Bitcoin and other crypto-currencies (secret currencies) are getting a lot of airtime and being considered with seriousness, for example at HM Treasury, for inclusion in or coalescence with the traditional payments eco-system.
At this stage there are more questions than answers, and this should be concerning for the market participants, regulators and supervisors on the traditional side. Financial Action Taskforce – in its June 2014 paper on definitions and AML risks – and the European Banking Authority – in its July 2014 ‘Opinion on virtual currencies’ – have made their positions clear: crypto-currencies have no validity and are a channel for money laundering, illicit financing, and tax evasion.
On the other hand we have the FinTech market bubbling, with all manner of incubators and venture funds trying to get a piece of the action on two distinct sides of the fence, in the EU at any rate:
- Start-ups that will register as Payment Institutions, or eMoney Institutions, or even as ‘Challenger’ banks if they are large and diverse enough
- Bitcoin and crypto-currency companies that appear to be intent on steering around the regulatory regime
Crypto-currency cannot be ‘money’ in the accepted sense. It is not a fiat currency issued by a national government and backed by the full faith and credit of its taxpayers. It cannot be legal tender as the designation thereof is another power reserved to national governments or associations of national governments (in the case of the euro).
It is ‘mined’ (i.e. manufactured) via computer algorithms and the difficulty of mining is supposed to limit supply, and where there is limited supply and significant demand, the price should go up. FATF and EBA have a very clear picture of where the demand is coming from.
The US Department of Justice has designated it as ‘goods’: if that treatment is replicated in the UK and the rest of the EU, then all exchanges involving bitcoins are sales by the giver, and subject to the VAT regime, including – for businesses - adding VAT to a bitcoin payment you are making, if you are VAT-registered. Since bitcoin is secret, do you even know who you are trading with, what VAT should be added, what you should put in your EU Sales List?
As regards accounting, should payments made with bitcoin be added to ‘Cost of Goods Sold’, and payments received added to ‘Sales’? In other words payments for sales and costs are themselves costs and sales i.e. a payment with bitcoin is a barter.
What about the valuation of bitcoin owned if it rises or falls? Are such profits taxable and any losses tax-deductible? Here we need the Inland Revenue to make a statement.
And what does an ‘owner’ of bitcoin own actually - shares, an account balance, an investment?
Who is behind a crypto-currency and what claim does the owner have on the sponsor or any assets that were purchased with the real money that the owner parted company with? What about transparency of pricing, certainty of delivery, and recourse to a lifeboat fund if a bitcoin ‘deposit’ goes bad or disappears?
It would appear that all of these characteristics are absent.
There are further monetary policy ramifications for authorities. If there is any easy link between the bitcoin world and the fiat currency world, such that the creation of ‘money’ in the crypto-world creates money in the real world too, how does that affect any attempts by central banks to manage money supply? Is it a sort of private and uncontrolled Quantitative Easing? What could be the ramifications for prices of assets, pensions and investments and so on?
Secondly, if economic activity does start to be conducted using bitcoin out in the ether, and such inconveniences as Online Pay-As-You-Earn filings and EU Sales Lists can be circumvented, that can leave a hole in national revenue accounts, at a time when demand for public services is rising and tax revenues and living standards are under pressure. FATF and EBA certainly see bitcoin as a large home for the black economy.
An Isle of Man-registered company is even proposing to offer physical bitcoins to UK persons that are “securely” numbered bits of brass or of silver, depending upon the denomination you buy, and they come in a velvet case. The silver ones will have an intrinsic value - their weight in silver. The brass ones are intrinsically valueless and would only ever have a value if they represented a claim on an asset or a legal person. Of course the item has a “value” at the start: the price the punter has paid out for it in real money.
The sponsor of this particular offering lays great emphasis on the measures to guarantee authenticity, non-repudiation, and avoidance of loss of the claim itself, but much less emphasis on what happens to the money paid in.
These tokens are very different from the £5 commemorative coins that are issued for royal wedding and anniversaries by the Bank of England, because they are legal tender for their face value. In a sense the issuance of physical bitcoin is an instance of a company launching a rival physical currency to that of the Bank of England in the UK. That might class as forgery or at least as an attempt to undermine the currency (literally – mining bitcoin = undermining fiat currency).
The sponsor of these tokens proposes to offer them as an "investment" to UK residents: surely the Financial Services Authority would have something to say about that.
What assets are the proceeds invested in such that the value of a partial claim on the asset portfolio might result in the price of the bitcoin rising? What is the pricing mechanism? What is the credit rating? Where is the liquidity? Where is the ombudsman? Are we looking at a form of Green Shield Stamps? What is the Capital Gains Tax treatment?
The precious piece is the statement that this company "need(s) to perform an analysis of what local regulations apply in each country we hope to sell in first, so are focussed on launching in the UK for the time being".
So there are no local regulations here in the UK? Of course there are but up to now none of the owners of the different areas of regulation has stepped up to the plate and claimed ownership of this topic for themselves.
There is a certain head of steam building around crypto-currencies and a corresponding dearth of education – a potentially dangerous combination for those who have money from which they might become parted, for example those liberated under the new private pensions freedoms.
Buyer Beware should not be the response here. We have regulators coming out of our ears: The Pensions Regulator, the Financial Conduct Authority, The Financial Services Authority, The Prudential Regulation Authority, The Payment Systems Regulator, HM Customs, Inland Revenue, The Bank of England, HM Treasury, The Financial Ombudsman and no doubt several more. They need to very quickly get together and decide whose bailiwick bitcoin and crypto-currencies fall within and what the regulatory regime will be, and block market access to those companies that do not comply.
By Robert Lyddon, General Secretary, IBOS Association