An Examination of Cryptocurrency: The 21st Century’s Competitor to the Dollar Economy

You probably have heard about online money, or cryptocurrencies, such as Bitcoin.  You even may have considered investing in one of the many cryptocurrencies now in circulation.  But what are cryptocurrencies?

  • Are they secure?
  • How do cryptocurrencies differ from one another?
  • Can a cryptocurrency replace traditional currency? 
  • Are there legal issues you need to be aware of?

Hage&Hage is an innovative, technologically savvy law firm; we stand ready to assist you in analyzing 21st century technology issues like those presented by cryptocurrency.

Traditional currency relies on trusted third parties like the Federal Reserve and banks which create a payment network with accounts, balances, transaction ledgers.  The traditional financial system employs systems to stabilize the money supply and to prevent currency fraud.  All transactions can be verified by the centralized network of banks.  Bank account holders trust that the bank is holding their money, protected to a point by insurance, and that the balance and transaction detail is what the bank says it is.

Cryptocurrencies, on the other hand, are a type of digital currency that is non-trust based; that is, there is no centralized authority verifying accounts, balances, and transactions.  Cryptocurrencies uses cryptography, rather than a centralized banking authority, to secure and validate the transactions, to create additional units, and to verify the transfer of assets.

It works like this:

When a cryptocurrency like Bitcoin is exchanged, the “seller” signs off on the transaction with a private key.  After the seller enters the key, the transaction is then broadcast over a peer-to-peer network of individual computers.  Almost immediately, everyone on the network will know about the transaction.  The transaction is not final, however, until a third party confirms the transaction.  Those third parties, called miners, use computers to solve a mathematical puzzle.  The answer to that puzzle, called a hash, then is used to create a block which is then added to the blockchain.  Once in the blockchain, the transaction cannot be forged, changed, or cancelled – the transaction is final, and the same unit of currency cannot be spent again by that seller.

There are many issues surrounding cryptocurrencies that prevent them from replacing traditional currencies.  Since the legal landscape of cryptocurrency is in its infancy, many of these issues have yet to be definitively resolved, and more issues are continually arising.

  • The anonymity inherent in cryptocurrency transactions brings a host of potential criminal abuses such as money laundering and funding of terrorism which are crimes under state and federal law.
  • Since cryptocurrencies are contained in digital wallets rather than banks, the value is not backed by insurance or by the full faith and credit of any government.  Further, cryptocurrency is subject to drastic fluctuations in value.  Thus, there is no way to truly protect the value of your cryptocurrency.
  • Various state and federal agencies treat cryptocurrency differently, thus there are several sets of laws and regulations which must be considered.  For example, the IRS treats cryptocurrency as property, thus income derived from cryptocurrencies may be reportable on your tax return, while losses may not be.  The Commodity Futures Trading Commission, alternatively, defines cryptocurrency as a commodity.  Finally, the SEC has found that in certain cases, cryptocurrency is a security subject to federal securities laws.
  • Municipalities take a keen interest in cryptocurrency mining operations within their respective municipalities because of the amount of electricity needed to validate cryptocurrency transactions.
  • The protections contained in the Electronic Funds Transfer Act, which affords consumers safeguards when purchasing goods online, do not apply to cryptocurrency transactions.

In 2015, New York enacted cryptocurrency regulations in the form of the Bitlicense regulatory scheme, 23 NYCRR Part 200 – Virtual Currencies.  In essence, New York now requires certain individuals and businesses to apply for, and obtain, a license to engage in what New York terms “Virtual Currency Business Activity”.

Hage&Hage stands ready to advise you about cryptocurrency issues, New York’s regulatory scheme, and a host of other, innovative technologies.  Contact us today for a consultation.

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