Whether counsel is defending a tax evasion case involving Bitcoin, or a case where Bitcoin was the currency allegedly used to buy or sell illegal goods or services, or Bitcoin was involved in allegations of money laundering, or the client allegedly committed a street robbery involving cash and Bitcoin, there is nothing mysterious about Bitcoin. Although there are a few prosecutors left who still think that Bitcoin is inherently criminal, the real‑world use of Bitcoin readily proves otherwise. Bitcoin can be confusing as a concept and in real world use, but it doesn’t have to be.
What is crypto‑currency, and specifically what is Bitcoin? Why is it worth anything at all, never mind that it was worth upwards of $50,000 per bitcoin within the past couple of months, and is still over $36,000 per bitcoin? In this article, we’ll discuss Bitcoin the network, as well as bitcoin, the crypto‑currency, what bitcoins are, and why they have value. We’ll also discuss the ways that Bitcoin intersects the real world, how that translates into criminal cases, and how criminal defense attorneys will likely encounter bitcoins. Finally, we’ll discuss how recent legislation, and an uptick of enforcement by the IRS over “massive under‑reporting of income” from Bitcoin transactions, among other concerns, will likely mean that lawyers see Bitcoin involved in many more criminal defense cases in the future. This article will not be a technical treatise on the blockchain and public ledger, but rather a nuts‑and‑bolts discussion of crypto‑currency. This article is also not tax advice, nor is it investment advice, and nothing herein should be considered as such.
Bitcoin is crypto‑currency, meaning that it is a digital store of value in which encryption techniques are used to regulate the generation of “coins” as well as to verify the transfer of funds, operating independently of a central bank, and without the involvement of any government in the issuance of the currency. Bitcoin is actually two separate and distinct things. Bitcoin the network is a decentralized peer‑to‑peer (P2P) payment network that doesn’t require a third party, such a bank, to hold or transfer virtual currency. While Bitcoin is a network, bitcoins are individual units of virtual currency that may be “mined,” purchased, traded for goods and services, purchased with or exchanged for fiat currency (U.S. dollars, for example), and also held as an investment. (Bitcoin referring to the network is capitalized; bitcoins, referring to coins held as currency, is not capitalized.)
Bitcoins are stored in a “virtual wallet,” and one user can send bitcoins to another user by using their “public key,” much like anyone who has a bank account number can deposit money into that account. Users can also transfer bitcoins using a program on a smart phone with QR codes, and transfer value with a single click. Users may print their virtual wallets as a backup, or have them stored on their computer, which then makes them vulnerable to theft, as well as seizure by law enforcement.
The U.S. Government has had a little trouble defining Bitcoin for the purposes of regulation; Bitcoin was essentially unregulated from its inception in 2009, until 2013 or so, as regulators began to grapple with it. The Anti‑Money Laundering and Corporate Transparency Act of 2020 defines all crypto‑currencies and digital currencies as “value that substitutes for currency or funds” and thus is considered legal tender by FinCEN. Meanwhile, the SEC says Bitcoin is a security, and the CFTC (Commodities Futures Trading Commission) says Bitcoin is a commodity. The IRS currently defines Bitcoin as property, but is hinting that their definition might soon more closely track that of FinCEN, so that Bitcoin wallet accounts would fall under the IRS’ FBAR (Foreign Bank and Financial Accounts) rules for the purposes of reporting and taxation. This is relevant, because the IRS has identified many Bitcoin owners who are U.S. taxpayers, as we’ll discuss later.
There are other crypto‑currencies in addition to Bitcoin, these include Ethereum, Dogecoin (pronounced doggie coin), Litecoin and hundreds of others; each hopes to be the next Bitcoin, creating their own equivalent of the “Bitcoin Billionaire.” There are also digital currencies that are not crypto‑currencies, such as the SandDollar, a digital currency issued by the government of the Bahamas, which is directly tied to the Bahamian dollar. Many other governments, including Australia, are looking into issuing digital currencies, as it solves several problems created by the production and circulation of cash, especially in rural areas.
