Daniela Dekhtyar Role of the State Attorney General – Seminar Paper

Role of the State Attorney General in the Oversight of

As 2015 comes to a close, positive reviews of Bitcoin are on the rise. Numerous financial press outlets praised Bitcoin’s year, noting that Bitcoin was the world’s best performing

“currency”1 in 2015.2 Furthermore, many financial industry experts report that even traditional banks are looking to incorporate the technology behind Bitcoin into their banking practices.3

Though Bitcoin’s short existence has thus far consisted of multiple upswings and downswings, recent funding announcements in Bitcoin-related ventures have given it renewed legitimacy, suggesting that this most recent upswing may have staying power.4

1 Though many refer to Bitcoin as a currency, such terminology is not entirely accurate. See infra note 5 and accompanying text. 2 See Mark Gilbert, Bitoinc Won 2015. Apple . . . Did Not, Bloomberg (Dec. 29, 2015), http://www.bloombergview.com/articles/2015-12-29/bitcoin-won-in-2015-but-apple-lost-big (calling Bitcoin the “comeback of the year”); Eric Rosenbaum, Bitcoin’s Back: Big Year for Controversial Digital Currency, CNBC (Dec. 28, 2015), http://www.cnbc.com/2015/12/28/only- one-global-currency-trounced-the-dollar-this-year.html [hereinafter, Rosenbaum, Bitcoin’s Back] (“[T]o find what’s arguably been the best global currency in 2015, an investor might need to put quote marks around the term ‘global currency.’”). 3 See Prableen Bajpai, 2015: A Blockbuster Year for Bitcoin’s Technology, Nasdaq (Dec. 30, 2015), http://www.nasdaq.com/article/2015-a-blockbuster-year-for-- blockchain-technology-cm559938 (reporting Bitcoin’s blockchain technology “has received an overwhelming response from a group, which doesn’t stand bitcoin one bit but is sure in love with blockchain. No points for guessing the group: big banks.”); Rosenbaum, Bitcoin’s Back, supra note 1 (“The number of financial institutions – as well as self-regulatory bodies, like the Depository Trust Clearing – endorsing the blockchain technology has given credit and value to bitcoin.”). 4 See Nathanial Popper, Start-up With Bitcoin in its DNA Stumbles on Fund-Raising Trail, NY Times (Dec. 28, 2015), http://www.nytimes.com/2015/12/29/business/dealbook/cash-call-for-a- new-technology.html?_r=0 (describing Bitcoin’s blockchain technology as “one of the hottest areas of growth on Wall Street today”). Everett Rosenfeld, Bitcoin is One of 2015”s Biggest Winners, CNBC (Dec. 29, 2015), http://www.cnbc.com/2015/12/29/bitcoin-is-one-of-2015s- biggest-winners.html (“[F]unding announcements from bitcoin-related start-ups helped to establish the legitimacy of the sector – and its underlying technology.”).

1 Daniela Dekhtyar – Seminar Paper

Perhaps because of the uncertainty regarding Bitcoin’s longevity, government agencies both domestic and abroad have approached oversight rather cautiously. In the United States, federal financial regulators have taken the most significant moves toward regulation, but certain state agencies are jumping in, as well. Undoubtedly, the question on every government agency’s mind (even those that have already addressed Bitcoin in some way) is, “How exactly do I fit in?”

This paper argues that there is a role for state Attorneys General (AGs) to play in the oversight of

Bitcoin and similar virtual currencies, particularly in the realm of consumer protection.

This paper proceeds in four parts. Part I provides an overview of Bitcoin, explaining its goals and how it works. Part II describes Bitcoin’s advantages and risks, highlighting why regulation is necessary. Part III discusses the various approaches that federal government agencies have taken in regulating Bitcoin and explores the potential role for state AGs. Part IV concludes.

I. What is Bitcoin?

Bitcoin is a decentralized digital peer-to-peer network that allows for the creation and exchange of bitcoins.5 In plain English, Bitcoin is an online payment platform.6 According to its creator, ,7 the primary purpose of Bitcoin was to establish a means of

5 Bitcoin is colloquially referred to as a currency, but legally its definition as a currency is widely debated. For a discussion of Bitcoin’s classification as a currency, commodity, or investment contract, see Nicholas Godlove, Regulatory Overview of Virtual Currency, 10 Okla. J. L. & Tech. 71 [hereinafter Godlove, Regulatory Overview of Virtual Currency] (2014). 6 See Daniela Sonderegger, A Regulatory and Economic Perplexity: Bitcoin Needs Just a Bit of Regulation, 47 Wash. U. J.L. & Pol’y 175, 181 [hereinafter Sonderegger, Bitcoin Needs Just a Bit of Regulation] (“Bitcoin, at its core, is . . . a payment system or platform through which payments can be made.”); see also Robert McMillan and Cade Metz, Bitcoin Survival Guide: Everything You Need to Know About the Future of Money, Wired (Nov. 25, 2013), http://www.wired.com/2013/11/bitcoin-survival-guide/ [hereinafter McMillan & Metz, Bitcoin Survival Guide] (stating Bitcoin “operates as an extremely low-cost money-moving platform.”). 7 Satoshi Nakamoto is the pseudonym of an anonymous programmer or group of programmers who released the software for Bitcoin onto the internet in 2009. See McMillan & Metz, Bitcoin

2 Daniela Dekhtyar – Seminar Paper processing electronic payments independently of financial institutions.8 Nakamoto argued that the dominant mode of online financial transactions today increasingly relies on financial institutions to act as intermediaries between senders and beneficiaries of payments and that such reliance has numerous disadvantages.9 First, requiring a single third party (the financial institution) to mediate disputed transactions yields transaction costs; the greater the number of transactions, the greater the number of disputes, and the longer it takes for a single party to resolve those disputes.10 Second, reliance on financial institutions places a practical limit on transaction size; because intermediaries charge fees for processing transactions, it becomes impractical for sellers to provide a low-value product online unless a certain minimum volume of

Survival Guide, supra note 6 (“About five years ago, using the pseudonym Satoshi Nakamoto, an anonymous computer programmer or group of programmers built the Bitcoin software system and released it onto the internet.”). While the true identity of this programmer(s) remained unknown for years, less than one month ago, numerous tech media outlets reported that Nakamoto’s true identity was likely discovered; Nakamoto is actually a pseudonym for an Australian businessman, , and a deceased U.S. forensic researcher, Dave Kleiman. See Sam Bidde and Andy Crush, This Australian Says He and His Dead Friend Invented Bitcoin, Gizmodo (Dec. 8, 2015) http://gizmodo.com/this-australian-says-he-and-his- dead-friend-invented-bi-1746958692 (“According to a cache of documents provided to Gizmodo which were corroborated in interviews, Craig Steven Wright, an Australian businessman based in Sydney, and Dave Kleiman, an American computer forensics expert who died in 2013, were involved in the development of the digital currency.); Andy Greenberg and Gwen Branwen, Bitcoin’s Creator Satoshi Nakamoto is Probably This Unknown Australian Genius, Wired (Dec. 8, 2015), http://www.wired.com/2015/12/bitcoins-creator-satoshi-nakamoto-is-probably-this- unknown-australian-genius/ (“In the last weeks, WIRED has obtained the strongest evidence yet of Satoshi Nakamoto’s true identity. All signs point to Craig Steven Wright, a man who never even made it onto any Nakamoto hunters’ public list of candidates, yet fits the creator’s profile in nearly every detail.”). 8 See Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System (2009), https://bitcoin.org/bitcoin.pdf (“What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”). 9 See id. (“While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model.”). 10 Id.

