Tag: Virtual Currency

Can I Secure a Loan with Bitcoin? Part I

Each day seems to bring another story about Bitcoin, Ethereum, Litecoin, or another virtual currency. If virtual currencies continue to grow in popularity, it’s only a matter of time before borrowers offer to pledge virtual currency as collateral for loans.  This article does not advise lenders on whether they should secure loans with virtual currency, but instead it focuses on whether a lender can use the familiar tools of Article 9 of the Uniform Commercial Code (“UCC”) to create and perfect a security interest in bitcoin.  (In this article, “bitcoin” is used as a generic term for all virtual currencies.)

Article 9 Basics

Article 9 allows a creditor to create a security interest in personal property. The owner of the property grants the creditor a security interest through a written security agreement. The security agreement creates the security interest between the secured party and the debtor. The secured party must then “perfect” the security interest to obtain lien priority over third parties and to protect its secured status should the debtor file bankruptcy.

Security interests are perfected in different ways depending on the type of collateral. Article 9 divides personal property into different categories, such as goods, equipment, inventory, accounts, money, and intangibles. The primary ways to perfect a security interest are (1) filing, with the appropriate filing agency, a UCC-1 financing statement containing a sufficient description of the collateral, (2) possession, or (3) control.

Bitcoin and Blockchain

Virtual currencies are electronic representations of value that may not have an equivalent value in a real government-backed currency. They can be used as a payment system, or digital currency, without an intermediary like a bank or credit card company. While virtual currencies can function like real currencies in certain transactions, and certain virtual currencies can be exchanged into real currencies, a virtual currency itself does not have legal tender status. Virtual currency is virtual—there is no bitcoin equivalent to a quarter or dollar bill.

Bitcoin operates on a protocol that uses distributed-ledger technology. This technology is called the blockchain. The blockchain eliminates the need for intermediaries such as banks. Unlike a dollar, which is interchangeable, each bitcoin is unique. The blockchain records all bitcoin transactions to prevent someone from re-spending the same bitcoin over and over.

Suppose you wanted to transfer cash to a friend. You could transfer funds from your bank account to her bank account. The banks act as intermediaries. Suppose you wanted to transfer cash to that same friend without a middle man. The only way to do that is meet her and hand over the cash. This exchange many not be practical for many reasons. You might live far from each other. Even if you’re near each other, you might not want to travel around town with a briefcase full of cash. Bitcoin and blockchain technology allow the transfer of cash directly and digitally without a middle man.

The blockchain is both transparent and opaque. It is transparent as to the ownership chain of every bitcoin.  In this way, it is easier to “trace” a bitcoin than to trace cash.  But the blockchain presently does not show liens on bitcoin.  So a secured party can confirm if a borrower owns bitcoin, but not if the borrower or a previous owner encumbered the bitcoin.

Is Bitcoin Money?

At first glance, bitcoin would seem to fall in the category of “money.” Article 9 defines money as a medium of exchange authorized or adopted by a domestic or foreign government. No government has adopted bitcoin as a medium of exchange. Dollars, euros, and pounds meet the definition of money—bitcoin does not. Therefore, bitcoin does not meet the definition of money. And a secured party perfects its security interest in money by physical possession, but because bitcoin is virtual, physical possession is impossible.

Is Bitcoin a Deposit Account?

A deposit account is a demand, time, savings, passbook, or similar account maintained with a bank. With a traditional deposit account, the secured party perfects its security interest by having “control” over that account. This is usually accomplished when the debtor, the debtor’s bank, and the secured party execute a deposit account control agreement. If the debtor defaults, the secured party can direct the debtor’s bank to transfer the funds from the account.

Bitcoin often is stored in a digital wallet with an exchange like Coinbase. The wallet is access-restricted by private keys or passwords, but that wallet is not a deposit account. The bitcoin itself is held by its owner on the blockchain, which is decentralized. Unlike a deposit account, there is no intermediary like a bank. With no intermediary, there is no way to establish “control” over the bitcoin. Consequently, bitcoin does not meet the definition of a deposit account.

Bitcoin is (Probably) a General Intangible

By process of elimination, bitcoin should be treated as a general intangible. A general intangible is personal property that does not fall into any other Article 9 category. A lender perfects a security interest in general intangibles by filing a UCC-1 financing statement. In North Carolina, you file it with the Secretary of State.

Although we can categorize bitcoin as a general intangible for Article 9 purposes, and create and perfect a security interest accordingly, several issues arise that question the overall effectiveness of that security interest. For starters, a security interest in general intangibles follows the sale, license, or other disposition of the collateral, unless the secured party consents to the transfer free of its security interest, the obligations secured by the security interest have been satisfied, or the security interest has otherwise terminated.

This is a problem for the lender wanting a first-priority lien on the bitcoin. Before approaching the lender, the borrower may have granted a secured party a security interest in bitcoin, or granted a security interest in “all assets whether now owned or acquired later” and then acquired bitcoin. In both instances, the bitcoin is encumbered by the security interest. The lender could not confirm prior liens without searching UCC-1 filings in all 50 states (and even that might not catch international liens).

