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Cryptocurrencies: An international and local perspective

Cryptocurrency, also known as ‘virtual currencies’ or ‘cryptographic money’ is a digital form of currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds. Cryptocurrencies operate completely independently of a central bank. They are essentially a decentralised digital cash system.

The European Central Bank defines cryptocurrency as:

a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a flat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically 

See a diagram indicating the process underlying cryptocurrencies here.

  1. Features of cryptocurrencies 
  1. Transactions are simple, streamlined and global

The transactions can be concluded extremely quickly, almost instantaneously and can occur internationally as it is a global network. Transactions can be made between users irrespective of their physical geographical location.

  1. The transactions are secure and anonymous

Due to the fact that cryptocurrencies are encrypted strings of data which are encoded in order to make up each unit of currency, they are secure and only the owner of a private key is able to send the cryptocurrency to another digital identity. Thus encryption is utilised for security.

Such transactions are more secure than traditional electronic payments and are protected against inflation as well as exchange control and tax implications.

The transactions as well as the individual accounts are not connected to the user’s actual identity or personal information in any way so a transaction cannot be traced back to the individual user’s identity or their account.

  1. Cryptocurrencies are decentralised and easily accessible

There is no overarching governmental oversight or centralised authority as cryptocurrencies are monitored by a peer-to-peer internet protocol and the software can be downloaded and used by anyone. 

  1. Challenges surrounding Cryptocurrencies
  1. Irreversible

Once made, the transactions cannot be reversed by anyone. There is also no limit on the amount that can be transferred.

  1. Unregulated

The progressive features of cryptocurrencies such as the decentralised nature, the virtual anonymity, the global scale and the ease of access allow both legal and criminal users to make transfers with ease, fast and efficiently.

This poses challenges for law enforcement, due to the ability of cryptocurrencies to instantaneously transcend national borders while providing anonymity and security.

Due to high-level encryption, the transmission of value across national borders without government interference makes cryptocurrencies an attractive payment option for illicit activities such as money laundering, pornography, drug and arms deals.

This is further exasperated by the fact that these transactions occur online between users that could be in completely different jurisdictions. As a result, investigating whether laws have been broken and crimes committed becomes incredibly challenging as there is no internationally accepted framework regulating these transactions and international collaboration and support is required in order to undertake such investigations.

  1. Government intervention in various jurisdictions 

Some governments are concerned that these private payment systems will weaken measures to control the value of their own currencies, which has led to regulatory measures being implemented in various jurisdictions, by way of example:

In Russia it is illegal to pay for anything with cryptocurrencies. Bitcoin is banned in China and Cryptocurrencies in general are illegal in Vietnam, Bangladesh and some countries in South America.

Cryptocurrency is unregulated in America and South Africa. However, Canada is the first jurisdiction in the world to have introduced legislation regulating Bitcoin.

D.1     The Legal Position in Canada 

In June 2014 Canada passed legislation regulating virtual currencies as “money service businesses”, treating virtual currencies, including Bitcoin as “money service business” for the purposes of its anti-money laundering legislation.

This legislation, Bill C-31, will apply to cryptocurrency transactions within Canada as well as those outside of Canada who transact with persons or entities within Canada.

The legislation, though not yet in force, will result in companies that deal in virtual currencies having to register with the Financial Transactions and Reports Analysis Centre of Canada (Fintrac). These companies will also have to implement compliance programs, such as to: “keep and retain prescribed records,” report suspicious or terrorist-related property transactions, and determine if any of their customers are “politically exposed persons.”

The new legislation prohibits banks from opening and maintaining accounts or having a “correspondent banking relationship” with companies dealing in virtual currencies, “unless that person or entity is registered with the Centre.”

D.2     The Legal Position in the United States of America 

In May 2017, a bill was introduced in the United States of America which regulates cryptocurrencies, in the sense that the bill incorporates and deals with instances in which funds are stored in digital format and includes these in the definition of monetary instruments.  The Bill is called the ‘Combating Money laundering, Terrorist Financing, and Counterfeiting Act’

Cases in the United States that dealt with cryptocurrencies by incorporating them into the definition of money: 

  • United States v Ulbricht 2014

The defendant, Ross Ulbricht was charged with trafficking narcotics, distribution of narcotics online, narcotics trafficking conspiracy, continuing a criminal enterprise, conspiracy to commit and aid and abet computer hacking, conspiracy to traffic in fraudulent Identification documents and money laundering conspiracy.

The charges arose from the fact that the defendant had launched, and supervised the administration of an online marketplace named ‘Silk Road’ for illicit goods and services. The site was ‘designed to operate like eBay: a seller would electronically post goods or service for sale, a buyer would electronically purchase the item.

The defendant, made the site available only to those using a unique anonymous internet browser, “Tor”, and he allowed payment only via Bitcoin.

With regards to the charges for money laundering, defendant argued that because Bitcoin is not a monetary instrument, transactions involving Bitcoin cannot form the basis for a money laundering conspiracy. He continued to state that virtual currencies have some but not all of the attributes of currencies of national governments and that virtual currencies do not have legal tender status.

The court found that the money laundering statute was broad enough to encompass the use of Bitcoin in financial transactions. The statute was intended to prevent criminals from finding ways to wash the proceeds of criminal activity by transferring proceeds to other similar or different items that store significant value.

