WBD189 Audio Transcription

Beginner’s Guide #8: How is Bitcoin Legal with Peter Van Valkenburgh & Jerry Brito

Interview date: Monday 27th January 2020

Note: the following is a transcription of my interview with Peter Van Valkenburgh & Jerry Brito from Coin Center. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.

In Part 8 of the Bitcoin Beginner's Guide and to help explain and navigate the regulatory landscape I talk to Peter Van Valkenburgh & Jerry Britto, the Director of Research & Executive Director at Coin Center a non-profit focused on the policy issues for Bitcoin. We discuss the Bitcoin regulatory landscape and the implications to the users.

“The invention of Bitcoin provides a way that people can transmit funds across space and time and help others do it without ever taking custody of it and that just does not fit into the paradigm that regulators have.”

— Jerry Brito

Interview Transcription

Peter McCormack: Jerry, Peter, how are you?

Jerry Brito: Very good, thanks for having us.

P. Van Valkenburgh: Great, thanks!

Peter McCormack: First time to get Jerry on. Peter, you've been on a couple of times, but great to have you both on. So I've been running this beginner's guide to Bitcoin. I've done seven recordings now, I've covered the prehistory of Bitcoin, why it's important and what it is. We've gone up the technical detail too, but now we're going to cover how this is all legal, which actually was an idea from Neeraj, so we have to say a big thanks to Neeraj. So we're going to cover why this is all legal, but for people who don't know who Coin Center are, I think as a good tee up, it'd be very useful to understand who you are and what is the work that you guys do.

Jerry Brito: Well, thanks for that. So Coin Center is an independent non-profit based in DC and we're focused on the public policy issues that affect cryptocurrencies and open blockchain networks. So things like Bitcoin, Ethereum, and the like, right? So these are open permission-less networks, they are unowned by anybody and so, as a result, there's a bit of a collective action problem where who's going to stand up for these networks that nobody owns?

So that's what we are. We're self-appointed lobbyists and advocates for these networks when it comes to policymaking. So an easy way to think about it is if you're familiar with the Electronic Frontier Foundation, what the EFF is to the open internet, we aspire to be to open blockchain networks.

Peter McCormack: Okay great! All right, so one of the complications of this show, that we don't have with other shows, is that legislation will be jurisdiction specific. So I've been out to Bolivia recently and found out that Bitcoin isn't legal there when I was there. We know certain uses of it, like it is illegal in China. We also know the likes of Estonia and Malta are quite open-minded.

So I think we need to just set the position for anyone listening to begin with. We're going to base this on the US and we're going to base it on the key areas that you guys look into, the key areas of policy and legislation. But if anyone is based out of the US, they really need to do the research in their own country. Is that a fair starting point?

Jerry Brito: I think it's absolutely right. It's regulation like all laws, jurisdiction by jurisdiction, even though the US has a habit of being extra tutorial in nature, which means the long arm of law in the US extends globally sometimes.

P. Van Valkenburgh: Yeah, so it's not a bad idea to get an idea of what US laws are even if you don't think you're subject to them because surprise, you never know when you are.

Peter McCormack: Okay and just another note on this is that it is a Bitcoin show and usually I don't ever cover alt coins, but I think it might be difficult to talk about this show and not talk in reference to some alt coins with regards to specific things, for example, when we get into the area of security. So that's absolutely fine if you feel you need to refer to alt coins in explanation of any area.

P. Van Valkenburgh: On the alt coin subject, Coin Center's work is generally coin agnostic. Most of the work we do is on Bitcoin, but from a regulatory policy standpoint, it doesn't matter as much as you might think because regulation, when it's good and most of the time is activities based, so it's about what you're doing, it's not about the technology you're doing it with. So if you're moving money using Bitcoin versus Litecoin for example, the same laws are going to apply.

Peter McCormack: Okay great. So quite a broad first question to kick off with, but what class as a regulation does Bitcoin fall under?

Jerry Brito: So as Peter was just saying, it's not Bitcoin itself that falls under regulation in the US anyway, Bitcoin itself is not regulated. It is activities that you might perform with Bitcoin that are going to be the regulated activities and we think about forming areas of law that we focus on. Those are investor protection, consumer protection, anti-money laundering and tax. Those are the four big broad areas.

P. Van Valkenburgh: Yeah and so the corresponding activities there for investor protection, the activity that's regulated is usually raising money, hence the question about pre-sales or about secondary markets where people trade Bitcoin or other cryptocurrencies. The area of consumer protection, the activity that might be regulated would be a company that helps you move money using cryptocurrency, like a money transmitter would and so that's when Coinbase or somebody else holds your Bitcoin for you. Then taxes, if you make money, that's an activity you made money, so you're probably going to get taxed.

Jerry Brito: And then the last is anti-money laundering, which again, that tends to apply to people who are engaged in what Peter said before, which is the transmission of funds.

P. Van Valkenburgh: Maybe especially in the cross-border context or things like that though.

Peter McCormack: And I guess depending on whether you are just a regular retail user who's buying and holding or using Bitcoin, the things you need to be aware of, are going to have to be slightly different for whether you're running some business, whether that's an exchange or a wallet. There's different considerations.

Jerry Brito: Exactly and we'll probably get into this later, but one of Coin Center's big focus is making sure that regulators understand the difference between someone who say, runs a node on a network and doesn't actually hold other people's Bitcoins, they just help the network run, versus a custodian who holds other people's Bitcoins and therefore puts them at risk and is more reasonably a target for regulation. Unlike the guy who's just running a node who shouldn't be regulated.

Peter McCormack: And what are the various regulatory bodies that you have to work with or liaise with based out there in the US?

Jerry Brito: So you obviously have legislative bodies like Congress at the national level and different state legislatures. But then going down the line in thinking through those broad areas, the Treasury department here in the US as a big one, because the Treasury houses both the IRS for tax policy, but also houses FinCEN, which is what's called the Financial Intelligence Unit, which basically administers the anti-money laundering laws. Then on investor protection, that is going to be the SEC and the CFTC. On the SEC, it's going to be for securities regulations obviously, and on the CFTC side it's going to be for derivatives regulation and potentially also for just market regulation of commodities markets, spot markets etc. So that could be just Bitcoin trading.

