerging technology is try to fit that new technology into an existing bucket. When you do that you tend to make mistakes, especially when you have radically different technologies like Bitcoin that don’t fit neatly into existing buckets. I've heard many people say that they believe that the governments will never allow Bitcoin to compete in the existing financial space or to compete with the monetary system. Maybe down the road that might be a problem. It may be a situation where the governments do want to exert that kind of control, but I think right now (certainly the situation that I see in Washington D.C.) is that of policy makers not so much trying to exert control, but of just trying to figure out what the heck Bitcoin is and trying to figure out what regs apply and how the regulations apply to this new technology. To me it’s not a matter of whether different parts of the Bitcoin ecosystem are going to be regulated or not, I think we know they’re going to be. I think it’s pretty clear and I’m not saying by the way that I think these regulations are necessary or wise, it’s just stating a fact. The question is do we want regulators to do as little damage as possible in the process of fitting Bitcoin into their buckets or creating new buckets. I think at this point, it is the policymakers’ ignorance that can do the most damage. To me, the example, A number one, is the FinCEN guidance that you were discussing, Jacob. First of all, it’s about virtual currencies as a whole. That is what they’re regulating, it’s virtual currencies and that is an umbrella term that is both de-centralized currency like Bitcoin and also centralized currencies like you might have heard of, Liberty Reserve. Whenever I speak to either folks on Capitol Hill or different enforcement agencies, they talk about virtual currencies. That’s what their interest is—virtual currencies. You have to draw that distinction for them. Now, the FinCEN regulation defines persons that are potentially subject to really significant regulation and you had to finish them up there. What a user is, an exchanger, an administrator…? With exchangers it’s very clear that they are subject to FinCEN registration and compliance. With users it's much less clear. It does not explain how the law applies when one obtains Bitcoins, not to purchase goods or services, but to do something else with it. For example, send to Remittance. Miners are the most unclear. Are miners administrators as defined in the FinCEN guidance? Well, there are no administrators in a de-centralized currency. That's why the guidance had to have a separate section about de-centralized currencies, by which they really meant Bitcoin, and it says that a miner who mines Bitcoins and then uses them to “purchase real virtual goods and services is considered a user, not subject to regulations, but if the miner sells the mined Bitcoins to another person for real currency where it’s equivalent then they do qualify as a money transmitter subject to regulation.” Right now I’m reading the guidance suggesting that miners really need to comply with the regulation which can be quite onerous. I think some folks think the government is acting maliciously here that they are doing this to hamper the growth of Bitcoin, but I think it’s just mistakes made out of ignorance. I think that if FinCEN had given notice and taken comment on these rules, they might have been able to put out more sensible rules and really had a more improved product. On that note, I would note that, personally, I think that the guidance probably could be challenged successfully in court, because they introduced new law and they did that without issuing notice and comment which is required under the Administrative Procedure Act when you create new law. The FinCEN regulations (these are regulations that pre-existed all of this; these are promulgated according to the APA) define currency as a currency of the State. FinCEN guidance says, we call that “real currency” and then it develops this new concept that it calls “virtual currency” and it predicates the entire guidance on this new definition of virtual currency. This definition of currency which is what they call “real currency” was adopted through rule making. The new substantive concept of virtual currency and convertible virtual currency exists only in the guidance. A problem that could have been avoided had they taken notice and comment. At the Mercatus Center at George Mason what we try to do is be a bridge between ideas in academia to real world problems in the policy space. We’re trying to engage FinCEN, but also other regulators, folks on Capitol Hill who have shown interest to tell them that they need to start engaging with the community. Just explaining what Bitcoin is. To that end, we are publishing a Bitcoin primer for policymakers in a couple of weeks which basically explains what Bitcoin is and what potential and the challenges are. We have been briefing the Senate Homeland Security committee who has been very interested in Bitcoin. They potentially will have hearings on virtual currency in the Fall and we have conducted courses for Hill staffers on Bitcoin. We’re working with the Bitcoin Foundation to get them more involved in D.C. and a bunch of other stuff. I’ll stop now, but I’ll be happy to answer questions. Thanks. (40:20)

RS: By the way, the Mercatus Institute’s doing all this really fascinating research as a non-profit. They do take donations. If you’re a fan and are a fan of how it’s influencing the regulations, you should donate. (40:35)

JB: We just recently started accepting Bitcoin. So, there you go. (40:39)

RS: which makes it very easy to donate. Bitcoin is an easy way to pay. Next up we have Greg from the Genesis block. The Genesis Block is one of first long form research and analysis groups to emerge in Bitcoin. As a result they became very early thought leaders and I think everyone I know is subscribed to them. (40:59)

