This morning, I came across a blog post by Daniel Friedberg from the law firm, Riddell Williams. In the post, he attempts to show how certain laws and regulations could be applied to various actors within the industry, were they to create or facilitate the adoption of a hard fork of the Bitcoin blockchain and software.
I would be interested to know whether Friedberg developed these interpretations while pursuing client work, or if he and his firm are just really into Bitcoin. I have to assume the former, since I am hearing rumors that some of the competing Bitcoin development teams are attempting to use lawyers to stop, or at least chill, the actions of others.
Let me start by saying how horrible of an approach this is. Lawyers are not going to solve Bitcoin consensus issues, they will only make them more expensive. For as long as Bitcoin remains truly decentralized, no one party can be held responsible for anything related to adoption or implementation of new Bitcoin software or forks. That said, I do think there could be liabilities for certain actors, like exchanges, who may fumble the transition to a new Bitcoin, but not in the context Friedberg is concerned with.
I’ll do this in footnote style. Friedberg’s original post is in italics below. All of my responses are in the superscript footnotes throughout. They are also listed in full at the bottom of this post.
Requirement for Creators to Register with FinCEN
The Financial Crimes Enforcement Network (“FinCEN”) … has issued numerous guidance and interpretations of the applicability of regulations implementing the Bank Secrecy Act (“BSA”) to persons creating virtual currencies. [note]That guidance is primarily here, and in some response letters to specific businesses. If I missed something relevant, please help out by linking![/note]
Bitcoin Classic and BitcoinXT (meaning in this case the new resulting currency itself rather than the software [note]This distinction is important, as I think Friedberg loses sight of it at will.[/note]) would likely be considered by FinCEN to be a new convertible virtual currency. FinCEN has made it clear that a creator of such convertible virtual currency, who issues such currency in order to sell those units for either real currency or its equivalent (including presumably an exchange with current bitcoin [note]Yes, exchanges are regulated by FinCEN, on that we can agree. However, creators are not. Bitcoin has no issuer, unless you want to get creative and call miners issuers, but they have already been specifically excluded from FinCEN obligations.[/note]), is deemed to be a money transmitter. [note]This is incorrect, FinCEN does not actually address any entity resembling a “creator” or “issuer”. FinCEN does not regulate what it defines as “Users” of virtual currency, nor does it distinguish between any form of creating units of them, to quote FinCEN: “How a person engages in “obtaining” a virtual currency may be described using any number of other terms, such as “earning,” “harvesting,” “mining,” “creating,” “auto-generating,” “manufacturing,” or “purchasing,” depending on the details of the specific virtual currency model involved. For purposes of this guidance, the label applied to a particular process of obtaining a virtual currency is not material to the legal characterization under the BSA of the process or of the person engaging in the process.”[/note] … The Bitcoin Classic development team is also publicly named. Under this approach, the creators of Bitcoin Classic or BitcoinXT would need to register with FinCEN as a Money Service Business (“MSB”). [note]As my prior note details, this perspective is obviously absurd. Being that none of these developers are distributing/exchanging/selling units of currency, they are under no regulations applicable by FinCEN.[/note]
Requirement to Include AML Protocols in Bitcoin Classic or BitcoinXT [note]Developers are not MSBs, therefore they are under no obligation to conduct AML actions. How exactly is one to launder money within the Bitcoin protocol in the first place?! Money is laundered when it is exchanged. This section is mostly useless unless you needed a reminder that MSBs/exchanges must have AML in place.[/note]
In addition to the registration requirements, an MSB is required to maintain effective anti-money laundering (AML) programs …
These requirements will require the replacement Bitcoin protocol to maintain the personal identifying information of its users. [note]This is a pretty huge leap, and a rather loaded comment. AML is only required by those exchanging/selling currency units, simple as that. This applies only to centralized business actors. FinCEN does note regulate software.[/note] This can presumably be done through the software code … [note] No, it can’t. If the government wants to develop and maintain a web-based identity protocol, then maybe we can start to have that conversation…[/note]
