47 minute read
Future of Financial Privacy and Digital Currency Regulation
Alexa Vickaryous
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ABSTRACT
Digital currency is an emerging payment system that utilizes blockchain technology and cryptography to cut out third-party intermediaries. Financial privacy builds on third-party doctrine: after information is willingly provided to a third party an individual has no reasonable expectation of privacy. Digital currency’s potential to remove third parties threatens anti- money laundering regulation. Currently, the Commodity Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC), and Financial Crimes Enforcement Network (FinCEN) have applied past definitions of financial instruments based on digital currency’s economic function, rather than its technology.
In 1996, internet theorist Michael Hauben coined the term “netizen” or a citizen of the network as a prediction for the future of internet users. Hauben explained that netizens exist “as a citizen of the world thanks to the global connectivity that the Net makes possible.”1 Hauben envisioned netizens as citizens of a new virtual state that occupied a virtual space rather than a physical one.2While his definition of netizenship may seem extreme, it is not unreasonable.
In January 2019, there were 4.39 billion internet users, and on average, those internet users spent approximately six and a half hours on the internet per day.3 The internet’s omnipresence in the twenty-first century has caused the use of the internet as an intermediary essential to fully participate in society and has required an unprecedented amount of personal information to be shared through online third parties.4 Not only has the internet anchored itself in society, but it has empowered people to circumvent traditional, physical institutions endorsed by the government.5
In 2008, netizens received their first currency when Satoshi Nakamoto introduced the first public-use digital currency (virtual currency or cryptocurrency) called Bitcoin. Upon Bitcoin’s announcement, Nakamoto released a paper called, “Bitcoin: A Peer-to-Peer Electronic Cash System.”6 He emphasized that the government and corporations have had a monopoly over commerce on the internet.7 All online transactions had to be processed by traditional financial institutions. Nakamoto created Bitcoin because he believed that the internet needed a currency
1 Micheal Hauben & Rhonda Hauben, Netizen: On The HistoryAnd Impact Of UsenetAnd The Internet (1997). 2 Id. 3 Simon Kemp, Digital 2019: Global Internet useAccelerates, WEARE SOCIAL, Jan. 13, 2019, https://wearesocial.com/blog/2019/01/digital2019-global-internet-use-accelerates. 4 W. F. McElroy, Closing the Financial Privacy Loophole: Defining “Access” in the Right to Financial PrivacyAct, 94 WASH. U. L. REV. (2017). 5 Oliver Barrett, Institutions and New World “Netizens”:Act 1, FOREIGN POLICYASSOCIATION, Jan. 12, 2012, https://foreignpolicyblogs. com/2012/01/12/institutions-and-new-world-netizens-act- 1/. 6 Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, BIT COIN, 2008, https://bitcoin.org/bitcoin.pdf. 7 Id.
that reflected its same decentralized nature and could foster peer-to-peer connections.8 While digital currencies were initially created to cut the third party out of financial transactions, there is much debate about how secure these transactions actually are from third parties.9 Digital currency technology raises many legal questions: (1) Should digital currencies be treated like regular currency? (2)Are digital currency companies considered third-party intermediaries? (3) Do digital currency users have a reasonable expectation of financial privacy? Within one decade, the number of digital currencies has increased to about 2,500.10 Despite the rise in the number of digital currencies, the United States has yet to pass significant regulation for this new form of currency and technology.11Some countries, like Vietnam, have outright banned certain digital currencies.12 While Vietnam’s approach unequivocally solves the issue of digital currency, some scholars argue that this approach inhibits innovation.13
Digital currency functions by using blockchain technology and cryptography.14 An oversimplified explanation of how these systems work is that each transaction is recorded on a decentralized, public ledger called blockchain, and each transaction has a digital signature or public-key cryptography to prevent double-spending on the public ledger.15 Blockchain provides many of the unique strengths of digital currency; however, it also poses some serious risks and concerns for regulators. This dichotomy is important for regulators to keep at the forefront of their minds when shaping law. Regulating digital currency means striking a balance between maintaining its intent to increase privacy through its innovative payment technology, but also, justifying legitimate concerns that this technology could foster illicit activity. Blockchain and cryptography often make it difficult to monitor and identify the senders and receivers of transactions.16 These features cause digital currencies to be susceptible to illicit activity.17 This paper addresses the problems of regulating digital currency’s privacy and potential solutions using current privacy law as a guide. In the past, the role of cash diminished in favor of electronic payments.18 With those changes policy makers had to re-evaluate how past regulation would apply to the new innovation. Likewise, digital currencies pose this same problem that causes reflection on former definitions of financial instruments. Comparing and contrasting digital currency’s qualities and characteristics to existing financial tools will allow us to determine if digital currency fits within the parameters of current regulation. Specific to this paper, this will help determine if the legal theory called “third-party doctrine” will apply to digital currencies and their companies. Third- party doctrine is the theory that after information is willingly provided to a third party the individual has no reasonable expectation of privacy.19 Financial privacy is important because it protects an individual’s safety from exploitation, future price negotiations, and tracking of payments by companies.20 This paper is organized in four parts to understand how financial privacy law should apply to digital currencies and their companies. Part I provides a comprehensive explanation of how digital currency functions; it also addresses the strengths and weaknesses of digital currency to not only understand the potential benefits and innovation that can be reaped, but also how its shortcomings make it difficult to regulate. Part II discusses financial
8 Id. 9 N. Kshetri, Cryptocurrencies: Transparency Versus Privacy [Cybertrust], 51 Institute Of ElectricalAnd Electronics Engineers 99 (2018). 10 Coin Lore, Cryptocurrency List, (October 3, 2019), https://www.coinlore.com/all_coins. 11 Pete Rizzo, CFTC Ruling Defines Bitcoin and Digital Currencies as Commodities, COIN DESK http://www.coindesk.com/cftc-rulingdefines-bitcoin-and- digital-currencies-as-commodities/. 12 Library of Congress, Regulation of CryptocurrencyAround the World, (Oct. 16, 2019), https://www.loc.gov/law/help/cryptocurrency/worldsurvey.php 13 Peter DeVries, An Analysis of Cryptocurrency, Bitcoin, and the Future, 1 International Journal Of Business Management And Commerce 1 (2016). 14 David Lee, Handbook Of Digital Currency: Bitcoin, Innovation, Financial Instruments,And Big Data 15 (2015). 15 Id. 16 William Magnuson, Regulating Fintech, 71 VAND. L. REV. (2018). 17 Jeffrey E. Glass, What Is a Digital Currency, 57 IDEA455, 492 (2017). 18 Trevor I. Kiviat, Beyond Bitcoin: Issues in Regulating Blockchain Transactions, 65 DUKE L.J. 569, 588 (2015). 19 W. F. McElroy, supra note 3, at 1057. 20 N. Kshetri, supra note 7, at 100.
privacy law up to this point. Specifically, Part II will analyze current privacy laws, and it will highlight why and how these laws were enacted. Part III addresses how digital currencies have been defined using federal guidance, as well as at a state level. It will explore some case law and the discrepancies in how the law has been applied. Ultimately, this paper will conclude that instead of applying broad definitions of current financial instruments, federal regulators need to prioritize blockchain when defining digital currencies to ensure that the narrow differences between digital currency and current financial instruments are not overlooked.