3 Daniela Dekhtyar – Seminar Paper that product can be sold.11 Lastly, Nakomoto argued that reversibility of payments, a staple feature of online transactions cleared by a financial institution, creates “costs and payment uncertainties” for merchants whose transactions are disputed.12 Nakamoto’s solution was

Bitcoin: a peer-to-peer network that would allow senders and beneficiaries of payments to transact directly with one another, without the need of a trusted third party like a financial institution.

I.A. How Bitcoin Works

Bitcoin has two key features. First, bitcoins are electronically created and stored.

Bitcoin users create bitcoins by a process called “mining.” 13 All of the bitcoins ever created and all of the transactions ever conducted via Bitcoin are recorded in a virtual public known as the “block chain.” 14 To mine for new bitcoins, a user must verify the block chain by solving a complex mathematical problem. 15 If that problem is solved successfully, 25 bitcoins are produced.16 The opportunity to verify the block chain (and as a result mine bitcoins) arises when

11 Id. 12 Id. 13 Bitcoin Project. How Does Bitcoin Work?, https://bitcoin.org/en/how-it-works [hereinafter, Bitcoin Project, How Does Bitcoin Work?] (last visited Dec. 28, 2015). 14 See id. (describing block chain as shared public ledger used to confirm transactions and ensure bitcoins are truly owned by purchaser); see also Kevin V. Tu & Michael W. Meredith, Rethinking Virtual Currency Regulation in the Bitcoin Age, 90 Wash. L. Rev. 271, 281 (2015) [hereinafter, Tu & Meredith, Rethinking Virtual Currency Regulation] (explaining Bitcoin users authenticate and approve transactions which are submitted to public ledger called “block chain”). 15 Duncan Elms, Bitcoin Explained, Vimeo (Sept. 2014), https://vimeo.com/63502573 [hereinafter Elms, Bitcoin Explained]. 16 See id. In 2016, the reward for mining, i.e. the number of bitcoins produced, will be halved. See Turr Demeester, 2016 Could Be Bitcoin’s Best Year Yet, CoinDesk (Dec. 28, 2015), http://www.coindesk.com/2016-bitcoin-best-year/ (“In mid July 2016, the amount of new bitcoins awarded to bitcoin miners will drop from 3,600 BT per day to 1,800 BTC per day.”).

4 Daniela Dekhtyar – Seminar Paper a transaction is attempted. 17 Limiting the ability of users to mine bitcoins in this way creates an incentive for users to “participate in the computationally intensive task of verifying the network’s transactions.”18 The number of bitcoins that can be mined is finite; Bitcoin was designed to include a cap of 21 million bitcoins.19 Roughly 25 bitcoins can be mined in a ten- minute period and the mathematical problem that must be solved in order to mine each set of 25 bitcoins gets harder as the number of bitcoins that have been mined approaches the 21 million cap.20 Each bitcoin is mathematically assigned a unique address in the ledger,21 as well as a

“private key,” which is stored in a user’s virtual wallet and used to sign transactions.22

The second, and arguably more important, feature of Bitcoin is that is not backed by a centralized agency like a government or central bank. Rather, the creation and usage of bitcoins is monitored entirely by Bitcoin users themselves.23 The consequences of this difference are

17 Joshua J. Doguet, The Nature of the Form: Legal and Regulatory Issues Surrounding the Bitcoin Digital Currency, 73 La. L. Rev. 1119, 1127 (2013) [hereinafter, Doguet, Nature of the Form]. 18 Id. 19 See McMillan & Metz, Bitcoin Survival Guide, supra note 6 (“Though the system continues to crank out bitcoins, this will stop when it reaches 21 million, which was designed to happen in about the year 2140.”). 20 See Anthony Volastro, CNBC Explains: House to Mine Bitcoins on Your Own, CNBC (Jan 23, 2014 1:48 PM), http://www.cnbc.com/2014/01/23/cnbc-explains-how-to-mine-bitcoins-on- your-own.html. See also McMillan & Metz, Bitcoin Survival Guide, supra note 6 (stating “25 bitcoins are paid out to the world’s miners about six timers per hour, but that rate changes over time”). 21 See Bitcoin Mining Guide - Getting Started with Bitcoin Mining, Bitcoinmining.com, https://www.bitcoinmining.com/getting-started/ (last visited Dec. 28, 2015) (“Bitcoins are sent to your Bitcoin wallet by using a unique address that belongs only to you.”); McMillian & Metz, Bitcoin Survival Guide, supra note 6 (“[B]itcoins are just long digital addresses, and balances, stored in an online ledger called the ‘blockhain.’”). 22 See Bitcoin Project. How Does Bitcoin Work?, supra note 13 (“Bitcoin wallets keep a secret piece of data called a private key or seed, which is used to sign transactions, providing a mathematical proof that they have come from the owner of the wallet.”). 23 To be sure, the processing power required to mine bitcoins and verify Bitcoin transactions is quite large. As a result, every single owner/user of bitcoins does not maintain copies of the block chain. Rather, only “power users” maintain copies and verify transactions. See

5 Daniela Dekhtyar – Seminar Paper significant. A centralized currency generally requires the involvement of a third-party intermediary who can verify that the purchaser’s money is valid – think the bank that “clears” the buyer’s check. Moreover, for online transactions, a centralized currency requires that a third- party company take on the risk that the buyer’s money may be invalid – think the credit card company that remits funds to a seller before the buyer’s money is received. With Bitcoin, intermediaries are unnecessary. A change to the block chain will only be made, (i.e. a transaction will only be deemed valid), if Bitcoin users can verify the transaction. This entails ensuring that the buyer has bitcoins in his/her wallet to spend and that the buyer is using those precise bitcoins for the transaction.24

I.B. Bitcoin and the Average Joe

Critical to determining a State AG’s role in regulating Bitcoin is understanding how businesses and consumers are actually using it. How does the average Joe go about getting his virtual hands on some bitcoins? And what could the average Joe do with those bitcoins once he has them?

The first thing a new Bitcoin user must do is download a wallet on his/her computer or mobile phone.25 Once a user has a wallet, he/she is capable of storing bitcoins. As discussed previously, mining for bitcoins requires significant computational resources, to which the average Joe is unlikely to have access.26 Thus, to obtain bitcoins, the average Joe must purchase

CuriousInventor, How Bitcoin Works in 5 Minutes (Technical), YouTube (Apr. 13, 2014), https://www.youtube.com/watch?v=l9jOJk30eQs. 24 For a technical explanation of Bitcoin transactions, see Bitcoin Wiki, Transaction, https://en.bitcoin.it/wiki/Transaction (last updated May 28, 2015). 25 Bitcoin Project, How Does Bitcoin Work?, supra note 13. 26 See McMillan & Metz, Bitcoin Survival Guide, supra note 6 (“Back in the day, you could do bitcoin mining on your home PC. But as the price of bitcoins has shot up, the mining game has morphed into a bit of a space-race --- with professional players, custom-designed hardware, and rapidly expanding processing power.”).

