Bitcoin Bifurcation, Third Parties, and Legal Issues

Bitcoin, Ethereum and other cryptocurrencies are surging in value, at least for the moment. That is also causing a surge in attention.

Governments are wary of cryptocurrencies for the same reasons that libertarians love them. As Wikipedia puts it:

In centralized banking and economic systems such as the Federal Reserve System, corporate boards or governments control the supply of currency by printing units of fiat money or demanding additions to digital banking ledgers. In case of decentralized cryptocurrency, companies or governments cannot produce new units …

Central bank representatives have stated that the adoption of cryptocurrencies such as bitcoin pose a significant challenge to central banks’ ability to influence the price of credit for the whole economy. They have also stated that as trade using cryptocurrencies becomes more popular, there is bound to be a loss of consumer confidence in fiat currencies. Gareth Murphy, a senior central banking officer has stated “widespread use [of cryptocurrency] would also make it more difficult for statistical agencies to gather data on economic activity, which are used by governments to steer the economy”. He cautioned that virtual currencies pose a new challenge to central banks’ control over the important functions of monetary and exchange rate policy.

The above sounds like a libertarian dream (at least some libertarians have embraced bitcoin), and a statist nightmare, though some libertarians dislike Bitcoin.

It shouldn’t be surprising that the Green Party is less enthusiastic. I can’t find anything on the US Green Party website. I did find something from the UK showing the Greens seeming to oppose it:

The Green party contend that money creation is far too important to be left to the profit-driven private sector, with its murky motives and moral hazards, and that a new state-funded organisation with day-to-day autonomy from the government should have that responsibility.

For more depth see this article on Greens and cryptocurrencies. Of course the Greens are not uniform and at least one Green candidate accepted Bitcoin donations.

Something I never see discussed about cryptocurrencies is what I see as a bifurcation of the market. There are essentially two worlds of Bitcoin. The better known end of it is what I refer to as the government-approved world, dominated by operators like Coinbase. Lesser known but perhaps more important is the part that operates outside of government control and supervision, which I will refer to her for fun as the netherworld. The most obvious example of this is LocalBitcoins.com but there are many “wallets” out there.

In the latter world cryptocurrencies offer tremendous advantages including anonymity, low transactions costs including across national borders, and security from government confiscation. For those who think that last benefit is silly, remember that FDR confiscated gold.

Excessive government interference forced this bifurcation and causes a substantial separation between the two worlds. My early efforts involved receiving Bitcoin from relatively anonymous sources in the unapproved world and then attempting to transfer that into a Coinbase account. Government paranoia over money laundering involves know your customer regulations. Greens, at least in Europe, support the notion of treating money laundering as a crime. Of course libertarians generally consider money laundering to be a made up crime and an excuse for government and banks to spy on us – see Mises – Banks as spies.

Side note, the Libertarian Party’s Bitcoin donation works through BitPay in the government-approved world.

As a result of those regulations Coinbase closed my account when I received money from my netherworld wallet. I know of at least one other person who had a similar experience, and it seems common with operations in the government-approved world. This makes it much more difficult for users to convert their cryptocurrencies into cash or to use them to shop online or otherwise. In a classic example of unintended consequences, cryptocurrency remains useful in the so-called Dark Net involved in more shady activities like gambling and drug dealing.

One outlet I have found is the website LocalBitcoins.com, where you can buy or sell Bitcoins in a variety of ways, including in-person cash transactions. But this creates its own set of potential legal problems.

The US government has made a substantial effort to prosecute those who transact business in cryptocurrencies. Some of the more famous cases have involved Bitcoin exchanges like Silk Road and BitInstant. Since few of us are likely to operate such an exchange, that’s not a concern for most. But there are still significant legal risks for smaller players.

For example, a chiropractor got caught up in Bitcoin and was charged with money laundering. Randall Lord was a Libertarian congressional candidate in 2014. For another article on his case see KTBS story.

As a criminal defense attorney, I see serious pitfalls for those interested in Bitcoin and other cryptocurrencies. The biggest concern is that one could face federal prosecution for money laundering.