PART I: WHAT IS DIGITAL CURRENCY?
Although each digital currency uses a slightly different system, this paper will use Bitcoin as a base example for understanding how digital currencies function. A digital currency is a peer-to-peer electronic cash system that operates using blockchain technology.1 Peer-to- peer means that digital currencies attempt to cut out the middleman or third party that is required for exchanges.2 Peer-to-peer transactions are meant to reduce transaction costs and decrease the amount of time a transaction takes. Unlike regular fiat money, digital currencies have no intrinsic value or derivation from law.3 In other words, the money is not backed by assets or the government. Digital currencies determine their value solely on supply and demand. For instance, Bitcoin’s programming has predetermined that there will only ever be 21 million bitcoins to prevent inflation.4
Instead of having a centralized bank run by the government to monitor the exchanges, digital currencies are regulated like an open source project. Open source means that the source of the software is public, so innovation can occur in a collaborative way.5 Every transaction is recorded by decentralized individuals or organizations known as “miners.”6 Anyone can become a miner; however, the individual or company would need to have purchased the hardware and software necessary to confirming transactions.7 Bitcoin incentivizes miners to check the transactions or complete a block by awarding a predetermined quantity of bitcoins to the miners.8 In February 2019, the rewards for completing a block was 12.5 bitcoins, which translates to earning $42,000 USD.9 Also, Bitcoin users can give miners a “tip” to encourage a faster transaction checking process.10 After a miner confirms a transaction, the cryptographically secured representation is recorded on a ledger through blockchain.11 Blockchain is a back-end database that maintains a distributed ledger that can be inspected openly.12 Digital currency coins are computer files that must be logged on to a ledger, which is a decentralized network operated and maintained by thousands of computers.13 While digital currencies have the reputation of anonymity, all transactions are publicly and permanently available on the ledger.14 However, public-key encryption technology allows the sender or receiver of the exchanges to remain pseudo-anonymous or completely anonymous.15 There are two mathematically-related keys: a private and public key. The sender uses the private key like a private password, and the public key is like the name of the bank or where the money resides.16
1 Mark Edwin Burge,Apple Pay, Bitcoin, and Consumers: TheABCs of Future Public Payments Law, 67 HASTINGS L.J. 1493, 1528 (2016). 2 Nikolei Kaplanov, Nerdy Money: Bitcoin, the Private Digital Currency, and the Case against its Regulation, 25 LOY. CONSUMER L. REV. 111, 116 (2012). 3 Id. 4 Jeffrey E. Glass, supra note 15, at 487. 5 WILLIAM MOUGAYER, THE BUSINESS OF BLOCKCHAIN (2016). 6 Jeffrey E. Glass, supra note 15, at 489. 7 Jeffrey E. Glass, supra note 15, at 489. 8 Id. 9 Adam Hayes, How Does Bitcoin Mining Work?, INVESTOPEDIA, https://www.investopedia.com/tech/how-does-bitcoin-mining-work/. 10 Id. 11 Id. 12 Trevor I. Kiviat, supra note 15, at 578. 13 Nikolei Kaplanov, supra note 22, at 116. 14 SumitAgarwal, Bitcoin Transactions:ABit of Financial Privacy, 35 CARDOZOARTS & ENT. L.J. 153, 160 (2016). 15 Id. 16 Id.
A person can obtain bitcoins through mining, purchase, or online exchange.17 After obtaining the bitcoin, it can be stored through an online wallet or on a personal computer.18 An online wallet functions as an online account by a third party.19 However, a user can also store their bitcoin in a personal digital wallet on their computer.20 Different digital currencies have varying levels of privacy.21 For instance, Bitcoin uses transparent addresses where the public-key address is not fully anonymous because it can be tracked to the user; therefore, making Bitcoin transactions pseudo-anonymous, since the pseudonym or address can be tracked to the user’s identity.22 However, some digital currency companies like Zcash and Monero focus on privacy by using shielded addresses and mixing their coins with other forms of payments; this strategy makes their senders and receivers anonymous and almost impossible to trace.23
Intertwined: Strengths and Weaknesses Two of the biggest advantages of digital currency over fiat currency, gold, or electronic payments is the speed of transactions and lack of transaction costs.24 Although electronic transfers greatly reduce transportation and time of moving value, it is still very costly relative to the cost of moving value through digital currencies.25 There are several different types of electronic payments includingAutomated Clearing House (ACH), wire transfers, card services, mobile payments, etc.26 To illustrate how transaction costs in electronic payment systems are greater than digital currency transactions, this paper will use card service payments as an example.
In a credit card transaction or open network purchase transaction, one bank serves as the card issuer and another bank serves as the acquirer, which processes the payments.27 Visa and MasterCard are examples of open network purchase transactions.28 The most obvious fee for users of credit cards includes the interest fee that accrues on a carried balance; eventually, this fee becomes profit for the card-issuing bank.29 However, the acquirer also receives a small percentage of the purchase price called the merchant discount.30 Typically in the United States, this percentage is approximately 1.5 percent to 3 percent of the purchase price.31 Closed network purchase transactions work in the same manner, but the card-issuing bank would receive the interest and merchant discount.32 The top five acquirers in 2018 reached $95 billion USD of card transactions for purchases of goods and services.33 Additionally, it takes time for these payments to be processed. For instance, Santander Bank will take about one day to process if it is paid using a Santander account, and it will take three to five business days if it is paid with a non-Santander account.34
Blockchain technology is uniquely developed to solve both the issue of high transaction costs and faster
17 Nikolei Kaplanov, supra note 22, at 124. 18 Id. 19 Id. 20 Id. 21 N. Kshetri, supra note 7, at 100. 22 Protect your Privacy , BITCOIN, https://bitcoin.org/en/protect-your-privacy. 23 N. Kshetri, supra note 7, at 100. 24 Trevor I. Kiviat supra note 15, at 585. 25 Id. 26 Types of Electronic Payment Systems, NATIONAL CREDIT UNION PUBLISHED GUIDES, https://publishedguides.ncua.gov/examiner/ Pages/Content/ExaminersGuide/ElectronicPaymen tSystems/EPS_Types.htm. 27 Andrew P. Morriss & Jason Korosec, Private Dispute Resolution in the Card Context: Structure, Reputation, and Incentives, 1 J.L. ECON & POL’Y 393, 424 (2005). 28 Id. 29 Id. 30 Id. 31 Id. at 421. 32 Mark Edwin Burge, supra note 19, at 1507. 33 Top U.S. MerchantAcquirers, THE NILSON REPORT, https://nilsonreport.com/mention/317/1link/. 34 Customer FAQ, SANTANDER BANK, https://customerservice.santanderbank.com/app/answers/detail/a_id/9508/~/how-long-does- it-take-for-credit-card-payments-to-be-applied-tomy-account%3F.
