Bitcoin has arrived in Canada!

For those who have been waiting for a primer on the muchdiscussed virtual currency, this article provides a brief overview and discusses Bitcoin’s usage and character as a financial instrument.

What is it?

Bitcoin is an anonymous digital “currency.” It can be used by marketplace buyers and sellers as a means of exchange to sell goods and services. It can also be converted to a more traditional form of currency, as well as bought and sold on a Bitcoin exchange.

Purchasing Bitcoins can be risky. The exchange rates fluctuate significantly, and buyers and sellers often disagree about the valuation of the digital currency. Indeed, the sharp spikes and drops in the various Bitcoin exchange rates have been cited as one of the major risks associated with Bitcoin.

Primarily, Bitcoin has been used to purchase services online. However, a number of popular retailers such as Overstock.com1 and newegg.com2 are accepting Bitcoin in exchange for physical goods. Ebay is reportedly considering accepting Bitcoin (they do not currently accept it).3 Smoke Bourbon Bar-B-Q – a brick-and-mortar retailer located on Harbord Street in Toronto – is advertising its acceptance of Bitcoin. Currently, 338 retailers are listed as Bitcoinaccepting merchants on BitCoinada.com.4

Who created it and why?

In 2008, an anonymous developer using the pseudonym Stoshi Nakamoto is said to have invented Bitcoin in order to create a peer-to-peer electronic cash system.

How is digital currency different from traditional currency?

Bitcoin is decentralized, with no central bank or clearing house. Because use is on an anonymous basis, there have been concerns that Bitcoins may be improperly traded – for example, by using a single Bitcoin for multiple transactions (double dipping). In order to prevent fraud, Bitcoin transactions are recorded through a public ledger (called the block chain) that keeps track of and publicizes every transaction in the Bitcoin community. The public ledger acts as a record of Bitcoin transactions. The block chain is set up in chronological order and is shared amongst all Bitcoin users to keep track of Bitcoin spending.

How are Bitcoins created and circulated?

Bitcoins are created by a complex process of ‘mining’ accomplished by individuals and companies. Miners devote massive amounts of computing power to solve increasingly difficult mathematical algorithms which confirm waiting transactions and include them in the block chain. In return for tracking and publicizing Bitcoin transactions, miners are rewarded with 25 newly minted Bitcoins per ‘block’ of transactions they successfully verify in the block chain.

The Bitcoin protocol is designed to ensure that bitcoins are created at a fixed rate, which makes Bitcoin mining very competitive. The system was set up so that no developer or central authority has the ability to manipulate the system to increase their profits. The maximum number of Bitcoins that will ever enter circulation is capped at 21 million. As of July 30, 2014, approximately 13 million Bitcoins had been mined and have an exchange rate of 1 Bitcoin per $568.61 USD.

The Regulatory Landscape in Canada:

In 2013, Canada Revenue Agency (“CRA”) declared that it considered Bitcoin to be the equivalent of goods exchanged under a barter system, as opposed to real currency.5 Nevertheless, retailers must declare revenues from transactions when they accept Bitcoin as a payment method, and if Bitcoins are bought and sold for purposes of investment or speculation, any profits or losses constitute taxable capital gains or losses. CRA has also suggested that income from the mining of Bitcoins would constitute income from a business and proper reporting will be required.

In the Federal Budget for 2014, the federal government announced its intention to adapt certain parts of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the “Act”) in order to specifically deal with digital currencies in general and, in particular, anonymous transactions (known as ‘cryptocurrencies’). Under the Act, activities that constitute a “money service business” must comply with extensive reporting requirements and register with the Financial Transactions and Reports Analysis Centre of Canada (“FINTRAC”), in an effort to deter and identify illicit activity.

FINTRAC requires money service businesses to perform identity verification on clients performing certain types of transactions. These transactions include receiving the equivalent of $10,000 or more in cash, selling or cashing the equivalent of $3,000 or more of travelers’ cheques or money orders, sending or receiving international money transfers of $1,000 or more, and any transaction suspected of being money laundering or financing for terrorists. Bitcoin businesses that fall into the category of money-services businesses (potentially, Bitcoin exchanges and dealers), will have to implement anti-money-laundering compliance systems and policies. Financial institutions will not be permitted to create bank accounts and maintain client relationships with digital currency businesses unless such businesses register with FINTRAC. Penalties for noncompliance under the Act are significant and include civil and criminal penalties.

The Effects of Regulation:

On June 19, 2014, the omnibus budget implementation bill received Royal Assent and reporting requirements for money services business became law. The bill refers only to dealers of virtual currency, and not to Bitcoin specifically; however, commentators are suggesting that the new reporting requirements will likely apply to Bitcoin exchanges and other businesses related to Bitcoin production.6 It is not yet clear how the new regulations will impact retailers accepting Bitcoins as payment, if at all. A consultation paper concerning the new laws will need to be released, along with draft regulations, before Bill C-31 comes into effect.7

As money services businesses, dealers of Bitcoins will be required to keep records and identify customers, thus removing the anonymity of a Bitcoin transaction. While some smaller Bitcoin businesses may view regulation as an unwanted interference and expense, others suggest the new regulations may help Bitcoin business to more easily form banking relationships.8

Initially, these new regulations may not seem overly stringent. However, in a nascent and volatile industry, increased startup costs related to regulatory complexes may deter the emergence of new Bitcoin businesses and reduce the speed of the digital currency’s dissemination and use throughout Canada. On the other hand, if regulation increases the stability and transparency of the Bitcoin system, it may drive new demand for Bitcoin and increase its availability as an alternative means of purchasing goods and services.

Liam Tracey-Raymount