This blog post discusses the legality of doing business using bitcoins. It was written by Addison Cameron-Huff, a lawyer who specializes in Bitcoin. He highly recommends that you seek legal advice when considering Bitcoin legal issues.

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Businesses are adopting bitcoin (BTC) as a payment method at an ever faster rate (20,000 merchants use the BitPay network and coinmap.org has mapped >3000 businesses). Despite the growing adoption, some people wonder whether “it’s legal”. This blog post takes a look at the legality of doing business with Bitcoin.

The starting point for any discussion about what’s legal or illegal is this default principle in Canadian law: it’s legal unless it’s not. You are permitted to do anything so long as there isn’t a (valid) rule that prohibits/ regulates that conduct. 

There have not been any laws passed in Canada that specifically address Bitcoin (although there will be). But there are laws of general application that apply to all transactions, and more specifically, barter transactions (trading good X for good Y). Canada has always taxed barter transactions and the Canadian Revenue Agency has provided guidance on bartering with digital currencies.

Beyond tax implications, the question of whether it’s legal to use Bitcoin can usually be rephrased as whether the transaction is legal. The use of bitcoins doesn’t affect a transaction any more than substituting soybeans for dollars would. Legal business remains legal and illegal business remains illegal.

The technology may be new but the legal principles are not. 

This blog post is about how the ideas of Bitcoin could be applied to Ontario’s land ownership records system (POLARIS). It was written by Addison Cameron-Huff, a lawyer retained by Decentral in Toronto.

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“Smart property” is a concept of great interest in the cryptocurrency industry. Smart property is property for which: 

1. the ownership can be verified through a decentralized trust system (like the Bitcoin protocol); and,
2. transfers can take place using the electronic system.

Could Ontario adopt a smart property system for land records?

Knowledge of how Bitcoin works is a prerequisite to thinking about how a property system based on it could function.

Explaining Bitcoin: Provable Transactions + Ownership

The Bitcoin protocol allows anyone to verify the transactions that have taken place within the system (the “blockchain”). This is possible because Bitcoin creates a snapshot every ten minutes of the last ten minutes of activity and adds that to the list of transactions that have happened since the start of Bitcoin (this is called “mining”). The records can’t be changed after the fact due to the use of hashing functions.

Bitcoin allows the holder of bitcoins to prove that they are the owner because they are the only person with the password (see this explanation of public key cryptography for details). The person with the password can “sign” a transaction with their password to prove that they are the owner.

If anyone can prove that they are the holder of a certain item and everyone else can see the history of transactions that led to them being the holder, then you have the basis of a system of provable ownership and secure transfer. 

Real Estate Smart Property: POLARIS

How could smart property concepts be applied to real estate?

At the heart of smart property is the idea of electronic records that prove ownership. For most kinds of property there is no official record of ownership that can be consulted – it’s generally up to the buyer to ascertain who the owner of something is. One notable exception is POLARIS: the database of ownership of real property in Ontario.

POLARIS is a part of the Land Titles System, the legal regime for property ownership that covers most land in Ontario. It is is the central repository for all records of who owns what real estate. You can read more about it here: http://www.teranet.ca/node/131.

POLARIS and smart property are complicated concepts so the following discussion can only touch on a few points of comparison but will hopefully illustrate the contrast between the two systems. This blog post considers a block chain-based smart property system.

POLARIS: Disadvantages

POLARIS has a few disadvantages:

1. it is centralized and access is provided only through a private company called Teranet (they bought the right to run the system until 2067 for $1 billion + royalties and are owned by Borealis, the investment arm of OMERS); and,

2. it’s very difficult to prove that the person transferring land is the possessor of that land (the problem is currently handled by only lawyers doing transfers); and,

3. it’s expensive to look up ownership of property (about $30 per search + $600 to register); and,

4. it’s not possible to build new applications that use property records.

Smart Property System: Benefits

A smart property system for land ownership could improve upon POLARIS in a few ways:

1. anyone could inspect any property record in real-time (because everyone has an up-to-date version of all of the records); and,

2. access to records would cost almost nothing (<1 cent); and,

3. authenticating the holders of property would be easy (because the holder is the one with the password) so owners could transfer land without using lawyers; and,

4. transactions fees could be very low; and,

5. anyone could build applications on top of the property system to provide new ways of accessing records (e.g. an automated mortgage fraud detection system).

Despite the upsides of a smart property system, changing the real estate database system would pose a number of significant challenges.