transaction time. Since digital currencies are not operated by companies, but instead as an open source project, they do not have to pay overhead or administrative costs. This allows digital currencies to charge very low transaction fees with only optional fees to speed up the process.35 Consequently, its peer-to-peer technology eliminates the need for card issuers or acquirers. Merchants have the potential to benefit by using digital currencies instead of credit card payments during routine purchases because they would not have to pay a percentage of their price to acquirers.36 Digital currencies can facilitate fast cross-border transfers without having to pay expensive fees for remittance.37 Unlike fiat money that can be fiscally manipulated by the government, digital currencies have a fixed supply to control for inflation.38 For instance, the mathematic rules to creating Bitcoin are designed to mimic the act of mining gold.39 Gold is governed by the laws of nature, but digital currency is governed by the law of mathematics.40 This feature is seen as a strength in countries that have extremely high inflation. InArgentina, there has been a growing use of digital currency due to the country’s high inflation rate.41 Digital currency meets the demand of Argentinians who seek to safeguard their currency from losing value due to hyperinflation.42 Moreover, there has been expansion in countries in economic crisis like Greece.43 And immediately after United Kingdom’s vote for “Brexit,” there were spikes in Bitcoin’s value which reflected the uncertainty of the pound.44
Digital currency’s safeguards on inflation are beneficial to countries with high inflation rates. However, this feature also causes digital currencies to be extremely volatile since there is no government regulating any risks.45 Governments use Central Banks to control monetary policy and to exert influence.46 If non-governmental digital currencies became more popular than fiat currency the government would not be able to control systematic risk. Bitcoin’s exchange rate against the U.S. dollar has jumped or crashed over 20 percent in a single day; whereas the USD to Euro exchange rate varies less than 2.5 percent in one day.47 Digital currency users are faced with an exchange-rate risk that rises and falls sharply with little stability.48 In cases in the past, digital currencies have been hacked and gone completely bankrupt, too.49 Digital currencies are susceptible to hacks. In 2016, a hacker made $50 million in Ethereum currency from a fund called the Decentralized Autonomous Organization.50 The value of Ethereum dropped from $355 to $0.10 in a matter of minutes.51 Hacking ranges from stealing information to causing complete system failure.52
Digital currencies offer increased privacy with their ability to have semi-anonymous and completely anonymous transactions. In a society that only uses cash, if a person were to go buy pizza at the store, there would be no way of tracking that cash payment to the individual unless someone witnessed the purchase.53 Digital currencies provide the same level of financial privacy that paying in cash provides.
35 David Lee, supra note 12, at 23. 36 Id. 37 Id. 38 Devries, supra note 11, at 3. 39 Trevor I. Kiviat, supra note 15, at 583. 40 Id. 41 Devries, supra note 11 page 3. 42 Id. 43 Mark Edwin Burge, supra note 19, at 1532. 44 Id. 45 Trevor I. Kiviat, supra note 15, at 584. 46 Orla Ward & Sabrina Rochemont, Understanding Central Bank Digital Currencies, INSTITUTEAND FACULTY OFACTUARIES, https://www.actuaries.org.uk/system/files/field/document/Understanding%20CBDCs%20Final%20-%20disc.pdf. 47 Id. 48 Tyler Moore, The Promise and Perils of Digital Currencies, INTERNATIONAL JOURNAL OF CRITICAL INFRASTRUCTURE PROTECTION, 147 (2013). 49 Peter DeVries, supra note 11, at 4. 50 William Magnason, supra note 14, at 1201. 51 Id. 52 Id. 53 William Magnason, supra note 14, at 1201.
On the other hand, digital currency’s pseudo anonymity or complete anonymity attracts the facilitation of criminal activity.54 From 2011 to 2013, Bitcoin was used by thousands of drug dealers for illegal activity because it was not being monitored by the government.55 In conjunction with a black market website called the Silk Road, criminals were able to trade drugs and counterfeit passports.56 In 2016, Arthur Budovsky, the founder of the digital currency called the Liberty Reserve, was sentenced to 20 years in prison for laundering hundreds of millions of dollars.57
PART II: FINANCIAL PRIVACY UPTO THIS POINT
In Griswold v. Connecticut, Justice Douglas explained how “the First Amendment has a penumbra where privacy is protected from governmental intrusion.”58 In other words, although the First Amendment does not explicitly grant a right to privacy, Douglas argued that it was implied. This idea of the right to privacy was further elaborated on in Katz v. United States, which was a search and seizure case involving a phone booth. In the Court’s opinion, Justice Stewart illustrated the idea of a “reasonable expectation of privacy;” he explained that when “a person knowingly exposes to the public, even in his own home or office, [it] is not a subject of FourthAmendment protection.”59 Through Katz, the courts created the Katz test to decide whether information would be considered private: (1) did the individual have a subjective expectation of privacy? (2) is this expectation one that society recognizes as reasonable?60 As society and technology evolve, perhaps society subjectively expects less privacy.61 In Raynor v. State, the Court ofAppeals defined how “common experience and social norms bear upon our assessment of whether one has an objectively reasonable expectation of privacy in a particular item or place.”62 Moreover, “it is necessary to look to the customs and values of the past and present … the structure of society, the patterns of interaction, [and] the web of norms and values.”63 In a Pew Research survey, most Americans were willing to trade their privacy for services provided by a third-party intermediary.64 The tangible benefits from a service outweighs the loss of privacy.65 However, many Americans noted they were more cautious in giving their information to untrustworthy companies and would be less likely to share their information if they believed it would be made available for a long period of time and to third- party companies.66
However, the tides changed nine years later in United States v. Miller, when the Court decided that when an individual hands their information over to third-party intermediaries like a bank, the person has no reasonable expectation of privacy.67 This case dealt with Mitch Miller, who was suspected of carrying alcohol distilling equipment and whiskey on which liquor tax had not been paid.68 The Bureau of Alcohol, Tobacco, and Firearms subpoenaed and requested that his banks hand over his financial records to use as evidence against him.69 Justice Powell stated in the Court’s opinion that “the depositor takes the risk, in revealing his affairs to another, that the information will be conveyed by that person to the Government.”70 Consequently, in Smith v. Maryland, this
54 David Lee, supra note 12, at 22. 55 Peter Devries, supra note 11, at 4. 56 David Lee, supra note 12, at 22. 57 Liberty Reserve Founder Sentenced to 20 Years For Laundering Hundreds of Millions of Dollars, THE UNITED STATES DEPARTMENT OF JUSTICE, https://www.justice.gov/opa/pr/liberty-reserve- founder-sentenced-20-years-laundering-hundreds-millions-dollars. 58 381 U.S. 479, 483 (1965). 59 389 U.S. 347, 351 (1967). 60 Lucas Issacharoff; Kyle Wirsha, Restoring Reason to the Third Party Doctrine, 100 MINN. L. REV. 985, 988 (2016). 61 Id. at 993. 62 440 Md. 71, 84 (2014). 63 Id. 64 Lee Rainie & Maeve Duggan, Privacy and Information Sharing, PEW RESEARCH CENTER, https://www.pewresearch.org/ internet/2016/01/14/privacy-and-information-sharing/. 65 Id. 66 Id. 67 425 U.S. 435, (1976) 68 Id. 69 Id. 70 Id. at 444