P. Van Valkenburgh: So for example, if you have questions about, "is the price of Bitcoin being manipulated" and things like that on various exchanges, that's something that in the US the CFTC might look into.

Jerry Brito: And then... What am I missing? Consumer protection, that's mostly done on a state by state basis. So that would be either the state banking or money transmission authorities. But then you also have federal legislation there as well. So, you've got the consumer financial protection Bureau, you have the OCC and they're more.

P. Van Valkenburgh: It quickly gets to be an alphabet soup, especially your non-US listeners are probably tuning out now. But these things are first relevant because usually a counterpart agency in any EU member state and in most East Asian nations all around the world, there's usually something similar, although usually there's fewer of them per country. Whereas in the US we've got an oddly large number of regulators who all have jurisdiction.

Peter McCormack: So like my other shows, I just did one on monetary policy and then previous to that I covered the Bitcoin protocol, technically how it works and my advice to everyone in every one of those episodes is, look this might be a bit complicated, it might go over your head a bit, just bear with it. If you've got any further questions, go into the show notes, get into Google, you know there is further information out there if you need it. I will be linking to the Coin Center website, so they can find out more information, so I would say to them, just bear with it.

Also, it depends on someone's experience, this might be someone who's a complete beginner, who has never even bought Bitcoin or it might be somebody who's got a bit of experience. We've got a wide range of people potentially listening to this. But one of the things they might not realize when they first get into Bitcoin, that Bitcoin is both a currency and a protocol. Do you have to consider them both separately with the work you do?

P. Van Valkenburgh: Yeah, absolutely. So as we were saying, regulation is always activities based and when you think of Bitcoin as a currency, you're talking about people who might be performing activities that move money, that do payments, that do store of value, the things that we would use a currency for traditionally and those regulations then are going to be focused on things like anti-money laundering for example, because if it's a currency, people are going to use it or a currency substitute, as FinCEN the anti-money laundering regulator uses the term.

They're going to use it to move money and maybe that means violation of sanctions, maybe that means support for crime, maybe that means any number of things. So at that point FinCEN takes an interest. Now the question of Bitcoin as a protocol, yes, it's true that Bitcoin as a protocol is helping to move the money at some level, but it's doing it in an information technology way. So just to give one example, even before Bitcoin, FinCEN would make a distinction between a money transmitter like Western Union and a telecommunications provider like AT&T and they'd say, "look AT&T might be the backbone of the telecommunications infrastructure that Western Union is using to move money."

But AT&T is not a money transmitter, it's a facts and circumstances limitation to the money transmitter definition, that if all you're doing is providing information throughput, you're definitely not a money transmitter. We need to make the same arguments and we've been very successful over the last five years making the same arguments about someone running a node on the Bitcoin network. The Bitcoin protocol is not a regulated thing, whereas Bitcoin as currency, depending on whether you're using it to move money around might be regulated.

Jerry Brito: And it's also further than that, it's not just that the Bitcoin protocol is unregulated, is that it must be unregulated in the US anyway, because in the US we have the First Amendment and the First Amendment protects your speech and freedom of assembly and we haven't had to make these arguments even though we've appeared to make these arguments.

But certainly developing open source software that makes up the Bitcoin protocol in running the software that basically listens for and repeats transactions, is all speech. Even publishing a block if you were a successful miner, there's a good argument that that's just a speech activity. So not only is it unregulated, it would be basically very, very difficult for the government to overcome the barriers that it would have to in order to regulate.

Peter McCormack: And does blockchain itself which we know has become a marketing term for protocols, but does blockchain itself have any consideration under regulation? Is it governed by anything or is it something that is still just a marketing term?

P. Van Valkenburgh: I think it's a marketing term as you say, but look to the extent you want to think about blockchains as basically databases, there's really no … Again, there's no regulation of databases, but it's to what use do you put these databases. So let's say that you are the New York Stock Exchange and you decide you're going to move away from whatever your infrastructure is today and you're going to move over to using a blockchain. I imagine that the SEC and whoever else and FINRA and whoever else your supervisors are, are going to want to be involved in that process. But that's not so much about the technology, it's about what you're doing with them.

Jerry Brito: It's more like there's a regulated institution, which might be say the New York Stock Exchange and then they just need to convince their regulator that they can use certain software vendors or protocols for their backend. But that's much different than the backend being the regulated entity.

Peter McCormack: And then there's two other things I want to ask you about before we get into the detail. So something that's come up regularly, even though this is a Bitcoin show, but something relevant to Bitcoiners, as like a complementary tool is stable coins specifically Tether. More recently we are starting to hear a lot more about Central Bank issued digital currencies. Where do these fit into the whole picture? Is Tether considered just like Bitcoin or is it different? And where do the Central Bank digital currencies come in?

P. Van Valkenburgh: So those are two very different things. Let's take them one in turn. So stable coins as Tether is and as others traditionally are, it's a company that takes custody of consumer funds and issues you a token. That token then travels freely on a permissionless network and it can always be redeemed for the dollar let's say.

Jerry Brito: Usually from the issuer.

P. Van Valkenburgh: Right, so this is a novel product and I'm not sure that there has been previously a very clear way that these are regulated and so what we've seen is different firms who are doing this, pursuing different ways to comply with law. Some, for example like Paxos and Gemini have created New York trust companies, which are basically bank like firms that basically through their charter are able to do this. Others like USDC have done it through money transmission.

I'm not sure how Tether does it. I think they probably just don't try to... They don't have customers in the US and that brings up one big question about these stable coins is that maybe it's regulated at the point where a customer deposits dollar and gets a stable coin and maybe it's regulated at the point where somebody comes with a stable coin and retrieves dollars. But in between, I'm not sure what the law that would apply would be.

Jerry Brito: This is a hard question. So unfortunately the stable coin topics are extremely popular right now. So while Coin Center primarily exists to defend permissionless cryptocurrencies and really Bitcoin at the heart of it, we get a lot of questions about stable coins because Facebook's launching one, China's talking about a government run stable coin potentially and the consumer protection risks are completely different. This is a point we often have to stress when we go into meetings on the Hill, for example Libra, Facebook's proposed stable coin, would have a reserve that a company holds and you have to trust them to hold that.

