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    January
    01
    2015

    Technology
    What Lawyers Need to Know About Bitcoins

    Bitcoins are digital currency – and yes, lawyers are beginning to accept them from clients. But should they? The authors explore the benefits and risks of accepting this virtual currency as fees.

    Sharon Nelson & John Simek

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    bitcoinsBitcoins are digital currency. They are also known as virtual currency or cryptocurrency since cryptography is used to control the creation and transfer of bitcoins. Use of bitcoins relies on peer-to-peer technology, with no central authority or banks. The issuance of bitcoins and the managing of transactions are carried out collectively by the network. The system was introduced as open source software in 2009 by Satoshi Nakamoto. For you trivia buffs, the capitalized “Bitcoin” refers to the technology and network and the lower case “bitcoin” refers to the actual digital currency.

    Bitcoins are created by a process called mining. We won’t go into all the technology that is used to create and verify bitcoin transactions since it will probably make your head hurt. Suffice it to say that users who provide computing power for Bitcoin get newly minted bitcoins in exchange for transaction fees to verify and record payments into a public ledger. All bitcoin transfers are recorded in a computer file called a block chain, which is equivalent to a ledger that deals with conventional money. Users send and receive bitcoins from mobile devices, computers, or Web applications by using wallet software.

    Legality of Bitcoins

    There is nothing illegal about bitcoins or the ability to trade or exchange them for services or real currency. However, because Bitcoin users are anonymous, bitcoins sometimes are used to support criminal activities such as illegal drug sales. In fact, according to an article posted on Reuters, in October 2013 the FBI shut down “Silk Road,” an anonymous Internet marketplace for illegal drugs such as heroin and cocaine and criminal activities such as murder for hire. The FBI also arrested Ross Ulbrich, the alleged founder of Silk Road, and seized 144,000 bitcoins from him, ironically making the FBI the holder of the world’s largest Bitcoin wallet.

    Usage Rules

    Even though bitcoins are virtual currency, there are still specific rules for this new payment method. Bitcoins have different recognition and status, depending on the jurisdiction. As an example, Germany does not classify bitcoins as a foreign currency but as a financial instrument under German banking rules. Bitcoins are considered “private money” and can be used for tax and trading purposes. At the other side of the spectrum, bitcoins are banned in Thailand and are illegal. But what about in the United States? In March 2014, the IRS finally answered that question, concluding that bitcoins are considered property, not money, for tax purposes. This means that gains will be taxed the same way as investments in other property (for example, when you buy low and sell high).

    How Bitcoins Are Used – and the Lawyers Who Use Them

    Bitcoins are used as a replacement for traditional credit card, cash, check, or electronic-fund-transfer transactions. They are a quick and cheap alternative form of payment. Patrick Murck, general counsel for the Bitcoin Foundation, said that he accepted bitcoins from clients when he was in private practice. Businesses that accept credit cards must pay processing fees. With bitcoins, he was paid within minutes in an irreversible manner without fees. Jay Cohen, a criminal defense lawyer in Houston, was one of the first attorneys in Texas to accept bitcoins for payment. He said that doing so helps preserve client privacy, since payment is made without using a bank.

    Sharon D. NelsonAttorney com snelson senseient Sharon D. Nelson is president and com jsimek senseient John W. Simek is vice president of Sensei Enterprises Inc., a legal technology, information security, and digital forensics firm based in John W. SimekFairfax, Va. (703) 359-0700.

    Apparently, anonymous transactions are very attractive to particular clients, and several attorneys use the technology for this reason. Noted criminal defense attorney Arkay Bukh specializes in cybercriminal cases. He has begun accepting bitcoins as payment, which helps ensure the privacy that his clients demand. Bitcoins eliminate the audit trail that accompanies checks or credit cards. Bukh, attorney for alleged Boston Marathon conspirator Azamat Tazhayakov, has also represented several well-known cybercriminals over the years.

    Criminal defense firms are not the only law firms that accept bitcoins as payment. Law 4 Small Business has clients all over the country and accepts bitcoins to avoid credit-card-transaction and wire-transfer fees. Texas business law firm Ram Law Firm PLLC accepts them. And across the pond, top-tier English entertainment and media law firm Sheridans has begun accepting them. By the time this gets to print, you can bet that more law firms will be accepting bitcoins – some are actually using the fact that they accept bitcoins as a marketing strategy.

    How Long Do They Last?

