Article By Emiliano Baidenbaum, an attorney for the Financial Services business unit of Hewlett Packard Enterprise
How can unrelated parties negotiate securely and transparently without having to rely on expensive intermediaries? Some programmers believe that bitcoin is the answer to that question and that it will revolutionize the way we do business.
What started as a nine page proposal in the white paper “Bitcoin: A Peer-to-Peer Electronic Cash System” by Satoshi Nakamoto (whose true identity remains unknown), has now become the way that more than 200,000 transactions per day are done. The rising popularity of bitcoin has caused markets and financial institutions to invest in the development of products based on this revolutionizing technology.
To understand what the buzz over bitcoin is all about and how to make the most of it, we need to become familiar with the concepts of bitcoin and blockchain, the opportunities that they are creating, and the approach that regulators are taking.
Bitcoin and Blockchain
The bitcoin technology is an open-source software (its license allows anyone to develop or improve the software program) that enables parties to complete a transaction without intermediaries and simultaneously records the transaction in a public ledger. The transactions represent the transfer of “bitcoin” units from one party to another, which are logged into a public ledger called “blockchain”.
Although the terms “bitcoin” and “Bitcoin” are generally used interchangeably, they are not the same. On one side, “Bitcoin” refers to the specific digital currency developed in 2009 by Satoshi Nakamoto. A number of people are more familiar with this term. On the other side, the term “bitcoin” refers to a broader category of software programs that are linked to specific assets. A bitcoin is basically the accounting unit shown for each transaction in the ledger that represents the asset being transferred.
The ledger where bitcoin transactions are registered is called “blockchain”. Blockchain is a single database that is massively distributed. The transactions are published to the entire network for validation by multiple sources and then reflected into an irrevocable block entry. The importance of bitcoin resides in blockchain. Blockchain makes it possible to rely on a secure, public record of transfers of digital property. Unlike data kept by traditional administrators, bitcoins are recorded in a decentralized manner to ensure that there is no single point of vulnerability for loss or alteration of entries.
To perform transactions, users of bitcoin are required to obtain a “wallet”, comprised of a public key and a private key. The public key is basically an account linked to the user, and the private key is the password to access such account. Whenever users enter into a transaction, blockchain publishes the transaction to the entire network so that it can be validated by multiple sources. Once blockchain creates a new block entry for such transaction, the user signs the transaction using its private key and blockchain will irrevocably reflect that such transaction is linked to the public key.
The Benefits of Bitcoin
The nature of bitcoin could revolutionize the whole structure of the financial industry and how business transactions are conducted in general. Unlike in other platforms, transactions in blockchain are maintained digitally in an irrevocable manner that is publicly verifiable and secured against outage, destruction or alteration. This creates areas of opportunity mainly seen in the form of currency, recordkeeping and smart-contracts.
As discussed earlier in this article, the most popular use of bitcoin is as the digital currency called Bitcoin. This currency has commercial value (approximately USD$640 as of June 27, 2016) and can be freely exchanged by parties without the need to rely on financial institutions or banking authorities. This means that one party in certain country could perform a faster international transfer to another party in a different country without having to pay substantial transaction fees to banks or depend on currency availability in its country. While Bitcoin may free users from some of the issues relating to international bank transfers or central baking restrictions; it may expose them to more volatility in value and to less acceptance by market participants, in comparison to deals involving other currencies such as the US Dollar or Euro.
Other less known uses of bitcoin are in the form of recordkeeping and smart-contracts. Parties could reduce costs by relying on blockchain’s digital entries as record of a transaction, instead of keeping duplicates in storage. Also, the transparency of blockchain could facilitate the auditability of transactions performed by a certain party. In regard to smart-contracts, parties could develop programs that rely in blockchain to automatically execute terms of a contract, such as transferring bitcoins upon the occurrence of certain event. The challenge would be to ensure that the external data that triggers the transfer can be consistently validated by all sources in the blockchain network.
U.S. and International Regulation
The regulation of bitcoin is still in an early stage. The few authorities that have issued regulation in this regard have focused on the financial or currency-like use of bitcoin, with particular interest in whether to grant bitcoin legal tender status and how to prevent potential money laundering. How authorities will approach the other blockchain uses is not clear yet.
In the United States, regulators have begun to analyze bitcoin at both state and federal levels. So far, regulators have not recognized that bitcoin possess legal tender status, but the trend has been to accept its use.
The federal authorities have acknowledged that bitcoin is taxable property and that it could be treated as a commodity or security, in some cases. At the state level, New York was the first to regulate bitcoin by requiring a license to use bitcoin for e-currency activities and imposing compliance requirements (recordkeeping, reporting, cybersecurity, anti-money laundering prevention, etc.) for such purposes. California issued a similar regulation. Both Washington and Virginia are on their way to developing their own regulations. Additionally, the Conference of State Bank Supervisors started drafting a unified framework that will serve as a guide for all states.
At the international level, the development of regulations is proceeding at a slow pace. Other than Russia (which took the position of banning bitcoin as a type of currency) or Luxemburg (which granted the first payment institution license to a bitcoin provider), most countries have taken a wait-and-see approach. The European Union has not developed legislation in this regard, but the expectation is that it will focus on anti-money laundering and anti-terrorism regulation.
The future of bitcoin is uncertain, but it is clear that it will change the way parties to a transaction interact with each other. This technology is challenging traditional market participants and regulators to come up with innovative solutions that keep up with the digital revolution.