Hardly a day goes past without some story in the press about Bitcoins or other ‘virtual’ currency. For the purpose of this article, all ‘cyber currencies’ will be described as ‘virtual’ – although they might better be described as cyber or digital.
There has been much hype and regrettably much of this has been directed to the fact that it is possible to use Bitcoins for illegal purposes – where its relative anonymity can be used to conceal the parties engaged in illegal activities whether on Silk Road[1] or on any other location on the DarkNet. However, we should not get carried away – it is after all perfectly possible for illegal activities to be conducted using another form of payment, which is largely untraceable whilst in the system; that form of payment is known as cash.
The challenge for any ‘criminal’ whether using Bitcoins or cash is really (or perhaps virtually?) the same; at some point the proceeds of illegality require to be repatriated into the traditional money systems and ‘laundered’ in some way. Hence the authorities have concentrated much of their activities against the intermediaries who, it is perceived, are facilitating this laundering.
It is clear from many of the pronouncements of regulatory authorities that they do not understand virtual currencies and that their first line of attack is to prohibit the use of virtual currencies – the approach adopted in Iceland and Vietnam.[2] The analysis of other jurisdictions reflects the misunderstanding as to the nature of a virtual currency.
UK Tax Treatment
In March 2014, HMRC issued Revenue & Customs Brief 09/14 – ‘Tax treatment of activities involving Bitcoin and other similar cryptocurrencies’.[3]
In brief, HMRC determined that the creation (or mining) of Bitcoins would fall outwith the VAT rules as would the conversion of Bitcoins into £ sterling. However, if products or services were to be sold and the purchase paid for in Bitcoins, then VAT would be charged at the usual rate(s). Of particular relevance here is that it is noted that ‘The value of the supply of goods or services on which VAT is due will be the sterling value of the cryptocurrency at the point the transaction takes place’. Existing traders who invoice in multi-currency will be aware of the potential issues which arise due to currency fluctuations – with VAT being due as at the transaction date and receipt from the customer being later. That can be significant even within the confines of traditional currencies – which tend to trade within a relatively narrow fluctuation band; however, we have seen Bitcoins drop in value by some 50% this year – it was below $100 on 2 October 2013 before rising to $1147 on 3 December 2013 and falling to some $440 on 29 April 2014 when this article was written.
If a trader had sold an item for 1 Bitcoin + VAT in December, he would have paid $229.40 in VAT to HMRC. However when that customer paid today, he would only have received $528; after the payment to HMRC, his net return would be less than $200 – some 17% of the expected invoice value. Perhaps not an ideal transaction.
On the other hand, had the transaction moved the other way, the trader would have incurred a capital gains tax liability in respect of the trade as well as the VAT.
Money Laundering and Other Regulation
The UK regulations in relation to money-laundering obligations of Bitcoin businesses are, at best, confusing and incomplete. There is no requirement per se to prevent dealings in Bitcoins for money laundering purposes – albeit that the US FinCEN Regulations, which may require some form of enhanced ‘know your customer’ compliance audit, are considered (at least by US authorities) as having extra-territorial effect.
Additionally, many Bitcoin and other virtual currency businesses have found it very difficult (if not impossible) to establish banking arrangements with traditional financial entities, due to the uncertainty as to the legality and scope of the financial services legislation and regulation in this area.
For the authorities, regulation and control of virtual currency is almost impossible (and arguably futile).
Definitions and Difficulties
No country has, apparently, yet managed to devise an adequate legal definition of virtual currency / cyber currency which would catch transactions affected with Bitcoins or SafeCoins or any other similar value system, but which would not inadvertently catch such alternative systems as Green Shield Stamps[4] and Pink Stamps and Rewards networks such as American Express Rewards Points or Tesco points.
I suppose that it might be argued that the distinction, were there one, would be that virtual currencies were convertible into ‘real’ currency, whereas supermarket loyalty points generally were not. However, the position becomes somewhat intermingled as there is no doubt that people did sell their trading stamps books. Equally, conceptually, given that a Bitcoin is not a traditional currency, perhaps it could be seen as a barter token. Were that the case, and I can see no reason why it might not be so, how is it to be distinguished from other barter type tokens?
We are familiar in the employment arena with the prohibition of payment on wages in anything other than currency to prevent the abuse effected by paying workers in vouchers only redeemable in company stores. Does this mean that it would not be possible to pay workers in Bitcoins? Certainly, it would be a brave worker who would accept payment in a form which has been seen to increase in value by a factor of 50 before collapsing by 60%.
Overhyped or Here to Stay
The angst in relation to Bitcoins does seem to be somewhat overhyped (if one can overhype angst?). Throughout the centuries, different tokens or symbols have been used as designators for value. Whether that be seashells, coloured glass beads, metal coins, paper IOUs or digital virtual currencies matters little; all that is relevant is that the token is one that is accepted (even within a limited geographic or product area) by others in respect of whatever goods or services that they are offering. My tailor gives vouchers with every purchase which can be exchanged for cash against future purchases; is that a digital currency?).
Taking this to its logical extreme, Scottish company Maidsafe (http://maidsafe.net) in April 2014 carried out a novel crowdfunding in which it sold its digital currency Safecoins in exchange for Bitcoins; hence one virtual money was purchased with another.[5] Perhaps the ultimate Bitcoin 2.0 application? For those that think that this is just another niche play by a small group of technology geeks, the fact is that Bitcoins with a present value of $6m were ingathered by Maidsafe in exchange for the issue of the Safecoins. Whatever some may think of the value of a Bitcoin, clearly some thought it was worth parting with $6m worth in order to purchase a different virtual currency.
As virtual currencies proliferate, some will succeed and some will not; we are already starting to see ‘virtual currency’ exchanges appear; according to the latest ‘State of Bitcoin’ report from CoinDesk,[6] some 60,000 businesses already accept Bitcoins; a search for ‘Bitcoin ATM’ discloses an almost weekly appearance of a new Bitcoin ATM – including the UK’s first at Shoreditch.[7]
Reality Check
As with any other financial phenomenon, there will be winners and losers; whether black tulips or sub-prime mortgages or virtual currencies, throughout history there have been investment bubbles; some have won and some have not. Virtual currencies are not, necessarily, giant Ponzi schemes as some have suggested. Indeed they are no more so than the paper currency with which we are all familiar.
After all, despite the statement on the banknote that we are promised the sum of £10 (or whatever), all we will ever get is more paper!
Now, which is the real and which the imaginary?
David Flint is Senior Partner at MacRoberts: df@macroberts.com
[1] Bitcoin was the only form of currency accepted on Silk Road, an anonymous marketplace that was only accessible over the TOR anonymous browsing network, and which was closed by the FBI in October 2013. Silk Road was commonly used to sell goods that are illegal in many countries, including narcotics.
[2] http://en.wikipedia.org/wiki/Legality_of_Bitcoins_by_country; http://www.coindesk.com/information/is-bitcoin-legal/
[3] http://www.hmrc.gov.uk/briefs/vat/brief0914.htm
[4] http://en.wikipedia.org/wiki/Green_Shield_Stamps
[5] http://maidsafe.net/article-wall-street-journal-24-04-14
[6] http://www.slideshare.net/CoinDesk/coindesk-state-of-bitcoin-q1-2014
[7] http://www.ibtimes.co.uk/britains-first-bitcoin-atm-arrives-london-cafe-1439017
