Noah Vardi
Abstract “Virtual currencies” are a monetary phenomenon not easily defi ned. Th ey set themselves at the crossroads between money, invest-ment instruinvest-ments, possibly commodities, and notwithstanding the fact that they are relatively widespread in practice (Bitcoin is the most prominent example), they are still lacking specifi c regulation in almost all legal systems. Th is poses a series of problems and risks that have caught the attention of regulators and market operators, some of whom have recently released important studies highlighting the need for ad hoc rules.
Th e paper aims at giving a brief overview of the legal nature of these cur-rencies and the possible rules which may be applied to them pending the approval of specifi c legislation.
N. Vardi ()
Associate Professor , University of Roma Tre , Law School, Italy
Introduction
Th e “paradox” of virtual currencies is that in trying to defi ne them from a normative point of view, it is easier to conclude what they are not, rather than what they are. A paradox all the more evident, when considering that a “currency” quintessentially requires a statutory defi nition. Virtual curren-cies, on the contrary, lack both a normative defi nition and broader still, any form of legal regulation. Th e “synthesis” of this syllogism that can be easily deduced is that virtual currencies are not, strictly speaking, “currencies”.
Th e legal vacuum surrounding virtual currencies renders them both extremely attractive and dangerous: neither illegal (mostly), nor prohib-ited, but still outside the domain of the law. Th e absence of regulation, however, does not mean that the phenomenon as such is not under close scrutiny of several agencies, governmental authorities, market operators and institutional actors. 1
Th e question that thus arises is whether and how markets, users, and regulators can cope with this legal vacuum. As a partial anticipation of the conclusions that some of the following considerations will lead to, a distinction should be made. A legal vacuum may not be so dangerous, as long as one stays within the domain of private autonomy, where certain existing tools may come to aid. When considering systemic risk, on the other hand, it seems that positive intervention may be required. 2
1 Th ere is a wide number of studies and reports, commissioned especially by national and transna-tional Banking Authorities that have examined the phenomenon of ‘Virtual Currencies’. In some cases these studies also contain tentative assessments of the risks associated with the use of virtual currencies, and/or a series of related ‘warnings’ to the public. References to these documents will be made throughout the text, however some of the most thorough, inter alia , can be recalled: European Central Bank, Virtual Currency Schemes , October 2012, https://www.ecb.europa.eu/pub/pdf/
other/virtualcurrencyschemes201210en.pdf , accessed July 2015; European Banking Authority (EBA), Opinion on ‘ virtual currencies ’, July 2014, https://www.eba.europa.eu/documents/
10180/657547/EBA-Op-201408+Opinion+on+Virtual+Currencies.pdf , accessed July 2015;
Law Library of Congress, Regulation of Bitcoin in Selected Jurisdictions , http://www.loc.gov/law/
help/bitcoin-survey/regulation-of-bitcoin.pdf , accessed July 2015; Financial Action Task Force, Virtual Currencies. Key Defi nitions and Potential AML / CFT Risks , June 2014, http://www.fatf-gafi . org/media/fatf/documents/reports/Virtual-currency-key-defi nitions-and-potential-aml-cft- risks.pdf , accessed September 2015.
2 Th e EBA opinion on virtual currencies for example has singled out more than 70 risks across several categories, including risks to users; risks to non-user market participants; risks to fi nancial integrity; risks to existing payment systems in conventional fi at currencies; risks to regulatory authorities (See EBA Opinion on ‘ virtual currencies ’, 5).
3 Bit by Bit: Assessing the Legal Nature of Virtual Currencies 57
Before trying to assess virtual currencies from a legal point of view a few brief words on how they work should be spent. Th e mechanism is quite complex and alien to non-specialists and the technicalities are beyond the scope of this paper. Th ere are currently diff erent schemes of so-called “virtual currencies” and each of them poses diff erent problems.