6 Daniela Dekhtyar – Seminar Paper from another user coins that already exist. The simplest way of doing this is to meet in person a user who already has bicoins and deliver physical cash.27 A more likely option, though, would be to purchase bitcoins with “real” money via a Bitcoin exchange.28 The most prominent Bitcoin exchange in the United States is : “For a one percent fee, Coinbase links to your bank account and then acts as a proxy for you, buying and selling bitcoins on an exchange.”29 Of course, providing bank account information removes the anonymity that many Bitcoin users find desirable; other exchanges, such as LocalBitcoins.com enable a consumer to purchase bitcoins without providing any personal identifying information whatsoever.30

There are three primary Bitcoin uses for the ordinary consumer. The first, unsurprisingly, is to purchase goods and services online. Professor Kevin V. Tu and practitioner Michael W.

Meredith recount Bitcoin’s “humble beginnings,” in which the first bitcoins were used to purchase Papa John’s pizzas and a pair of alpaca wool socks, and its subsequent rise among well- known retailers.31 Today, more than 21,000 retailers, including big names like Amazon,

Overstock.com, CVS, and Expedia, accept Bitcoin.32

27 Id. 28 See id. (“In the U.S., the easiest way to buy and sell bitcoins is via a website called Coinbase.”). 29 Id. 30 LocalBitcoins.com, How to Begin, https://localbitcoins.com/guides/how-to-buy-bitcoins (last visited Dec. 29, 2015). 31 Tu & Meredith, Rethinking Virtual Currency Regulation, supra note 14 at 285. 32 Jillian Kumagai, More Than 21,000 Retailers Accept Bitcoin Payments, Mashable, (Nov. 15, 2014) http://mashable.com/2014/11/15/bitcoin-retailers-infographic/#KctMoQsv9SqM. To say these large retailers accept Bitcoin is a bit misleading. In actuality, large retailers are using intermediaries like Coinbase to “accept” bitcoins. When a consumer makes a purchase, he/she pays Coinbase in bitcoins, and Coinbase in turn gives the retailer U.S. dollars. See Jacob Davidson, No, Big Companies are Not Actually Accepting Bitcoin, Money (Jan. 9, 2015), http://time.com/money/3658361/dell-microsoft-expedia-bitcoin/ (explaining large retailers “partner with a middleman --- generally either Coinbase or Bitpay --- who takes a customer’s bitcoin, immediately converts it into cash, and deposits the cash in the company’s bank account.”). Nevertheless, the establishment of relationships between reputable retailers and

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The second primary use of bitcoins is to purchase good and services at brick and mortar stores. A relatively small number of physical stores accept bitcoins as payment,33 but owners of stores that do accept bitcoins often site the extremely low transaction fee, the non-reversibility of transactions, and the quick processing of payments, as attractive reasons for doing so.34 While physical stores that accept bitcoins tend to be smaller businesses, some larger businesses like the

Sacramento Kings, and Reed Jewelers, which maintains 64 retail locations in the eastern United

States, also take bitcoins at their physical locations.35

The third primary use of bitcoins is to treat their purchase as an investment opportunity.

Because bitcoins are not tied to any physical asset or guaranteed by a central authority, many argue that bitcoins have no intrinsic value. In 2013, Former Federal Reserve Chairman Alan

Greenspan said, “You have to really stretch your imagination to infer what the intrinsic value of

Bitcoin is. I haven’t been able to do it. Maybe somebody else can.”36 Greenspan’s position is

services such as Coinbase show Bitcoin’s progress towards becoming an integrated part of the broader financial payment system. 33 For an interactive map of stores across the globe that accept bitcoins as payment, see www.coinmap.org. 34 See Sara Ashley O’Brien, Retailers See Big Upside By Accepting Bitcoin, NY Post (Dec. 28, 2013), http://nypost.com/2013/12/28/nyc-retailers-see-big-upside-by-accepting-bitcoins/ (describing accepting bitcoin as “very low-risk” for merchants because of its low fee and prohibition of chargebacks); see also Tu & Meredith, Rethinking Virtual Currency Regulation, supra note 14 at 289 (explaining “[b]itcoin payment processing allows retailers to convert bitcoins to United States dollars within twenty-four hours whereas credit card processing typically requires forty-eight to seventy-two hours to complete”). 35 Coindesk, What Can You Buy with Bitcoin? http://www.coindesk.com/information/what-can- you-buy-with-bitcoins/ (last updated Oct. 19, 2015) (listing well-known businesses that accept bitcoins at their physical locations). 36 Jeff Kearns, Greenspan Says Bitcoin Is a Bubble Without Intrinsic Currency Value, Bloomberg Business (Dec. 4, 2013), http://www.bloomberg.com/news/articles/2013-12- 04/greenspan-says-bitcoin-a-bubble-without-intrinsic-currency-value. For video of the interview in which Greenspan’s statement was made, see Greenspan on Bitcoin: I Guess It’s a Bubble, Bloomberg Business (Dec. 4, 2013), http://www.bloomberg.com/news/videos/b/32efbb68-30bd- 43c8-bf6f-48526b88ba5c.

8 Daniela Dekhtyar – Seminar Paper not universally accepted, though, and numerous investors have chosen to purchase bitcoins, not to buy goods and services, but to speculate on what its value might be.37 More recently, financial experts have suggested that bitcoin may be treated like a high-risk asset class in which investors, both individual and institutional, may want to invest in order to diversity their portfolios.38

II. Bitcoin’s Benefits and Risks

It is clear from going through these primary uses that Bitcoin does not necessarily enable business or consumers to do anything new, per se. Rather, it provides a new method for making payments and potentially a new investment opportunity. This Part discusses the benefits and risks of using Bitcoin either for payments or as an investment, and lays out a case for its regulation.