Even if a secured party acquires a senior lien in bitcoin, that party still has the problem of lack of control over the bitcoin. Without control, bitcoin collateral is susceptible to unauthorized transfers. Even if a borrower has an account at an online currency exchange like Coinbase—which allows you to exchange bitcoin into traditional money—the exchange may be unwilling to sign a tri-party control agreement to restrict the debtor’s ability to exchange the bitcoin. Upon default, without the debtor’s cooperation, it will be difficult or impossible to enforce, take possession, and liquidate the bitcoin.

Conclusion

Putting aside its value and volatility, the intrinsically unique nature of bitcoin makes it an imperfect and problematic form of collateral under Article 9. Part II of this article will discuss the pros and cons of using Article 8 of the UCC to create and perfect a security interest in bitcoin. Article 8 has the potential to be a safer and more reliable solution for these transactions.

© 2018 Ward and Smith, P.A.. All Rights Reserved.

This post was written by Lance P. Martin of Ward and Smith, P.A.

               

Tax Treatment of Bitcoin Has Many Open Questions

bitcoinIt has been over two years since the IRS came out with its initial position on the tax treatment of Bitcoin and other virtual currencies, but there has yet to be any follow-up on questions that this initial position has raised. The American Institute of Certified Public Accountants has written a letter to the IRS urging the Service to publish additional guidance to provide more certainty on these open issues.

IRS Notice 2014-21 stated that virtual currencies are to be treated as property, not as currency. This was potentially good news to Bitcoin investors, since it would allow them to pay the lower long-term capital gains tax rate on profits if they held the Bitcoin for over a year. On the other hand, this position was  inconvenient for consumers and merchants who use and accept virtual currencies as a means of exchange, because each transaction, no matter how small, must be reported in order to determine the amount of gain  or loss every time a consumer uses the virtual currency as a means of exchange, and every time the merchant converts the virtual currency received in a transaction into U.S. currency.

In the two years since the IRS published Notice 2014-21, this classification of virtual currencies as property rather than a currency, many other questions have been raised, but have not been addressed. The letter from the AICPA sets them out:

(1) Determining Fair Market Value of the Virtual Currency: The IRS should publish guidance on whether a taxpayer can use any published exchange rate to determine the fair market value of virtual currencies, and whether the taxpayer must use the same published exchange rate for all other transactions. The letter notes that there are  wide variance in the fair market value of Bitcoin on four Bitcoin published rates (Google, Bitcoin exchange rate, Bitstamp, CEX and Winkdex), citing an example selected at the same time, reflecting a range of value from a low of $227.84 to a high of $231.14.

(2) Expenses of Obtaining Virtual Currencies: Are the expenses to mine virtual currencies currently deductible, or are they to be added to the basis of the mined currency? This would normally be an easy call – costs would normally be added to the basis of the property that is manufactured – but the 2014 guidance intimates that this might not be the case.

(3) Tracking Basis of Virtual Currency: Because virtual currencies are treated as property, the taxpayer must track the cost of purchasing each unit acquired, in order to determine the taxable gain when it is sold (including every time a consumer uses it to purchase goods and services).  The AICPA letter says that tracking the basis for virtual currency is virtually impossible when it is used in everyday commerce, and asked for the IRS to consider alternative means to determine basis.

(4) General Transaction Rules Applicable to Property: The AICPA letter asks whether the general tax rules applicable to property (rather than currencies) would apply to virtual currencies. For example, the letter asks whether a taxpayer would be able to take advantage of the tax free like-kind exchange rules of section 1031 if one type of virtual currency is exchanged for a different type of virtual currency (for example, a Bitcoin for Ethereum exchange).

(5) Character of Virtual Currencies Held By Merchants: How should virtual currencies that are accepted by a merchant be classified for tax purposes – as a capital asset or as an ordinary income asset?

(6) Charitable Contributions: Does a contribution of virtual currencies to a charitable organization require a formal appraisal? The general rule is that if a taxpayer donates property worth more than $5,000 to a charitable organization, the taxpayer must obtain a formal appraisal to support the amount to be deducted as a charitable contribution. There is an exception, where an appraisal is not needed for the donation of securities that are traded on a published exchange. The letter asks whether the donation of virtual currency should be subject to the same exception, since they are traded on published exchanges.

(7) Is Virtual Currency a Commodity: If virtual currencies are treated as a commodity, would it be subject to the mark-to-market rules for commodity traders?

(8) How About a De Minimus Exception For Small Transactions: The letter asks the IRS for an exception to the rule requiring a taxpayer to report each virtual currency transaction as a taxable sale of property when used to make small consumer purchases.

(9) Retirement Accounts: Can virtual currencies be held as an investment in a qualified retirement plan (like a 401(k) plan)? The rules for eligible investments in such plans limit the types of property than can be held in a qualified retirement plan.

(10) Foreign Reporting Requirements: Are virtual currencies subject to Foreign Bank Account Reports (FBAR) and/or Foreign Bank Account Tax Compliance Act (FATCA) reporting?

As these issues get worked out, others are likely to arise. Until they are addressed by the IRS, the uncertainty will likely inhibit the growth of virtual currencies in the U.S. economy.

