At the end of March, the U.S. Internal Revenue Service (IRS) published its guidance (IRS Notice 2014-21) on the tax treatment of virtual (or digital) currencies, such as Bitcoin. The IRS indicated that for federal tax purposes virtual currencies should be treated as property and thus could be subject to income or capital gains tax.
While this virtual currency may act like “real” currency, it is not a currency according to the IRS and the U.S. Financial Crimes Enforcement Network (FinCEN). Employee salaries may be paid in bitcoin, products purchased using bitcoin and investments made in bitcoin, but at the time of writing bitcoin does not have legal tender status in any jurisdiction. Its status is, however, evolving worldwide as more and more governments are being forced to express an opinion on virtual currencies such as bitcoin, dogecoin or litecoin.
The current digital cryptocurrencies (de-centralised virtual currencies based on the principles of cryptography, of which Bitcoin is the best known example) have not been issued by governments, so this makes classifying them as a currency in the traditional sense difficult. Nevertheless several governments have already pronounced on the legality of using bitcoin. While some have sought to restrict its use, few are currently looking to ban it altogether. The Central Bank of Iceland reportedly indicated that engaging in foreign exchange trading with bitcoins is prohibited, in line with restrictions on capital movements in place since the collapse of the Icelandic banking sector during the recent global financial crisis. Brazil and China are among the few countries that have specific regulations related to bitcoin use.
China, which defines bitcoin as a special “virtual commodity”, specifically prohibits financial and payments institutions from dealing in it. Mexico and India have suggested financial authorities may not be allowed to engage in operations with digital currencies, while Russia hints at cryptocurrencies being monetary surrogates, which are prohibited by current law. In contrast, Italy—adopting the more favorable stance held by the EU—allows the use of virtual currencies but restricts it to banks and electronic money institutions that are authorized and registered by the Central Bank of Italy. Meanwhile, the German Finance Ministry refers to bitcoin as a financial instrument, which in most use cases would not require bank supervisory licensing.
Many countries warn the public about the inherent risks of using virtual currencies and focus on fraud and tax evasion issues. Some European countries, such as France, have called for European regulators to define a common set of regulations related to digital currencies.
With so many different approaches towards the regulation of virtual currencies, the position of banks seeking to define their virtual currency strategy is a difficult one. Few banks today operate in solely domestic markets. As global banks seek to expand, they are increasingly confronted with different local banking regulations, yet virtual currencies were specifically designed as transnational currencies. Global banking authorities need to create some common understanding of basic regulations related to engagement with virtual currencies so banks may play an active role in the innovative digital payment solutions helping safe-guard their customers, while cutting down the potential for fraud.