idea about financial privacy and third-party intermediaries was extended to communication information.71 In Smith, the Court concluded that data from a pen register (a device that keeps track of dialed numbers) would be allowed as evidence in a trial and as support to obtain a search warrant.72 This decision parallels Miller because it emphasizes that there is “no constitutionally protected reasonable expectation of privacy in the numbers dialed into a telephone system.”73 When a person “voluntarily conveyed numerical information to the telephone company and exposed that information to its equipment,” the person “assumed the risk that the company would reveal to police the numbers he dialed.”74
Both Miller and Smith support the legal theory called the third-party doctrine.75 With the invention of the internet and the rise of the information age, more information than ever falls outside the scope of the First and Fourth Amendment’s protection.76 The rule of reasonable expectation of privacy has evolved over time to emphasize whether the individual gave consent to have his or her information collected. Hoffa v. United States illustrates this idea in a physical space, where a wire-taped conversation is not considered an invasion of privacy if the person invited the conversation.77 In a physical space, an individual can pick and choose with whom they share confidential information; however, when communicating through a virtual forum or exchanging money through a bank, it makes it almost impossible to do so without the provided intermediaries.78 Consequently, although it is possible to revert back to carrier pigeons or using gold coins, it is not practical in modern society.79
Despite being more educated about the lack of privacy online,American adults have not made significant changes to how they utilize the internet.80 Fifty-four percent believe that it is “somewhat” or “very” difficult to find the tools and strategies to protect their privacy online and when using their phones.81 In Smith’s dissent, Justice Marshall expressed many of the subsequent concerns.82 He emphasized that “unless a person is prepared to forgo use of what for many has become a personal or professional necessity, he cannot help but accept the risk of surveillance,” and that “as a practical matter, individuals have no realistic alternative.”83 Blockchain technology challenges these current intermediaries that we use for communication and transactions.84 Consequently, blockchain will potentially create new intermediaries, too, that will disrupt the traditional intermediary-driven way of the internet.85
After Miller, Congress was concerned that the Internal Revenue Service (IRS) would have the power to ask for any citizen’s financial records.86 In order to address this, Congress passed the Right to Financial Privacy Act (RFPA) in 1978. It was motivated to “strike a balance between customer’s right to privacy and the need for law enforcement agencies to obtain financial records pursuant to legitimate investigations.”87 The RFPAnarrowly defines a financial institution by listing existing institutions like a bank, card issuer, trust company, industrial loan company,
71 442 U.S. 735, (1979) 72 Id. 73 442 U.S. 735, 738. 74 Id. at 744. 75 W. F. McElroy, supra note 3, at 1057. 76 W. F. McElroy, supra note 3, at 1058. 77 385 U.S. 293, (1966) 78 Michael W. Price, Rethinking Privacy: FourthAmendment Papers and the Third-Party Doctrine, 8 J. NAT’L SEC. & POL’Y 247, 267 (2016). 79 Id. 80 Mary Madden, Why someAmericans have not changed their privacy and security behaviors, PEW RESEARCH CENTER, https://www. pewresearch.org/fact-tank/2015/04/14/why-some- americans-have-not-changed-their-privacy-and-security-behaviors/. 81 Id. 82 Smith, 442 U.S. at 750. 83 Id. 84 WILLIAM MOUGAYER, supra note 23, at 37. 85 Id. 86 W. F. McElroy, supra note 3, at 1061. 87 Right to Financial PrivacyAct, 12 U.S.C. § 3401 (1978).
etc.88 It is important to note that a company that creates digital currency is not a company or financial institution, it is an open source project.89 For instance, Bitcoin would not fall under the RFPA since it is an open source project; however, digital currency businesses or other actors that exchange digital currency more likely than not will have to follow RFPA. The RFPAoutlines five scenarios where a government departmental unit would be authorized to request financial information: (1) departmental unit must subpoena the information, (2) reasonable belief that the records are relevant to a law enforcement inquiry, (3) request is issued by correctly ranked official, (4) must be written in a formal request, (5) all notice requirements are satisfied.90 The RFPA prevents a customer’s information from being obtained from the government, but also prevents their financial information from being released by financial institutions.91 If a government agent or financial institution fails to adhere to the RFPA, there are fines for $100, actual and punitive damages (if applicable), and attorney fees.92
Also, in 1978, Congress passed the Electronic Funds TransferAct (EFTA). The EFTA’s purpose is to “protect individual consumers engaging in electronic fund transfers ... and remittance transfers.”93 The EFTA is implemented through Regulation E.94 The EFTA outlines the rights and liabilities of a consumer and the requirements for financial institutions to identify under which circumstances their customer’s financial information may be disclosed to third parties.95 The EFTA has had several amendments since its enactments; however, in 2010, the EFTAwas amended again to account for changes due to the Dodd-Frank Wall Street Reform and Consumer ProtectionAct (Dodd-Frank).96 Dodd-Frank was created out of the financial crisis of 2008. It requires new regulatory requirements such as restrictions on investments, mandatory stress tests of a bank’s ability to withstand various crises, and much stricter financial reporting.97 Dodd-Frank focuses on larger financial institutions.98 For instance, the Dodd-Frank reform focuses on preventing traditional banks from becoming “too big to fail.”99 The idea of “too big to fail” refers to the idea that once banks reach a certain the government must intervene and bail them out in a financial crisis because the bank’s failure would impose significant costs on other sectors of the economy.100 Certain financial institutions were labeled “systematically important” and required to provide more financial reporting and structural requirements.101 While this reform seeks to diminish systematic risk and immoral behavior, it also erodes more of our financial privacy. The EFTAoriginally sought to protect the consumer; however, Dodd-Frank shifted the EFTAas a means to protect against excessive risk-taking by large financial institutions.102 Although Dodd-Frank indirectly protects consumers from risk and financial crisis, the trade-off is the consumer’s financial privacy.103 Consequently, it allows the government to bypass the strict regulations from the RFPAto easily access consumer financial data.104 In 2017, Dodd-Frank was revised with the Financial CHOICE Act.105 The Financial CHOICE Act made it so only fewer than 10 banks have to deal with the strictest regulations of Dodd- Frank.106 Digital currency will challenge the widespread assumption that systematic risk in the financial sector dominantly comes from large
88 Right to Financial Privacy Act, § 3401. 89 Id. 90 Id. 91 W. F. McElroy, supra note 3, at 1062. 92 Id. 93 Regulation E Electronic Fund Transfer Act, FEDERAL RESERVE CONSUMER COMPLIANCE HANDBOOK, https://www. federalreserve.gov/boarddocs/supmanual/cch/efta.pdf. 94 Id. 95 Sumit Agarwal, supra note 32, at 167. 96 Electronic Fund TransferAct, 15 U.S.C. §1693 (1978). 97 William Magnuson, supra note 14, at 1168. 98 Id. at 1169. 99 Id. 100 Id. at 1194. 101 Id. at 1169. 102 Sumit Agarwal, supra note 32, at 167. 103 Id. 104 Id. 105 Financial Choice Act of 2017, CONGRESS.GOV, https://www.congress.gov/bill/115th- congress/house-bill/10. 106 Id.
banks and other financial institutions if it gains mainstream popularity.107 The U.S. government requires large banks and other financial institutions to report in detail their earnings to prevent financial downturns like 2008.108 Digital currencies would be able to circumvent this regulation currently and have the potential to be a huge liability for the government and economy as a whole.