Smart Property Real Estate System: Challenges

POLARIS has been in place since the 1980s. It may not be ideal but a new system is likely to introduce “bugs” that would have enormous costs for some people (e.g. a bank might foreclose on the wrong person).

There would also be problems that are specific to switching to smart property:

1. passwords would have to be distributed to the current owners of land; and,

2. if a user loses their password they’d lose ownership of the land (and if they didn’t, the ownership database would be out-of-sync, defeating the purpose of having the system); and,

3. theft of real estate passwords would become a massive fraud issue (although real estate fraud is currently a major problem for banks, consumers and insurers).

Any sane system that follows smart property principles would have to figure out a method of “recovering” ownership when the password is lost. (This problem could be mitigated by implementing “multisignature transactions”). 

Although there would be advantages to a smart property system, many of them would be hard to quantify, such as the benefit from new applications that are impossible to create under the current system. In 1980 no one could have calculated the value of the Internet (and what is Wikipedia worth?). Furthermore, many people misplace their car keys – they’re not going to be able to keep track of the password for their home ownership record.

In addition to the practical issues of switching to smart property the province would be forced to pay billions to Teranet (the operator of POLARIS) if it cancelled its 57 year monopoly agreement.

Conclusion: Looking Forward

2014 isn’t going to be the year of smart property real estate records. That said, it will be a year where these ideas move closer to application, and the power of decentralized crypto trust systems gains wider recognition. By 2067 we’ll probably have something better than POLARIS.

Discussion

Smart property and real estate are big, challenging topics. Please do contact the author (addison@bitcoindecentral.ca) if you think a mistake has crept in or there’s an aspect you’d like to see explored in a follow-up blog post. 

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In Bitcoin parlance an “exchange” is an online service that lets customers buy and sell bitcoins from each other. Exchanges do not sell or buy on their own account. They’re similar to stock markets in that the price of bitcoins is set by the prices that participants are willing to buy or sell at at any given time. 

The two largest exchanges in Canada are Canadian Virtual Exchange and Vault of Satoshi. As of March 28th, Canadian Virtual Exchange is doing 30 day volume of $4.2 million (~6500 bitcoins). Vault of Satoshi has a seven day volume of under $250,000 (300 bitcoins). 

—

Note: the figures above are (of course) now out-of-date. You can check the volume of these exchanges by going to their respective websites.

This blog post explains what a “compliance officer” is within Canada’s money laundering regime. It was written by Addison Cameron-Huff, a lawyer who specializes in Bitcoin. He highly recommends that you seek legal advice when faced with money laundering compliance issues.

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Compliance with the Proceeds of Crime (Money Laundering) and Terrorist Financing Act may require the appointment of a “compliance officer”. 

A compliance officer typically performs the following roles:

“Puts in place and maintains the compliance regime.

Ensures that all employees are trained as required.

Monitors and observes that all policies and procedures are respected and applied.

Reports on a regular basis to the board of directors or senior management, or to the owner or chief operator.”

http://www.fintrac-canafe.gc.ca/msb-esm/compliance-conformite/officer-agent-eng.asp

In a small business the compliance officer could be the owner/operator of the business. At a larger organization (e.g. a bank) a compliance officer is typically a full-time role.

FINTRAC also refers to their own inspectors as compliance officers: http://www.fintrac-canafe.gc.ca/publications/brochure/05-2005/4-eng.asp.

This blog post outlines criminal money laundering under s. 462.31 of the Criminal Code. It was written by Addison Cameron-Huff, a lawyer who specializes in Bitcoin. He highly recommends that you seek legal advice when considering issues related to criminal money laundering.

Photo from http://www.flickr.com/photos/59937401@N07/5857345827

Criminal money laundering is a serious offence and can result in a ten year jail sentence. The offence for “laundering proceeds of crime” is found in s. 462.31 of the Criminal Code:

“462.31 (1) Every one commits an offence who uses, transfers the possession of, sends or delivers to any person or place, transports, transmits, alters, disposes of or otherwise deals with, in any manner and by any means, any property or any proceeds of any property with intent to conceal or convert that property or those proceeds, knowing or believing that all or a part of that property or of those proceeds was obtained or derived directly or indirectly as a result of

(a) the commission in Canada of a designated offence; or

(b) an act or omission anywhere that, if it had occurred in Canada, would have constituted a designated offence.”

Criminal Code, R.S.C. 1985, c. C-46, s. 462.31

The term “designated offence” in s. 462.31 means:

“(a) any offence that may be prosecuted as an indictable offence under this or any other Act of Parliament, other than an indictable offence prescribed by regulation, or

(b) a conspiracy or an attempt to commit, being an accessory after the fact in relation to, or any counselling in relation to, an offence referred to in paragraph (a);”

Criminal Code, R.S.C. 1985, c. C-46, s. 462.3(1)

The punishment for violating s. 462.31 is up to ten years in jail (s. 462.31(2)(a)).

