Claire Wivell Plater

Bitcoin businesses should actively seek advice on whether their businesses are compliant, as there may be difficulty in applying existing Australian Financial Services (AFS) licensing laws, according to Claire Wivell Plater, Managing Director of the Fold Legal and Amor Sexton, Digital Currency Lawyer atAmor Sexton.

AFS regulatory expert, Ms Wivell Plater says bitcoin isn’t easily characterised. While some regard it as money others call it a digital currency. A third view is that it’s a commodity.

“There could be other views,” she says. “What we do know is that it’s one of the fastest-growing technologies since the birth of the Internet, primarily because it offers a low-fee payment gateway that can bypass foreign currency remitters and banks.”

Ms Wivell Plater says it seems unlikely that bitcoin itself is a financial product under the AFS laws as they currently stand.

“Therefore, some businesses, like bitcoin exchanges or ATMs, may not need an AFS licence,” she says. “However, some services associated with bitcoins may well be financial products. For example, a facility by which people can use bitcoin to pay for goods and services may be what’s known as a non-cash payment system for which an AFS licence would be required. Similarly, bitcoin futures or other derivatives based on bitcoin would clearly be a financial product.”

The need for a licence will depend on the business model, Ms Wivell Plater warns. “Even small variations may be important. Bitcoin businesses should take advice at an early stage to ensure that they are aware of their legal obligations. Operating without an AFSL can attract serious penalties, not the least of which could be the need to suspend trading until the AFSL is granted.”

Ms Sexton, who is an adviser to a number of bitcoin businesses, warns against taking a ‘one-size fits all’ approach. “For most regulatory requirements, the focus is on what the business is actually doing with bitcoins,” she says. “It is important to get advice that is specific to your business model and processes.”

Bitcoin businesses need to be aware of possible obligations under the Corporations Act, the Competition and Consumer Act, the Privacy Act, the Payment Systems (Regulation) Act, the Anti-Money Laundering and Counter-Terrorism Financing Act, the Financial Transactions Reports Act, the Banking Act, the various State consumer protection legislation, the GST Act and other tax laws.

Ms Sexton believes the novelty of bitcoin means that the application of these laws to bitcoin businesses can be complex and difficult to determine.  However she believes that it is only a matter of time before this changes.

“It will be interesting to see how the law develops as the adoption of bitcoin increases. At the moment bitcoin is a new concept and it is easier for the regulators to try to fit bitcoin within the existing legal framework,” she says. “When bitcoin use becomes more mainstream, it will challenge the government to tailor the legal framework for digital currencies.”

Ms Sexton also highlights the potential impact that developments overseas can have on the Australian legal status of bitcoin. “If an overseas country decides to declare bitcoin as legal tender, this would mean that it would be considered ‘foreign currency’ under Australian law.  This would have a massive impact on the way that the regulators approach bitcoin.”

According to Ms Sexton, this possibility is not too far-fetched. “A country can adopt whatever currency they want as legal tender. For example, in Zimbabwe both US dollars and South African rand are legal tender. The central bank in Zimbabwe has also begun to allow the use of Australian dollars, Chinese yuan, Indian rupees and Japanese yen. It is possible that another government may see value in allowing a digital currency to be another form of legal tender.”

Until a change like this happens, bitcoin businesses will need to consider how their activities fit within the traditional legal framework, she says.

Although compliance can be time consuming, both Ms Sexton and Ms Wivell Plater see commercial benefits for a bitcoin business. “The rules are based around best practice. If the public sees that bitcoin businesses are complying with the rules, their confidence in using bitcoins will increase.  This will have a positive commercial effect on the businesses and the industry as a whole,” Ms Wivell Plater says.

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Is Bitcoin a replacement for money?

“If it was created out of thin air and it vanishes, there is nowhere to get it back from”

Bitcoin is just the latest in a series of attempts to create a digital currency which is a medium of exchange, a unit of account and a store of value. The early micropayment systems such as egold and GoldMoney used precious metals to perform the “store of value” function.

In 1996 egold, a micropayments system backed by bullion was launched and by 2008 it had more than $US2bn in transactions.  Unfortunately the anonymity it provided account holders facilitated criminal activity and the business was found to be money laundering.

GoldMoney enabled precious metals to form the basis for instantaneous transactions in an on-line patented currency. It had extensive money laundering and customer identification security. By 2011 it had over $2bn of customer assets in the form of stored precious metals all fully insured and independently audited, but in early 2012 it decided that it’s future was as a savings process and turned off the payment process citing poor demand and the high costs of regulatory compliance.

Bitcoin which was devised in 2009 was a cryptocurrency which means that it used cryptography  to create and transfer money.

Bitcoin created a network of its users’ computers, and used an algorithm to release new bitcoins into the network, beginning with 50 every 10 minutes and halving the pace of issue in increments until 2140 when the limit of 21 million bitcoins was reached.

The protection against fraud was the maintenance of a public ledger of every transaction. If a user was able to crack one of a number of cryptographic puzzles and was the first to do so there was a “prize” of 50 new bitcoins. The public ledger was secured using public-key encryption which generates a private key  retained by an individual and used to approve any transfers to another’s account; and a public key used to encode payments. This was not a fool-proof system but it was enhanced by the use of the cryptographic techniques of hashing and forced work. A hashing algorithm converts a message into a number described as a hash value or a digest. If the number is large enough it provides a unique representation of the original and could not be reconstructed.

All transactions were analysed in portions referred to as “blocks”. For the latest block to be valid, there is a forced work task of using the valid blocks and the new transactions to generate a digest comprising 256 bits, and the task is complete when the system’s algorithm provides a hash value below a preset target. Bitcoin’s view was that it would be necessary for an intending fraudster to control over half the network’s capacity in  order to have a fictitious block created and validated. The system has been “hacked” successfully so this has not offered sufficient security.

Does this make Bitcoin a substitute for money? It was accepted as a medium of exchange by some but it only had a limited issue and it could function as a unit of account, but it failed as a store of value as its only value was what someone else would pay for it, and  the value was highly (and unpredictably) volatile .

Bitcoin could not survive in the US unless it was issued by, cleared by or settled through a supervised bank which means it would have to incur regulatory costs. Remember that GoldMoney found the regulatory costs too high.   JPMorgan Chase now has  a patented method of making anonymous payments, through a Payment Portal Processor (PPP)  an enhanced electronic wallet with automatic credit and form-filling features, that provides the user with a secure and guaranteed form of virtual cash . What distinguishes it from Bitcoin is that payments will still be processed using existing Electronic Fund Transfer (EFT) networks and the e-wallets will be stored on a host web server controlled by a bank.

What have we learned?

1. Never boast that your internet system is “totally secure” it just attracts hackers who successfully hacked Bitcoin
2. Do not avoid the regulatory authorities because they will not allow unidentifiable participants as part of your business
3. There is a role for a cheaper way to transfer funds internationally, but Bitcoin is not it.

By Rae Wilson Dragon Wild Blue Pty Ltd 

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