More specifi cally, virtual currencies have been classifi ed according to their relation with “real money” and the “real economy”, that is, by tak-ing into account if and how the monetary fl ow between virtual currencies and real currencies work, and if and how virtual currencies can be used to purchase real goods and services. According to these parameters, the existing virtual currency schemes have been divided into (i) closed virtual currency schemes (that have scarce, if any, interaction with the real econ-omy, and include currencies used for online games); (ii) virtual currency schemes with unidirectional fl ow (that imply an irreversible conversion at a specifi c exchange rate from the “real currency” to the “virtual currency”
that can then be used both to buy virtual and real goods and services, and include “credits”, “vouchers”, “points” or other “bonus” systems); (iii) virtual currency schemes with bidirectional fl ow (virtual currencies can be bought and sold according to exchange rates with real currencies and can be used to purchase both virtual and real goods and services; they include Bitcoins). 3
However, the type that is under closest observation (and that also enjoys one of the widest circulations at the moment) is the Bitcoin, one of a series of so-called “peer-to-peer” electronic cash systems. 4 Th e Bitcoin scheme can serve as a useful paradigm not only of the way in which virtual currencies work, but also of the reasons for their success and the concerns they raise.
Bitcoins are considered as “cryptocurrencies” specifi cally because they rely on a mechanism of peer-to-peer cryptography for the validation of transfers. Users can exchange Bitcoins (electronic tokens) through a mechanism of verifi cation known as “mining” which is based on a
3 For this classifi cation, see ECB, Virtual Currency Schemes , October (2012): 13–15
4 A fi rst-hand illustration of the Bitcoin can be found in the document authored by their (pre-sumed) inventor, who goes under the pseudonym of Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System”, https://bitcoin.org/bitcoin.pdf , accessed September 2015.
public ledger that records “ownership” of the digital currency. When the owner of a Bitcoin transfers it to a recipient, a group of so-called “min-ers” consults the ledger to verify the owner’s claim of ownership, solves a complex cryptographic problem, and annotates the transfer to the recipi-ent by logging the transaction on the ledger (where the recipirecipi-ent will now appear as the new owner). As a “reward” (and as an incentive) for the activity of mining, which involves the solution of complex sequences of algorithms, the “miner” that solves the cryptographic problem is awarded with a new batch of cryptocurrencies that are automatically generated by the software.
Given that the number of possible combinations of algorithms is fi nite and as long as the creation of new Bitcoins through mining activ-ity keeps a geometric rate of growth, it is possible to estimate both the maximum number of Bitcoins (about 21 million) that can be poten-tially “minted” (or “mined”) and the moment in which this plafond will be reached (in 2140). Th is renders Bitcoins chattels that are, to a certain extent, potentially “scarce”, given their fi nite number; and it is precisely due to this characteristic, that some observers have expressed some fears regarding a possibly inherently “defl ationary” nature of these tokens. 5
A fundamental feature of this mechanism is that it is decentralized and “private”, since the public ledger that records ownership of the Bitcoins functions without the control or the need either of a central bank, or of a private bank or other credit institution and without a cen-tral clearing house. Th is decentralized system does not confer a power of control on monetary emission or of liquidity to a single central institu-tion and according to the ideology behind Bitcoin, this avoids some of the “eff ects” (namely, infl ation) of central banking policies. It comes as no surprise thus, that some observers have recalled analogies between the ideology of the Bitcoin and the doctrines of the Austrian School
5 A sudden raise in their price of ‘purchase’/demand, provoked by an increase in the number of users, might incentivise users not to spend the Bitcoins but rather keep them as ‘scarce chattels’ See ECB, Virtual Currency Schemes , cit., at p. 25, (with some criticisms towards these theories); See also Reuben Grindberg, “Bitcoin: An Innovative Alternative Digital Currency”, Hastings Science &
Technology Law Journal 4 (2012): 177 ff .
3 Bit by Bit: Assessing the Legal Nature of Virtual Currencies 59
of Economics and that some commentators have referred to Bitcoin as
“Hayek money”. 6