There is no doubt that if a narcotics transaction was paid for in cash, which was later exchanged for gold, and then converted back to cash, that would constitute a money laundering transaction. The court further submitted that  Bitcoin carry value and act as a medium of exchange, they can be exchanged for legal tender whether it is US dollars, euros or other currency.

  • United States v Murgio 2016

The defendant, Anthony Murgio was charged with among other offences, operating a Bitcoin exchange site in violation of the money transmitting laws.

The Bitcoin exchange he ran was called Coin.mx, which was an “unlicensed money transmitting business”. The defendant argued firstly that Bitcoin does not qualify as “funds” for the purpose of the definition in the statute. Secondly exchanging Bitcoin does not involve “transferring” customers’ funds to other persons or places. Thirdly operating a Bitcoin exchange in the state of Florida, where Coin.mx operated, does not require a license.

The court rejected all of the defendant’s arguments. The court found that Bitcoin does constitute “funds” within the plain meaning of that term. Rejecting the defendant’s argument that “funds” refers only to “currency,” it was found that the term instead encompasses any “pecuniary resources” that can be used as a “medium of exchange,” and that Bitcoin meets that description. 

B.3     The Legal position in South Africa  

Although cryptocurrencies are not regulated in South Africa there has been much debate surrounding how to treat cryptocurrencies for the purposes of tax and exchange control. The debate centres around whether they should be treated as “assets” to which taxes such as Capital Gains Tax would apply, or legal tender, to which taxation on normal income would apply.

  1. Exchange control implications

The SA reserve bank has issued a Position Paper in which it is stated that cryptocurrencies such as Bitcoin, are a digital representation of value that can be digitally traded and function as a medium of exchange, a unit of account and or a store of value, but does not have legal tender status’. It is thus not subject to regulation by the SA Reserve Bank.

It has been submitted that the SA Reserve Bank intends releasing a new Position Paper dealing with private cryptocurrencies. 

  1. Tax Implications

The National Treasury has submitted that South Africa’s tax laws are already broad enough to deal with transactions encompassing cryptocurrencies.

In their media release of April 2018, the South African Revenue Service (SARS) stated that they shall “continue to apply normal income tax rules to cryptocurrencies and will expect affected taxpayers to declare cryptocurrency gains or losses as part of their taxable income”.

However, how do we define cryptocurrencies for tax purposes? Are they regarded ‘currencies’, or ‘assets’, in which case one would deal with them under the ordinary principles of tax legislation.

In their media release SARS states that ‘Cryptocurrencies are neither official South African tender nor widely used and accepted as a medium of payment or exchange and are therefore not regarded by SARS as a currency for income tax purposes or Capital Gains Tax (CGT).

Instead, cryptocurrencies are regarded by SARS as assets of an intangible nature.

They continue to state that cryptocurrencies can be valued to determine whether an amount has been received or accrued as envisaged in the definition of “gross income” in the Act’ and therefore taxed on the revenue account under “gross income”. If they are capital in nature, they will be dealt with as such in the Eighth Schedule to the Act for taxation under the CGT paradigm.

However, the circumstances of the specific taxpayer should also be taken into account when determining whether the transaction should be treated as that of capital or revenue and thus subject to income tax or capital gains tax.

The Taxation Laws Amendment Bill of 2018 proposes that ‘any cryptocurrency is to be included in the definition of ‘financial instrument’.

There is also debate around the fact that the supply of Bitcoin in exchange for value could be vatable as the supply of a service. Some are of the opinion that Bitcoin constitutes an incorporeal right, due to the fact that it cannot be physically delivered and are neither corporeal movable things, fixed property or real rights in a corporeal thing and therefore the sale of same should constitute the supply of a service for the purpose of the VAT Act.

In their media statement SARS states that the ‘VAT implications of cryptocurrencies will be reviewed. Pending policy clarity in this regard, SARS will not require VAT registration as a vendor for purposes of the supply of cryptocurrencies.

  1. Conclusion

In an age of accelerated technological advances and innovations, it is imperative for the law of any nation to stay updated and for legal minds to be able to adapt swiftly to the constant changes in our society.

Cryptocurrencies bring with them a brave new world, an increasingly popular and effective private payment method with many benefits and equally as many risks attached. South African legislators need to adapt in order to regulate their use.

The prevailing view appears to be that it serves little purpose in trying to over-regulate the use of cryptocurrencies when the existing legal framework and traditional methods and procedures are equipped to deal with the innovations. Minor amendments to current legislation in order to incorporate the use of cryptocurrencies may be all that is required in order to regulate their use.

 

BIBLIOGRAPHY

  • Charith Pathirana. What is cryptocurrency: 21st Century Unicorn – or money of the future? 2017.
  • Jason de Mink, The rise of Bitcoin and other cryptocurrencies. De Rebus.2017.
  • Jason de Mink, Dangers inherent in Bitcoin and other cryptocurrencies. De Rebus. 2018.
  • Robert Gad, Megan McCormack and Jo-Paula Roman, The tax and exchange control implications of cryptocurrency transactions. De Rebus. 2018.
  • Tariq Ahmad, Global Legal Monitor. Canada: Canada Passes Law Regulating Virtual currencies as “Money Service Businesses”. 2014.
  • SARS Media Release. SARS’s Stance on the Tax Treatment of Cryptocurrencies. 2018.
  • United States v Ulbricht 2014
  • United States v Murgio 2016

 

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