So why is Bitcoin worth anything at all, and why in the world would each bitcoin be worth $50,000 or more? The answer is the same as the answer to the question “Why is the U.S. dollar worth anything?” – the answer is: the Network Effect. The U.S. first abandoned the gold standard in 1933, out of efforts to pull the U.S. out of the Great Depression. The price of gold was artificially held at $35 an ounce until 1971, when President Nixon announced that the U.S. would no longer convert gold to dollars at a fixed value. Thus, the U.S. dollar is only worth more than the paper it’s printed on because people deem it to have value – that’s the Network Effect. Bitcoins have value because people deem them to have value. The value of Bitcoin shot up from a few dollars to over $50,000 in a few short years, buoyed recently by huge corporate investments.
We all already use virtual currency every day. The bank doesn’t have a box of cash stored in their vault with your name on it; the bank stores the value of your account in little zeroes and ones in a computer. When you use your credit or debit card, wire transfer funds, or even write a check, that value is exchanged digitally between your bank and the merchant’s bank. The majority of people in the U.S. don’t even carry cash anymore, and with the advent of the COVID‑19 pandemic and concerns over passing around objects that might carry the virus, using cash has become even less popular.
In some ways, though, Bitcoin is like cash – once stolen, it’s gone forever, transactions cannot be reversed or retrieved, and there are no fraud protections. Cash is fairly anonymous in that it is difficult to trace to a particular individual. Cash has been favored by criminal enterprise for all of these reasons, so it makes sense that those individuals with criminal intent would seize on Bitcoin for some of these same reasons.
In other ways Bitcoin is like a credit or debit card. Transactions take place in the virtual world, the exchange may be managed by a 3rd party for a fee, value can be easily transferred around, payments can be made using a phone app or virtual wallet, and cash can be deposited or withdrawn using a Bitcoin ATM.
The volatility of Bitcoin makes it act like a stock, and is one thing that dramatically differentiates it from government‑backed fiat currency, like the U.S. dollar. Like a stock, people purchase Bitcoin for speculation on its future value. In fact, certain companies like MicroStrategy ($MSTR) have invested so heavily in Bitcoin that people are buying that stock as a proxy for directly investing in Bitcoin, thus essentially turning MicroStrategy into a Bitcoin mutual fund. Tesla ($TSLA) has invested heavily as well, recently reporting $100 million dollars, or nearly a quarter of its profits directly attributable to their purchase and sale of Bitcoin. The market capitalization of Bitcoin is over $1 trillion dollars, so it’s not going away anytime soon, regardless of definition or regulation.
Even though Bitcoin shares some attributes with cash, credit cards, and stocks, it is also completely unique, like nothing before it. Bitcoin can be “mined” by individuals or corporations, who essentially do the work of the peer‑to‑peer network by solving cryptography problems in exchange for bitcoins (or fractions of bitcoins). Also unique to Bitcoin is the online ledger, which makes the details of each and every Bitcoin transaction available to anyone, anytime, anywhere. In fact, anyone can watch transactions happening live at https://www.blockchain.com/explorer. Bitcoin can be stored in networked wallets, with Coinbase being the largest wallet provider, or offline in a printed paper wallet (that if lost, is irretrievably gone).
Now that we know what Bitcoin is, and why it has value, where is criminal defense counsel likely to see Bitcoin in criminal defense cases? Bitcoin is involved in crimes from the extremely low‑tech, to the extremely high‑tech, and everywhere in between. Bitcoin robberies are occurring in all major cities, and are spreading to rural areas as well. Those who wish to buy or sell Bitcoins can do so from 3rd parties, but those are treated like money service businesses (MSB’s) for the purposes of regulation, and those 3rd parties now perform due diligence on their customers, similar to opening a bank account. Thus, if someone wants to buy Bitcoin with cash, they can reach out to those individuals who wish to sell Bitcoin, via websites which match buyers and sellers, who set their own exchange rate. The most popular of these services is https://localbitcoins.com/buy-bitcoins-online/us/united-states/cash-deposit/. The problem with carrying large amounts of cash to meet a stranger is, or should be, obvious, and it’s no surprise that sometime those buyers instead become robbery victims, losing their cash, and sometimes their bitcoin, as well.