To see a copy of the AICPA letter to the IRS, please click here.

ARTICLE BY Marvin A. Kirsner of Greenberg Traurig, LLP

©2016 Greenberg Traurig, LLP. All rights reserved.

Department of Justice Settles Virtual Currency Enforcement Action

The US Attorney’s Office in the Northern District of California recently settled an enforcement action against Ripple Labs Inc., a Delaware corporation providing virtual currency exchange services. According to the settlement agreement, Ripple Labs was not registered with the Financial Crimes Enforcement Network (FinCEN) as a money services business (MSB) pursuant to the Bank Secrecy Act of 1970 while engaged in currency trading, and lacked required anti-money laundering controls.

Ripple Labs is a virtual currency exchange service dealing in XRP, the second-largest cryptocurrency by market capitalization after Bitcoin. Between at least March and April 2013, Ripple Labs sold XRP in its exchange. During the time of the sales, Ripple Labs was not registered with FinCEN. In March 2013, FinCEN’s released guidance clarifying the applicability of registration requirements to certain participants in the virtual currency arena. Ripple Labs also lacked an adequate anti-money laundering program, and did not have a compliance officer to assure compliance with the Bank Secrecy Act.

The settlement agreement reached by Ripple Labs and the US Department of Justice (DOJ) called for a $450,000 forfeiture to the DOJ, as well as a civil money penalty of $700,000 to FinCEN. Ripple Labs agreed to cooperate with any DOJ or regulatory request for information. In addition, Ripple Labs agreed to operate its XRP exchange as an MSB registered with FinCEN and to maintain all necessary registrations. Ripple Labs also agreed to implement and maintain an effective anti-money laundering program, complete with a compliance officer and training program. Finally, Ripple Labs agreed to conduct a review of prior transactions for evidence of illegal activity, as well as monitor transactions in the future to avoid potential money laundering or illegal transfer activity.

U.S. Department of Justice Settlement Agreement (May 5, 2015)

ARTICLE BY

Michael M. Rosensaft & Zachary D. Denver of Katten Muchin Rosenman LLP
©2015 Katten Muchin Rosenman LLP

Currency Conversion Concerns: New York Issues Guidance on Virtual Currencies

Mcdermott Will Emery Law Firm

On December 5, 2014, the New York Department of Taxation and Finance (Department) released TSB-M-14(5)C, (7)I, (17)S.  This (relatively short) bulletin sets forth the treatment of convertible virtual currency for sales, corporation and personal income tax purposes.  The bulletin follows on a notice released by the Internal Revenue Service (IRS) in March of this year, Notice 2014-21.

The IRS Notice indicates that, for federal tax purposes, the IRS will treat virtual currency as property, and will not treat it as currency for purposes of foreign currency gains or losses.  Taxpayers must convert virtual currency into U.S. dollars when determining whether there has been a gain or loss on transactions involving the currency.  When receiving virtual currency as payment, either for goods and services or as compensation, the virtual currency is converted into U.S. dollars (based on the fair market value of the virtual currency at the time of receipt) to determine the value of the payment.

The IRS Notice only relates to “convertible virtual currency.”  Virtual currency is defined as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”  Convertible virtual currency is virtual currency that “has an equivalent value in real currency, or that acts as a substitute for real currency.”

The Department’s bulletin also addresses only convertible virtual currency, and uses a definition identical to the IRS definition.  The Department indicates that it will follow the federal treatment of virtual currency for purposes of the corporation tax and personal income tax.

For sales and use tax purposes, the bulletin states that convertible virtual currency is intangible property and therefore not subject to tax.  Thus, the transfer of virtual currency itself is not subject to tax.  However, the exchange of virtual currency for products and services will be treated as a barter transaction, and the amount of tax due is calculated based on the fair market value of the virtual currency at the time of the exchange.

The Department should be applauded for issuing guidance on virtual currency.  It appears that these types of currencies will be used more and more in the future, and may present difficult tax issues.

However, the Department’s guidance is incomplete.  There are a couple of unanswered questions that taxpayers will still need to ponder.

First, the definition of convertible virtual currency is somewhat broad and unclear.  The Department and the IRS define “convertible” virtual currency as currency that has an “equivalent” value in real currency, but equivalent is not defined in either the IRS Notice or the bulletin.  Many digital products and services use virtual currency or points that cannot be legally exchanged for currency to reward users, and the IRS and the Department should be clearer about the tax treatment of those currencies.

Second, although the Department will follow the federal treatment for characterization and income recognition purposes, the bulletin does not discuss apportionment.  This is likely a very small issue at this point in time, but the Department will, some day, need to address how receipts from gains in the exchange of virtual convertible currencies are apportioned.

Virtual currencies will create issues not only in the tax world, but also in the unclaimed property world.  The Uniform Law Commission has begun its efforts to rewrite the Uniform Unclaimed Property Act, and the treatment of virtual currency will be an issue discussed during the rewrite.  Companies that use virtual currencies, convertible or not, should follow the rewriting process to make sure the drafters are informed of all of the issues these companies will face.

ARTICLE BY

Mark Yopp
OF
McDermott Will & Emery