Sharon D. Nelson and John W. Simek 2014-11-27 09:57:30
What are bitcoins? Bitcoins are digital currency—and yes, lawyers are beginning to accept them from clients. They are also known as virtual currency or cryptocurrency since cryptography is used to control the creation and transfer of bitcoins. They use peer-to-peer technology with no central authority or banks. The issuance of bitcoins and the managing of transactions are carried out collectively by the network. The system was introduced as open source software in 2009 by Satoshi Nakamoto. For you trivia buffs, the capitalized “Bitcoin” refers to the technology and network and the lower case “bitcoin” refers to the actual digital currency. Bitcoins are created by a process called mining. We won’t go into all of the technology that is used to create and verify the bitcoin transactions, but suffice it to say that those users who provide computing power for Bitcoin get newly minted bitcoins in exchange for transaction fees to verify and record payments into a public ledger. All bitcoin transfers are recorded in a computer file called a block chain, which is synonymous to a ledger that deals with conventional money. Users send and receive bitcoins from their mobile device, computer, or Web application by using wallet software. Legality of bitcoins There is nothing illegal about bitcoins or the ability to trade or exchange them for services or real currency. However, bitcoins tend to be used to support criminal activities since Bitcoin users are anonymous. In fact, in October of last year the FBI shut down “Silk Road,” an anonymous Internet marketplace for illegal drugs like heroin and cocaine and criminal activities such as murder for hire, according to an article posted on Reuters. They also arrested Ross Ulbrich, the alleged founder of Silk Road and seized 144,000 bitcoins from him. Usage rules Even though bitcoins are virtual currency, there are still specific rules for this new payment method. Bitcoins have different recognition and status, depending on the jurisdiction. As an example, Germany does not classify bitcoins as a foreign currency, but rather a financial instrument under German banking rules. It is considered “private money” and can be used for tax and trading purposes. At the other side of the spectrum, bitcoins are banned in Thailand. But what about in the United States? The IRS finally answered that question in March of this year. They said that bitcoins are considered property, not money, for tax purposes. This means that gains will be taxed the same way as investing in other property when you buy low and sell high. How lawyers use bitcoins Bitcoins are used as a replacement for traditional credit card, cash, check, or electronic funds transfers. They are a quick and cheap alternative form of payment. Patrick Murck, executive director to the Bitcoin Foundation, said that he accepted bitcoins from clients when he was in private practice. With credit cards, you get hit with a processing fee. With bitcoins, he was paid within minutes in an irreversible manner without fees. Anonymous transactions are attractive to particular clients, and several attorneys are taking advantage of the technology. Noted criminal defense attorney Arkady Bukh specializes in cybercriminal cases. He has begun accepting bitcoins as payment, which helps ensure the privacy that his clients demand. Bitcoins eliminate the audit trail that accompanies checks or credit cards. Bukh, attorney for alleged Boston Marathon bombing conspirator Azamat Tazhayakov, has also represented several well-known cybercriminals over the years. Not all law firms accepting bitcoins are criminal defense firms. Law 4 Small Business has clients all over the country and accepts bitcoins to avoid credit card transaction and wire transfer fees. English entertainment and media law firm Sheridans has begun accepting them. By the time this gets to print, you can bet that more law firms will be accepting them—some are actually using the fact that they do as a marketing strategy. How long do they last? Lost or stolen bitcoins are gone forever. If you buy bitcoins or use them as payment, the transaction is transmitted via code using a private key. If you lose the private key, then access to the bitcoins in your wallet goes up in virtual smoke. No key—no access. There is no person or central bank to reclaim your key. What does this mean for the common user? Make sure you protect your key and wallet. You should also consider encrypting your wallet to protect it from being stolen by hackers. According to Digital Forensic Investigator News, for just $35, you can buy a specialized malware tool designed to steal bitcoins. They also report that the detection rate of such malware by the antivirus tools is below 50 percent— even more reason to protect your electronic currency. Finally, make sure you back up your encrypted wallet. Volatility Make no mistake about it, bitcoin valuation is a very volatile market. The value of a bitcoin has soared to huge heights and then rapidly crashed to nearly nothing. As an example, in January 2013, the value of a bitcoin was $15.68. On April 3, 2013, the value went from $106 up to $147 and then down to $125 in a single day. In December 2013, the market value of a bitcoin approached $1,200. As you can see, the value of bitcoins is all over the place. Some people count on the volatility to make some big money very quickly, but you can also lose in fast fashion, too. Investing in bitcoins seems more like gambling than a solid financial strategy. Technology hiccups Let’s face it—at some point, technology will fail. In the case of Bitcoin, high-volume traffic can cause a temporary shutdown. As we’ve mentioned before, a hard disk failure could cause you to lose your entire wallet. That’s one of the reasons why the really serious Bitcoin users have multiple wallets in multiple locations. In March 2013, a technical glitch caused a fork in the block chain (ledger for bitcoins). Half of the network added blocks to one version of the chain and the other half added to another chain. This meant that there were two Bitcoin networks operating at the same time (version 0.8 and version 0.7). In order to fix the problem there was a temporary halt of all transactions, which caused a sharp sell-off. In layman’s terms, there was a failure of the database upgrade used in version 0.8, which caused the fork to occur. The major Bitcoin developers and miners spent several hours switching the network back to version 0.7 to ultimately have a single network. The incident marked the closest moment to complete failure of the Bitcoin protocol. Ethical issues We are not aware of any states issuing an ethical opinion specifically for Bitcoin usage. However, it is well known that an attorney can’t access client funds until they are earned, hence the existence of trust accounts. Also, an attorney can accept property as payment, but there must be a valuation for the property. This is where accepting bitcoins could get a little muddy. The Model Rules note that a fee for legal services must be “reasonable.” If an attorney receives bitcoins, they should immediately convert and exchange those bitcoins to actual currency and put it in their escrow account. This effectively (and actually) puts a value on the bitcoins. As part of the reconciliation and billing process, the lawyer would just note the number of bitcoins and the market value at conversion. Obviously, it would be wise to check with your state bar ethics counsel prior to accepting bitcoins for payment. Criminal defense lawyers, of course, can face potential ethical and even criminal issues if clients pay them with assets that are determined to have been acquired through illegal conduct. And yet, almost invariably, when we hear about lawyers accepting bitcoins as payment, the lawyers involved are criminal defense attorneys. For all the talk of “privacy” and the frequent inability to prove the connection between illegal conduct and bitcoins, it is clear that federal authorities believe the bitcoins are used to keep criminal activities financially untraceable. The future We’re pretty good at predicting some things and lousy at predicting others. Some have predicted the end of the line for Bitcoin, especially now that the once largest bitcoin exchange, Mt. Gox, lost some $400 million in funds, closed its doors, and is reported to be under criminal investigation in the U.S. and Japan. Bottom line, your digital money can be hacked and stolen just like your identity or other digital property. Unless some serious security measures are built into Bitcoin, we wouldn’t recommend that you invest any serious wealth with the virtual currency. And you still might want to think about accepting bitcoins as lawyers. The bulk of people we know regard bitcoins as “shady money” and they may well regard lawyers accepting bitcoins as “shady lawyers.” Will bitcoins be legitimized one day in the eyes of average Joes and Janes? Maybe—but not soon. SHARON D. NELSON and JOHN W. SIMEK are the president and vice president of Sensei Enterprises, a legal technology, information security, and digital forensics firm based in Fairfax, Virginia. For more information, go to senseient.com. This article was reprinted with permission of the authors. 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