In 1999, The Gramm-Leach-BlileyAct (GLBA) was created with a similar purpose to the EFTA. The GLBAestablishes that “financial institutions—companies that offer consumers financial products or services like loans, financial or investment advice, or insurance to explain their information-sharing practices to their customers and to safeguard sensitive data.”109 Financial institutions include all businesses regardless of size and businesses that may not necessarily define themselves as a financial institution.110 For instance, real estate appraisers, credit reporting agencies, mortgage brokers, etc.111 The Safeguards Rule requires that all companies have a written information security plan that assesses the risks to customer information in all areas of their operation.112Consequently, information security emphasizes an individual’s right to decide whether to reveal personal information; whereas, data security is an institution’s strategy to ensure only authorized people may have access to the personal information.113The GLBAfocuses on protecting consumer’s financial information, especially non-public information (NPI).114 NPI includes personally identifiable information like a customer’s name, income, Social Security number, etc.115 Information that would not be considered NPI would be phone numbers and other information that has already been distributed online or through paper.116 This aligns with the Smith decision because it did not consider phone numbers as private information once an individual chose to use a telephone company.117 In combination with the Banking SecrecyAct (BSA), the government wields great power over our financial information and has the tools necessary to procure the evidence to convict someone of nefarious, criminal activities.118
The Bank Secrecy Act was created in 1970 to prevent money laundering of illicit funds and terrorist financing.119 It requires financial institutions to cooperate with federal regulators by maintaining records and making reports to enforce various criminal and tax regulations.120 Sixteen years later, the Money Laundering ControlAct of 1986 enhanced the BSAby imposing criminal liability on the financial institutions for knowingly assisting in the laundering of money or not creating sufficient enough structures to prevent money laundering.121 InApril 1996, a SuspiciousActivity Report (SAR) was developed for use of all banks.122 Banks are required to file a SuspiciousActivity Report (SAR) when they detect possible violations or suspicious activity.123 Also, banks must file a Currency Transaction Report (CTR) for each non-exempt deposit, withdrawal, exchange of currency or other payment that involves currency more than $10,000.124 Failure to adhere to the BSA can result in civil money penalties or even criminal charges.125 For instance, criminal penalties for money laundering or terrorist
107 William Magnuson, supra 14, at 1170. 108 Sumit Agarwal, supra note 32, at 167. 109 Gramm-Leach BlileyAct, 15 U.S.C. § 6801 (1999). 110 Financial Institutions and Customer Information: Complying with the Safeguards Rule, FEDERAL TRADE COMMISSION, https://www. ftc.gov/tips-advice/business-center/guidance/financial- institutions-customer-information-complying. 111 Id. 112 Id. 113 Lauren Henry, Information Privacy and Data Security, 2015 CARDOZO L. REV. 107, 115 (2015). 114 Sumit Agarwal supra note 32, at 166. 115 Id. 116 Id. 117 Smith, 422 U.S. 118 Sumit Agarwal, supra note 32, at 168. 119 Robert S. Pasley, Recent Developments in Bank SecrecyAct Enforcement, N. C. BANKING INST. 61, 61 (2005). 120 Id. 121 Bank SecrecyAct/Anti Money Laundering Examination Manuel, FFIEC, https://bsaaml.ffiec.gov/docs/manual/01_Introduction/01.pdf. 122 Id. 123 Id. at 62 124 Id. 125 Id. at 63
financing includes penalties of up to $500,000 and up to 20 years in prison.126 After the September 11, 2001 terrorist attack, Congress responded by creating the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct TerrorismAct of 2001 (USAPatriotAct).127 Title III of the USA Patriot Act specifically relates to anti-money laundering and the BSA.128 Title III criminalized the financing of terrorism, strengthened customer identification services, prohibited business with foreign shell banks, and enhanced due diligence procedures for foreign correspondent and private banking accounts.129Although years of legislation aimed at establishing some privacy protections had been in work, the circumstances of 9/11 fueled the creation of the USA Patriot Act.130 The USA Patriot Act allows the government to circumvent many of the regulations put in place by the RFPA, GLBA, and EFTA.131 Especially in times where the government needs to actively fight terrorism and investigations, the USA Patriot Act allows the government to conduct investigations on individuals without notifying them that they are being monitored.132
This paper is not attempting to analyze or criticize these legislative decisions; however, it is looking to see how financial privacy up to this point will fall into place with digital currencies. Smith and Miller solidified third-party doctrine. Individuals do not have a reasonable expectation of privacy if they give information to a third party.133 In response, RFPA, EFTA, and GLBAattempt to give greater protections to financial privacy. However, Dodd-Frank, the BSA, and USAPatriotAct allow for circumvention of financial privacy to ensure other protections against criminal activity, terrorist funding, and economic downturns. More specifically, this paper seeks to find if the safeguards from the subsequent legislation will apply to digital currencies and if any actors in digital currencies will act as third-party intermediaries.
PART III: HOW DO WE LEGALLY DEFINE DIGITAL CURRENCIES?
Although digital currency has the word currency in its name, there is much debate about how digital currencies should be labeled legally.134 This paper will focus on the financial privacy effects and consequences of legally defining digital currencies; however, definitively labeling digital currencies will also cause a range of other effects regarding regulation of tax reporting and laundering illicit funds. Most of the regulation so far has been created with an eye toward preventing abuse of digital currency through facilitating black market transactions, money laundering, terrorist financing, and tax evasion.135 Across the board, the United States has not been consistent in its legal approach to defining digital currencies. There is no comprehensive federal regulation for digital currencies, and different government bodies have provided differing definitions and limited action in enforcing these definitions.136 The Federal Trade Commission has warned users about the risk of owning digital currency. For instance, there is no Federal Deposit Insurance Corporation securing any cash deposits into digital currency. The IRS has defined digital currency with the term “virtual currency.”137 Its definition highlights that virtual currency is a “digital representation” of value that functions as a medium for exchange with no legal tender status in any country. The IRS distinguishes how digital currencies are different from online payment systems like PayPal or Apple Pay because they facilitate transactions with a national currency.138 Likewise, digital currency transactions differ from
126 Id. 127 Id. 128 Id. 129 Id. 130 Sumit Agarwal, supra note 32, at 169. 131 Sumit Agarwal, supra note 32, at 169. 132 Id. 133 W. F. McElroy, supra note 3, at 1057. 134 W. F. McElroy, supra note 3. 135 Trevor I. Kiviat, supra note 15, at 589. 136 Trevor I. Kiviat, supra note 15, at 589. 137 Id. 138 Id.
