Bitcoin / digital currency

Bitcoin, Litecoin, Xcoin, PPCoin and numerous other systems are commonly referred to using the term “digital currency”. Motivated by significant profit margins when trading with Bitcoins, these digital currencies are becoming more and more prominent and attracting the interest of a wide public.

The currency originated as an independent alternative to the conventional banking system, which is not even trusted by its Japanese inventors. That is why the Bitcoin system is not controlled by a central office or by financial institutions and dependent, rather, it is comprised of an independent and decentralised, worldwide community of users. For a long time Bitcoins were regarded as dubious currency and were particularly well known as being used for illegal weapon and drug transactions, for example on the “Silk Road” online black market.

However, many see the "digital currency" or "e-currency" as a real alternative to existing currency systems and the idea of the "digital currency" becoming established as a real payment alternative, particularly in online trading, appears to be within reach. In the meantime, not only more companies are accepting Bitcoins as currency, such as the largest Chinese Internet portal, Baidu, but American sceptics are also becoming increasingly positive.

Trading with digital currency also appears to be tempting – while at the beginning of 2013, 1 Bitcoin could still be purchased for approx. €100.00, the price in November 2013 is at approx. €750.00.

What are the advantages and disadvantages of Bitcoin?

Bitcoin proponents particularly count on the advantages, such as low transaction fees for worldwide payments, high transfer speed and anonymity. In addition to this, the transfer is simple and secure, as everyone can acquire Bitcoins and pay with them just by opening a free account on a Bitcoin trading platform. Furthermore, the system is inflation-proof, as the number of possible Bitcoins generated cannot exceed 21 million. Therefore, Bitcoins could not only replace other online payment systems, such as PayPal, but could also be used as a means of preserving value with a high security function, similar to gold or silver.

However, the Bitcoin system is regarded critically and is still seen as an experimental system, which can also be seen by the significant price fluctuations in recent years. Not many businesses and service providers currently accept the new currency. Furthermore, the underlying computer system is complicated and cannot be managed by each individual. Not least, because errors sometimes still occur in the software and viruses could also threaten the security of the safekeeping and transactions. Also, the fact that a Bitcoin transfer cannot be reversed requires care and caution with the business partners.

Current economic situation


Due to the currency and financial crisis in Europe and the weakening share prices for many years, the alternative currency systems have moved more into focus for a wider public. Previously, enormous earning margins were possible when trading Bitcoins, with several early entrants virtually increasing their invested capital nearly thousand-fold one or two years ago. Recently, Bitcoins have been subject to extreme price fluctuations. Price rises of up to 20% within a few hours and declines in the same amount a short time later clearly show this. Particularly, the virtually unstoppable euphoria in China is currently driving the prices upwards again. The fact that the number is limited to 21 million Bitcoins due to technical calculation restrictions also motivates the buyers.

However, the increasing attention of the public is also moving the “digital currency” into focus for banks, which naturally have little interest in a parallel currency system being established, particularly one that was not subject to the strict banking and financial supervision regulations (BaFin) until recently. However, in the meantime, it is clear that operators of Bitcoin exchanges must also stand up to the requirements and controls of the BaFin.

Technical background of Bitcoin

What is a Bitcoin from a technical point of view?

A Bitcoin is an asymmetric cryptographic code (so-called key), which can be imagined as a multi-digit combination of numbers and letters. This code is generated on a computer system using a highly sophisticated method. The Bitcoins are stored in a type of digital wallet. This wallet is either situated on the user's own computer or with a provider.

How are Bitcoins generated?

Bitcoins are “scooped” in a decentralised manner, i.e. from the various participants and computer networks. In order to "earn” a Bitcoin, a program must be installed on the computer, a so-called “Bitcoin-miner", which performs complicated algorithms and calculates. The aim is a so-called hash value. If the calculation is solved by the computer, a specific number of Bitcoins is received as a reward. These are not backed by an intrinsic value. Anyone can basically create Bitcoins, as the required programs are free and the source code is also freely available, however, the required processing power is so high, that it is not worthwhile for normal consumers to generate Bitcoins themselves. The electricity bill and the costs for a computer with appropriate processing power would by far exceed the value of the generated Bitcoins.