II.A. Bitcoin’s Advantages

The first advantage of Bitcoin is its cost advantage. Whereas traditional payment methods involve mandatory transaction fees, some of which can be quite expensive, Bitcoin has no mandatory fees.39 Any transaction fees are set by the participants of the transaction and are

37 Tu & Meredith, Rethinking Virtual Currency Regulation, supra note 14 at 292. 38 See Chen Y. Wu and Vivek K. Pandey, The Value of Bitcoin in Enhancing the Efficiency of an Investor’s Portfolio, 27 J. Fin. Planning 44 (2014), https://www.onefpa.org/journal/Pages/SEP14-The-Value-of-Bitcoin-in-Enhancing-the- Efficiency-of-an-Investor%E2%80%99s-Portfolio.aspx (conducting empirical analysis of bitcoin’s worth as a medium of exchange and store of value, and concluding “individual investors can benefit from holding a small amount of bitcoins in a diversified portfolio”); Bobby Cho, 3 Reasons You Should Consider Investing in Bitcoin, The Street (Aug. 19, 2015), http://www.thestreet.com/story/13259698/1/3-reasons-you-should-consider-investing-in- bitcoin.html (describing Bitcoin as becoming “a viable alternative asset class for institutional and retail investors alike”); Eric Rosenbaum, Bitcoin’s Back: Big Year For Controversial Digital Currency, CNBC (Dec. 28, 2015), http://www.cnbc.com/2015/12/28/only-one-global-currency- trounced-the-dollar-this-year.html (comparing investing in Bitcoin to investing in gold, and suggesting investors with “sizeable portfolios” can afford to apportion roughly one percent of their investment portfolios for higher-risk investments like Bitcoin). 39 See Bitcoin Wiki, Transaction Fees, https://en.bitcoin.it/wiki/Transaction_fees (last updated Dec. 11, 2015) (“Transaction fees are voluntary on the part of the person making the bitcoin

9 Daniela Dekhtyar – Seminar Paper used to incentivize other Bitcoin users to verify the transaction.40 The result of this system is that, on average, the Bitcoin transaction fee is one percent, which is significantly lower than the average two to four percent transaction fees extracted by credit card companies and payment services like Western Union or PayPal.41 While the transaction fee set by Bitcoin users is likely to go up as the 21 million cap is reached and the reward for mining decreases,42 most predict that the fee will never reach the aforementioned fees of two to four percent.

Along the same lines, Bitcoin also has an advantage of increasing the ease with which money is transferred. The average bitcoin transaction takes about ten minutes to be verified.43

Once the transaction is verified, bitcoins are remitted to the recipient and the transfer is complete.44 Moreover, the length of time required to process the transaction does not increase if the parties to the transaction are father apart physically. This advantage has been particularly impactful in developing countries, where remittances represent a significant portion of people’s

transaction, as the person attempting to make a transaction can include a fee or none at all in the transaction.”). 40 See id. (“[N]obody mining new bitcoins necessarily needs to accept the transactions and include them in the new block being created. The transaction fee is therefore an incentive on the part of the bitcoin user to make sure that a particular transaction will get included into the next block which is generated.”). 41 See Roger Wu, Why We Accept Bitcoin, Forbes (Feb. 13, 2014), http://www.forbes.com/sites/groupthink/2014/02/13/why-we-accept-bitcoin/ (“The obvious an short-term benefit to using Bitcoin as compared with other clearinghouses like credit card companies, PayPal, and Western Union, are the lowered transaction costs, averaging in at 1%, as compared with the aforementioned 2-4%.”). 42 See supra note 16 and accompanying text (explaining mining reward will be halved in 2016). 43 CoinDesk, How do Bitcoin Transactions Work?, http://www.coindesk.com/information/how- do-bitcoin-transactions-work/ (last updated Mar. 20, 2015) (“Because your transaction must be verified by miners, you are sometimes forced to wait until they have finished mining. The bitcoin protocol is set so that each block takes roughly 10 minutes to mine.” 44 See id. (explaining bitcoins first sent from sender to wider , then bitcoin miners verify transaction, and recipient then receives bitcoins).

10 Daniela Dekhtyar – Seminar Paper income45 and remittance fees for traditional payment services are exceedingly high.46 Bitcoin provides both a faster and cheaper way for people to send and receive any amount of money across the globe.

A third advantage of Bitcoin is the decreased risk to merchants. With traditional online payments, there are multiple reasons why a chargeback might be requested from a merchant. For example: (1) the customer claims he/she did not authorize the transaction (ordinary fraud); (2) the intermediary claims that the purchaser was attempting to use the same currency twice (the double-spending problem); or (3) the purchaser falsely claims that the product has not been delivered or the service has not been rendered (chargeback fraud). In each of these scenarios, a merchant will have expended resources to provide a good or service, only to have the transaction disputed and the funds charged back by the financial intermediary. Bitcoin does not allow for this reversibility of transactions.47 Once a transaction is verified (which assumes the assurance that the bitcoins were signed with the correct private key and that they have not already been used, thereby addressing the ordinary fraud and double-spending problem scenarios), the transfer cannot be undone. Irreversibility assures merchants that once they have received payments,

45 See Bert Cramer, Kyrsyzstan Bitcoin Experiment Promises Migrant Workers Big Savings, (July 8, 2014), http://www.theguardian.com/world/2014/jul/08/kyrgyzstan-bitcoin- experiment-migrant-savings (“The World Bank estimates that last year migrant remittances totaled the equivalent of 31% of Kyrgyzstan’s gross domestic product . . . . Most of that money, several billion dolalrs, was transferred through expensive, fee-based services such as Western Union and Zolotaya Korona . . . .”). 46 See Mark Anderson, Bitcoin Shakes Up Remittances as Poorer People Offered Digital Deals, The Guardian (Aug. 18, 2014), http://www.theguardian.com/global- development/2014/aug/18/bitcoin-remittances-market-digital-cash (“Entrepreneurs claim they are using bitcoin to give some of the world’s poorest people a better deal on the money they receive from abroad. The World Bank calculates the average fee on remittances at 8%, yet charges can be three times as high.”). 47 See Bitcoin Project, Some Things You Need to Know, https://bitcoin.org/en/you-need-to- know (last visited Dec. 31, 2015) (“Any transaction issued with Bitcoin cannot be reversed, they can only be refunded by the person receiving the funds.”).

11 Daniela Dekhtyar – Seminar Paper those payments are theirs to keep. This assurance eliminates the “payment uncertainties” that

Nakamoto sought to eliminate.48

Bitcoin fans tout two more advantages to the system that are a bit more controversial.

The first is increased anonymity for users.49 Traditional payment systems require personal identifying information including, at minimum, name, address, and/or account number. Banks and credit card companies in the United States require greater information, like date of birth and social security number. None of this information is required to engage in a Bitcoin transaction; the only pieces of information housed in the block chain are the mathematically created bitcoin addresses and balances of every user.50

The second controversial advantage of Bitcoin is that it is less susceptible to government manipulation and inflationary pressures. Once the 21 million bitcoin cap is reached, no additional bitcoins will be created. This removes discretion and human error from the functioning of the currency.51 As one Bitcoin believer put it, in the entire history of money,

“[t]here is not a single instance until bitcoin, of a truly trustworthy form of money, one whose value was constrained not by the laws and weaknesses of man, but by the universal laws of

48 See supra note 12 and accompanying text (explaining elimination of payment uncertaintees was one of Nakamoto’s goals). 49 See Adam Ludwin, How Anonymous is Bitcoin? A Backgrounder for Policymakers, CoinDesk (Jan. 25, 2015), http://www.coindesk.com/anonymous-bitcoin-backgrounder- policymakers/ (visually comparing anonymity and privacy of Bitcoin, cash, charitable gifts, and credit/debit cards). 50 While this is the only information that is required, the anonymity aspect of Bitcoin is removed for many individual consumers. See supra notes 29--30 (explaining some exchanges require customers to provide personal identifying information). 51 See Daniela Sonderegger, supra note 6 at 184 (arguing Bitcoin’s capping mechanism prevents governments from “saturating financial markets with bitcoins simply because they think the market needs more money”).