    Lost or stolen bitcoins are gone forever. If you buy bitcoins or use them as payment, the transaction is transmitted via code using a private key. If you lose the private key, access to the bitcoins in your wallet goes up in virtual smoke. No key – no access. There is no person or central bank to reclaim your key. What does this mean for users? Certainly, make sure you protect your key and wallet. You should also consider encrypting your wallet to protect it from being stolen by hackers. According to Digital Forensic Investigator News, for just $35 you can buy a specialized malware tool designed to steal bitcoins. It also reports that the detection rate of such malware by the antivirus tools is below 50 percent. Even more reason to protect your electronic currency. Finally, make sure you back up your encrypted wallet. Without a backup, if you lose the computer or hard disk that holds your wallet, your bitcoins are lost forever.

    Volatility

    Make no mistake about it; bitcoin valuation is a very volatile market. The value of a bitcoin has soared to huge heights and then rapidly turned around to nearly crash to nothing. As an example, in January 2013 the value of a bitcoin was $15.68. On April 3, 2013, the value went from $106 to $147 and then down to $125 in a single day. In December 2013, the market value of a bitcoin shot past $1,000 and approached $1,200. Today the market value is around $480, quite a drop from the highs only four months ago. As you can see, the value of bitcoins is all over the place. Some people count on the volatility to make some big money very quickly, but you can also lose in fast fashion. Investing in bitcoins seems more like gambling to us than a solid financial strategy.

    Technology Hiccups

    Let’s face it: at some point, technology will fail. In the case of Bitcoin, high-volume traffic can cause a temporary shutdown. And as mentioned, a hard-disk failure could cause you to lose your entire wallet. That’s one reason why the really serious Bitcoin users have multiple wallets in multiple locations.

    In March 2013, a technical glitch caused a fork in the block chain (the ledger for bitcoins). Half the network added blocks to one version of the chain, and the other half added blocks to another chain. This meant two Bitcoin networks were operating at the same time (version 0.8 and version 0.7). To fix the problem, all transactions were temporarily halted, which caused a sharp sell-off. In layperson’s terms, there was a failure of the database upgrade used in version 0.8, which caused the fork to occur. The major Bitcoin developers and miners spent several hours switching the network back to version 0.7 to ultimately have a single network. This incident was the closest the Bitcoin protocol has come to complete failure.

    Ethical Issues

    Unless some serious security measures are built into Bitcoin, we do not recommend that you invest any significant wealth with the virtual currency.

    We are not aware of any states issuing an ethics opinion specifically for Bitcoin usage. However, ethics rules prohibit attorneys from accessing client funds until they are earned; hence the existence of trust accounts. Also, although attorneys can accept property as payment, there must be a valuation for the property. This is where accepting bitcoins could get a little murky. The ABA Model Rules of Professional Conduct note that a fee for legal services must be “reasonable.” If an attorney receives bitcoins, the attorney should immediately convert and exchange those bitcoins to actual currency and put it in his or her escrow account. This effectively (and actually) puts a value on the bitcoins. As part of the reconciliation and billing process, the lawyer should note the number of bitcoins and the market value at conversion. Obviously, it would be wise to check with your state bar ethics counsel before accepting bitcoins for payment.

    Lawyers can face potential ethical and even criminal issues if clients pay them with assets acquired through illegal conduct. And yet, almost invariably, when we hear about lawyers accepting bitcoins as payment, the lawyers involved are criminal defense attorneys. For all the talk of “privacy” and the frequent inability to prove the connection between illegal conduct and bitcoins, it is clear that federal authorities believe bitcoins are used to keep criminal activities financially untraceable.

    The Future

    Humans are pretty good at predicting some things and lousy at predicting others. Some people have predicted the end of the line for Bitcoin, especially when the busiest online exchange, Mt. Gox, was frozen for days following rumors that hackers had stolen $350 million of Bitcoin wealth. It shut down for several days. Supposedly, an internal memo is circulating that says 744,408 bitcoins have disappeared in a “theft which went unnoticed for several years.” Mt. Gox is back, but not letting customers trade or make any withdrawals. It is unknown if customers will be able to recover any of the lost funds during the coming bankruptcy proceedings. Bottom line … your digital money can be hacked and stolen just like your identity or other digital property.

    Unless some serious security measures are built into Bitcoin, we do not recommend that you invest any significant wealth with the virtual currency. And you still might want to think twice about accepting bitcoins for professional work. Most people we know regard bitcoins as “shady money,” and they may well regard lawyers accepting bitcoins as “shady lawyers.” Will bitcoins be legitimized one day in the eyes of average Joes and Janes? Maybe – but not soon.




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