How are Bitcoins transferred?

Anyone can pay and be paid, who has installed an online wallet and has obtained a Bitcoin address. Transactions can take place through these exchanges. In order to verify with certainty that a transaction has actually taken place by an authorised party and only once, “proof-of-work” chains are added. The network gives the transactions a time reference, in which it sequences a continuing “proof-of-work" chain. This creates a record that can only be changed by modifying the “proof-of-work”. This prevents multiple use. With a Bitcoin transfer, an electronic signature is also added, in order to ensure additional security. After a confirmation, the transaction is permanently and anonymously saved in the entire network.

Legal assessment and classification of Bitcoins

On 7 August 2013, the German Ministry of Finance classified Bitcoins as “units of account” in an official opinion and therefore recognised it as private money. This classification was already carried out in the same way by the BAFIN and confronts the following legal background:

Bitcoins = currency?
Bitcoins cannot be a real currency as foreign exchange, as Bitcoins are not a real currency, are not issued by a central bank and are not subject to any state guarantee.

Bitcoins = e-money?
A classification as e-money is also ruled out.

E-money is defined as any electronically or magnetically stored monetary value in the form of a claim against the introducer, which is issued against payment of a monetary amount, in order to perform the payment processes of § 675 f Par. 3 Sentence 1 BGB [German Civil Code], and which is also accepted both other natural persons or legal entities than the issuer.

However, Bitcoins are missing the following criteria:
- “electronically stored monetary value” and

- “the claim against the issuer”


The classification as e-money therefore fails on the basis of the Bitcoins being generated in a decentralised manner by private individuals and redemption is not possible with the relevant introducer who has generated the Bitcoins. A basic return exchange of these generated Bitcoins with the relevant decentralised producers into real currency is not possible.

An example of e-money is the cash card, where a monetary amount that has been previously paid in is stored on a chip on the card.

Bitcoins = units of account!

The characteristic of the units of account is that they are not legal currencies, but are equivalent to foreign exchange in terms of their handling.

The German BAFIN regards private currencies are units of account in accordance with § 1 Par. 11 KWG [German Banking Act] and thus as financial instruments. Furthermore, in all of the assessments so far, the BAFIN has regarded Bitcoins as such a private currency.

Ramifications of this classification

But now, the exciting question is which concrete ramifications the now clear legal classification of Bitcoins has?

Ramifications for private individuals

Private individuals who trade with Bitcoins in order to generate price provides with rising Bitcoin prices must usually tax these profits.
Under tax law, the “Bitcoin” asset is created by exchanging euros into Bitcoins. A return exchange constitutes a private sale transaction in accordance with § 23 I 1 No. 2 EStG [German Income Tax Act]. 


Ramifications for companies that offer Bitcoins as products or services in relation to Bitcoins

Operators of so-called Bitcoin exchanges or companies that offer services in relation to Bitcoins must note in future that this usually constitutes a financial service transaction in accordance with § 1 Par. 1 a Sentence 2 KWG.

The financial service transactions are subject to authorisation. This means that the majority of business models that are related to Bitcoins require the prior authorisation of the BAFIN.

The issuance of such authorisation is subject to enormously high hurdles and strict requirements, such as deposits in individual cases of more than EUR 730,000.

  

CONCLUSION:

Bitcoins and all other types of digital currency are an enticing and interesting business field, which is by all means worth taking a closer look at. In legal terms, it involves a relatively new phenomenon, which has not yet been the subject of case law. This will certainly change during the coming years, which will also provide a significantly higher amount of legal certainty for all transactions using Bitcoins.