Bitcoin has also been used to buy and sell illegal drugs, child pornography, murder‑for‑hire, and has been a preferred medium of exchange for alleged criminals via Dark Web websites like the Silk Road. Some of these crimes are identified via software and research of the public ledger, but most are solved due to the intersection between Bitcoin in the virtual world and the physical world. Drugs can be bought via the Dark Web with Bitcoin, but the drugs have to be physically shipped and delivered to customers in the real world. Once law enforcement discovers the FedEx account used for the drug deliveries, all the customer’s and seller’s information become readily accessible to investigators, in one convenient place.
Bitcoin is pseudonymous, which is to say it is almost but not quite anonymous. Bitcoin physically touches the real‑world individual and their identity via email, credit card transactions, shipment of goods, and delivery of services. Very few alleged criminals have the discipline to keep their Bitcoin transactions completely anonymous, and it inevitably can be traced back to them. Even one single usage in the real world irrevocably links the individual to the public blockchain, where all their other transactions become traceable to each other, and to that individual. Federal agencies have technology and consultants who are quite adept at tracing Bitcoin ownership and usage to individuals, as well as having the ability to determine which users are U.S. citizens. This ability be‑ comes important in tax cases involving Bitcoin.
The IRS has served a series of John Doe Summons on the largest wallet holding companies, and has done so for several years in a row. Thus, the IRS now knows the identity and value held by many, if not most, U.S. citizens who have Bitcoin valued at over $20,000. The IRS recently sent “soft” letters to individual taxpayers who were identified in the summons. The letter suggests that the taxpayer might want to restate their taxes for prior years, since they evidently forgot to mention the Bitcoin. Anyone receiving that letter who failed to restate their taxes to include taxable Bitcoin transactions should anticipate hearing from the IRS in the near future, and should plan on seeing that letter as an exhibit at trial.
Software, consultants, and John Doe summonses aside, many Bitcoin cases involve more old‑school investigation than anyone in law enforcement might wish to admit. The operator of the Silk Road drug website was only successfully prosecuted because while he sat in a public library using the internet, one FBI agent distracted him and another agent literally grabbed his computer off the table and ran away with it, while it was open and turned on. Bitcoin frequently becomes involved in a criminal defense case as an artifact of an investigation into real world crime, rather than being the starting point for an investigation. The Silk Road case is USA v. Ross William Ulbicht aka: Dread Pirate Roberts (Southern District of NY 14‑CR‑68 (KBF) July 9, 2014).
A few lawyers accept Bitcoin for payment of services in a flat‑fee case or for services already rendered; but even fewer will consider accepting Bitcoin into a retainer account. Dealing with bitcoins and IOLTA accounting is problematic, at best. There are also concerns that Bitcoin paid to defense attorneys will be clawed‑back by the government if the Bitcoin is determined to be the proceeds of ill‑gotten gain. As with all payments where claw‑back is a concern, attorneys should consider getting assurance that the prosecutor has no plans to go after fees, or have a forensic accountant evaluate the funds as legitimate source income prior to accepting them.
Bitcoin isn’t difficult to understand or use, as we have seen. However, criminal defense counsel may find it helpful to hire a consulting or testifying expert in Bitcoin cases, to help counsel with the understanding of the case or to assist the defense team in educating the judge and jury about Bitcoin. Bitcoin has a stigma in the minds of some jurors and judges, and an expert may be able to help to dispel that notion. Ultimately, Bitcoin is just another currency, and its involvement in a criminal defense cases is not that much different than any other currency allegedly involved in a crime.