12 Daniela Dekhtyar – Seminar Paper mathematics.”52 For those who believe that government control does more harm than good to the value of currencies, the decentralization of Bitcoin and its cap present a distinct advantage to fiat currencies.

For all of Bitcoins successes, it is not without its flaws. Indeed, while Bitcoin may remove the need to trust a single intermediary, it does not remove the need for trust entirely.

Instead, Bitcoin requires that users trust the block chain technology, other users, and their own computational resources. This creates distinct risks, discussed below.

II.B. Bitcoin’s Risks

The flip-side to the advantage of reversibility is quite obvious: If, in fact, a bitcoin transfer is fraudulent (i.e. if an individual’s bitcoins are stolen), the stolen bitcoins cannot be returned to their rightful owner.53 While bitcoins themselves may be “equally secure as any encrypted website or online purchase in terms of pure cryptography,” the exchanges and third- party wallet services upon which many Bitcoin users rely are only as secure as they are programmed to be.54 In other words, a poorly programmed exchange or wallet service can leave consumers quite vulnerable to theft. To understand the gravity of this disadvantage, one need only travel back to March 2014, when Mt. Gox – the world’s largest bitcoin exchange at the time

– reported that hackers had been stealing coins from the exchange for years, resulting in a loss of

52 Trevor Murphy, The Real Advantage of Paying with Bitcoin, CNBC (Dec. 9, 2014), http://www.cnbc.com/2014/12/09/the-real-advantage-of-paying-with-bitcoin-commentary.html. Trevor Muprhy is Chief Technology Officer of BitStash, which stores including Bitcoin. He has long been involved in financial services start-ups. Id. 53 See Nicholas Weaver, Once You Use Bitcoin You Can’t Go “Back” – And That’s Its Fatal Flaw, Wired (Nov. 26, 2013), http://www.wired.com/2013/11/once-you-use-bitcoin-you-cant- go-back-and-that-irreversibility-is-its-fatal-flaw/ (“Without an undo/back button, it’s only possible to prevent fraud. With an undo, it would also be possible to detect and mitigate fraud; to see that something bad happened and then actually do something about it.”). 54 Nicholas Godlove, supra note 5.

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850,000 bitcoins worth more than $460 million.55 Bitcoin users are also vulnerable to more innocuous causes of bitcoin loss, including hard drive failures, malware, and user error.56 Add to this security vulnerability, the fact that bitcoin users have few means of redress for loss, and these disadvantages become all the more risky.57

A second risk is of particular concern to law enforcement: the anonymity feature of

Bitcoin makes it the perfect mechanism to engage in criminal activity.58 Bitcoin and other virtual currencies enable criminals to use their ill-gotten gains without having to hoard or figure out how to transport piles of cash.59 With increased anonymity and ease of payment transfers,

Bitcoin is a money-laundering haven. The most notorious example of this risk was the online marketplace, the Silk Road, which was launched in February 2011 and shut down by the government in October 2013.60 The Silk Road, which was primarily sued for the exchange of

55 Robert McMillian, The Inside Story of Mt. Gox, Bitcoin’s $460 Million Disaster, Wired (Mar. 3, 2014), http://www.wired.com/2014/03/bitcoin-exchange/. 56 Daniela Sonderegger, supra note 6 at 187. 57 See id. (“Given the lack of a Federal Deposit Insurance Corporation equivalent for Bitcoin, users who have lost coins have no means of redress.”); Nicholas Godlove, supra note 5 (“[F]or crimes contained within the Bitcoin network – like thefts from apparently reputable online wallets where Bitcoins are stored, there has been almost no accountability.”). 58 See Joon Ian Wong, Dark Markets Grow Bigger and Bolder In Year Since Silk Road Bust, CoinDesk (Oct. 6, 2014), http://www.coindesk.com/dark-markets-grow-bigger-bolder-year- since-silk-road-bust/ (“Bitcoin’s creation and subsequent explosive popularity has been a crucial factor in the growth of global dark markets . . . . “). 59 See Stephen Mihm, Are Bitcoins the Criminal’s Best Friend?, Bloomberg View (Nov. 18, 2013), http://www.bloombergview.com/articles/2013-11-18/are-bitcoins-the-criminal-s-best- friend- (describing the historical “logistical challenge” of moving cash out of the United States and stating, “[w]hen it comes to moving ill-gotten gains, hitting a few key son a laptop beats shipping bogus toasters stuffed with cash”). 60 See Matthew Kien-Meng Ly, Harv. J. L. & Tech. 587, 595 (2014) (“[T]he Silk Road online marketplace, launched in February 2011 . . . facilitated the exchange of illegal drugs and weapons for bitcoins – with all parties cloaked in anonymity.”).

14 Daniela Dekhtyar – Seminar Paper illicit drugs and weapons, saw annual sales as high as 22 million dollars.61 The shutdown of Silk

Road did not bring an end to the operation of illegal markets via Bitcoin. Since then, at least three known black markets have arisen, each larger than the Silk Road was when it was shut down.62

The final significant disadvantage Bitcoin poses is its price volatility. The price of bitcoins has fluctuated greatly since Bitcoin’s public release. In 2013 alone, the price of Bitcoin rose from $100 to $1,240, and dropped back down to $50.63 Numerous factors including good or bad press, successes and failures of bitcoin-related ventures, ideologically-motivated actions, and uncertainty as to Bitcoin’s intrinsic value cause the price of bitcoins to fluctuate.64 This volatility makes it difficult for merchants to price their goods and services in Bitcoin and ultimately dissuades both merchants and consumers alike from using the service.65 In addition, for the uneducated small business owner or investor who decides to use Bitcoin, he/she runs a significant risk of losing money without appropriately hedging that risk.66

61 See Andy Greenberg, Black Market Drug Site ‘Silk Road’ Booming: $22 Million in Annual Sales, Forbes (Aug. 6 2012), http://www.forbes.com/sites/andygreenberg/2012/08/06/black- market-drug-site-silk-road-booming-22-million-in-annual-mostly-illegal-sales/. 62 See Tobias Feakin, Cryptomarkets: Illicit Goods on the Darknet (Nov. 6, 2014), http://www.aspistrategist.org.au/cryptomarkets-illicit-goods-on-the-darknet/ (“Three of the largest markets are Silk Road 2.0 (largely based on its predecessor), Agora and Evolution, each of which all have more listings than the original Silk Road did at the time of its demist.”). 63 Jonathan Todd Barker, Why is Bitcoin’s Value so Volatile?, Investopedia (May 27, 2014), http://www.investopedia.com/articles/investing/052014/why-bitcoins-value-so-volatile.asp. 64 Id. See also, Joshua Doguet, The Nature of the Form, supra note 17 at 1140 (“Both in the short and long term, the currency has been prone to significant value fluctuations, arguably the result of ideological enthusiasm and widespread speculation.”). 65 Id. 66 See Jack Tatar, How I Lost Half of My Retirement Investment in Bitcoins, Market Watch, (Oct. 7, 2014), http://www.investopedia.com/articles/investing/052014/why-bitcoins-value-so- volatile.asp (discussing poor investment of retirement funds in bitcoin, which dropped in price from $64.51 at time of investment to $31.16, but concluding Bitcoin investment was not bad because it constituted less than 5% of his overall portfolio; to “invest that much money in bitcoins” would make him stupid).

