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The brave new world of Bitcoin

Market trends

Given the convenience of established currency and payment systems, what is driving the ever-growing interest in Bitcoin and other virtual currencies?

There are several benefits to virtual currencies, which have led to their growing worldwide popularity:

  • Unlike traditional currencies, a decentralised virtual currency, such as bitcoin, gives its owner an absolute sense of ownership without the need to rely on banks or financial institutions in order to store or transfer currencies or make a payment.
  • Virtual currencies are used globally and are unconnected to the financial stability of any specific country; hence, they provide a safe option for people who worry about saving for a ‘rainy day’ – especially in developing countries, where the inflation of local currency can cause a dramatic devaluation.
  • The digital era has opened doors to new forms of online transactions. Virtual currencies play a crucial role in this field, enabling instant transactions, smart contract infrastructures and decentralised applications, such as Ethereum and similar applications based on blockchain.

Regulation

Has your jurisdiction taken steps to regulate virtual currencies? What is their current status?

Israel is considered to be advanced with respect to its regulatory adoption of virtual currencies, in part due to the increasing role of Israeli entrepreneurs in the blockchain sphere.

Israel’s first law concerning virtual currencies will come into force in October 2018. It will regulate the exchange of such currencies and impose licensing requirements on businesses that provide exchange services.

In addition, in 2018 the Israel Tax Authority published a circular on various tax issues relating to virtual currencies which set out that:

  • profits arising from investment in virtual currencies are generally subject to capital gains tax; and
  • companies involved in the issuance of initial coin offerings (ICOs) can, under certain conditions, distribute tax duty on these funds over the course of several years.

Different EU member state authorities have thus far taken different approaches to the regulation of virtual currencies. Is this due to the different legal frameworks of the member states or (mainly) by institutional practices of the respective authorities?

Not applicable.

How likely is it that the regulation of virtual currencies will be harmonized at EU level? Could a consistent regulatory approach be reached through institutional guidelines for the competent authorities in the member states?

Not applicable.

Taxation

How are transactions using virtual currencies as the medium of exchange taxed in your jurisdiction?

Given that the tax authorities generally consider virtual currencies to be potential assets, retail transactions made in consideration of virtual currencies are seen by the tax authorities as a barter deal. Therefore, the market value of a sold product or service in fiat currency is considered to be the true value of the transaction for tax purposes.

Once a transaction has been completed, if the retailer chooses to keep the virtual currency rather than immediately convert it to fiat currency, any future profit arising from the appreciation of the virtual currency will be taxed in line with capital gains tax.

Inflation

If virtual currencies were to become a mainstream payment system, how might this affect the ability to control inflation in your jurisdiction?

In recent years, Israel's economy has experienced a negative inflation rate. This has been the result of active measures taken by the Central Bank, including high interest and increasing foreign currency reserves. Consequently, as the role of virtual currencies in Israel's economy might grow, a lower impact on Central Bank monetary policies is expected. However, due to the high volatility of virtual currencies, prices will still be linked to stable fiat currencies for the foreseeable future, even if paid in virtual currency in practice. Further, virtual currencies are limited in supply; hence, they are unlikely to be the cause of inflation of fiat currencies. These factors can provide some comfort in that the Central Bank will have the power to control inflation for many years to come. Finally, if virtual currencies become a major part of global financial transactions, this would indicate that the world's economies have switched to global currencies (eg, bitcoin), which may have far broader implications on the world's economy – both positive and negative. However, the rate of inflation may not be the most significant.

Fraud and money-laundering

What are the potential risks of virtual currencies in terms of fraud? How would these be addressed in your jurisdiction? Have any specific instances emerged in which virtual currencies have been used for money-laundering or other fraudulent purposes?

The anonymous nature of virtual currencies is criminals’ favoured method for cyber and traditional crime. The most common uses are:

  • demanding virtual currencies through ransoms and blackmailing; and
  • stealing virtual currency through hacking attacks.

Other common frauds linked to virtual currencies include fraudulent ICOs that raise funds with false promises to develop projects with no actual intention to deliver them.

To address these issues, the Anti-money Laundering Authority protects the gateways between virtual and fiat currencies by demanding that all exchanges maintain records and report on suspicious transactions.

In addition, local police and other law enforcement bodies use the most advanced technology to monitor and track transactions relating to the illegal use of virtual currencies.

Recent examples of fraud involving virtual currencies in Israel include the following:

  • In late 2017 Israeli entrepreneurs raised millions of US dollars for a project called Coindash. However, a hacker breached the project's website during the ICO and switched the wallet’s bitcoin address. As result, within a short period, bitcoins worth millions of US dollars were transferred to the hacker and were subsequently irretrievable.
  • In early 2017 an extensive international investigation led to the arrest of a 19-year-old hacker from Israel who was accused of making over 2,000 threatening phone calls, anonymously alerting companies and authorities to terrorist attacks. The investigation revealed that the young hacker was using highly-sophisticated tools to cover his tracks and had paid for proxy servers with bitcoin, which made the investigation far more difficult.

With regards to the use of virtual currencies for money laundering, it is not as practical as commonly thought. Virtual currencies keep their records on a public ledger, meaning that all transactions are recorded and remain accessible indefinitely. As a result, moving large funds via blockchain is transparent and can sometimes even be traced to the person behind it. Therefore, there are no known cases of large-scale money laundering using virtual currencies, other than transactions which are illegal in their nature, as in the infamous Silk Road case.