Bitcoin of course, there's no reserve that backs it, it's backed by people's trust in the stability of the number of the supply, which is something that's determined through the protocol, through math and thus far effectively impossible to change. So we're usually at pains to make that distinction because the laws that apply are different if you understand that distinction and should be different because you don't have to worry in the same way you have to worry about a company keeping a reserve with Bitcoin.

P. Van Valkenburgh: And just briefly on Central Bank digital currencies, the one major distinction with a stable coin is that whereas with the case of Libra or Tether, there's a reserve of consumer funds that backs it, with Central Bank digital currencies, there's no such reserve, it's just that the issue coin is Central Bank money. To me, the thing that's interesting there is... I think that there are a lot of benefits certainly for Central Banks and potentially for consumers to Central Bank digital currencies, but I think they're marginal.

We already have, certainly in the developed world, we already have digital money and digital dollars. So what advantage would you get from having it be tokenized? I can imagine that the advantages that I would be interested in, probably wouldn't exist in what ultimately is launched.

It would probably be a much more tightly controlled tokenized government currency and so I guess I would have to wait and see and people are very... I guess on their edge of their seats about the Chinese digital Yuan. I think it's crazy to be so excited about it until we see what the design is. I think once we see it, we're going to be less excited by it.

Peter McCormack: So let's get into the detail now. The first area we're going to cover is payments, but as we go through these different classes of regulation and different areas of regulation, it would be good to just start out by explaining who it impacts, and how it impacts them differently. If it is consumers or if it's businesses and if it's both, how it affects them differently. So let's start with payments.

P. Van Valkenburgh: Sure! So when you're thinking about payments, you're mostly thinking about money transmission regulation. What that means is that if you are a company that has a business, you are taking custody of consumer funds in order to help consumers complete a transaction, whether that is sending money from point A to point B or helping a merchant accept funds from a consumer, you are going to be licensed, Again, as Peter was saying earlier, the reason for that licensing, the theory behind it, is if you're holding consumer funds in custody, you are, even if it's for a moment, putting those consumers money at risk because you could run away with the money, you could lose it, you could be hacked and so what's required of you is a license.

So you have to go and get permission to operate your business and that permission is going to be dependent on a background check, making sure you're not a criminal, you're going to have to post a bond of some kind, you're going to have certain restrictions on what you can keep, the funds that you've taken from your consumers, what those can be kept in etc. So it's pretty straightforward. I think the biggest issue that the industry has faced is two things. Number one, in the US this is a State by State regulation. So if you open an exchange, you've got 50 plus different regulators that you have to get a license from, so that's very owners.

Secondly, especially earlier on, 5, 6, 7 years ago especially, these regulators had never heard of Bitcoin and so they didn't know what to do with it. Some States, like what New York did and went the Bitlicense route and created very, very onerous restrictions. Since then, I think we've gotten a pretty good settlement, where you have to get a lot of licenses, but at this point, regulators understand what crypto firms are.

Some States have basically said that you don't need a license at all depending on what you're doing and so it's much more navigable. It's not perfect and there are different efforts that we could spend a couple of hours talking about to try to create a uniform law around this across the States that's basically where we are. So me, as a retail user, I don't have to consider anything related to regulations of sending Bitcoin to other people in terms of payments. Except you might want to be aware whether there's a company that you're using, like an exchange is regulated, maybe that's important to you.

Now you as a regular user of say the Lightning network, which is important technology to make Bitcoin scale, one of several solutions, but probably the most promising at the moment. There is a question here, Coin Center's mission is to make sure you don't as a member of the Lightning network, ever need to worry about this sort of payments, licensing regulation because you could see people maybe, and no one's trying to do this yet, but you could see people making the argument that an intermediary node on the Lightning network is like a Coinbase or what have you.

They temporarily have some control over the money as it moves through the lightning channel. But Coin Center thinks that that's the wrong legal analysis because a Lightning node can't unilaterally decide to redirect your funds to somebody else. They can only complete their part of the channel and if they try to redirect, they get penalized by the protocol and they're simply not able to. So from Coin Center's analysis, they don't put consumers at risk like a Mt. Gox puts consumers at risk, because they can't lose and runaway with the money and therefore, they shouldn't fit in to the State by State licensing requirements that normal payment providers are required to fit into.

That's good policy because if you're not putting consumers at risks, you shouldn't need to get a license and it's also essential to maintaining people's freedom to use these technologies because if every Lightning node had to be regulated, the Lightning network wouldn't have the throughput that it would need to actually deliver on promises like microtransactions and low fee payments.

Jerry Brito: Again, luckily we're prepared for that argument if the day comes, but it's not ever been really bad.

Peter McCormack: If somebody listened to this is new, they might be like, "what are you on about here?" We haven't covered this yet. So the Lightning network we're going to be covering soon, but Peter, you rightly also said that it's a way for Bitcoin to scale. What I think people don't realize is the technicals behind how it works in that, if I'm on the Lightning network and you're on the Lightning Peter, and you're on the Lightning network Jerry, if I send money to you via Bitcoin on the standard protocol, it goes from me to you.

But if on the Lightning network it might go via Peter, so in the traditional sense of money transmitters, that's why Peter could be considered a money transmitter. But as you can't control those funds, you're really just relaying the transaction and this is why it shouldn't require a license, which is great.

So in terms of money transmission, I understand this, this is somebody is risking my money and I think in the traditional fiat world, whether it's the banks or whether it's PayPal or Stripe, I understand why they might want money transmission licenses and I imagine a lot of these businesses in many ways are similar. But what does Bitcoin do that's very different from these traditional fiat based systems and what challenges does that bring to the regulators?

P. Van Valkenburgh: So the first answer I'd give you is it shouldn't give them any challenges. Money transmission regulation is not about money transmission, it's about custody and risk from custody. So the fact that the money, and I'm doing scare quotes right now, is Bitcoin money instead of dollar money, shouldn't matter. The one question is the custody risk. So we wouldn't want different regulations to apply to someone who is risking your Bitcoin by holding it, than we would for someone who is risking your dollars while holding it. We often say if it walks like a duck and quacks like a duck, it's a duck. So the differences there are slight in the context of a company that's holding Bitcoin.