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It is without question that a large part of Bitcoin’s allure is in its lack of regulation. But that does not mean that Bitcoin should remain unregulated. To the contrary, the previously described risks are quite significant, and with the appropriate regulatory regime, they could be mitigated without nullifying Bitcoin’s advantages.

III. Regulating Bitcoin – The Role of the State AG

Before setting out what state AGs may be able to do with respect to the world of Bitoin, it is worth understanding what different agencies have done thus far. This Part provides an overview of federal attempts at regulating Bitcoin, and argues that there is a role for state AGs, particularly in the realm of consumer protection.

III.A. Federal Regulation in the United States

The United States has cautiously approached the regulation of Bitcoin and with good reason. Regulations created with Bitcoin as a model will likely impact the oversight of all virtual currencies and not just Bitcoin, as regulation abroad has done. Furthermore, unnecessary or overly aggressive regulation can stifle technological development. Still, regulation at the federal level is not entirely absent. The Financial Crimes Enforcement Network (FinCEN), the Internal

Revenue Service (IRS), the Securities and Exchange Commission (SEC), and the Commodities

Futures Trading Commission (CFTC) have all, at minimum, provided guidance on Bitcoin’s legal status.

1. FinCEN

In March 2013, FinCEN issued guidance indicating that existing federal anti-money laundering regulations are applicable to virtual currency.67 Specifically, the agency stated that

67 See Tu & Meredith, Rethinking Virtual Currency Regulation in the Bitcoin Age, supra note 14 at 306—07 (“In doing so, FinCEN unambiguously clarified the applicability of the existing federal anti-money laundering regulatory regime to virtual currency.”).

16 Daniela Dekhtyar – Seminar Paper companies or individuals that serve as sellers or exchangers for Bitcoin could be regulated as money transmitters.68 In 2014, FinCEN extended its position, advising that bitcoin payment processors, in addition to sellers and exchangers, can be regulated as money transmitters.69 Such regulation subjects sellers, exchangers, and payment processors of Bitcoin to state licensing requirements (if such requirements exist), minimum recordkeeping requirements, and reporting requirements.70

2. IRS

The IRS issued guidance in March 2014 stating that even though virtual currency does not have legal tender status, it is “treated as property for U.S. federal tax purposes” and that

“[g]eneral tax principles that apply to property transactions apply to transactions using virtual currency.”71 The IRS highlighted three implications of this guidance: (1) wages and payments paid to employees, independent contractors, and other service providers are taxable; (2) people who invest in Bitcoin are subject to the capital gains tax; and (3) payments made using virtual

68 Id. at 306. 69 See Pete Rizzo, FinCEN Rules Bitcoin Payment Processors, Exchanges are Money Transmitters, CoinDesk (Oct. 27, 2014), http://www.coindesk.com/fincen-rules-bitcoin- payment-processors-exchanges-money-transmitters/. Bitcoin payment processors are companies that “facilitate purchases between consumers and merchants, only accepting and transmitting funds as necessary to the sale,” as opposed to companies like Coinbase which aid consumers in exchanging real money for Bitcoins unrelated to the purchase of a particular product or service. Id. 70 For regulations applicable to money transmitters, also known as money services businesses (MSBs), see FinCEN, BSA Requirements for MSBs, https://www.fincen.gov/financial_institutions/msb/msbrequirements.html (last visited Dec. 29, 2015). 71 Internal Revenue Service, IRS Virtual Currency Guidance: Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply, https://www.irs.gov/uac/Newsroom/IRS-Virtual-Currency-Guidance (last updated Feb. 25, 2015).

17 Daniela Dekhtyar – Seminar Paper currencies are subject to the same reporting requirements as payments made in any other form of property.72

3. SEC

In July 2013, the SEC took the position that an investment scheme that relies on the investment of bitcoins falls within the definition of a security as provided in the Securities Act of

1933.73 Specifically, such a scheme represents an investment contract.74 According to the 1933

Act, an investment contract is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”75 Charged by the SEC with defrauding customers in a Bitcoin Ponzi scheme,

Trendon Shavers argued that Bitcoin could not fit the definition of an investment contract because bitcoins are not a real currency or money recognized by the U.S. government. Therefore no person “invests his money” in a scheme that relies solely on the investment of bitcoins. 76

In September 2014, a U.S. district court in Texas agreed with the SEC’s position, ruling that even though bitcoins may not be money as recognized by the U.S. government, they can be used as money to purchase goods or services and can be exchanged for conventional currencies;

72 Id. 73 See Dan Stroh, Secure Currency or Security?, The SEC and Bitcoin Regulation, University of Cincinnati Law Review (Nov. 18, 2014), http://uclawreview.org/2014/11/18/secure-currency-or- security-the-sec-and-bitcoin-regulation/ (“The Securities and Exchange Commission (SEC) took a bold step in the regulation of virtual currencies on July 23, 2013, when it charged Trendon Shavers and his company, Bitcoin Savings and Trust (BTCST), with defrauding customer sin a Ponzi scheme.”). 74 Id. 75 American Bar Association, Definition of a Security, 5 (2003), http://apps.americanbar.org/buslaw/newsletter/0014/materials/investmentch2.pdf. 76 See Dan Stroh, Secure Currency or Security?, supra note 73 (“The defense offered by Shavers in the motions leading up to the judgment was that bitcoin is not a real currency or money recognized by the U.S. government. Because securities fraud law requires an ‘investment of money’ to form an investment contract, Shavers argued that because the SEC could not show this investment, the statutes did not apply to Bitcoin and the SEC’s prosecution must be dismissed.”).

