If you haven’t heard of Bitcoin yet, you soon will. Bitcoin, the peer-to-peer digital currency launched in 2009 and taking the Internet by storm, appeared before Congress last month in a hearing before the Senate Homeland Security and Governmental Affairs Committee on the “Challenges and Promises of Digital Currencies.”

This has been Bitcoin’s breakout year. Prior to 2013, Bitcoin was mainly known for its reported connection to Silk Road, an underground encrypted website which allowed users to purchase drugs and guns anonymously over the Internet. Today, however, Bitcoin is popular among many innovative small business owners looking for novel ways to gain customer loyalty, cut costs by avoiding processing fees charged by credit card companies and e-commerce payment processors, and obtain security in business transactions through Bitcoin’s format of irrevocability.

In addition to the many online vendors turning to Bitcoin, in recent months brick-and-mortar businesses accepting Bitcoin have been popping up—Greene Avenue Market stores in New York, N.Y. and a Subway sandwich shop in Lehigh Valley, Pa., for example. The first Bitcoin ATM launched in Vancouver last month with roughly $95,000 processed through it during the first week, according to reports.

While gaining momentum, Bitcoin is not without its critics—the instability in its value and unknown regulatory barriers are two of the major criticisms leveled at Bitcoin.

 

BIT OF CHANCE

Despite these issues, certain businesses hopped onto the Bitcoin bandwagon early and enthusiastically. During Bitcoin’s short existence, Internet-based casinos have become one of its most popular outlets. Bitcoin casino operators have been and continue to accept bets from U.S. players (although some sites maintain certain age and location restrictions). But does this run afoul of U.S. internet gaming laws?

In 2006, Congress passed the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA) after determining that new mechanisms for enforcing gambling laws on the Internet were necessary, especially where gambling crossed state or national borders. UIGEA doesn’t itself make Internet gaming illegal, it makes the processing of payments related to unlawful Internet gaming illegal. What is considered “unlawful Internet gambling” under UIGEA is Internet bets or wagers unlawful under any applicable Federal or State law. UIGEA contains an intrastate exception—intermediate routing of electronic data is not considered for the purposes of determining where a bet or wager was initiated and received. The passage of UIGEA brought Internet gaming in the U.S. to a screeching halt, as many banks, payment processors and credit card companies refused to transact business in the Internet gaming market.

Up until 2011, in addition to state laws prohibiting Internet gambling, the Wire Act was considered the federal trigger for UIGEA. Under the Wire Act, “[w]hoever being engaged in the business of betting or wagering knowingly uses a wire communication facility for the transmission in interstate or foreign commerce of bets or wagers or information assisting in the placing of bets or wagers on any sporting event or contest, or for the transmission of a wire communication which entitles the recipient to receive money or credit as a result of bets or wagers, or for information assisting in the placing of bets or wagers, shall be fined under this title or imprisoned not more than two years, or both.

For decades, the U.S. Department of Justice (DOJ) considered the Wire Act applicable to all types of gaming. However, in 2011, the Department of Justice reversed its long-standing position, finding that “interstate transmissions of wire communications that do not relate to a ‘sporting event or contest’ fall outside the reach of the Wire Act.” This came in response an inquiry from the Illinois and New York regarding the legality of the use of the Internet and out-of-state payment processors for intrastate sale of lottery tickets.

 

STATE OF PLAY

Due in part to the 2011 DOJ opinion interpreting the Wire Act and UIGEA’s intermediate routing exemption, Bitcoin hasn’t been the only Internet wagering entity gaining notoriety this year. This has also been the launching year for state-sponsored Internet gaming. Nevada, New Jersey and Delaware have all legalized Internet gaming, and other states may be looking to do the same in 2014. The method by which Nevada, New Jersey and Delaware have moved to legalize Internet gaming places Bitcoin Internet casinos in a tough position—continue to operate under a cloud of legal ambiguity and uncertainty or find ways to adapt to the regulatory environment growing around them. As Bitcoin’s popularity increases, the former option becomes less and less of a possibility. 

Bitcoin casinos operated despite the halt of Internet operations in the U.S. post-UIGEA and outside the regulatory schemes launched in Nevada, New Jersey and Delaware on legal theories that were largely based on the uncertainty and unknown that was Bitcoin.  First, Bitcoin is not a currency and thus does not constitute gambling.  Second, Bitcoin does not use banks or e-commerce payment processors to process payments, thus no violation of UIGEA occurs.

However, the attention Bitcoin received in 2013 from government regulators weakens these arguments significantly.