Jerry Brito: I'll say that the challenge that regulators, who have been so used to the legacy system that they have, is thinking in terms outside of transmission. These things are called money transmission licenses, they're not called money custody licenses, even though it's really what they're trying to get at. The reason is, is that before the invention of Bitcoin, the only way that you could transmit funds was by first custodying it.

So the invention of Bitcoin provides a way that people can transmit funds across space and time and help others do it without ever taking custody of it and that just does not fit into the paradigm of the regulators have. Sometimes it doesn't fit into the law as it's written and there are some States where you look up the definition of money transmission and the definition literally is transmission of money by wire or other means. So technically that could cover Bitcoin as a protocol, which would be very problematic. But I think regulators have slowly been able to interpret those laws to make sense rather than not.

Peter McCormack: Okay, that makes sense. So I think we can conclude this section by saying, if you were just a regular user or buyer of Bitcoin, you don't really have to worry too much unless you want to just check that the company that you using does have the licenses?

Jerry Brito: There's one thing though, which is very important and maybe this gets more to anti-money laundering, but if you are a user but maybe you start using it more and more and you get into the habit of buying and selling a lot and maybe putting up advertisements that you are willing to...

P. Van Valkenburgh: Help people buy Bitcoin, by selling it to them. If you're really getting a lot of people onboarded onto the platform, then regulators who are interested in regulating the on ramps and off ramps to Bitcoin because... And that's why Jerry has said this might be more about anti money laundering, it's like people want to get onto the Bitcoin network to do something illegal. Then if you're becoming one of those on and off ramps because you're doing so much sale and buy volume and you're advertising that you'll help people get onto the platform, then people might start thinking of you as a money transmitter.

Jerry Brito: That's a tricky area to watch out for!

P. Van Valkenburgh:Absolutely! So we've seen this with, for example, people who use LocalBitcoins. Different regulators around the world will look at people who buy and sell LocalBitcoins and say, "hey, at this point you're doing it as a business and so what you're doing is actually money transmission." So something to watch out for.

Peter McCormack: Right okay, so we can separate it here. Just a regular user who's buying for themselves, they're absolutely fine. The only time they need to consider regulations around payments is with regards to whether they want to check the company they using has the right licenses. But if somebody was regularly buying and selling on behalf of other people, maybe use an exchange like LocalBitcoins, so for people who don't know, that's a little bit like an open market for buying and selling Bitcoin. LocalBitcoins provides a platform for buyers and sellers to come together.That's when you'd have to really think about it. But if you're a business or you're thinking of starting to set up a business and you might be involved in the transmission of Bitcoin from one person to the other, then you will possibly need a license. Okay, so now we're going to move on to securities and I've visited the SEC a couple of times and I've done a couple of interviews there and this is a very interesting area. The reason this one is interesting, because I think this is going to separate Bitcoin, the grey possibility of Ethereum and a lot of other crypto based projects existing.

So a very good area of starting for this is, just for people who don't know, let's explain what a security is and then let's define what the measure of what a security is, which is I know is the Howey test, Let's go through that so people understand and also, you should probably add in there why it's important to classify something as a security or not.

P. Van Valkenburgh: Sure! So to go back to our original layout investor protection, consumer protection, the different areas, securities regulation is about investor protection and the normal run of the mill security that you'd find is generally going to be a bond or a share of stock. Those are what we normally think of as security. So a share of Apple stock that you buy using Robinhood or some app on your phone or talking to your broker, that's what we normally think of as securities. So the question might be, "well that's very different than Bitcoin because that's either a debt, obligation or an equity obligation that a corporation owes its investor.

It's like you get 5% of this company or you get a regular $2,000 payment from us because you gave us money and we owe you, it's a debt obligation." So that seems very different than Bitcoin, where when you own a Bitcoin, you don't have a claim against Bitcoin corporation as there is no Bitcoin corporation that owes you the value of the Bitcoin. There's no Bitcoin corporation that owes you a share of its total net worth. There's no Bitcoin corporation period. So, the question might be, "okay, well why is securities law relevant here?" Because Bitcoin is obviously not a traditional debt instrument or bond or stock or thing like that.

The answer is what you were saying Peter, the definition of a security is a little bit broader than just a bond or a stock. The definition in the US especially is broad enough that it might reach some other things beyond just stocks and bonds and that definition comes from the court case called W.J. Howey versus the US which was a court case where somebody was selling some real estate in Florida and that looks like a real estate transaction. But they were also promising to maintain the land and grow the oranges on the real estate that you are buying and give you a share of the profits from the orange grove.

So you're not just buying the land, you're buying this stream of revenue from the guy who's maintaining the oranges on the land. The SEC said that that's not just a real estate purchase, that's actually like having a share of ownership in an orange grove and so we're going to regulate that. It was a stock because it's like having stock in an orange company or an orange grove, but it's different and the test they came up with in the Supreme Court case that that said, "yes, the SEC can regulate that financial instrument" is called the Howey test today.

The test says you're going to be subject to securities regulation if what you're selling or advertising or promoting is something where an investment of money is made in a common enterprise with an expectation of profits dependent on the efforts of a third party promoter. That's a three or four pronged test, depending on how you count the clauses in that sentence and they're all pretty important. It's true that when we buy Bitcoin we invest money, so it's obvious that even just a Bitcoin sale involves an investment of money.

Maybe you're mining it, but even then you're investing in a certain sense because you're investing in computer hardware to get the Bitcoins when you mine. Now in a "common enterprise" was the next part of that test and the question is, "is Bitcoin a common enterprise?" And the answer we think is no, not in the same way that Howey with his land full of oranges was a common enterprise. Everyone goes to Howey to ask for their profits from the orange grove because as I was saying earlier, there is no Bitcoin corporation where you can go to and say, "hey, I want the value of my Bitcoin."

That's not how Bitcoin works. Bitcoin is more like a commodity, it's more like the oranges themselves, than the person who owes you the money from the oranges. You can just own it out right, and trade it. The third prong was an expectation of profits. So you're investing your money in a common enterprise with an expectation of profits. Do people expect profits when they buy Bitcoin? Yes, probably. But a lot of people think of it as a payment instrument where you don't necessarily think of profits as much or as a store of value where you just hope for a steady long-term price.

