Photo courtesy of Steve Jurvetson via Flickr.

Taxed, Monitored, Regulated: Bitcoin’s Success Brings Unwelcome Attention

Photo courtesy of Steve Jurvetson via Flickr.

Update 3/25/2013: According to an Internal Revenue Service FAQ posted by Business Insider, Bitcoin will be treated as property, not currency, for tax purposes.

This means that anyone who receives bitcoin as payment for a service must include the “fair market value” of the coins when calculating gross income.

Bitcoins will therefore be subject to income taxes, although bitcoins held as investments will be subject to a lower capital gains tax, according to the Wall Street Journal.

Could Bitcoin be regulated, and if so, how?

The fall of Mt. Gox, a major Bitcoin exhcange, was only the latest in the young cryptocurrency’s history of extreme highs and lows – but one that cost its customers more than $450 million.

Now, many are wondering whether Bitcoin trade should be regulated to prevent something like this from happening again.

Proposals for regulation

As we’ve explained earlier, bitcoins only exist digitally, as part of a peer-to-peer network that connects each transaction to two Bitcoin addresses.

This protocol, which is installed on every computer on this network, can’t be modified without the cooperation of nearly all users, according to the Bitcoin Foundation.

In other words, the fundamentals of BTC – such as the anonymous transactions, their creation and how they’re transmitted between users – are nearly impossible for authorities to alter.

Instead, the focus has been on the intersection between regular currencies and cryptocurrencies.

Currently, Bitcoin has no clear legal status in the U.S., but Federal Reserve chairwoman Janet Yellen has stated that the Fed does not have the authority to supervise or regulate it.

Any regulation, therefore will have to come from Congress, and be enforced by federal agencies.

Here are a few proposals that have been made:

  • While it’s not binding regulation yet, the federal Financial Crimes Enforcement Network published a guidance stating that any business that exchanges Bitcoin for another currency should apply for a “money transmitter” license. This would require them to “to submit tax information, contact information, bank information, and details on the types of transactions it handles.”

  • Under Bank Secrecy Act regulations designed to prevent anonymous transactions, Bitcoin exchanges registered as money transmitters would also have to collect identifying information on its customers, according to NY Times.

  • Anyone holding over a certain amount of the currency might also have to report it to the government, similar to how the Securities and Exchanges Commission requires anyone holding more than 5% of a public company to report any transaction.

  • Maybe the most drastic step the government could take, however, would be to require the centralization of virtual currency trading, in order to make the currency less vulnerable to manipulation, according to the NY Times. This could mean that only certain approved sites would be able to exchange BTC for cash. Those sites might also be subject to additional disclosure and capital requirements.

Who’s regulating already?

While the U.S. government is still mulling how to react to the rise of virtual currencies, others have already made up their mind:

  • In Hong Kong, Bitcoin is classified as a “virtual commodity” as opposed to a currency, which has allowed business such as the first physical Bitcoin ATM to open. Selling Bitcoins in this way requires a money service operator license, however, and customers have to present an ID and a proof of address.

  • In Japan, the home of Mt. Gox, authorities are also leaning towards classifying BTC as a commodity, which would mean more relaxed regulations, but would apply local taxes to transactions. It also wants to ban banks from trading in the virtual currency.

  • In Singapore, which recently got its first Bitcoin ATM, the currency is not regulated, but is also not considered legal tender, according to Bloomberg.

  • In China, banks have been barred from trading Bitcoin, though among private individuals it’s still the world’s largest market.

  • In Europe, both Germany and Norway have stated that they don’t consider BTC real money. The latter, however, will charge a 25% capital gains tax on transactions.

As market turmoil continues to focus scrutiny on the virtual currency, however, expect more announcements from regulatory authorities on how to deal with such unsanctioned business activity.

New York state, often an early indicator of federal regulation, could have a comprehensive framework for Bitcoin trading ready by late 2014.

Ole Skaar