This blog post discusses the definition of “money laundering”. It was written by Addison Cameron-Huff, a lawyer who specializes in Bitcoin. He highly recommends that you seek legal counsel to obtain advice about money laundering.

Photo from http://www.flickr.com/photos/59937401@N07/5857345827

“Money laundering is the process used to disguise the source of money or assets derived from criminal activity” according to FINTRAC, Canada’s money laundering regulator. 

Money laundering is how criminals earn money illegally and convert it, through a series of steps, into money indistinguishable from legitimately earned income. The “series of steps” that money launderers use are diverse and constantly changing as they attempt to outwit law enforcement/tax authorities. 

The OECD’s Financial Action Task Force explains the reason why criminals need to launder money:

“In order to be able to spend money openly, criminals will seek to ensure that there is no direct link between the proceeds of their crime and the actual illegal activities. They may also seek to construct a plausible explanation for an apparent legal origin of the money that they possess. In this way, criminals seek to “launder” their proceeds of crime before spending or investing it in the legal economy.”

The primary source of law in Canada regarding money laundering is the Proceeds of Crime (Money Laundering) and Terrorist Financing Act. There are also Criminal Code offences (to be covered in future posts).

FINTRAC (the anti-money-laundering regulator in Canada) maintains a public database of every registered money services business: 

http://www10.fintrac-canafe.gc.ca/msb-esm/public/msbregistry/searchByName/clf-eng.html

Here’s an example from the registry for Canada’s largest Bitcoin trading network: VirtEx.

This blog post looks at the issue of whether sellers of bitcoins need to charge HST. It was written by Addison Cameron-Huff, a lawyer who specializes in Bitcoin. Tax is a complex area and you should seek accounting/legal advice before acting.

Most stores in Ontario that sell goods are required to charge 13% HST. According to the CRA:

“Almost everyone has to pay the GST/HST on purchases of taxable supplies of property and services (other than zero-rated supplies). A limited number of sales or supplies are exempt from GST/HST.”

One transaction that is exempt from HST is the sale of “gift certificates”, as provided for in s. 181.2 of the Excise Tax Act:

“… the issuance or sale of a gift certificate for consideration shall be deemed not to be a supply and, when given as consideration for a supply of property or a service, the gift certificate shall be deemed to be money.”

The Excise Tax Act does not define “gift certificate” but in 2012 the CRA issued a policy statement that explains their view on what a gift certificate is. The CRA’s definition of gift certificate requires the following five attributes:

“1. It has a monetary exchange value that is evident on the certificate or that is easily determined by the parties involved in the transaction. The monetary exchange value may, for example, be specified on the face of the certificate or it may be stored on the certificate electronically. In certain cases, the customer may be permitted to add additional amounts to the monetary exchange value of the certificate. Alternatively, the gift certificate may be for a particular supply of property or a service that is identified on the certificate.

2. It is issued or sold for consideration by the supplier of the property or service or another party for use at a particular supplier. The consideration paid for the certificate may not necessarily be the same as the monetary exchange value.

3. It is accepted as payment or partial payment of the consideration for a supply of property or a service offered by the supplier of that property or service.

4. It does not require the bearer to do anything to redeem the certificate other than to present it as a means of payment or partial payment for the property or services being acquired. The holder of the certificate should not be required to meet other conditions, such as, making a purchase of a particular value (i.e., a required minimum value) or purchasing one item to exchange the gift certificate for another item (e.g., buy one, get one free) in order to redeem the certificate.

5. It does not have any intrinsic value. The certificate should not have any value other than its monetary exchange value.”

In addition to the CRA’s policy statement there is case law that helps to explain what “gift certificate” means in Canadian law such as Royal Bank of Canada v. The Queen, 2007 TCC 281.

There are severe penalties for failing to comply with tax obligations. A seller of goods who fails to charge HST could be liable for the entire amount that should have been charged (with interest and penalties) and, if the seller is a corporation, liability may extend to the director(s). 

It is possible to request from the CRA a tax ruling or interpretation regarding HST obligations: http://www.cra-arc.gc.ca/E/pub/gp/rc4405/rc4405-e.html, but this please note that interacting with the CRA may result in negative tax consequences. You are strongly advised to seek the advice of a tax professional before starting to sell bitcoins or charging/not charging HST.