Consumer Finance Insights (CFI)

On June 26, 2014, the Government Accountability Office (GAO) issued a report entitled “Virtual Currencies: Emerging Regulatory, Law Enforcement, and Consumer Protection Challenges.”  The report discusses the benefits and disadvantages of virtual currency and reviews efforts to date by federal agencies to regulate the virtual currency market.  The report concludes that, while multiple financial and law enforcement agencies are beginning to think about their role in regulating virtual currency transactions, the CFPB should get involved to establish consumer protection regulations to govern virtual currencies.

Virtual currency (a digital representation of value that functions like currency in the markets that recognize it, but it is not government-issued legal tender) is not widely accepted in place of regular currency, though some virtual currencies can be exchanged for goods and services, and can even be converted into real currency though virtual currency exchanges.

The most widely-known virtual currency today is bitcoin, developed in 2009.  There are nearly 13 million bitcoins currently in circulation, and as of the time of this writing, one bitcoin was worth $644.56, making the bitcoin market worth nearly $8.4 billion total.  (The current exchange rate can be found here: http://www.coindesk.com/price/).

Virtual currency systems like bitcoin offer many user benefits, including anonymity, low transaction costs, and the ability to access the currency from anywhere in the world.  The increased privacy of virtual currency transactions, in particular, has earned broad attention for currencies like bitcoin: virtual currency transactions do not require disclosure of either transacting party’s name, Social Security Number, bank account number, or other identifying information. This feature makes such transactions more private and possibly more secure.

Government agencies are finding virtual currencies to be logistically difficult to regulate.  Nonetheless, to address the risks virtual currency may pose – including risks to individual investors and concerns about criminal activity, a number of U.S. financial regulators and law enforcement agencies have acted to control the use of virtual currencies:

• The Financial Crimes Enforcement Network (FinCEN), which administers the Bank Secrecy Act (BSA) to prevent U.S. financial institutions from being used as intermediaries for the transfer of money connected with criminal activity, has been especially active in adapting to the demands of virtual currencies. In July of 2011, FinCEN modified the definition of “money transmitters” to include certain virtual currency exchangers and administrators, bringing them under the ambit of the BSA.  Since then, FinCEN has issued several clarifying administrative rulings in March 2013, January 2014, and April 2014 to more clearly define who is subject to the BSA requirements and who is not.

• In July of 2013, the Securities and Exchange Commission (SEC) charged a company called Bitcoin Savings and Trust with defrauding investors in a “bitcoin-denominated Ponzi scheme.”  The SEC has also issued two investor alerts (available here and here) warning of potential fraud risks associated with virtual currencies.

• Law enforcement agencies, including the Department of Justice, the FBI, the Drug Enforcement Administration, the Bureau of Alcohol, Tobacco, Firearms, and Explosives, U.S. Immigrations and Customs Enforcement, and the Office of Foreign Assets Control, have individually and cooperatively worked to investigate and stop illegal activities relating to virtual currencies.  Well-known examples include the indictment against Ross Ulbricht, the owner of the black market website Silk Road, the seizure of the accounts of Mt. Gox, and the shutdown of the virtual currency system Liberty Reserve.

As the GAO report notes, however, little has been done to protect consumers from risks like market volatility or risk of loss due to theft.  As a result, the GAO proposes that the Consumer Financial Protection Bureau (CFPB) take the lead in establishing consumer protections for the use of virtual currencies.  According to the GAO, CFPB representatives reported that the young agency has not yet been active in regulating virtual currencies – in part because the risks to consumers have been slower to emerge than law enforcement concerns like money laundering and other financial crimes.  The CFPB has indicated that it has not received many consumer complaints regarding virtual currencies, and more fundamentally, it is still unclear to what extent average consumers are actually using virtual currencies.

As the use of virtual currency increases, however, consumers complaints – whether due to fraud, sudden devaluation, loopholes in applicable consumer protection laws, or some other risk not yet anticipated – are likely to increase.  If that happens, the CFPB will join other financial industry regulators in imposing consumer protection requirements.