But I think it’s right that a lot of people do expect profits, but that's okay if there is no common enterprise, you can meet some of the answers to this test. Like yes, there was an investment of money and yes there's an expectation of profits and fail others like common enterprise and it's not a security. To be a security, you have to meet all the elements of this test. Then the last prong there is that the profits come from the efforts of others and this is again where Bitcoin seems to fail the test because what controls the price of Bitcoin?

It's really just open markets where people are deciding independently to either buy or sell and the amount of Bitcoin, which is the other input to the economic calculus. So the buying and selling decisions is the demand on an economic graph and the supply is the other input to determine the price. That input is set by the protocol and is not in control of any person or affiliated group of persons. There's always going to be 21 million Bitcoins. So where is this mythical person whose efforts we're relying on for the price? They don't exist. Hence why Bitcoin seems to fail two of the four prongs of the Howey test, common enterprise and efforts of others.

Now you suggested that this might be a place where we see differentiation between Bitcoin and the other alt coins and the other blockchain projects out there and you're absolutely right. So the reason why the SEC is particularly interested in this broader area, if not Bitcoin in particular, is because some people have copied the original source code of Bitcoin, decided to launch their own alt coin or alternative crypto currency and then they've sold them to the public or a promise of them to the public before the networks even running and we call that a pre-sale or an ICO or any number of other bad marketing terms. In that context, now run that.

So we'll call it S-coin, which may or may not stand for shit. S-coin is going to be sold to the general public, but the network's not going to launch for another year or two. At that point, people are investing their money in a common enterprise because there's S-coin Corp that's promising to build S-coin in two years with an expectation of profits, most of these things are marketed as great ways to like double or triple your money, so that prong is going to work. Then reliance on efforts of a third party.

Again, there's an S-coin Corp who in two years may or may not deliver on their promise to build a new cryptocurrency and maybe once they do deliver, it's a fully decentralized cryptocurrency where there isn't reliance on the efforts of others, but up until the point where they do deliver, you bet you're relying on them because we're still waiting for them to deliver the thing they promised. So those pre-sales and ICO agreements are usually going to be regulated as securities, whereas Bitcoin and a running network is not going to be regulated as a security.

Just to now put this in context, why are we even talking about this? It matters whether you're regulated as a security or not. It matters for a couple of reasons. The promoter would need to register with the SEC, they can't just start selling it or promoting it without checking in with the SEC and effectively getting permission. If it's a security, it can only trade on national securities' exchanges, which means you won't be able to have your coin traded on Coinbase, it'll have to trade on the New York Stock Exchange, which may or may not be all that ready to list your particular S-coin.

Jerry Brito: I'll say one more thing since you mentioned Ethereum, there's a question around Ethereum and what is its security status and I think the SEC and now even the CFTC has been very clear that Ethereum is not a security. I think that's a right conclusion because as Peter was saying, if you run the Howey test on Ethereum, it's the same as running it on Bitcoin, you have this decentralized network, you're not relying on anybody in particular etc.

Now notice that when the SEC made that statement, they said nothing about the Ethereum pre-sale, right? So you need to separate out what in this analysis, when Peter was talking about S-coin, you have the S-coin offering, which Peter was saying, clearly a security and then you have S-coin itself, if it ever is launched and it's running and it's decentralized, that coin is not a security, but the offering certainly was.

Peter McCormack: So can you give me an example of something that has turned out to be a security, how the SEC has reacted and the sanctions they've put on the people who run that security? You don't have to name the coin if you don't want to, but just a good example of what the risks are for people who might end up creating a security via a crypto currency.

Jerry Brito: So what's interesting, since this is all very new, we've only seen the SEC begin with enforcement action starting in what, 2018? We really don't have these yet. We've had settlements and so when you have the SEC basically alleged that you've issued a security and the person settles out of court, they typically accept the fine. They might have to return the funds to investors, they might promise not to engage in that business again etc. But what we have not had, and we're looking forward to, are court decisions because so far it's just a theory.

The SEC says that if you do these things that meet the Howey test, then you're a security. But ultimately for that to be law, a court has to say so. We haven't had those precedents yet. Right now, there are two cases. You have Kik and you have Telegram where the SEC is having to go to court and try to prove that these things are securities and that's going to turn a lot on what the facts are in those cases.

P. Van Valkenburgh: Yeah, basically looking at the facts of Kik or the facts of Telegram and comparing them to the legal questions inherent in the Howey test, investment of money, common enterprise, all that. On the settlement side, which as Jerry said, is how most of the things have gone so far, the two things to look out are probably the SIA coin settlement and the recent Block.One or EOS settlement.

So both of those were projects where somebody raised money to build a decentralized cryptocurrency or alt coin and in both those cases the SEC struck the exact balance that Jerry was talking about earlier saying, "look, when you pre-sold a promise of future profits from your network that you were promising to build, that was a security. But the decentralized token, either EOS in the case of Block.One or SIA coin in the case of the SIA note settlement, those are not securities.

Now, the SEC didn't come out and say that those derivative innovations and technologies were not securities, but the fact that they settled with them and said, "we're only fining you for the pre-sale" is pretty good evidence that this is how the SEC sees this right now and we think is definitely the right policy balance to strike.

When you're asking for people to just hand you money to build something that's speculative, you should probably follow the same rules that other people selling securities follow. But once you've built it and you're not actually in control of it and people aren't relying on you anymore for its functionality and for its value, then it shouldn't be a security.

Peter McCormack: Okay, so the biggest risk here is for somebody who's listened to this show might be thinking of creating some kind of cryptocurrency project that could end up becoming or being classed as a security. Now I would put out there, I don't recommend creating any cryptocurrency project because they all are pretty much doomed to failure. As I've covered in my show with Nic Carter that's coming out next week, alt coins are essentially a history of failure. But if you choose to go down that route, that's the risk you're taking.

P. Van Valkenburgh: But Peter, can I say one thing?

Peter McCormack: Yeah!