Randall Lord, a libertarian, was sentenced to 46 months in federal prison

Randall Lord and his son went beyond merely investing in Bitcoin or treating it as a hobby. He and his son offered “Bitcoin services” through LocalBitcoins.com where they would both buy and sell, and engaged in transactions totaling over $3.5 million. That took them to the level of being treated as a money services business, which the Feds feel requires registration, licensing, and following FinCen regulations (the “know your customer” rules mentioned above).

I myself have engaged in a small number of in-person transactions facilitated through the same website. One can advertise on that website to both buy and sell bitcoin, charging a percentage of each transaction as a fee. Thus you can make a profit on both types of transaction. That starts to look like a money services business. That term is defined in Title 31 of the Code of Federal Regulations, section 1010.100(ff).

Being aware of cases like that chiropractor, I have kept my activity very limited. I do not treat my activities as a business, but rather as a hobby. I only advertise to sell Bitcoins – I don’t buy – that I have accumulated in other ways and I don’t make a significant profit from the transactions. I also keep the transaction sizes down – I haven’t done any for more than $1000. I usually deactivate the ad after one or two transactions and go on hiatus for a while. Some players on the website have multiple ads in multiple locations. I only have one ad for one location. I also conduct business openly in my own name – I don’t hide what I’m doing. And when I receive cash for Bitcoins I deposit the cash in my bank account and properly report it for tax purposes. To be especially picky, what I’m doing is protected by a safe harbor provision in the CFR. But federal law and federal regulations can be so vague you can never be sure you’re safe. As Harvey Silverglate’s book puts it, the average professional unknowingly commits three or more federal felonies a day.

A couple of times when I did transactions I got the feeling the person I was dealing with was either an undercover agent or an informant. Maybe that makes me paranoid but we know the Feds do things like that. I get particularly suspicious when someone asks me to do larger transactions. That’s the kind of thing that could move you up on the federal sentencing guidelines to a much longer prison sentence. Lord got nearly four years and his son got almost nine years.

I would love to see comments on this from libertarian, Green, and other perspectives.

8 thoughts on “Bitcoin Bifurcation, Third Parties, and Legal Issues

  1. dL

    Governments are wary of cryptocurrencies for the same reasons that libertarians love them

    True…

    some libertarians dislike Bitcoin.

    Not really. You linked to a very old article for that evidence . Today, even the gold bug LewRockwell.com takes bitcoin.

    It shouldn’t be surprising that the Green Party is less enthusiastic. I can’t find anything on the US Green Party website. I did find something from the UK showing the Greens seeming to oppose it:

    Less enthusiastic, no doubt. However, I know would be a mistake to use, say, the UK libertarian party as a proxy for the US LP to fill in any blanks on any issues not explicitly addressed at lp.org. Perhaps likewise RE: the US Green Party and the UK Green Party.

    Something I never see discussed about cryptocurrencies is what I see as a bifurcation of the market. There are essentially two worlds of Bitcoin. The better known end of it is what I refer to as the government-approved world, dominated by operators like Coinbase. Lesser known but perhaps more important is the part that operates outside of government control and supervision, which I will refer to her for fun as the netherworld. The most obvious example of this is LocalBitcoins.com but there are many “wallets” out there.

    The bifurcation in bitcoin is between core and unlimited, with threat of a hard fork over transaction scalability. No part of the essential bitcoin transaction system is under government control and supervision. Exchanges–which involve converting currency to coins and vice versa–may be under FinCEN reporting regulations. Exchanges are classified as MSB, but the fundamental MSB bifurcation between “white” and “netherworld” you are trying to establish here would better apply if “mining” was classified as a MSB.

    in the latter world cryptocurrencies offer tremendous advantages including anonymity, low transactions costs including across national borders, and security from government confiscation. For those who think that last benefit is silly, remember that FDR confiscated gold.

    Bitcoin is pseudo-anonymous, not anonymous. It doesn’t matter the source of the coins, FinCEN MSB exchange or not. The blockchain is a public ledger. If you buy coins from “localbitcoins,” your subsequent transactions can be tracked and your identity outed. Forensic analysis of the blockchain by governments and government contractors is a big business. Make no mistake. Anonymity is achieved by tumbling your coins. If bitcoin was considered “money” by governments, this would be considered money-laundering.

