Regulating bitcoins

The government on March 7 issued a written statement announcing that bitcoins are not a currency and that transactions using them should be taxed based on the income, corporate and consumption tax laws. It also said that under the Bank Law, banks in Japan cannot open bitcoin deposit accounts, broker the buying and selling of bitcoins or exchange them for traditional currencies.

The statement came a week after Mt. Gox, the world’s largest bitcoin exchange based in Tokyo, filed for bankruptcy in a major international scandal that took a financial toll on customers both in Japan and abroad. Mt. Gox claimed that its system was hacked and that it had lost its deposits of 750,000 bitcoins (valued at around ¥50 billion), ¥2.8 billion in cash from customer accounts and 100,000 bitcoins of its own.

Finance Minister Taro Aso said government ministries are collecting information on bitcoin. Both ruling and opposition parties are calling for some form of regulation. The government should work out effective measures as soon as possible to protect bitcoin users and to prevent the use of bitcoin for illegal purposes.

Bitcoins came into being around 2009. At first, they were used only by enthusiasts. Although bitcoins themselves are only electronic data, later they started to be used as a currency. For example, some restaurants accept them as payments.

The popularity of bitcoins got a boost from the fact that payments could be made through personal computers and tablets, and transnational payments could be made almost instantly at the cost of only a small commission. At one point Mt. Gox had some 100,000 customers.

Unlike ordinary currencies, bitcoins have no central entity like a central bank to regulate their issuance and quantity in circulation and they are not guaranteed by a central bank or a government.

When payments are made with bitcoins, the information is fed into the bitcoin system’s public transaction database and shared by participants across the world. They cooperate by using their personal computers to examine bundles of transactions to determine whether they are legitimate. Each evaluation takes about 10 minutes. The first participant to examine and confirm a transaction earns a certain amount of bitcoins.

As long as the computing for transaction confirmation does not exceed the system’s total computing capacity, counterfeiting or theft of bitcoins is impossible. It has been argued that the large amount of computing power that participants require to examine transactions ensures the security of bitcoins.

But one expert points to the possibility that a hacker attacked Mt. Gox’s system by taking advantage of the 10 minute time lag between payments and their confirmation. People with no expert knowledge of bitcoins buy them through an exchange where they are sold by people who have obtained them through transaction examination. Since the bitcoin exchange rate fluctuates, some people buy them to speculate. The government plans to impose an income tax on people who have made profits this way. But since bitcoins cross national boundaries, it is not clear to what extent the government can regulate them. It has been pointed out that bitcoins may be used for money laundering, and it will be necessary for Japan to cooperate with other countries to prevent use of bitcoins for illegal purposes.

For some people the convenience of bitcoins seems to outweigh the risks. The government needs to work out an optimum form of regulation by taking into consideration both the positive and negative sides of this new form of money.