The adherence to such requirements will be a large deviation from the current Bitcoin protocol which does not maintain personally identifiable information about its users. The inclusion of such information would make Bitcoin Classic and BitcoinXT much more accepted by financial institutions [note] To my knowledge, neither of these protocols ever had any intent to implement identity features into their software, but sure, if a virtual currency had such features a bank would be more keen to get involved. But that isn’t Bitcoin, that’s something R3CEV and friends will attempt instead.[/note], but runs counter to the essence of bitcoin. Bitcoin’s creator designed bitcoin to allow peer-to-peer financial exchange without the use of financial intermediaries and all the complexities involved with such intermediaries, such as identifying the users. [note]Exactly! So why contradict yourself?[/note]
Issues for Exchanges and Wallets
… The implementation of a “hard fork” would require exchanges to differentiate between bitcoin and “Bitcoin Classic” or “BitcoinXT” bitcoin, as its customers would inherently have rights to either one or the other. [note]Incorrect, they have rights to both. The new chain is a copy, not a replacement.[/note] Exchanges could not mix or intermingle the two, as each has its own rights. [note]While this is true, an exchange can maintain both versions and allow customers to withdraw both types of units. However, the exchange can freely decide whether to offer fiat exchange services for either, neither, or both versions within its own decision process for profitability.[/note] …
The “hard fork” would hurt the liquidity of bitcoin, and impair exchanges ability to legally operate. [note] It’s odd for Friedberg to make this comment without backing it up. How does a hard fork newly impair an exchange’s ability to legally operate? It makes it more expensive, sure, but less legal, how?[/note]
Potential Liability for Miners who Adopt New Protocol
Miners who unilaterally adopt the new replacement software could face liability under either tortious or statutory claims. A tort is a wrongful act or an infringement of a right leading to civil legal liability.[note] WOW, just WOW! What “rights” are you even referring to? Bitcoin is not legal tender. A miner is not a MSB, nor is it under any obligation to provide hashing service with/without discrimination.[/note] A trespass to chattels is a tort whereby a party intentionally interferes with another person’s personal property. To the extent that a recipient of bitcoin expects normal bitcoin but instead receives “Bitcoin Classic” or “BitcoinXT” virtual currency due to the actions of a miner, that recipient could argue that the actions of the miner resulted in a dispossession. [note] No miner has the ability to take your version of Bitcoin away, or replace it.[/note] To the extent that the market value of the two types of virtual currency differ, damages would be easy to prove. [note]Friedberg does not understand that no one loses any coins or ability to own coins after a hard fork. They simply now own coins on both networks. Miners are under no obligation to apply their hashpower to any specific fork or virtual currency, get real man.[/note]
There are also numerous state statutes prohibiting computer crimes which could be applied to miners who unilaterally convert bitcoin into a new type of virtual currency. [note]Again, there is no conversion in the forking process. It is a duplication where the new copy has new software properties. Every actor has free ability to choose which fork to support and service.[/note] Bitcoin users have a business expectation that their Bitcoin transactions will be processed by miners using the established Bitcoin protocol, and miners should be cautious about interfering with this expectation. [note]This is an outright misinterpretation of the roles in place. Miners provide hashpower at will, to service whichever purpose/coin/fork their business determines to be most prudent or profitable. Bitcoin holders have no expectation of service from any one miner, only an expectation that the protocol will execute with all compatible and participating actors. Miners have no ability to interfere, in this context at least.[/note]
The current proposed “hard fork” replacement software seems at first blush to be a reasonable way to solve Bitcoin’s growth issues. However, due to the lack of consensus of applicable Bitcoin network participants, the enactment would create serious legal consequences for the creators of the new replacement software [note]This is where the author should have realized his mistakes, he places “legal consequences” on “software”.[/note], unless the creators [note] Again, FinCEN specifically notes that creators are not under their regulatory requirements.[/note] adhere to the rules of MSB registration and compliance. In addition, the “hard fork” would create serious operational issues for exchanges and wallet operators [note]Sure, but an “operational” issue is only a legal issue if they fuck up and try to make decisions for their customers. If they provide parallel ability to withdraw, they should be fine.[/note], the risk of liability for participating miners, and unnecessary confusion in the marketplace.