credit card transactions in the same way.139 The IRS has instructed for digital currencies to be treated as noncurrency property.140 Whereas, the European Court of Justice decided that bitcoins should be subject to value-added tax in the EU.141
In December 2014, the Commodity Futures Trading Committee (CFTC) defined digital currencies as commodities.142 It emphasized that they are using a broad application of the definition of commodity that includes both traditional agricultural commodities and derivative contracts.143 Digital currencies would fall under derivative contracts.144 The Commodity ExchangeAct defines commodities as “all services, rights, and interests” that “contracts for future delivery.”145 And defines derivatives as “a financial instrument, traded on or off an exchange,” where the price is derived from “the value of one or more underlying securities, equity indices, debt instruments, commodities, other derivative instruments.”146 Each digital currency exchange must be registered with the CFTC. For instance, in 2016, the CFTC found Bitfinex operated for approximately three years as an online platform for trading and exchanging digital currencies (mostly Bitcoin) without the proper registration with the Commission.147 Since Bitfinex “held the purchased bitcoins in bitcoin deposit wallets that it owned and controlled,” it therefore “engaged in illegal, off-exchange commodity transactions and failed to register as a futures commission merchant.”148 The CFTC charged a civil monetary penalty of $75,000 to Bitfinex for illegal, off-exchange transactions and failing to register as a Futures Commission Merchant.149
By defining virtual currencies as commodities, the CFTC has oversight over virtual currencies when in pursuit of anti-manipulation rules of spot market transactions.150 The CFTC in certain instances has the ability to enforce authority because spot market transactions can affect derivative market prices.151 This power was augmented after Dodd-Frank because it gave them jurisdiction over cover swaps and redefined manipulation as both actual and attempted manipulation.152 The CFTC exercised this power in the case of TeraExchange, LLC.153 Although Tera was registered as a swap execution facility (SEP), they arranged two traders to participate in “a fully offsetting transaction in the Bitcoin swap for the same price and notional amount.”154 According to the CFTC, not only is wash trading and prearranged trading prohibited, but companies must have infrastructure to discourage that activity. Since Tera both prearranged a trade and had no infrastructure set in place, it was decided that it had violated CFTC’s regulation. There were no monetary penalties involved.
Defining digital currency as commodities puts to rest the argument that digital currencies should be considered securities and, therefore, should be regulated by the Securities and Exchange Committee (SEC).155
139 Id. 140 Jeffrey E. Glass, supra note 15, at 482. 141 Mark Edwin Burge, supra note 19, at 1533. 142 Timothy Massad, Testimony of Chairman Timothy Massad before the U.S. Senate Committee on Agriculture, Nutrition & Forestry, COMMODITY FUTURES TRADING COMMISSION, https://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-6. 143 Id. 144 Id. 145 Legal Definition of Commodity, COMMODITY FUTURES TRADING COMMISSION https://www.cftc.gov/ConsumerProtection/ EducationCenter/CFTCGlossary/index.htm#_comm odity 146 Legal Definition of Derivative, COMMODITY FUTURES TRADING COMMISSION https://www.cftc.gov/ConsumerProtection/ EducationCenter/CFTCGlossary/index.htm#D. 147 BFXNAINC. d/b/a BITFINEX, COMMODITY FUTURES TRADING COMMISSION, https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents /legalpleading/enfbfxnaorder060216.pdf. 148 Id. 149 Id. 150 Trevor I. Kiviat, supra note 15, at 594. 151 Id. 152 Trevor I. Kiviat, supra note 15, at 594. 153 TeraExchange LLC, COMMODITY FUTURES TRADING COMMISSION, https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents /legalpleading/enfteraexchangeorder92415.pdf. 154 Id. 155 Id. at 163
In 2018, the Chairman of the SEC Jay Clayton addressed the role of the SEC and CFTC in digital currency exchanges.156 He emphasized that while an Initial Coin Offering (ICO) may appear to look like an Initial Public Offering (IPO), ICOs are not protected under the same regulation and safeties of an IPO.157 Consequently, the SEC has not approved any electronic-traded products like an exchange traded fund (ETF) holding digital currencies.158 He warns that digital currencies do not have the same market protections from broker dealers on registered exchanges or alternative trading systems.159 Clayton highlighted that “U.S.-based cryptocurrency trading platforms have elected to be regulated as money transmission services,” and how traditionally, money transmission services have predominantly been state regulated, and the SEC and CFTC have not had direct oversight.160 In 2017, the SEC’s Division of Enforcement established a new Cyber Unit to combat misinformation and misconduct involving “distributed ledger technology and ICOs.”161 However, Clayton’s statement contradicts a press release from a year earlier in 2017 that claimed a SEC’s investigative report found that tokens offered or sold by a DecentralizedAutonomous Organization (DAO) are securities and are subject to the federal securities laws.162 Despite these findings, the SEC decided to not charge the DAOs for violation, but instead heavily cautioned against participating.163
In March 2013, the Financial Crimes Enforcement Network (FinCEN) identified administrators and exchangers of “convertible virtual currencies” as money service businesses.164 They defined convertible virtual currencies as a medium of exchange that “operates like a currency in some environments” and “has an equivalent value in real currency,” but does not have “legal tender status in any jurisdiction.”165 The FinCen’s assertion that digital currency’s administrators are considered money service businesses causes several contradictions on the application of money service businesses’definition of digital currencies. Originally, money transmitter licensing laws were created to “combat the growing use of money transmitting businesses to transfer large amounts of the monetary proceeds of unlawful enterprises.”166 Some examples of money service businesses include PayPal, American Express, and Barclays. Specifically, digital currencies are most similar to a money transmitter business, which is a specific type of money service business.167
Under federal law, money transmitters are normally considered a business or service that transfers money between parties for a fee.168 This aligns with digital currencies because the miners who double-check transactions provide a service and receive compensation in the form of digital currency. However, under U.S. Code, a money transmitter business is considered a business that is either formally or informally outside of the conventional financial depository institution.169 While virtual currency companies like Bitcoin would most likely not be considered a business due to its highly decentralized nature, there is strong argument that mining pools, which are groups of miners, could be considered money transmitter businesses.170 One of the largest mining pools is BTC. com.171 Mining pools are a joint group of digital currency miners who combine their computations resources over
156 Jay Clayton, The Roles of the SEC and CFTC, SECURITIESAND EXCHANGE COMMISSION, https://www.sec.gov/news/testimony/ testimony-virtual-currencies-oversight-role-us- securities-and-exchange-commission. 157 Id. 158 Id. 159 Jay Clayton, supra note 166. 160 Id. 161 Id. 162 SEC Issues Investigative Report Concluding DAO Tokens, a DigitalAsset, Were Securities, SECURITIESAND EXCHANGE COMMISSION, https://www.sec.gov/news/press-release/2017-131. 163 Id. 164 Trevor I. Kiviat, supra note 15, at 590. 165 Id. 166 U.S. v. Velastegui, 199 F.3d 590, 592 (1999). 167 Am I a MSB?, FINANCIAL CRIMES ENFORCEMENT NETWORK, https://www.fincen.gov/am-i-msb. 168 Nikolei Kaplanov, supra note 22, at 153. 169 Id. 170 Nikolei Kaplanov, supra note 22, at 154. 171 About Us, BITMAIN TECHNOLOGY HOLDING COMPANY, https://btc.com.