P. Van Valkenburgh: On that subject, I think even if you do want to build your own cryptocurrency, follow the beautiful example of Satoshi Nakamoto and don't do a pre-mine and don't do a pre-sale or an ICO, just write cool software that you think people will want to use as a network and if they want to use it, they'll use it. You will benefit if people use it! But at no point are you asking people to give you a bunch of money to trust you on your better cryptocurrency idea, because as you said, most cryptocurrency ideas since Bitcoin have been a little bit disappointing.

Peter McCormack: Well I'd say a little bit, majority very disappointing, some moderately disappointing, most very disappointing. But just to close this one out, I've got two final questions. The first one is if someone has listened to this beginner's guide, they've gone through it and despite me telling them to focus on Bitcoin, to not trade, just to consider this as their investment, but they still end up deciding they want to invest in other cryptocurrencies and for some reason they invest in an ICO and it turns out to be a security, are there any implications on them as a retail buyer of the ICO?

P. Van Valkenburgh: No, except because the secondary markets will have to be securities exchanges if it's a security, at least in the US, the depth of the market where someone can go back to sell the thing to somebody else if they want to get rid of it might be shallow because you won't have access to Coinbase or the other major cryptocurrency exchanges to sell it. You'll have to sell it on a national securities exchange, which probably won't list it, in which case you'll probably have to sell it on an international market if you want to sell it.

Jerry Brito: But there's no legal liability that I'm aware of for the user. In that case, you're the victim.

P. Van Valkenburgh: Yep, somebody owes you money!

Peter McCormack: All right, so let's get into KYC/AML. This is the thing that's probably going to touch people most of all, especially if you're a Bitcoiner. KYC/AML might be something that you're like, "what the hell is this?" And you might not even realize you're actually engaged with the KYC/AML process when you first get into this. But KYC is know your customer, AML is anti-money laundering, it's very much something that's directed by the US but is highly relevant around the world. Can you talk about what they are and why the government deems this important?

P. Van Valkenburgh: Sure, so first a little preface about the US versus international law because I think this is an area where we can be very helpful to people beyond the US. The US standards for anti-money laundering and know your customer laws are in the Bank Secrecy Act, which is a particular act of Congress and in the implementing regulations that the relevant agency FinCEN has promulgated. So I'm going to talk about those regulations, but let's point out first that the US was recently the president of an international body called the Financial Action Task force, the FATF.

As president of the FATF for the last cycle, which is I think like a year or two, the US promulgated new international standards about AML/KYC regulation for cryptocurrencies and FATF made those standards official in Recommendation 15 and a few other pieces of guidance. So we exported our policy through the FATF to this international body and this international body has members in all of Europe, all the European nations are members of FATF, all of Africa, all of Asia and all of South America.

So those member nations will now need, it's called Recommendation 15, it's called the FATF recommendations, but effectively they're not really optional. Nations around the world now are going to have to implement the same anti-money laundering laws that we have in the US and that's just how it's worked out. Now that might sound scary, but at least here at Coin Center, we're here to tell you that it's not such bad news if you're really just a normal user of Bitcoin and the reason is because the US policy on anti-money laundering has been not so bad, it's struck the right balance. So here's that policy that's now going to be exported to the rest of the world.

Jerry Brito: And let me just say one thing before you explain that. When you think about it was as good or bad, is to consider the alternative. The current president of the FATF which took over after the US was done is China and so query what virtual currency AML regime would they have implemented had the US not hurried up and done it.

P. Van Valkenburgh: If China had gotten the first stab at regulating virtual currencies for AML, we might not have had such a rosy outcome. So the US policy compromise on anti-money laundering is this, you are regulated from an anti-money laundering, know your customer perspective. If you are again, a money transmitter, and the US definition of who is a money transmitter in Europe we often use the word "Virtual Assets Service Provider" or VASP, so these are similar things, is somebody who accepts and transmits currency or currency substitutes and Bitcoin is almost certainly a currency substitute, as it's something people use as a substitute for currency.

So the question is, you are regulated for AML if you accept and transmit Bitcoin as a customer business. So that's in a nutshell what say Coinbase does, they will accept Bitcoin from their customers and transmit their customers Bitcoin to other people. It's custody, it's just like our discussion earlier about custodians being regulated from money transmission licensing. Now there's some questions on the edges is somebody who's just holding their own Bitcoin, a money transmitter?

They accept Bitcoin from people paying them and they might transmit it to people they want to pay, but they're not doing it as a business. They're just receiving Bitcoin from someone who wants to pay them or paying someone with Bitcoin. So they're not a money transmitter any more than someone who decides to pay somebody with a $20 bill or receive a $20 bill from someone is a money transmitter.

FinCEN clarified exactly which Bitcoin businesses are money transmitters in the guidance they released in May 2019 and they went so far as to even say that people who set up say decentralized exchanges where you could do an atomic swap of a Bitcoin for Ethereum for example, on a cross chain swap, if they don't as a business accept and transmit the currency's substitute being traded by the platform, if it's just individually users settling outside of the platform, they're not money transmitters.

This ruling goes so far as to say that say if you had a multisig agreement where you are offering a multisig wallet product to your users and you're going to hold one key of three in the Bitcoin multisig arrangement on behalf of your user, but your user has the other two keys, something like what Bitcoin might do as a multisig provider, you're not a money transmitter because simply holding one key out of three in a multisig arrangement, which is not accepting anything from your customer or transmitting anything on their behalf.

It's just holding one key. You can't unilaterally or independently move the Bitcoin that your customers hold, you're helping your customers store. So this particular May 2019 FinCEN guidance was very clear about things like multisig, decentralized exchange and individually users, that unless you're really operating as a business that holds other people's Bitcoin for them, like a Coinbase or a Kraken, you are not regulated for anti-money laundering purposes.

Now that means that if you are a Coinbase or a Kraken or if you are somebody who wants to start a Bitcoin business that'll help people hold their own Bitcoin or hold their Bitcoins so you're going to hold their Bitcoin for them, you will be regulated for AML, which means you need to monitor for suspicious activities. You need to file reports with FinCEN when somebody withdraws a whole bunch of Bitcoin from you maybe and you need to know all the people who keep their Bitcoin with you. You need to know their name; you need to know their address, you may want to know their social security number and other things.