GS: Howdy everyone. Thank you all for having us here today. As Ryan said, my name is Greg, I’m the managing editor of the Genesis Block. The Genesis Block is a research and data firm in the digital currency space. We’ve read about everything from trading in regulation to mining and protocol updates. We also have a suite of data products for the community. My background is I started out as a fixed income analyst at Citigroup and then I started a payment software company before starting the Genesis Block most recently.  I want to hopefully use my background with the experience with regulators and also my experience in Bitcoin to hopefully offer some context for a lot of people here in the Bitcoin space and highlight a couple things that we get questions about a lot. First of all, Jerry, I totally agree on the idea that innovators, particularly technical innovators, tend to see the things are different and unique about what they are doing. Regulators tend to bucketize everything into existing regulations. That said, the FinCEN rules that applied to Bitcoin exchanges are not new regulations. Money transmitters or people who take any substitute value and act on it by the direction somebody else, that's been the definition of a money transmitter for a longtime. There are definitely some new definitions that entered into that guidance, but at its core it’s not particularly different than anything that has existed for many, many years. A couple of things in particular, that I wanted to talk about in that [space]. When Bitcoin businesses are setting these things up, what you have to realize is that getting the licenses (which is expensive and takes a long time) is the first step in the process. Over the period of time that you’re conducting your business, that's when the actual regulations come into play. Your business has to comply with those. They actually have to occur in your business. There are a number of ways that you can reduce the load on a young company to try to make this a little easier to do. Tradehill partnered with a number people, MeCard, I believe. There are people that will handle some of the compliance issues if you partner with them. There are companies already. There are Bitcoin exchanges who have partnered with people who have existing licenses and are acting as an agent of those people.  There are people who are stepping into the industry certified as money transmitters in 50 States as an agent of an existing principle. The beauty of that is you can step in very quickly. The difficulty is finding someone who trusts a Bitcoin exchange with their licenses, which is extremely difficult to do, but it's happening. There are ways to outsource a lot of the difficulties of this for a young company. The second thing I want to talk about is miners in particular. The FinCEN guidance… Jerry just read a quote… Jerry, you substituted a couple key words there that I’d actually like to clarify. I say this not to be adversarial, but to point out a lot of the confusion that we try to address. In the FinCEN guidance it says that a person that creates units of virtual currency, etc., etc., and it goes into what Jerry was talking about. Jerry had substituted the word “mining” there, “miners,” for a person that creates the virtual currency. That’s a common substitution and it is something that’s been largely debated in this space. The stands of our firm and a number of lawyers that we’ve talked to is that miners are actually not constituted as money transmitters because, miners, for people who understand the Bitcoin protocol do not create Bitcoin. They are the first recipients of Bitcoin, they help provide a service of payment processing in a Bitcoin infrastructure, but they do not actually create the currency.  To define it as a person that creates units of the currency as a money transmitter, that's simply not a miner. The reason I bring that up is because if you're falling within the regulations then it can be to your benefit to act in line with the law. As Jim was saying, miners should expect to be taxed on their income. If you are going to be taxed on the income (and again I’m not a tax advisor or a lawyer, you should talk to them), setup a business entity. Right off the investment. Take advantage of the tax structures that many businesses take advantage of everyday. If you’re spending $50,000 on mining equipment, that may or may not have positive ROI, well, if you set up an LLC and take pass through losses against your personal income, there’s a lot of ways to stay above the law and use it to your advantage. Don’t be afraid of regulation necessarily and if you can find ways to play within the structure it can be to your benefit. The third thing we’ve seen popup a lot... If you’re going to be funding a business, you could go the bootstrap route which is try to earn revenue and grow it from there or you could go the investment route with venture capital. Two other things that have happened a lot in the Bitcoin space that I want to address real quick. One, there’s different methods of crowd funding and there’s an important distinction that needs to be made. One is rewards crowd funding, where you are pre-selling a product or some sort of reward for helping you get a business off the ground. The other is selling unregistered publically traded securities and that will trigger a lot of problems for people from a series of regulators, particularly the SEC. We've seen some regulation about this and some prosecution of it in just the last week. People think that because it’s a new technology, because it's not dollars that therefore they’re going to be immune from the felony prosecution of selling unregistered nonexempt publically traded securities. That’s simply not the case. Just in the interim we saw a Colored Coins commercial was playing on loop and there’s a cartoon chameleon with a cigar saying now you can sell your own bonds and stocks. Not if the SEC has anything to do with it, so you may want to double-check that before you go down that road whether or not it’s technologically capable. I’ll stop there and am happy to answer any questions. (47:05)