 

A MATTER OF OPINION

In addition to the first congressional hearing last month, Bitcoin is getting attention from regulators in several industries—the Securities Exchange Commission, Financial Crimes Enforcement Network (FinCEN), the Federal Elections Commission and New York State Department of Financial Services to name a few.

• Securities Exchange Commission—Trendon Shavers is the founder and operator of Bitcoin Savings and Trust, which offered investors up to a 1 percent daily interest rate of return. On July 23, 2013, the SEC sued Shavers, accusing him of running a Ponzi scheme, using new investors to pay returns on previous investments and scamming investors out of Bitcoin valued at approximately $4.5 million. The SEC sought to freeze Shavers’ assets.

Shavers argued that the Court was without jurisdiction over Bitcoin because the Bitcoin Savings and Trust transactions were not within the securities law of the United States. On August 6, 2013, the Court determined the BTCST investments constituted an “investment contract” and were “securities” under Federal Securities Laws.  Thus, the Court had proper subject matter jurisdiction over the suit. In making this determination, the Court found it “clear that Bitcoin can be used as money.” Thus, the BTCST investment was considered an investment of money. The Court rationalized that Bitcoin can “be exchanged for conventional currencies, such as the U.S. dollar, Euro, Yen, and Yuan. Therefore, Bitcoin is a currency or form of money, and investors wishing to invest in BTCST provided an investment of money.”

• Financial Crimes Enforcement Network—On March 18, 2013, FinCEN issued interpretive guidance to clarify the applicability of Bank Secrecy Act regulations to virtual currencies, such as Bitcoin.  FinCEN determined that “administrators” and “exchangers” of Bitcoin are subject to money services business registration because the term “money transmission services” does not differentiate between real currencies and convertible virtual currencies. FinCEN determined that although virtual currency “does not have all the attributes of real currency…virtual currency either has an equivalent value in real currency, or acts as a substitute for real currency.” FinCEN then confirmed that “[a]ccepting and transmitting anything of value that substitutes for currency makes a person a money transmitter” under the FinCEN regulations implementing the Bank Secrecy Act.

• Federal Election Commission—Just last month, the Federal Election Commission issued a draft advisory opinion determining that campaigns can accept Bitcoin as in-kind contributions. At the request of the Conservative Action Fund, the FEC recently took up the issue. The FEC determined the contributions may be accepted as in-kind contributions because the FEC regulates two categories of contributions—“money” and “anything of value,” and Bitcoin falls into the latter. Interestingly, the FEC chose not to make a determination as to whether Bitcoin constituted “money,” acknowledging the question still remained to be answered.

• New York State Department of Financial Services—New York traders of Bitcoin may be required to obtain a BitLicense from the New York State Department of Financial Services beginning sometime soon. The Department announced last week its plans to hold public hearings on the matter in order “to balance both allowing new technologies and industries to flourish, while also working to ensure that consumers and our country’s national security remain protected.” At issue in the hearing will be how activities surrounding virtual currencies fit into the Department’s current regulatory scheme and/or whether new regulatory guidelines will be necessary do to the “unique characteristics of virtual currencies.”

 

SHORT-TERM UNCERTAINTY

In 2013 we’ve seen the SEC argue, and a U.S. District Court accept, that Bitcoin is a form of currency or security subject to U.S. Securities laws; FinCEN determine that certain (if not most) practices related to Bitcoin constitute activities requiring registration under the Bank Secrecy Act; the FEC determine Bitcoin is “something of value” (and leave the question out there as to whether Bitcoin is money); and New York State announce that a close look at Bitcoin is coming. What does all this mean for the Bitcoin gaming industry?

As U.S. regulators in various industries have taken notice of Bitcoin, it’s only a matter of time until gaming regulators do the same (if they haven’t already). Bitcoin gaming operators taking action in the U.S. are at a crossroads—continue the risk of operating without regard for the trend in increased regulatory scrutiny or find ways to operate within the Internet gaming regulatory environment that exists today and is likely expanding tomorrow.

 How soon will we see an application from a state Internet gaming licensee requesting permission to accept wagers in Bitcoin? Could an operator soon offer the first state-licensed Bitcoin-only intrastate casino? While playing ball with the current regulatory environment of Internet gaming in the U.S. may stunt short-term growth, the spread of Internet gaming in the U.S. may lend itself to long-term potential. 

 Editor’s note: Footnotes for this article were removed for space reasons. For a complete version of this article with footnotes and citations, please contact the author at www.duanemorris.com