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Friday, September 18, 2015

Bitcoin Is A Commodity? How Digital Currency Will Be Treated

The question of how to define Bitcoin has troubled its inventors, developers and certainly regulators and lawyers. Here's the latest conclusion. Don't be surprised, but regulators who regulate commodities have opined that Bitcoin and other "digital currencies" are, in fact, commodities.

What a surprise!

Here is an interesting administrative ruling from the Commodity Futures Trading Commission just issued Thursday, September 17th.  An online exchange of Bitcoin options contracts is now subject to registration and regulation as a swap execution facility and designated contract market under the Commodity Exchange Act.

Buried in a footnote of the CFTC ruling is a definition of bitcoin as a "digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value." 

In regular font, the CFTC ruled that bitcoin was a commodity, relying on the expansive definition of the term in a 7th Circuit Court of Appeals case "all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in." As such, the ruling means, at least for the moment, that bitcoin exchanges are subject to registration requirements of and regulation as commodity swap exchanges.

However, unlike some industry observers and legal experts, I believe that Bitcoin may also be defined by regulators as a security, and that Bitcoin may simultaneously be considered a security and commodity. The basis for this opinion is the likewise broad definition of "security" derived from the four-part test from the seminal security-definition case from the United States Supreme Court, United States v. W.J. Howey. The so-called Howey test found that "investment contracts" were any "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."

In this commenter's view, one regulator's treatment of Bitcoin as a commodity does not mean, and surely does not preclude, any other regulator (or court) from determining that Bitcoin is also a security. The definition of commodity is broad, but so is the definition of security. So Bitcoin can be both a commodity and a security -- the terms are not mutually exclusive.

Among the first official attempts to define the nature of digital currency was the first introduced congressional bill on Bitcoin (H.R. 5777, 113th Cong., 2d. session, introduced by now-former Rep. Steve Stockman (R-TX) (and drafted entirely by yours truly!) sought to achieve "cryptocurrency protocol protection" from unfavorable and unfair tax treatment by having "virtual currency" be treated for tax purposes as currency, instead of property. The bill held that Bitcoin and other altcoins could be illiquid and hard to value, factors making its treatment as property as proposed by the IRS in its 2014 guidance (referenced in the congressional bill, and which helped prompt the bill's conception) unfair because its "basis" for calculating taxable value could end up increasing taxable value well over Bitcoin's real value which arguably should be discounted on account of both volatility and illiquidity. 

More to come on this issue....

Eric Dixon is a New York lawyer who works extensively with blockchain and cryptocurrency innovators and startups.

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