So that's what anti-money laundering regulation is, you need to effectively know a lot of information about your customers and give that information to the regulator. But that again does not apply to somebody just using Bitcoin and that's important because if it did, you'd be basically asking people to spy on other people, to learn information about who they're paying or who they're getting paid by and report that to the government, which would have Fourth Amendment constitutional concerns about our rights to privacy for example.

But we don't need to make those constitutional arguments because FinCEN, Coin Center believes, has made really good choices as to limiting the set of entities that are actually regulated as anti-money laundering or know your customer obligated entities.

Peter McCormack: Right okay. So firstly I'm just going to say, if you're listening in and you're wondering what an atomic swap is, then don't worry, you don't have to worry just now. If you're wondering what a multisig wallet is, don't worry, we're going to cover that in the future.

But these are all very important points that Peter is making. But I think the key separation here is and the basics that someone needs to understand, that is if you're running a business and you are giving people the opportunity to buy or sell Bitcoin, there are also odorous requirements that you have to follow with regards to your customers and I think more with regards to the customer. If you're signing up to a website and you're buying and selling Bitcoin, you're most likely going to have to give identification over which links you to that purchase.

Jerry Brito: That's right. Then two things quickly about where AML/KYC type laws definitely will apply to you as an individual and you should watch out. The first is, as we were saying earlier, if you're going on LocalBitcoins and advertising your services as someone who will buy a lot of Bitcoin from somebody who wants to sell a lot of Bitcoin or sell a lot of Bitcoin to people who want to buy some, and you're doing that regularly in order to make a profit, you might be regulated as a Bitcoin exchange, effectively as somebody who needs to do know your customer and anti-money laundering controls because you're operating as a business that helps people get onto the Bitcoin protocol.

So if you're selling or buying a lot on LocalBitcoins and advertising your services like, "hey, you need Bitcoin, I'll give you some Bitcoin." You probably need to know your customers. You probably need to register with FinCEN. The other area where this matters is in the context of sanctions law. So this is not the same AML/KYC laws as what I was talking about with FinCEN, this is something called OFAC here in the US, the Office of Foreign Asset Control. OFAC is the division of Treasury that enforces US sanctions.

US sanctions are things like, don't do business with people in Iran or don't do business with people in North Korea. OFAC applies to all American citizens. It doesn't apply to just businesses, it also applies to American citizens. So if you start paying someone in Iran and you know that they're in Iran, or maybe you don't even know that they're in Iran, you're technically in violation of sanctions law and that doesn't matter if you pay them in Bitcoin or in dollars.

OFAC, the office that will enforce the sanction laws against people who violate them, has recently started listing Bitcoin addresses as sanctioned because they've identified them maybe as the Bitcoin addresses used by a terrorist or used by someone in Iran or North Korea

So if you really want to be diligent and you're afraid that this person I'm paying, I don't know anything about them and it's sketchy, you could check the address they want to receive payment out against the OFAC list because technically if you do end up sending to one of those OFAC sanctioned addresses, you would be in violation of sanctions law, which can have very strict penalties.

Peter McCormack: All right, so the last area here we're going to cover is tax and this is the area I think that's most important to retail users, the thing they need to consider most and is probably the area that people need to do most research in their local jurisdiction. So I know there's a difference from country to country. I know for example in the UK it is considered a capital gains tax.

I know for example in Germany they have specific tax laws where I think if you don't spend it for a certain period of time, its tax-free. I know it differs from country to country. So more than anything else we've discussed in this session, you really should be checking your local laws in your local jurisdiction. But just for the sake of this, there's a couple of key questions that we can ask. So firstly you can obviously explain what the tax laws just briefly are in the US. 50% of my listeners are from there, so they'll probably benefit from that. But the most interesting question here, and I think this affects everyone, is why is taxation of Bitcoin so complicated?

Jerry Brito: So just to explain briefly what the tax laws are. As you're saying, it varies from jurisdiction to jurisdiction. In Germany, it depends, sometimes it's a currency, in the US and the UK it's capital gains, in South Korea there's no tax, in Australia I think there's a VAT tax on the purchase of Bitcoin, which makes it very difficult to use. So it's very different. Why is it so complicated? It's so complicated because it's this new asset that is not quite a payment system, not quite clearly a commodity like gold, but it's used in all of these ways and I think also because the regulators haven't yet decided how to treat it.

P. Van Valkenburgh: Because it's a currency and kind of an investment asset like gold, the question of how it fits into capital gains tax is hard because normally you pay capital gains when you sell a big investment and you only do that once or twice every year. But if you're always using Bitcoin to buy and sell goods because you're using it as a currency, you might end up with a whole bunch of independent taxable moments where you have to pay capital gains tax. Jerry's going to talk about how we're trying to improve that situation here in the US in a second.

The other area where it's complicated is that these are open protocols that can fork and both the software forks, but the blockchain can fork sometimes too, as we saw when Bitcoin Cash forked out of Bitcoin and then Bitcoin SV forked out of Bitcoin Cash. Now the issue there is if it's one of these blockchain forks, before the fork you had 5 Bitcoin at address X, after the fork you have 5 Bitcoin at address X and you also have five Bitcoin Cash at address X on the Bitcoin Cash blockchain.

If you wanted to, you could use your same private key to sell your Bitcoin Cash now, because maybe you believe that Bitcoin is the real Bitcoin and Bitcoin Cash is just silly. You might believe that. When you go to sell your Bitcoin Cash, what was your basis? When you have capital gains tax, you say, "I bought this share of Apple stock at 5 and now it's 10, so my basis is 5, so I owe 20% of the gain, which is $5." Well what's your basis with Bitcoin Cash?

You bought the Bitcoin at some price before there was a fork and then there was a fork and you have this new thing. How do you figure out how much your capital gains was? Bitcoin's price has changed since you bought it and Bitcoin Cash didn't even exist, but now it has changed.

Maybe your basis is zero, maybe your basis is a split of the value of Bitcoin when it forked. These are open questions and they're very difficult to answer and it's even possible that when the fork happened, the new Bitcoin Cash that you got out of thin air effectively was income, not even capital gains. It's like somebody gave you a valuable gift or a not so valuable gift depending on what the price of Bitcoin Cash is and how you feel about it.