RS: I’m going to let Patrick, Patrick works at OpenCoin. They’re the company behind Ripple and after that I have a couple of questions for the panel and then I’ll open it up to you guys’ questions. (47:13)

PG: Great. Thank you, Ryan. My name is Patrick Griffin. I am part of the founding team of OpenCoin. We’ve developed the open source payment network called Ripple and I want to offer everyone in the room a slightly different perspective on what these distributed systems are really all about. When we talk about Bitcoin and we talk about Ripple, we talk about Color Coin, the inherent, obvious focus tends to be on the currency. Virtual currency is what grabs the headlines, but I think if you scratch a little bit more and you look a little bit below the surface what was really going on here is that these are protocols that can convey transactions. These are transactional protocols that can simply confirm transactions without a central authority. That is the big innovation of Bitcoin and Ripple. For the first time in the history of electronic transactions these systems have figured out how to bring the confirmation process from a central server or central entity out another layer to the level of the network where now the network collectively is acting to confirm transactions without an authority. What that means is since there is no network operator, there are no network operator fees [and] there are no middle-men that get involved in the processing of a transaction. I would posit that there is nothing inherently contradictory with a low cost distributed financial system and the actions and efforts of enforcement. The big takeaway here is that these protocols can be utilized for clearing transactions of any sort, whether it’s Bitcoin, whether it’s US Dollars. This is really just about clearing transactions in a more efficient and global way. When you apply that logic that these protocols are really about clearing transactions, and not necessarily about the currencies within them, you can start to look at these protocols in the sense of pre-paid access and apply the same framework that exists today under the current regulatory regime on issuing pre-paid access, taking deposits, conveying those balances and those values across a network. A strong corollary I think to Bitcoin and to Ripple is probably something more closer to SWIFT [Society for Worldwide Interbank Financial Telecommunication] or VisaNet or NACHA [National Automated Clearing House Association] rather than to the U.S. Dollar. What’s currently being done at the state level is that there’s some uncertainty within this space. At the state level we still don’t have any guidelines, any guidance. At the federal level we have received some guidelines from FinCEN, so we are operating within an environment of uncertainty. Beyond that, as has been echoed, I would echo some of the voices on the panel [that] have described some of the lack of complete understanding of how these systems work from a regulatory perspective. Given that we have both uncertainty on the regulatory side and uncertainty on the side of the businesses using the protocols, I think it’s safe to say that the industry collectively needs to be very proactive on setting standards [and] creating best practices. What we can do today is implement strong KYC standards, strong on-boarding standards, something that looks a lot like current banking on-boarding standards. There are already companies that are utilizing services of background check providers like Jumio and GBGroup and Ideology to sufficiently on-board customers and comply and setup strong AML [Anti-Money Laundering] and strong BSA and strong KYC standards. [For] what needs to be done and what remains unclear on how to resolve this, the industry really does need to look to SWIFT and the U.S. government action on applying the travel rule to these protocols, making sure that we have visibility into the identity of the beneficiary of a transaction [and] setting up strong standards for sharing information about the beneficiary of a transaction. That is what I think remains to be done. Implementing strong KYC standards, coupled with strong know your counterparty standards and then bring that into a public ledger framework, that’s very powerful for law enforcement and that’s something that law enforcement can really get behind. (51:47)

RS: It’s a great point. This is something that has come up a lot in our discussions with the regulators and in our discussions with the lawyers. The knowing the final counterparty is very, very powerful and Bitcoin and Ripple are allowing for the first time the idea that you can know the transactions and know the counterparty without necessarily a direct reporting. It’s potentially an incredibly value tool for law enforcement instead of a threat. Opening up to some questions, my first one’s for Jim. Jim, I think me and a lot of my competitors and clients really understand when we get Bitcoin in we value it at market rates the day we got it in, that’s income. The day we sell it if we sell it at more than we valued it at, that’s gain. If we sell it for less, it’s a loss. The taxes, in terms of how to do it with our own firms is clear. The question, especially since a lot of us are running merchant processors or payment processors or pre-paid access issuers is what kind of thoughts should inform our reporting strategies? And what does the GAO and the IRS want to see from us in terms of what information we disclose to the government about third parties? (53:07)