18 Daniela Dekhtyar – Seminar Paper accordingly, Bitcoin is a form of money.77 Since this ruling, the SEC has identified and brought multiple actions against perpetrators of Bitcoin ponzi schemes, leading the agency to issue an investor alert entitled “Ponzi Schemes Using Virtual Currencies,” in May 2015.78

4. CFTC

The CFTC has ruled that bitcoins are commodities and are therefore subject to the

CFTC’s jurisdiction.79 The CFTC’s ruling is not without its ambiguities. It remains unclear whether the CFTC’s oversight is specific to exchanges where bitcoin derivatives are traded, or if the agency’s oversight could reach more broadly to exchanges where bitcoins, and not just bitcoins derivatives are traded.80 At least one CFTC commissioner has suggested that the

CFTC’s oversight would be restricted to exchanges that involved trading of bitcoin derivatives, only.81

III.C. Potential Role for the State AG

The authority of the state AG is quite broad. It is bounded by the general concept of parens patriae, which literally means “parent of the country,” and in practice means that a state

77 Id. 78 Office of Investor Education and Advocacy, SEC, Ponzi Schemes Using Virtual Currency (2015), https://www.sec.gov/investor/alerts/ia_virtualcurrencies.pdf. 79 See Jared Paul Marx, Bitcoin as a Commodity: What the CFTC’s Ruling Means, CoinDesk (Sept. 21, 2015), http://www.coindesk.com/bitcoin-as-a-commodity-what-the-cftcs-ruling- means/ (“Last Thursday the United States Commodities Futures Trading Commission (CFTC) settled charges against a small and now-defunct operation in San Francisco called Coinflip, which marketed bitcoin derivatives. In the process, the CFTC asserted for the first time that bitcoin is a ‘commodity.;”). 80 See id. (“More broadly, the classification now means it is more likely the CFTC could, under its market manipulation authority, police fraudulent activities on exchanges where bitcoins – and not just bitcoin derviatves – are traded. However, the CFTC has suggested it is not particularly interested in going down that path. . . .”). 81 See Pete Rizzo, CFTC Commissioner: Market Manipulation Could Shape Bitcoin’s Future, CoinDesk (Jan 8, 2015), http://www.coindesk.com/cftc-commissioner-mark-wetjen-bitcoin/ (“The CFTC, [Commissioner Wetjen} said, does not have extensive oversight over bitcoin exchanges that do not offer derivatives contracts.”).

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AG has the authority to sue on behalf of both the state and its citizens to not only enforce the state’s laws, but also to ensure the health, safety, and welfare of the state’s citizens.82 In simpler terms, the state AG is the people’s lawyer. To ascertain the state AGs’ role in the oversight of

Bitcoin, it is worthwhile to consider who is most vulnerable to Bitcoin’s risks; who would the state AG’s client be? This section takes the previously described risks of Bitcoin in turn and discusses how a state AG might act to mitigate each risk.

1. Addressing Bitcoin’s Security Risks

As discussed in section II.B, once a bitcoin is removed from a user’s wallet, it is gone for good. While Bitcoin itself may involve fairly sophisticated cryptography, third-party wallet services and exchanges that manage large numbers of currency conversions are based on their own proprietary programming. Unbeknownst to individual consumers, they may be vulnerable to significant monetary loss if they have chosen to purchase or store bitcoins via a service that has been negligently programmed.

The most natural means for state AGs to mitigate this risk would be via consumer education programs. States have historically been the primary safeguard of consumers,83 and education insofar as it is an ex-ante method of oversight can be particularly cost-effective. At least one state AG has taken this approach: Michigan Attorney General Bill Schuette’s office

82 See Richard P. Ieyoub and Theodore Eisenberg, State Attorney General Actions, The Tobacco Litigation, and the Doctrine of Parens Patriae, 74 Tul. L. Rev. 1859, 1863 (2000) (“Parens patriae literally means parent of the country’ . . . . American courts uniformly recognize a state authority to sue, as parens patriae, to vindicate the state’s and its citizens’ interests.”). 83 See Jason Lynch, Federalism, Separation of Powers, and the Role of State Attorneys General in Multistate Litigation, 101 Colum. L. Rev. 1998, 2005 (2001) (explaining state AGs stepped up in Reagan and Carter years to fill void of federal consumer protection enforcement).

20 Daniela Dekhtyar – Seminar Paper released a broad consumer alert entitled “Virtual Currency Has Real Life Risk” in July 2014.84

Of the risks addressed by the alert, the first pertained to Bitcoin’s security risk, stating “[f]ailing to keep your virtual ‘wallet’ secure can result in losing all of your virtual currency.”85 Other

AGs would do well to follow in Schuette’s footsteps, as issuing an advisory notice is a way of doing something to protect state citizens without expending a significant amount of precious resources.

If AGs are to take this approach, an additional consideration they might want to keep in mind is broadening the intended audience of their educational alert. Rather than just addressing the individual consumer, AGs may also want to address small business owners, specifically. As previously discussed, accepting bitcoins has particular appeal to small business owners who want to avoid higher transaction fees and payment uncertainties resulting from disputed transactions.86

A merchant that accepts bitcoin and uses a third-party wallet service to store its bitcoins or an exchange to convert its bitcoins to real currency is just as susceptible to the aforementioned security risks as individual consumers.

The general consensus among legal experts is that as long as Bitcoin remains unregulated, there are no consumer protections in place for individuals that incur loss.87 State

84 Bill Schuette, Attorney General, Virtual Currency Has Real Life Risk, http://www.michigan.gov/ag/0,4534,7-164-17337_20942-332337--,00.html (last visited Dec. 30, 2015). 85 Id. 86 See notes 47--48 and accompanying text. 87 See id. (“At this time, there are no regulations in place to protect consumers harmed. . . .”); National Associates of Attorneys General, Bitcoin and its Implications for Consumer Protection (June 24, 2014), http://www.naag.org/publications/naagazette/volume-8-number-6/an- explanation-of-bitcoin-and-its-implications-for-consumer-protection.php (discussing legal recourse for Mt. Gox bitcoin loss and stating, “[t]he only legal redress available for consumers were those remedies that exist to anyone who entrusts their property to an institution that fails to keep it protected such as negligence, breach of contract or fraud”).

21 Daniela Dekhtyar – Seminar Paper agencies are slowly beginning to regulate Bitcoin-regulated ventures. To date, 24 states have begun to require money transmitter licenses for bitcoin companies.88 As with FinCEN’s MSB requirements, these state licensing requirements involve recordkeeping and reporting obligations, in addition to mere registration obligations.89

Furthermore, in June 2015, the New York State Department of Financial Services

(NYDFS) passed a regulatory regime specifically designed for virtual currencies, including bitcoin.90 The regime includes a section on consumer protection that requires businesses engaged in “virtual currency business activity”91 to adequately disclose all material risks associated with using bitcoins and to take reasonable steps to detect and prevent fraud.92 Under a regime such as this, exchanges like Mt. Gox that are negligent in establishing adequate security protections against fraud could be sued by state AGs for violations of state law. Though New York is the only state thus far to pass specific regulations for virtual currencies, other states including New

