When Is Bitcoin “Money” Versus a “Security”? In motions involving a high-profile criminal prosecution with ties to Silk Road and a Securities and Exchange Commission (SEC) enforcement action, two federal courts have clarified the circumstances in which Bitcoin will be considered money or a security. 

Bitcoin Is Money. U.S. District Court Judge Jed S. Rakoff denied in late August a motion to dismiss a pending indictment alleging money laundering by an “underground” Bitcoin exchanger. The defendant, Robert M. Faiella, argued, among other things, that Bitcoin is not “money” for purposes of federal law and that such a novel and unanticipated construction of the statute would operate like an ex post facto law, in violation of his due process rights. He also argued that operating a Bitcoin exchange does not constitute transmitting money under relevant U.S. law and that he was not a money transmitter.

But Judge Rakoff disagreed on the first argument, ruling that “Bitcoin clearly qualifies as ‘money’ or ‘funds,’” as the digital currency “can be easily purchased in exchange for ordinary currency, acts as a denominator of value, and is used to conduct financial transactions.” Congress likely “designed the statute to keep pace with evolving threats,” he added.

He also rejected the argument that the sale of Bitcoin was not transmitting money to another person or location because Bitcoin was transferred to and held under the control of Silk Road – and not the users – for a profit. Finally, he said that Faiella “clearly qualifies” as a money transmitter pursuant to guidance issued by the Financial Crimes Enforcement Network (FinCEN) in March 2013 clarifying when virtual currency exchangers constitute “money transmitters” under its regulations.

Bitcoin Is a Security. Similarly, in the now long-running Shavers case, a federal court granted in part and rejected in part the defendant’s motion for reconsideration of a civil action accusing him of violating federal securities laws in his operation of Bitcoin Savings and Trust (BTCST).

Trendon T. Shavers, who was charged in 2013 by the SEC with scamming consumers out of 263,104 Bitcoin by offering investors a specific percentage in interest daily, sought to dismiss the charges, telling the court that all of his transactions involved Bitcoin, so that no money ever changed hands.

The SEC took the position that the BTCST investments met the definition of a “security” because they were both investment contracts and notes.

U.S. District Court Judge Amos L. Mazzant said the SEC established that the BTCST investments constituted an “investment contract” under the statute as a transaction involving an investment of money in a common enterprise with the expectations that profits will be derived from the efforts of the promoter or a third party. The court added that Bitcoin did not need to be cash, as the “investment of money” is understood to take the form of “goods and services” or other “exchange of value.”

Judge Mazzant was not swayed by the Internal Revenue Service’s declaration that Bitcoin is property, not money. “[T]he IRS Notice did not make any determinations about whether Bitcoins are money or not, only that for federal tax purposes, Bitcoins are to be treated as property,” the court said, adding that FinCEN’s guidance further “demonstrates that virtual currencies, like Bitcoin, are being treated like money for purposes of federal regulation.”

“Even if the court accepts defendant’s contention that Bitcoin is more akin to property rather than money, Bitcoin still satisfies the ‘investment of money’” requirement, the court wrote. “For example, in order to participate in defendant’s investment scheme, investors were required to give up a specific consideration, Bitcoin, in return for the promised consideration, which was the 7 percent return on their investment brought about by the efforts of Shavers.”

Note: The court subsequently issued a permanent injunction against Mr. Shavers and BTCST from violating federal securities, ordered disgorgement of more than $40 million and imposed a civil fine of $150,000 on both parties.

Is the Shrem Plea a New Way to Prosecute Bitcoin Ventures? Following the determination that Bitcoin is money for purposes of federal criminal statutes, former BitInstant CEO and 24-year-old Charlie Shrem pleaded guilty in New York federal court to one count of aiding and abetting his codefendant in the operation of a money transmitting business that was (a) unregistered and (b) involved in the transportation and transmission of funds intended to be used to promote and support the unlawful activity of narcotic trafficking on the Silk Road website. His codefendant Robert Faiella pleaded guilty to one count of operating an unregistered money transmitting business.

According to documents filed by the Department of Justice, Shrem allowed Faiella to use BitInstant to buy Bitcoin that Faiella’s customers could use to buy illegal drugs on the “sprawling and anonymous black market bazaar” Silk Road website, shuttered last year by the federal government. The original complaint, which had been sealed, was filed in January 2013. Shrem and Faiella – high-profile members of the Bitcoin community – were arrested and charged in January 2014.

FTC Acts to Close Manufacture of Bitcoin Mining Equipment. At the request of the Federal Trade Commission, a federal court has granted a temporary restraining order and asset freeze against BF Labs, Inc., a manufacturer of equipment used in mining Bitcoin, and several individuals. The lengthy order states that the company, commonly known as Butterfly Labs, must stop immediately representing how much Bitcoin can be mined using the equipment and when the equipment will be delivered. The order also appoints a temporary receiver with extraordinary powers over every aspect of the company and permits the FTC and the temporary receiver to repatriate assets outside the U.S. The company had been the subject of numerous consumer complaints in recent months.

To read the order in United States v. Faiella, click here.

To read the order in United States of America v. Shrem, click here.

To read the order in Federal Trade Commission v. BF Labs, Inc., click here.

To read the order in Securities and Exchange Commission v. Shavers, click here.

Why it matters: As the adoption of digital currencies expands, regulatory agencies and the courts are confronted with interpreting existing laws in the context of the new technology. The courts are not shying away from their duties in this regard. The stakes are high–criminal convictions, court orders to shut down businesses and freeze assets, substantial fines and orders to disgorge. For both businesses and investors in the digital currency community, these stakes increasingly make imperative the task of ensuring that they properly understand how existing laws and regulations may apply to the business models and take the necessary actions to protect the enterprise.