a network in order to make greater profits to split with the pool.172 On BTC.com’s About page, it explains how “the team and brand” of BTC.com is growing, and how they offer multi-node deployment through the nearest regional node.173
While mining pools would be considered money service businesses, individual miners would not be defined as money transmitters when purchasing goods and services with virtual currency.174 The conversion of virtual currencies to fiat currencies would also not fall under the money transmitter category.175 However, if a miner is selling a virtual currency as a business, then the person would be defined as a money transmitter.176 On May 5, 2015, the FinCEN charged a $700,000 fine and simultaneous settlement agreement to Ripple, a company that mines and sells a digital currency called XRP.177 In their settlement agreement with the U.S.Attorney’s Office in the Northern District of California, Ripple recognized that although it registered its subsidiary as a money service business due to FinCEN’s regulation, it started selling XRP without setting up a proper anti-money laundering program.178
In May 2019, FinCEN issued its most recent guidance on digital currency.179 It emphasizes how “this guidance does not establish any new regulatory expectations or requirements.”180 However, this interpretive guidance is meant to remind money service businesses, specifically convertible virtual currencies, about their obligation to follow the BSA regulations.181 In the “money transmission services” definition, FinCEN emphasizes that the portion “other value that substitutes for currency” specifically pertains to digital currencies. FinCEN does not limit or qualify the scope of the definition. In any case, individuals who create or distribute value may be subjected to regulatory frameworks like the BSA. It reiterates that money service businesses do not include banks, persons registered with the SEC or CFTC, or a natural person who engages in money service business activities, but on an infrequent basis with little profit.182
State Regulation Forty-nine states have their own version of a Money Transmitter Act to regulate digital currencies.183 While many states are using FinCEN’s guidance as a general approach to regulate digital currencies, some states are taking vastly different approaches. There have been three main approaches by states: incorporating digital currencies into existing money service business regulation, exempting digital currencies from money service business regulation, and requiring separate digital currency licenses.Although state-level regulation varies, these highly contrasting approaches will hopefully pressure for more definitive Federal regulation.
The state of Washington’s Uniform Money ServiceAct includes virtual currency in its definition of “Money Transmission.”184 It defines money as “a medium of exchange that is authorized or adopted by the United States or a foreign government or other recognized medium of exchange.”185 TheAct specifically addresses money transmission
172 Jake Frankenfield, Mining Pool, INVESTOPEDIA, https://www.investopedia.com/terms/m/mining-pool.asp. 173 Multi-node Deployment, BITMAIN TECHNOLOGY HOLDING COMPANY,https://help.pool.btc.com/hc/en-us/articles/360020547292Multi-node-Deployment. 174 Trevor I. Kiviat, supra note 15, at 591. 175 Id. 176 Id. 177 Id. at 594 178 Id. 179 Application of FinCEN’s Regulations to Certain Business Models Involving Convertible Virtual Currencies, FINANCIAL CRIMES ENFORCEMENT NETWORK, https://www.fincen.gov/sites/default/files/2019- 05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf. 180 Id. 181 Id. 182 Id. at 4. 183 Jennifer Moffitt, The Fifty U.S. States and Cryptocurrency Regulations, COINATM RADAR, https://coinatmradar.com/blog/the-fifty-u-sstates-and-cryptocurrency-regulations/. 184 About Virtual Currency Regulation In Washington State, WASHINGTON STATE DEPARTMENT OF FINANCIAL INSTITUTIONS, https://dfi.wa.gov/bitcoin. 185 Legal Definition of Money Transmission, WASHINGTON STATE LEGISLATURE, https://app.leg.wa.gov/RCW/default.
as “receiving money or its equivalent value (equivalent value includes virtual currency) to transmit, deliver, or instruct to be delivered to another location, inside or outside the United States.”ˆ186 By incorporating virtual currency into the definition of money transmission, Washington asserts that virtual currency should be regulated under the already existing money transmission regulations.
Whereas, in Wyoming’s House Bill 70 or “Utility Token Bill,” it has exempted virtual currency from money transmission laws as long as they are exchangeable for goods or services and are not marketed as securities.187 Wyoming defines an “open blockchain token” as recorded on a “digital ledger or database … mathematically verified in nature, especially relating to the supply” and “capable of being traded or transferred between persons without an intermediary.”188 Wyoming is one of the first states to squarely attempt to define digital currency. It emphasizes that “a person who facilitates the exchange of an open blockchain token shall not be deemed a broker-dealer or a person who otherwise deals in securities.”189 In comparison to Washington’s treatment of digital currency, Wyoming has been much more lenient and has made less barriers to participation in digital currency exchanges.
In addition to money transmitter laws, several states have enacted separate laws aimed at requiring virtual currency businesses to acquire separate licenses. In 2015, The New York State Department of Financial Services (NYSDFS) established its own comprehensive framework for regulation of digital currencies.190 It requires licensing to digital currency businesses operating in New York State.191 A digital currency company must obtain a “BitLicense” when engaging in any “Virtual Currency Business Activity,” which includes receiving or transmitting virtual currency, storing, holding, or maintaining control of virtual currency, buying and selling virtual currency, performing exchange services, or controlling, administrating or issuing a virtual currency.192Additionally, any companies involved with a large amount of virtual currency transactions must also be licensed. The purpose of these licenses is to give New York the authority to establish specific requirements.193 Since its enaction, the NYDFS has the application of 19 different digital currency companies.194
Case Law and Digital Currencies Current case law addressing digital currency attempts to use the federal guidelines outlined above as a guide. However, there is a lot of inconsistency due to the fact that these decisions focus on the nature of digital currency.195
While the SEC has emphasized that digital currencies are not considered securities, in SEC v. Shaver, the SEC found that Bitcoins Savings & Trust, owned by Trendon Shavers, was “violating anti-fraud and registration provisions of security law.”196 Shavers advertised that he was selling bitcoins and offered investors up to 1 percent interest daily. He collected approximated 700,467 bitcoins or $4,592,806 USD; however, his investors suffered net losses collectively of 263,104 bitcoins or $1,834,303 USD. In the Court’s opinion, the Texas judge asserted that “it
aspx?cite=19.230.010. 186 Id. 187 House Bill No. HB0070, STATE OF WYOMING, https://www.wyoleg.gov/2018/Introduced/HB0070.pdf. 188 Id. 189 Id. 190 Virtual Currency BusinessActivity (BitLicense), NEWYORK DEPARTMENT FINANCIAL SERVICES, https://www.dfs.ny.gov/apps_ and_licensing/virtual_currency_businesses. 191 Id. 192 Id. 193 Id. 194 DFS GRANTS VIRTUAL CURRENCY LICENSE TO BITSTAMP USA, INC., NEWYORK DEPARTMENT FINANCIAL SERVICES, https://www.dfs.ny.gov/reports_and_publications/press_releases/pr1904092. 195 Sumit Agarwal, supra note 32, at 162. 196 SEC v. Shavers, 2014 U.S. Dist. (2013).