Jim: I think you’re right. There’s uncertainty on both sides. There’s some uncertainty about what constitutes taxable income. There’s definitely uncertainty about the third party reporting requirements and right now there isn’t any IRS guidance on either one of those. Again, that was the basis for our recommendation. By the way, I forgot to add our report’s on our website. The website is gao.gov. If you search virtual currency you’ll be able to easily find the report. (53:38)

RS: Looking forward to reading it. Does anybody in the panel have questions for the other people? (53:46)

JB: I wanted to address what Greg was saying. Greg, you mentioned that miners are not subject to regulation because they do not make coin, they’re issued coins, are the first recipients of coins. I wrote about this a while back. The uncertainty around the FinCEN regulations applied to minors and I had a producer for the Stossel show write to me and say, “Hey, you know, I followed up with FinCEN, and I asked them just to be clear, does this cover miners?” The response that he got back from FinCEN was quote, and this was quote FinCEN, “Miners, if they’re in the business to be miners, also need to register. Average Bitcoin users are likely to be unaffected by our guidance.” FinCEN seems to have an opinion about this. I would have to go back and pull the transcript, but I’m sure that I’ve heard the director of FinCEN, Jennifer Shasky Calvery, mention miners specifically. I don’t think we can say with any certitude that miners are not subject to the regulation. I think the best that we can say is that there’s a lot of uncertainty surrounding the application of the regulations to miners. (54:58)

GS: Definitely. One of the things that we see in the space as they define these new terms, they’re subject to change. What I was using is the language that was in the FinCEN document. FinCEN historically when they receive these kinds of questions from people, they’ll publish the answers. If that’s the case, they owe that to the community to publish that, because there is no way from anybody to know what was said on the Stossel show. That’s one of the regulators jobs is to publish that information. I appreciate you bringing that to light. The other question is do they actually understand the role of miners in the Bitcoin community? And is that something that they’re going to roll into the official regulation or guidance? Or is that something that remains in a one off email where they might be confused. I certainly agree that it’s subject to change, but as of now the language in the actual guidance says what it says. (55:57)

RS: This brings up an interesting question for Jacob as the resident payments attorney. If a miner registers with FinCEN that comes with it certain reporting requirements like CTRs [Currency Transaction Report] and SARs [Suspicious Activity Report]. If the miner’s basic business is they plug machines into the wall, the machines produce Bitcoin, and they sell those Bitcoin on an exchange, and they don’t know their counterparty, what should they report to FinCEN? (56:22)

[Laughter] (56:26)

Jacob: Ding, ding, ding… [Laughter]. That’s why it’s a mess. I’ll answer your direct question in a minute, but I’m also going to take a middle position and say these guys were both right. You’re [Greg Schvey] right in the way the guidance defines what it’s talking about. You can read it not to mean miners, but it’s also true that if you look at the definition of money transmission and I mentioned this earlier, because you’re taking value as a miner (Dollars) and you’re sending somebody Bitcoins to another location, arguably under the definition you are a money transmitter. Nobody really knows. I’d heard about this too. It really is a murky world and clarification is probably necessary. One of the concerns is that if you want to get the right ruling, you got to make the right request. The industry should take that seriously and it should go in in a well-thought out manner. There have been a couple kind of casual requests sent in and you want to set yourself up to get the answer you want. You just have to be cautious when you approach a regulator. You want to ask a question that you know what the answer you’re going to get is. On your question, Ryan, the answer is nobody knows what you’d report. You can’t know when you’re trading on an exchange who your counterparty is. That’s how they work. As far as anybody can figure, you report the exchange as the counterparty. There’s no better answer right now. (57:57)

RS: I hate to do this. The conference guys just told me that we don’t have time for audience questions which really bums me out, because we don’t normally get this many high quality experts here, but they’ve told me that all of the speakers, including myself, will be at the reception tonight and we’ll be available to answer any questions. I love meeting virtual currency businesses. I love having them join my company as clients and all of the other speakers are there too. I know both OpenCoin and Perkins Coie are also looking to meet you an answer your questions. Of course, Genesis Block would love to interview you and the Mercatus Center needs to donations. Please find us. Please ask us questions after and we’re looking forward to meeting you and looking forward to hearing from you. I’d really like to thank you guys for coming out. (58:47)

[Clapping] (58:52)

AL: Thanks for listening to this portion of our special Let’s Talk Bitcoin conference coverage. Big thanks to Mediabistro for putting on a wonderful event, Inside Bitcoins. Stay tuned for more to come over the course of August. If you have any questions or comments for me directly you can email [email protected]. If you have questions, comments, or topic suggestions directed at the show broadly, please visit letstalkbitcoin.com/reddit. (59:16)

[Music] (59:29)