    In practice, bitcoin is not necessarily a “low transaction” system. You add up all the fees , including exchange fees, tumbling fees, miners’ fee, and you are paying more than Credit Card transaction fees(those are typically assessed on the merchant or seller side) w/ the added “feature” of being slower.

    The US government has made a substantial effort to prosecute those who transact business in cryptocurrencies. Some of the more famous cases have involved Bitcoin exchanges like Silk Road and BitInstant. Since few of us are likely to operate such an exchange, that’s not a concern for most. But there are still significant legal risks for smaller players.

    We should be accurate here. Silk Road was taken down b/c of the product being exchanged. BitInstant was shut down by a class-action lawsuit from its own customers before the Feds jumped in w/ a charge of operating an exchange for silk road. The chiropractor was using his credit card merchant account to run what the feds considered a MSB money transmitting business. As of now, the feds only apply FinCEN to exchanges, not to users, miners or protocol developers.

    A couple of times when I did transactions I got the feeling the person I was dealing with was either an undercover agent or an informant. Maybe that makes me paranoid but we know the Feds do things like that. I get particularly suspicious when someone asks me to do larger transactions. That’s the kind of thing that could move you up on the federal sentencing guidelines to a much longer prison sentence. Lord got nearly four years and his son got almost nine years.

    The Feds are indeed on localbitcoins, posing as buyers, trying to nab sellers moving a volume to classify them illegal MSBs. However, if you are a buyer, you cannot get stung. Too paranoid, here. At least at this juncture.

    MY CONCLUSION:

    Bitcoin perfectly demonstrates the libertarian critique of the state. The state is the organization of plunder. It has little tolerance for any productive enterprise that has the nerve to operate outside its purview. It wants its cut, and more importantly, it wants the permissory, discretionary authority to stand between supply and demand. However, a naive libertarian analysis would be preoccupied w/ government control of bitcoin by simple bureaucratic fiat. No, the bitcoin venture capitalists will a potentially achieve this for them. In partnership. They will author the statist regulatory framework(bitcoin as money) for the bureaucrats. Thus, the actual bitcoin bifurcation: crypto-libertarians vs venture capitalists(who are on the hook for a transactional scalability to compete w/ the card payment system).

  2. wredlich Post author

    First of all, thank you dL for commenting. I thought this article would have gotten more response, but maybe it’s just a long weekend thing.

    The bifurcation in bitcoin is between core and unlimited

    Maybe, but the bifurcation I’m talking about is real and no one else seems to be talking about it.

    Bitcoin is pseudo-anonymous, not anonymous. It doesn’t matter the source of the coins, FinCEN MSB exchange or not.

    Yes and no. I suspect you know more about this than I do, but I would say it’s more a matter of degree. With a credit card purchase the buyer, seller and the credit card company all know the buyer and seller’s identities (and more) and they know these details immediately. With a Bitcoin purchase no one knows anyone’s identity automatically or immediately. Yes the identities can be found but it is much harder to do so.

    In practice, bitcoin is not necessarily a “low transaction” system. You add up all the fees , including exchange fees, tumbling fees, miners’ fee, and you are paying more than Credit Card transaction fees

    I’m not sure what you mean. I think this depends on the size of the transaction. For small transactions bitcoin fees can be relatively high. But for larger transactions (say $500 or more) I think the fees are much lower. Please explain if I’ve got this wrong.

    As of now, the feds only apply FinCEN to exchanges, not to users, miners or protocol developers.

    The key language there is “as of now”. As I read the definition of Money Services Business is broad enough to cover someone who making a profit on transaction fees from buying and selling Bitcoin, with certain exceptions.

    The Feds are indeed on localbitcoins, posing as buyers, trying to nab sellers moving a volume to classify them illegal MSBs. However, if you are a buyer, you cannot get stung.

    I think your first sentence here is a contradiction of what you said above, but maybe I’m missing something.

    And as I said above, I’m not sure a buyer can’t get stung. Besides, doesn’t a buyer eventually sell?

    Thus, the actual bitcoin bifurcation: crypto-libertarians vs venture capitalists(who are on the hook for a transactional scalability to compete w/ the card payment system).

