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Corporate Counsel Connect collection

January 2014 Edition

The rising popularity of digital currency and its impact on your organization

Craig J. Blakeley and Jeffrey H. Matsuura, Alliance Law Group LLC

Craig J. Blakeley and Jeffrey H. MatsuuraA rapidly growing number of businesses and other organizations now accept payments made in digital currency. A recently announced example of this trend was the notice issued by the University of Nicosia, in Cyprus, indicating that it had become the first university in the world to accept payments for tuition and fees in digital currency. Recognizing the increasingly widespread use of digital currency, the United States Senate recently held hearings to explore the public policy implications of widespread digital currency use. Those hearings demonstrated that digital currencies will play a significant role in future commerce and that they raise important regulatory and policy issues that have not yet been fully resolved. Given this increasing popularity, it is likely that, in the near future, your organization will consider some form of digital currency use. Accordingly, it is important to recognize the legal implications for your organization that are associated with use of digital currency and other forms of virtual exchange of economic value.

What is digital currency?

Digital currency is an electronic platform that enables the virtual exchange of economic value. It provides an electronic system that processes payments without the use of traditional payment mechanisms such as tangible cash, credit cards or debit cards. Perhaps the most widely recognized form of digital currency is the "Bitcoin" system which is now widely used for a range of products and services around the world.

Digital currency can be used to purchase goods and services in the tangible world. This makes it different from electronic value systems such as virtual money or digital tokens which are limited to purchases of goods and services within online communities.

Although digital currency can function like traditional currency, it is not guaranteed by any governments. As a result, digital currencies do not bring with them the backing and support of any government and this is a critical difference relative to traditional currencies. Digital currencies can, however, be converted into traditional cash.

It is important to recognize that the designation, digital currency, can be somewhat misleading. Digital currency platforms can provide the electronic equivalent of cash, but they can also provide the electronic equivalents of other traditional economic value exchange systems including commodities and securities. Depending on how a digital currency system is structured and operated, the digital currencies involved can function as cash, a commodity or as a security (or other form of financial instrument).

Currently, the more popular digital currency platforms, such as Bitcoin and Litecoin, make use of systems that are secured through use of encryption. These more popular platforms are also de-centralized, avoiding use of a single hub and thus reducing the risk of total system security compromise or operational failure.

Why is digital currency popular?

Digital currency is popular largely because it presents several important advantages. As there is no physical manifestation of the currency, digital currency is often seen to be more secure than traditional cash. With digital currency, there are no tangible coins or bills that can be stolen or lost. Users of digital currency will not be the victims of robberies.

In many contexts, digital currency can be more convenient to use than traditional cash. Digital currency can be readily accessed through most mobile devices. When using digital currency, there is no need to carry or exchange any tangible coins or bills. Recently, digital currencies became accessible through a limited number of automated teller machines (ATMs).

Digital currencies also have the advantage of being readily used internationally. In effect, the most popular digital currencies constitute transborder payment platforms. There is no need to exchange digital currencies into different national currencies when payments cross national borders.

Digital currency systems also have the capability, when appropriately managed, to provide for payments that are less readily traceable than those processed through traditional electronic payment vehicles such as credit cards. Thus digital currency, like its traditional cash counterpart, can enable anonymous payments.

What challenges are associated with digital currency use?

Digital currency does not provide a perfect payment mechanism. It carries important challenges. For example, although digital currencies do not have the problem of physical loss or theft, they are subject to the electronic versions of those risks. Digital currency systems may be immune from traditional robberies, but they can fall prey to electronic theft and attack. It is increasingly common for digital currency platforms to be the target of malicious software used for theft or to compromise the security of computers that access the currency platforms.

Digital currency platforms can also be used to support fraudulent and other illegal transactions. Currently, many observers are concerned that digital currency is becoming the global payment vehicle of choice for transactions involving illegal goods and services. There are also multiple instances in which digital currency systems are used to facilitate fraudulent activities. Digital currencies are also increasingly viewed as a convenient global system to support money-laundering, the conversion of funds obtained through illegal activities into "clean" money.

Another important challenge to be recognized is the fact that digital currencies do not carry the same level of government backing and support as traditional currencies. As digital currencies are not guaranteed by governments, users of the currencies accept greater risk of loss of value than they do when using traditional, government-backed currencies.

What are the key legal issues associated with digital currency use?

Users of digital currency face several significant legal compliance issues. There are important legal compliance issues associated with the actual use of digital currency. As noted previously, digital currency platforms can be used as cash payment systems, commodities for investment purposes, and markets for investment of securities equivalents. Depending on the ways in which an individual or organization uses digital currencies, it may face multiple legal compliance requirements. When digital currency is used as a form of cash, currency regulations must be met. When it is used as a commodity or a security, the rules associated with trading of those financial products must be satisfied. Thus, use of digital currencies carries significant and often complex financial regulatory compliance obligations.

Digital currency use also brings important security issues. Organizations using digital currency must ensure that their systems and transactions are effectively secured and that the terms and conditions associated with digital currency use are comprehensive, adequately documented, and enforceable.

Closing thoughts

Legal counsel can provide critical input as each organization considers whether and how to use digital currencies in its operations. Lawyers play a vital role assisting their organizations to understand the legal compliance issues associated with use of digital currencies. Counsel must assist organizations to manage regulatory compliance associated with digital currency in multiple jurisdictions. Attorneys should also help their organizations to understand the legal implications, including the risks of loss and liability, associated with digital currencies. Finally, lawyers can assist their organizations to make appropriate choices among the different available digital currency platforms. Issues such as security, operational stability, risk, and regulatory compliance are critical during the development of digital currency strategies and systems. Legal counsel should play an active role in the digital currency planning and development process.