Money for Nothing …

Preamble

There has been plenty media coverage of Bitcoin, and many community figures have been compelled to state their opinion. As Bitcoin is a multifaceted topic, covering cryptography, software engineering and finances, it is problematic to grasp its essence and implications with only a superficial look at it. Thus, some commentators might not have a clear picture of how it works and the implications. It is the objective of this post to train the reader with the facts to assess the merits of this technology and to understand the linked legal risks..

What is Bitcoin?

To understand what is a Bitcoin as a currency, let start by introducing the other currencies. Most currencies (Euro, US Dollar, Pound, Yen) are fiat money. Fiat money does not have intrinsic value, as it is not backed by anything. It is so-called fiat money because there is a government decree (“fiat”) stating the currency to be permitted. If confidence in a currency is lost, typically because of foolish monetary policy, fiat money can stop being accepted. Experience has revealed that leaving monetary policy in the hands of governments is regularly not an innovative idea, as governments could have an incentive to upsurge the monetary stock to answer persistent short-term financial difficulties. The conventional answer is to delegate monetary policy to a semi-independent central bank. The central bank is tasked with handling the monetary policy, usually with the objectives of economic growth, price stability, and, in in other cases, stability of the financial system.

Bitcoin is a decentralized digital currency. This means there is no individual or institution behind it, either supporting it or governing it. This might appear counter-intuitive at first glance: The answer to this apparent paradox is that Bitcoin is just a computer program. The program has a creator (or creators): Satoshi Nakamoto. Bitcoin is an open source implementation. This is the original open source project, written in C++, realizing the protocol. Both the source code and complied binaries can be freely downloaded from bitcoin.org/en/ download

Bitcoins are created through the process of ‘mining’ - a process which rewards users for contributing computing power to the network by giving newly created bitcoins to every user who resolves a complex mathematical problem (the so-called ‘Proof of Work’) whose struggle increases with overall network strength.

Bitcoin is not controlled in a tight sense by anyone. One of the most innovative features of Bitcoin is that it is decentralized. There is no central server where Bitcoin is running. Bitcoin operates through a peer-to-peer network of connected computers. Bitcoin is the first digital currency built in a decentralized way, a technological breakthrough.

The core of the Bitcoin network is a database landing, the transactions that have happened in the past as well as the up-to-date holders of the funds. This database is named a ledger, since it holds the entries relating the owners of the funds. Financial databases must be resilient against users trying to double-spend their funds, which Bitcoin solves elegantly with distributed database. The Bitcoin’s database is known as a blockchain. Transactions are assembled in blocks of transactions roughly every 10 minutes. These blocks of transactions are then logged one after the other in a chain of blocks, henceforth the name blockchain.

Investment Perspective

When it comes to investment Bitcoin is watch as a gold hence both have a lot of common as assets. Both are restricted in supply, have functional use and are considered by investors, regardless of their volatility, to be good supplies of values.

Bitcoin’s increasing value and its proven investor performed compared to the gold standard, are indicators that is high time to assess the opportunities and risks that come with financing in the world’s foremost digital currency.

When applied to Blockchain, the investment applications are Bigger and can be in: Peer to Peer payments, Syndicated Loans, Real Estate, Trade Finance, Securities trading and issuing, Interbank settlement, Precious Metals Etc.

 Legal & Regulatory Risks

Despite Bitcoin’s impressive annualized returns since its inception in 2009, the reality is that the currency is still in its infancy and no one knows whether it will really become globally accepted or whether it will eventually disappear. This uncertainty surrounding Bitcoin’s future is reflected in its price volatility with a significant impact on financial stability, in case of any important economy decides to ban virtual currency. When it comes to investing in Bitcoin, there are a few legal risks stockholders and investors must be aware of:

AML & Know Your Customer 

Even if, each transaction is registered in the blockchain with a publicly available distributed ledger, which offers valuable evidence beyond a traditional cash to-cash exchange, it does not provide the actual identities behind the agreeing wallets: in a Bitcoin transactions’ exchange scenario, investor has an established virtual wallet or an account with an Exchanger to conduct a transaction. The investor gets virtual currency from the Exchanger, which permits the Investor to transfer funds in and out of that account. In conjunction to Bitcoin, in a transfer between two individuals, no personally recognizable information is revealed to the two individuals or to any third-party intermediaries … Therefore, know your customer (KYC) is an important of a legitimate exchanger’s AML program.