    Very interesting and this may go along with my take on bifurcation. I’m not sure whether it’s VCs or government that are responsible for the statist regulatory framework – probably some of both. But that has created a meaningful bifurcation for regular people, who have to choose between the flawed statist version of Bitcoin or the purer but more difficult dark Bitcoin.

  3. Andy

    I am the one who had the idea for the Libertarian National Committee to start accepting donations in Bitcoin, and I in fact suggested it repeatedly right here on IPR. LNC At Large Representative, Starchild, saw my posts on this subject, and took it to the LNC. I participated in an email thread with some LNC members where I shot down some of the naysayers, and where I suggested that the LNC use BitPay to convert the Bitcoin donations to Federal Reserve Notes. The LNC voted on this proposal, and it passed, although there were dissenting votes from the naysayers.

    Part of my suggestion included making a big announcement about the LNC accepting donations in Bitcoin, and releasing a video on the subject, there was not announcement made at first, and the Bitcoin donation link was buried on the LP.org website. The fact that the LNC started to accept donations in Bitcoin did get mentioned as blurb in an email that went out to the party’s national email list, along with several other items of news, and the fact that the LNC was now accepting donations in Bitcoin got a little bit of coverage from a few alternative media outlets. A few months later, the LNC office staff ended up moving the Bitcoin donation link to the front of the LP.org website because it was successful, as in the party began to receive thousands and thousands of dollars in Bitcoin donations (this was even mentioned in an LNC report).

    Unfortunately, when the LNC changed the LP.org website last year, the person who did this removed the Bitcoin donation link from the front page, but I was told recently that the Bitcoin donation link is still on the site when you click the link on how to donate.

    I never received any credit from anyone for being the originator of this idea, and for informing the LNC about how to convert the Bitcoin donations to Federal Reserve Notes (except for Starchild, who is the LNC member who brought the proposal to the LNC).

    The LNC ought to start accepting donations in other cryptocurrencies (like Ethereum, Dash, Monero, Litecoin, etc…).

  4. paulie

    As of about a week or two ago when I looked for it, the bitcoin donation link at lp.org was accessible through the page’s search box, but not from any menus or from the regular donate/join pages. In the past there have been several LP.org blog posts, social media postings, an email blast or two and I believe an LP News story about it. I brought it up in a discussion with LP staff, LNC etc recently to unbury the link but I don’t think they did it yet. I would have to check though.

  5. dL

    Maybe, but the bifurcation I’m talking about is real and no one else seems to be talking about it.

    I dunno about that. I wrote an old post way back in 2011 on the topic
    https://rulingclass.wordpress.com/2011/06/09/bitcoin-and-agorism/

    With a Bitcoin purchase no one knows anyone’s identity automatically or immediately. Yes the identities can be found but it is much harder to do so.

    Depends on who is doing the looking.

    The key language there is “as of now”. As I read the definition of Money Services Business is broad enough to cover someone who making a profit on transaction fees from buying and selling Bitcoin, with certain exceptions.

    “As of now” indeed is key. As of now, government do not legally treat bitcoin as “money.” So, the MSB designation does not apply across the bitcoin ecosphere like you think it does. If governments were to recognize bitcoin as money, it would be a very bad development.

    I think your first sentence here is a contradiction of what you said above, but maybe I’m missing something.

    Let us be clear. If you use a credit card to buy bitcoin to buy stuff, you are not a MSB. If use a credit card to buy lots of bitcoin for purposes of investment/speculation, you might have reasons to be paranoid about tax evasion if you do not report any gains. If you use a credit card(s) to buy lots of bitcoin and turn around and try to resell for it currency for a fee, you might have a reason to be paranoid about being view as an “illegal” MSB by the feds. Paranoia about the latter two examples does not translate to the first. No reason to be paranoid about being arrested for buying bitcoins from LocalBitcoins.

  6. dL

    Great read! Thanks. You were way ahead of the curve.

    Retrospectively, not as ahead I would have liked to have been. Underestimated the near-term international political economic impact on bitcoin prices, a life-changing bank account oversight…So, as it turns out, the “network effect” wasn’t necessarily predicated on proliferation of “white market exchanges.”

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