If it's income, then maybe you had a taxable moment simply because somebody decided to fork Bitcoin and maybe you don't even know that Bitcoin forked, but because somebody else forked it and you don't even know you technically might've had income in that moment because you had the private key, which might have allowed you to spend that Bitcoin. So this gets very complicated very quickly as you as you can understand and we've been working with the IRS to hopefully make it not so bad and not so complicated.

Jerry Brito: Just a fun other example of how forks creates this complication, take Ethereum. I think when Ethereum forked and you had Ethereum and Ethereum Classic, I think a lot of folks probably tried to do everything by the book and let's say they kept their Ethereum and they sold all their Ethereum Classic and they filed their taxes for capital gains and paid capital gains.

But now when you look at the IRS guidance, it's not so clear which was the forked coin because I think just colloquially people think, "well Ethereum Classic is the fork of Ethereum. But wait a minute, Ethereum Classic is the one that never changed, so Ethereum might be the forked asset." So you did your taxes wrong! It's very common.

Peter McCormack: I will say if anyone came into this struggling and thinking of "God, some of this Bitcoin stuff's complicated!" Without doubt, this is the one session they're going to be like, what the hell? But I think we can keep this simple, right? I think if we were to kind of summarize, look, if you're just a regular new user to Bitcoin, you might be just buying it for your first time, the thing you really need to think about like where you're buying it, you might be giving information over for your KYC and AML and you should really check your local taxes.

The people who need to really get in detail and understand about all of this stuff in terms of payments, security, KYC, AML and tax in a different way, is anyone who's thinking, "I think I want to create a company, we're going to create a business that's involved in Bitcoin or cryptocurrency" they're the people have to spend a little more time, but the main issue for retail users, I would say is the primary thing is their tax.

Jerry Brito: I think that's right. I think if you are buying and holding, what you want to make sure is that you're keeping very accurate records of what you're buying and when and at what price. So that the day that you sell, you can have an accountant help you comply with whatever tax law is in your jurisdiction and maybe if you hold on long enough that'll be certain and clear.

Peter McCormack: I will include a bunch of notes in the show notes so people can follow this and they can find out more information. I think I've kind of interesting way to close this out though is let's take this back to Coin Center. This is a very complicated area, what are the things that you as an organization are pushing for? Where do you want to see changes? Where do you think this could all get a little bit easier?

Jerry Brito: So a lot of the work that we do is, you might say defensive in nature or educational in nature. So there are some very bad ideas that oftentimes showed up and we have to go in and explain how the technology actually works and how these ideas might not be the best fit. A good example of that recently was in response to the government's reaction to Libra.

There are any number of legislative proposals that would have regulated, not just the stable coin of Libra would be, but all stable coins and indeed in some of these bills, the way that stable coin was defined, it could have included Bitcoin, which is crazy, but that's the way it is. So a lot of what we do is defensive that way. On a proactive note, I think at this point we're very happy with, generally with the regulatory settlement that we've reached in the US.

We think tax is the one notable area where we need more clarity and an example of something there is a trying to get an exemption from capital gains for small Bitcoin and crypto currency transactions. So again, if you are buying let's say $1,000 of Bitcoin a month, because you're want to hold and you sell after a few years, clearly you did it as an investment and you're going to have to pay capital gains on whatever gains you've made.

But if you are buying Bitcoin because you want to tip Neeraj or you want to quite frankly maybe notarize some documents on the Bitcoin blockchain or something like that, those are small personal transactions that should be exempted from capital gains, because if they're not, that means you owe capital gains on every time you use the Bitcoin blockchain and that creates basically a law that nobody could possibly comply with.

So we've worked with representative Schweiker and representative DelBene in Congress to introduce a bill that would create an exemption from capital gains for cryptocurrency, the same way that one exists for foreign currency.

P. Van Valkenburgh: The only thing I'd add since we have your platform Peter, is that Coin Center is a non-profit. We rely on donations from people who like the work we do in order to operate and even if you think a lot of the sort of more lawyerly egghead stuff that we've described so far, isn't that important? Again, what Jerry said is right. Most of what we do is defensive, so it's two pronged.

We spend time building relationships with members of Congress and their staff so that there'll be a few members of Congress who understand the technology and believe in it when the day comes where something terrible happens and people start calling for a ban the protocol or a ban on people's use of the protocol. You need rational people to stand up and say, "look, just like we can't ban encryption, we can't ban Bitcoin" and we help cultivate those relationships.

Then the other is I write a number of pretty dense legal reports about things like the constitutional law of free speech and privacy in the US and why on any attempt to ban Bitcoin or use of the protocol might be unconstitutional because it would stop people's exercise of their free speech rights or their privacy rights. So if you think that work's important, which Jerry and I of course dedicate our lives to, please think about supporting Coin Center and don't hesitate to reach out to us.

Peter McCormack: Yeah, I will echo that. Firstly, if you guys didn't exist doing what you were doing, well firstly we wouldn't be doing this interview, but if I was doing this interview with somebody else, undoubtedly the things we would be discussing would be even more complicated because you've helped and guided some of the regulate the regulations that exist. You've been deeply involved and almost certainly you're going to make this... You say it's defensive, but almost certainly you got to make this all easier for us in the future.

So absolutely, if somebody is listening to this and you are a long-term Bitcoiner, you should be supporting Coin Center. But if you're new and you're just getting in, down the line, just remember these guys exist, remember the work they're doing. Also, go back and check out my other interviews with Peter. There's two previously, they're worth listening to and I will have Jerry on at some point, we will do our own one. We're going to go a little bit cypherpunk and a little bit radical and anarchist at some point. All right, so listen, if people do want to find out more, how do they find out? Where do they go to?

Jerry Brito: So we put all of our public advocacy materials on coincenter.org and you can also donate there if you'd like.

Peter McCormack: Awesome! Well listen, thanks guys for coming on, this was awesome. It's definitely going to be a little bit complicated for some people, but I think we summarized it up nicely, so appreciate you coming on.

P. Van Valkenburgh: Thanks for having us!

Jerry Brito: Thanks Peter!