In summary, I believe I have fully refuted all of Friedberg’s perspectives on these matters. It’s sad that the legal world is so behind when it comes to Bitcoin. I have experienced this first hand, and I was reminded again today by Mr. Friedberg.
UPDATE: Someone shared this post with me, from Dan Friedberg three years ago, on behalf of the Bitcoin Foundation. Interesting to see what has and has not changed in today’s version. Also interesting to note the connection to Jon Matonis’ organization. I am putting the full original article in this last footnote for posterity, since I have no faith in their website being up for more than a year from now. [note]Original post link: https://bitcoinfoundation.org/guest-post-fincen-guidance-validates-bitcoin-industry-but-targets-satoshi/
“Guest Post: FinCEN Guidance Validates Bitcoin Industry but Targets Satoshi
Below is a guest post from Dan Friedberg, an attorney and friend of the Foundation. Dan and I were having a drink and discussing the implications of FinCEN’s latest guidelines and, as usual, Dan hit on some interesting points. So, I asked that he write them up to share with you all here. All thoughts and opinions, brilliant or otherwise, are his own.
*FinCEN Guidance Validates Bitcoin Industry but Targets Satoshi
By Dan Friedberg *
A week ago, a bureau of the US Treasury Department issued guidance on the application of money transmitter rules, which significantly impacts the Bitcoin industry. Although the guidance imposes obligations on certain industry participants, it is a positive first step towards regulatory acceptance, and, at least so far, the volatile bitcoin trading market has treated it as such.
FinCEN, the Department of the Treasury Financial Crimes Enforcement Network, issued guidance on March 18, 2013 available at HYPERLINK “http://www.fincen.gov” www.fincen.gov that addresses the legal treatment of virtual currencies such as Bitcoin.
For the uninitiated, FinCEN is a law enforcement bureau with the mission of safeguarding the financial system from illicit use, combating money laundering, and promoting national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities.
FinCEN clarified that in the eyes of the US Treasury, “virtual currency” is different from “real currency”. “Real currency” includes the United States dollar or money or other legal tender. “Virtual currency” like Bitcoin is not “real currency”. However, FinCEN indicated that certain “virtual currency” industry participants are money service businesses subject to registration requirements as well as a range of anti-money laundering and reporting responsibilities.
The guidance pulled no punches with respect to a “creator” of a de-centralized virtual currency. The creator of Bitcoin, known as Satoshi Nakamoto, falls squarely within these rules to the extent he is “a person that creates units of convertible virtual currency and sells those units to another person for real currency”.
Is a “miner” of bitcoin, a person who receives “new” bitcoin in exchange for his computing efforts, considered a “creator” under the guidance? A person who obtains bitcoin by his own manufacturing effort is not differentiated from an ordinary “user” under the guidance, and informal communications from regulatory sources indicate that it is unlikely the guidance intended to consider every “miner” a “creator”. This is confusing because in the bitcoin community, a successful miner might be thought of as creating new coin.
Also “exchangers” and “administrators”, including certain persons “engaged as a business” in “virtual currency” transactions are subject to money transmitter limitations and may be subject to licensure requirements.
One very positive aspect of the guidance is that it opens the door for the largest licensed money transmitters to accept and deal in bitcoin transactions, albeit subject to significant limitations, including BSA/AML requirements which would make bitcoin transactions much more transparent, in contrast to the anonymity of the current regime.
The FinCEN guidance has a significant impact on participants in the bitcoin industry. Market participants should retain qualified counsel to assess their business strategies, risks and compliance programs in light of this guidance.
About the Author
Dan Friedberg of Graham & Dunn PC is a business lawyer specializing in complex transactions and regulatory compliance, including digital currency. Dan works with many different members of the bitcoin community. Graham & Dunn PC is a Seattle business law firm founded in 1890 with an established non-banking payments, virtual currency and e-commerce practice.“[/note]