The banking regulators have yet to issue guidance or regulations governing how banks are to deal with Bitcoin, outside of the anti-money laundering framework; The final regulations may require that businesses involved in transmitting, storing, buying, selling, exchanging, issuing, or administering a virtual currency must be licensed in the future. Before granting a license, the regulator must consider the financial condition and general impact on conducting the Bitcoin Business of any applicant.

The 2015 FATF Guidance is aimed at explaining how FATF’s risk-based approach to standards for anti-money laundering and anti-terrorist financing apply to exchanges of virtual currencies that can be converted into fiat money. The goal is to aid national authorities seeking to develop regulatory regimes

However and in the context of money transfer, the average fee in the remittance market is stated to be between 8% to 9% (World Bank, 2016; Normand, 2014). Bitcoin transaction fees are in the order of 0.01% to 0.05% as of today. In principle, Bitcoin has a cost advantage compared to current money transmitters. However, there might be significant barriers to entry to the remittance market, even for traditional companies. One such barrier might be acquiring and maintaining banking relationships, as banks must experience significant costs related to Anti-Money Laundering (AML) regulations when servicing remittance businesses.

Fraud Risk

One of the issues with the primary use of Bitcoin as a payment method is the irreversibility of outflows, in distinction with other electronic payment technologies such as credit cards. Bitcoin does not have dispute mediation services, which can make it cheaper, especially for merchants dealing with charge-back fraud i.e. a customer looking for a retraction of a payment once the good has been delivered. This is a double-edged sword, as the ones who are subject to fraud risk are the customers. the SEC published advisories for investors in 2013 and 2014 on the threat of virtual currency scams on the Internet; filed a criminal fraud complaint charging a Bitcoin exchange with engaging in a Ponzi scheme; and successfully convinced a federal district court that Bitcoins are money.

Resolving part of the fraud risk can be by combining multi-signature with machine-learning and fraud-detecting algorithms, to give a risk score to each new requested transaction. The algorithm considers factors such as the user’s spending habits and the holder of the address to which the assets are being sent, in other words, whether it is a reputable company. Depending on this risk score, the service either executes the transaction automatically (for low risk scores), requests two factor authentication or out-of-band confirmation (for medium risk transactions), or even assigns a company representative to manually check the transaction and call the client (for medium- and high-risk transactions).

Cyber Attacks

Research has revealed that since the commencement of Bitcoin in 2009, about one-third of bitcoin exchanges have been hacked. Even with efforts to establish a strong cyber security at exchanges and Bitcoin startups, the risk of large-scale hacks is real and one that will most likely occur again in the future. However, high profile hacks should only have short term effects on the price of bitcoin and should not really affect its long-term price development.

The possible of large Bitcoin companies and digital currency exchanges suffering losses from cyber- attacks are a practical risk that has established to have a strong impact on the price of bitcoin in the past. The hack of Mt. Gox in 2014 and the Bitfinex hack in August 2016 have both pushed down the price of the digital currency.

One risk that not every stakeholder is aware of is the probable for a so-called 51 percent attack. A 51 percent attack means to one centralized Bitcoin mining operation gaining over 50 percent control of the blockchain, at which point it might reverse transactions, which would make the entire blockchain unusable as no confidence would be left in the network. For now, mining operations are spread out transversely the world and the Bitcoin network is fully decentralized. However, should one mining operation gain a significant amount of control over the blockchain close to 50 percent, the future of Bitcoin’s survival could be at stake.

 Should You Invest in Bitcoin Now?

Another risk often cited is that one or more superior digital currencies could overtake bitcoin and become the leading investment option. Bitcoin has some challenges, such as its scalability issue, which could be improved or alleviated by a new digital currency that could then go on to take bitcoin’s place. However, bitcoin’s first-mover advantage and the growth of its ecosystem, have positioned it so firmly as the leading digital currency that this possibility seems rather unlikely.

Finally, some economists argue that Bitcoin and cryptocurrencies in general could increase the resilience of the economy as they create an alternative payment system that could be useful in case of turmoil or malfunctioning of the existing financial structures.