is clear that Bitcoin can be used as money” and there was a clear expectation that profits would be “derived from efforts of the promoter or third party.”197 Shavers and Bitcoin Savings & Trust were ordered to pay $40 million in disgorged profits.198 The SECemphasized how this was a sham and Ponzi scheme and that “fraudsters are not beyond the reach of the SEC.”199 Immediately after the SEC v. Shaver’s decision, the SEC issued an investors alert.200
There have been several cases where the CFTC has pursued digital currencies in court. In CFTC v. McDonnell, the Commission charged Patrick McDonnell’s company CabbageTech, which is New York-based, with operating a “deceptive and fraudulent virtual currency scheme,” where he gave alleged virtual currency trading advice and misappropriated investor’s funds.201 In its opinion, it emphasizes while traditionally the CFTC’s jurisdiction is limited to future contracts for commodities, the CFTC’s powers have expanded to spot trade commodity fraud. Moreover, they conclude that CFTC’s regulatory authority over “manipulative schemes, fraud, and misleading statements” applies to McDonnell.202 In other words, the CFTC’s anti-fraud authority applies broadly to any manipulative device in relation to the contract of sale of any type of commodity.203 CabbageTech was charged with over $1.1 million in civil monetary penalties.204
Later in the same year, in CFTC v. My Big Coin Pay, Inc., the CFTC claimed a fraudulent “virtual currency scheme” in violation of the Commodity Exchange Act due to manipulation in connection with the sale of a commodity.205 Randall Crater, the owner of My Big Coin, made various false and misleading claims that My Big Coin was “backed by gold,” could be used wherever Mastercard is accepted, and was being “actively traded” on several currency exchanges.206 In its opinion, it describes how “the court is construing the term ‘commodity’ not in a vacuum, but rather as it functions within the CEA’s anti-fraud enforcement provision.”207 While the definition of commodities includes “future delivery” and technically future deliveries of virtual currencies are immediately “dealt in,” the court utilizes case law from United States v. Brooks,208 to support the irrelevance of “future delivery.” In United States, the defendant attempted to argue that a specific type of natural gas was not a commodity because it was not subjected to future contract, but the court decided that defining a commodity is not solely based on the characteristic of “future delivery.”209
In State of Florida v. Espinoza, an undercover detective bought Bitcoin from Reid Espinoza and implied that he was going to use the Bitcoin to fund illicit activity like purchasing stolen credit cards.210 After the fourth transaction, Espinoza was arrested on two counts of money laundering and one count of engaging in money transmitter business without a license.211 Since their transactions involved conversions of $30,000 of cash into Bitcoin, which exceeds the maximum amount threshold in Florida, Espinoza was charged with anti-money laundering law violations.212 However, the trial court’s decision dismissed charging him with three counts using the
197 Id. at 6. 198 Id. 199 SEC Charges Texas Man With Running Bitcoin-Denominated Ponzi Scheme, SECURITIESAND EXCHANGE COMMISSION, https:// www.sec.gov/news/press-release/2013-132. 200 Id. 201 CFTC v. McDonnell, 287 F. Supp. 3d 213 (2018). 202 CFTC 287 at 229. 203 CFTC Wins Trial against Virtual Currency Fraudster, COMMODITY FUTURES TRADING COMMISSION, https://www.cftc.gov/ PressRoom/PressReleases/7774-18. 204 Id. 205 CFTC v. My Big Coin Pay, Inc., 334 F. Supp. 3d 492, (2018). 206 Id. 207 Id. 208 United States v. Brooks, 681 F.3d 678, (2012). 209 Id. 210 State v. Espinoza, 264 So. 3d 1055 (2019). 211 Id. 212 Sumit Agarwal, supra note 32, at 163.
Internal Revenue Service (IRS) notice that Bitcoin is not considered money.213 In 2019, the state of Florida appealed, and the Third District Court reversed the trial court’s decision.214 In its opinion, it states that while Bitcoin is not considered a currency, Bitcoin “does fall under the definition of payment instrument” and, therefore, has “monetary value” or “a medium of exchange, whether or not redeemable in currency.”215 The Florida judge compares and contrasts the definition of a money services businesses on a state level and federal level. Florida’s definition contains no third-party transmission requirement in the definition; however, the federal definition does include a third-party transmission requirement.Although the federal definition includes a third-party transmission requirement, the appellate court emphasizes that Legislature purposefully does not include the unambiguous language to have a broader definition than “third-party.”216
CONCLUSION
In a 2019 joint public statement by leaders of the CFTC, SEC, and FinCEN, they reiterated that digital currency or digital assets must adhere to the BSA’s obligation to prevent anti-money laundering and countering the financing of terrorism.ˆ217 Digital currencies potentially can qualify as “securities, commodities, and security- or commodity-based instruments such as futures or swaps.”218 These regulatory bodies apply definitions broadly and emphasize that the underlying technology used is irrelevant when deciding which category digital currency use falls under.219 Instead, definitions of digital currency will focus on the currency’s activity and service, including its economic reality and use.220
This distinction is important because it asserts that despite the blockchain technology used for digital currency transactions, digital currencies will have to follow the same enforcements and regulations as other financial institutions. Although digital currencies were originally created to cut out intermediaries, it inversely created new intermediaries. For instance, mining pools or digital currency businesses that function as money transmitter services. Or how in certain circumstances, digital currency can act as a commodity. By broadly applying these definitions, regulatory agencies have the ability to categorize digital currencies loosely off its main economic function. Digital currency businesses that do not comply with RFPA, GLBA, EFTA, and BSA will be subject to potentially both civil and monetary penalties.
Additionally, this broad application of definitions implies that a person does not have a reasonable expectation of privacy when using digital currencies. Although digital currencies promised to be a libertarian’s dream,221 if digital currencies are used in the United States and broadly fall under any financial category, then due to third-party doctrine, the user really had no expectation of privacy. That being said, digital currencies will also gain the same financial privacy protections from RFPA, EFTA, and GLBA.
While their approach allows digital currency to encompass many existing financial instrument definitions, regulators should seek to learn and understand the mechanics of blockchain, and why it makes digital currency unique. Likewise, digital currency companies, businesses, and mining pools should be transparent about their
213 Id. 214 State v. Espinoza, 264 So. 3d 1055 (2019). 215 Id. 216 Id. 217 Leaders of CFTC, FinCEN, and SEC Issue Joint Statement onActivities Involving DigitalAssets, SECURITIESAND EXCHANGE COMMISSION, https://www.sec.gov/news/public-statement/cftc-fincen- secjointstatementdigitalassets. 218 Id. 219 Id. 220 Id. 221 Jeffrey E. Glass, supra note 15, at 490.
systems and work collaboratively with government agencies. Focusing solely on digital currency’s economic function will admittedly provide regulation for the weaknesses of digital currency; however, it will also neglect its strengths. Digital currency functions vastly differently from any electronic transfer technology, and its blockchain technology provides strengths such as faster transaction time, lower transaction costs, and higher level of privacy.222
It would be a grave mistake to not consider technology when defining a new payment system.After Miller v. United States, the Supreme Court and legislators failed to understand how physical and virtual spaces differentiate from each other; consequently, that decision has caused an erosion of financial and communication privacy protection in all virtual spaces. The government’s choice to apply definitions broadly will have even larger implications on future blockchain technology like smart contracts.223 Regulators have an obligation to protect consumers by mitigating potential risks of fraud, money laundering, and terrorist funding facilitated by digital currency. Likewise, regulators also have an obligation to protect digital currency users’ privacy. In the future as regulators seek to make a categorical federal definition of digital currencies, they should closely follow state regulation’s three main approaches. Regulators should also consider that perhaps blockchain technology makes digital currencies so different from past financial instruments that it needs its own definition and framework for regulation. By reflecting on the effects of current regulation and the structure of blockchain, regulators will hopefully strike a balance between maintaining digital currency’s original intent to foster greater financial privacy and the government’s need to obtain financial records to protect consumers.
222 Nikolei Kaplanov, supra note 22, at 125. 223 Trevor I. Kiviat, supra note 16, at 605.