88 See PYMNTS.com, Bitcoin Regulation Roundup, Regulator Divide and “Life on Bitcoin,” (May 29, 2015), http://www.pymnts.com/in-depth/2015/bitcoin-regulation-roundup-regulator- divide-and-life-on-bitcoin/ (listing states and U.S. territories that require money transmitter licenses). 89 See Thomson Reuters, Financial Services Money Service Businesses Registration (Regulations), WL 0090 REGSURVEYS 13 (2015) (summarizing 50 states’ MSB registration requirements): Thomson Reuters, Financial Services Money Service Businesses Record Keeping (Regulations), WL 0090 REGSURVEYS 12 (2015) (summarizing 50 states’ MSB record- keeping requirements). 90 See Stan Higgins, NY Bitcoin Businesses Now Have 45 Days to Apply for BitLicense, CoinDesk (June 24, 2015), http://www.coindesk.com/ny-bitcoin-business-45-days-bitlicense/ (stating NYDFS officially adopted BitLicense, making New York “first U.S. state to formally launch a custom-made regulatory approach to bitcoin and digital currencies.”). For a copy of the entire regulation, see http://www.dfs.ny.gov/legal/regulations/adoptions/dfsp200t.pdf. 91 See N.Y. Fin. Serv. Law §200.2 (McKinney 2015) (defining “virtual currency business activity” as conduct falling within five categories including “storing, holding, or maintaining custody or control of virtual currency on behalf of others,” “buying and selling virtual currency as a customer business,” “performing exchange services as a customer business,” and “controlling, administering, or issuing a virtual currency”). 92 N.Y. Fin. Serv. Law §200.19 (McKinney 2015)

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Jersey, North Carolina, and California have expressed intentions of doing the same.93 It is also worth noting that any negligent bitcoin-related venture is likely to impact citizens of multiple states, as bitcoin is an inherently jurisdiction-less enterprise. If other states follow New York, violations of these laws would be yet another area of consumer protection that is conducive to multi-state litigation. This would enable state AGs to pursue Bitcoin-related cases with the added benefit of combined resources.

Another way state AGs may be able to mitigate the security risk of Bitcoin is by applying existing products liability statutes to poorly programmed third-party wallet services and exchanges. Such statutes may have been designed to address the negligent manufacture of tangible products, but products liability lawsuits have reached less tangible items such as gas, pets, real estate, and writings such as navigational charts.94 No state AG has yet to apply products liability statutes to Bitcoin operations, but there does appear to be a conceptual fit – a product whose sole purpose is to store a virtual currency securely or exchange it for real money is inherently defective if it cannot prevent outsiders from accessing that currency. While this approach may be far from a slam-dunk, it could be a viable option for AGs who do not want to wait for their state legislatures to pass legislation specifically designed for virtual currencies.

2. Addressing Bitcoin’s Susceptibility to Criminal Use

93 See PYMNTS.com, Bitcoin Regulaiton Roundup, Regulator Divide and “Life on Bitcoin,” (May 29, 2015), http://www.pymnts.com/in-depth/2015/bitcoin-regulation-roundup-regulator- divide-and-life-on-bitcoin/ (describing New Jersey, North Carolina, and California as exploring legislative means to protect consumers). 94 See Legal Information Institute, Cornell University Law School, Products Liability, https://www.law.cornell.edu/wex/products_liability (last visited Dec. 31, 2015) (“While products are generally thought of as tangible personal property, products liability has stretched that definition. . . .”).

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When it comes to the use of virtual currencies for illicit activity, the potential victim is society at large. Black marketplaces have not only been used to launder funds gained illegally in the real world, but also to facilitate further illicit activity. The criminal prosecution of Bitcoin users who use the system for illicit activities is well-established.95 Thus far though, prosecutions have largely been at the federal level, as money laundering is a classic federal crime prohibited by the BSA. Nevertheless, some states have their own anti-money laundering statutes, too.96

State AGs with criminal jurisdiction may want to allocate resources to the investigations of black marketplaces, particularly those that foster rather serious crimes like the sale of dangerous weapons and human trafficking.97

3. Addressing Bitcoin’s Price Volatility

Similar to addressing Bitcoin’s security risk, the people most vulnerable to Bitcoin’s price volatility are unwitting consumers who choose to exchange real money for bitcoin to use as currency or as a standard investment and small business owners who seek a cheaper means of accepting payments. Accordingly, the most obvious response to this risk for state AGs would also be to engage in consumer education. AG Schuette included this risk in his consumer alert,

95 See Daniel Roberts, Bitcoin’s First Criminal Goes to Prison Today, Fortune (Dec. 15. 2015), http://fortune.com/2015/03/30/bitcoins-criminal-prison-shrem/ (describing sentencing of as first of many). 96 Thomson Reuters, Anti-Money Laundering Statutes, WL 0090 SURVEYS 16 (Oct. 2014) (listing each state’s money laundering statutes and associated penalties or lack thereof). 97 Until recently, the Agora marketplace – a much larger successor to Silk Road – permitted the sale of dangerous weapons. See Richard, Sale of Lethal Weapons Are No Longer Allowed on Agora Market, Agora Drugs (July 10, 2015), http://www.agoradrugs.com/sale-of-lethal- weapons-are-no-longer-allowed-on-agora-market/ (“The Agora Market admin recently posted a message on their onion site, announcing that from July 15th, 2015 they won’t be dealing in lethal weapons anymore.”). State prosecutions related to Bitcoin are not unheard of. See Susannah Nesmith, Miami Bitcoin Arrests May Be First State Prosecution, Bloomberg (Feb. 10, 2014), http://www.bloomberg.com/news/articles/2014-02-09/miami-bitcoin-arrests-may-be-first-state- prosecution (describing state law charges related to use of Bitcoin as part of money laundering scheme).

24 Daniela Dekhtyar – Seminar Paper stating “[g]iven the nature of virtual currency, value fluctuations can happen quickly and without warning,” and “[b]ecause it is not a real currency, virtual currency should be treated like an investment.”98 Here, too, the program should be addressed to both individual consumers and small business owners, whose pricing of goods is greatly impacted by fluctuations in Bitcoin’s value. Both the SEC and the Consumer Financial Protection Bureau (CFPB) have issued advisories, warning consumers of the risks involved with investing in bitcoin.99 There is room for state AGs to partner with these federal agencies to ensure consistent information is being released and that a wider audience is reached.

Insofar as consumers are already treating bitcoins as an investment, they should be aware of the prevalence of Bitcoin ponzi schemes. In addition to including this information in consumer advisories, state AGs may also be able to sue operators of Bitcoin ponzi schemes based on violations of state blue-sky laws (assuming Bitcoin meets the definition of a security provided in the blue-sky laws). State AG offices with committed investment protection bureaus would be particularly well equipped to incorporate investigations of Bitcoin ponzi schemes into their existing caseloads.

IV. Conclusion

Some have argued that because of Bitcoin’s global nature, oversight should be left to national and international bodies in order to avoid a pathwork system of regulation; but such a position ignores the vast assortment of tools that smaller authorities like state AGs have at their

98 Bill Schuette, Attorney General, Virtual Currency Has Real Life Risk, http://www.michigan.gov/ag/0,4534,7-164-17337_20942-332337--,00.html (last visited Dec. 30, 2015). 99 For SEC alert, see supra note 78 and accompanying text. For the CFPB advisory, see CFPB, Risks to Consumers Posed by Virtual Currencies (Aug. 2014), http://files.consumerfinance.gov/f/201408_cfpb_consumer-advisory_virtual-currencies.pdf.

25 Daniela Dekhtyar – Seminar Paper disposal. With such a broad mandate to protect the safety, health, and welfare of its citizens, state AGs are uniquely situated to respond to the advent of this new technology in a multitude of ways. There is not just one role for state AGs in the oversight of Bitcoin; there are many.

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