Can You Cash Your Coins?

Can you Cash Your Coins?

Written by: Blan Jarkasi and Lauren Ross

Bitcoins, a nearly-anonymous virtual currency,[1] are becoming an increasingly popular method of payment for vendors of legitimate goods.[2] Despite this increase in mainstream popularity, bitcoins are also a prime payment choice for individuals looking to make illicit transactions.[3] In October of 2013, the Federal Bureau of Investigations arrested Ross Ulbricht, a 29-year old San Francisco man suspected to be the mastermind behind Silk Road,[4] an online marketplace that allowed users to buy and sell a variety of illegal goods using bitcoins.[5]

Silk Road is a platform that functions not much differently from eBay, where buyers and sellers of goods can pair up and effectuate transactions through the web[6]. However, Silk Road, unlike the traditional online marketplace, allows buyers to select from a cornucopia of illegal narcotics.[7] The purchaser pays the dealer in bitcoins, which stay in an escrow account until they receive their order, at which point the purchaser’s funds transfer to the drug dealer.[8] This allows purchasers to pay online in a virtually anonymous manner and receive their wares in the mail without ever making a face-to-face interaction with a drug dealer[9]. In exchange for operating the sophisticated platform, the Silk Road administrative team collects a commission for each transaction[10].

The charges against Ross include one count of participation in a “money laundering conspiracy.”[11] In his defense, Ulbricht argued that bitcoins are not currency within the meaning of the federal money laundering statute.[12] On March 25, 2014, the IRS published a notice stating its treatment of virtual currency.[13] Under section 4 of the notice, the IRS announced that virtual currency would be treated like property for the purpose of federal taxation.[14] An individual receiving virtual currency will be taxed on the value of the currency on the date it is received.[15] The IRS recognizes gains and losses on virtual currency when the holder realizes it through sale or exchange.[16]

In his pre-trial motion to dismiss, Ulbricht contended that because the IRS classified virtual currency as property and not as monetary instruments in Notice 2014-21, transactions involving virtual currency lack legal tender status and cannot be “funds” constituting the basis of the money laundering charge.[17] The court rejected this argument, stating “that ‘financial transaction’ is broadly defined under the money laundering statute.”[18] The court defined the term “funds” as something that “can be used to pay for things in the colloquial sense” and held it is possible to use bitcoin to launder money.[19]

Ulbricht is scheduled for trial on November 1, 2014.[20] The rejection of Ulbricht’s pre-trial defenses has bitcoin enthusiasts worried about the ultimate outcome of the case.[21] Ulbricht’s case will set important legal precedent on how the government treats virtual currency for reasons other than taxation, something bitcoin users fear will further complicate the government’s regulation of bitcoins.[22] Although Ulbricht awaits trial, the U.S. Marshals service has already auctioned off nearly 30,000 of the bitcoins seized in connection with his investigation, at the time valued near 18 million dollars.[23]

 

[1] Russell Goldman, What are Bitcoins? Virtual Currency Explained (Like You’re an Idiot), ABC News (Nov. 18, 2013), http://abcnews.go.com/Technology/bitcoins-virtual-currency-explained-idiot/story?id=20926230 (Bitcoins are transferred between user “wallets,” which are attached to an “anonymous identification number.”).

[2] See Gertrude Chavez-Dreyfuss and Michael Connor, Bitcoin is Here to Stay, Business Insider (Aug. 28, 2014, 4:59AM), http://www.businessinsider.com/r-bitcoin-shows-staying-power-as-online-merchants-chase-digital-sparkle-2014-8.

[3] See Bitcoin: Monetarists Anonymous, The Economist (Sept. 29, 2012), available at http://www.economist.com/node/21563752 (discussion on the reasons bitcoin is “a natural conduit for criminal funds).

[4] Tim Hume, How FBI Caught Ross Ulbricht, Alleged Creator of Criminal Marketplace Silk Road, CNN, http://www.cnn.com/2013/10/04/world/americas/silk-road-ross-ulbricht/ (last updated Oct. 5, 2013, 11:10 AM).

[5] Id. Silk Road must be accessed through the TOR network, an online network that effectively anonymizes the browsing activity of its user;

Zach Epstein, How to find the Invisible Internet, Boy Genius Report (Jan. 20, 2014, 11:26 AM), http://bgr.com/2014/01/20/how-to-access-tor-silk-road-deep-web (provides more information on the technical aspects of the TOR network).

[6] Adrian Chen, The Underground Website Where You Can Buy Any Drug Imaginable, Gizmodo Australia (June 2, 2011, 3:14AM), http://www.gizmodo.com.au/2011/06/the-underground-website-where-you-can-buy-any-drug-imaginable/.

[7] See James Ball, Silk Road: The online drug marketplace that officials seem powerless to stop, the guardian (Mar. 22, 2013) http://www.theguardian.com/world/2013/mar/22/silk-road-online-drug-marketplace (gives a screenshot of some previously available merchandise.

[8] The Economist, supra note 3.

[9] See Chen, supra note 6.

[10] Adam Clark Estes, The Silk Road is Showing Cracks, MOTHERBOARD (Jan. 31, 2013, 4:20 PM), http://motherboard.vice.com/blog/the-silk-road-is-showing-cracks (The FBI alleges that Ulbricht “reaped commissions worth tens of millions of dollars[.]”).

[11] United States v. Ulbricht, No. 14-cr-68 (KBF), 2014 U.S. Dist. LEXIS 93093, at *1 (S.D.N.Y. July 9, 2014).

[12] Id. at *68.

[13] IRS Virtual Currency Guidance: Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply, IRS (Mar. 25, 2014), available at http://www.irs.gov/uac/Newsroom/IRS-Virtual-Currency-Guidance.

[14] I.R.S Notice 2014-21, 2014-16 I.R.B. 938.

[15] Id. at 4-5.

[16] Id. at 5-6.

[17] Ulbricht, No. 14-cr-68 (KBF) at *68-69.

[18] Id. at *69.

[19] Id. at *70, *72.

[20] Daniel Stuckey, Ross Ulbricht, Alleged Silk Road Kingpin, Gets His Court Date and His Data, MOTHERBOARD (Feb. 7, 2014, 3:45  PM), http://motherboard.vice.com/blog/ross-ulbricht-alleged-silk-road-kingpin-gets-his-court-date-and-his-data.

[21] Adam Clark Estes, Why the Future of Bitcoin Depends on the Bitcoin Trial, GIZOMODO (Apr. 1, 2014), http://gizmodo.com/why-the-future-of-bitcoin-depends-on-the-silk-road-tria-1556410399.

[22] See id.

[23] Devin Coldewey, Feds Auction 30,000 Bitcoins Seized in Silk Road Raid, NBC News (June 27, 2014, 8:12 PM), http://www.nbcnews.com/tech/tech-news/feds-auction-30-000-bitcoins-seized-silk-road-raid-n143091.