Bitcoin
Bitcoin Photo by Reuters
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Eyal Toueg
Tali Yaron-Eldar. Don't forget to report your profits. Photo by Eyal Toueg

It’s been hard to ignore the flurry of reports about virtual currency Bitcoin in recent months, but for now Israeli officials are doing just that.

Israeli banks, which have engaged in some Bitcoin transactions, would like clear guidance from regulators on the matter. But sources close to the issue say discussions among representatives from the Bank of Israel, the Israel Securities Authority and relevant units in the justice and finance ministries ended with a decision not to draw up Bitcoin-specific regulations.

Instead, said the sources, who asked not to be identified, Israeli regulators will wait to see how their peers in other countries handle the issue.“The banks supervisor did not find it appropriate at this stage to prohibit or set bank action toward customers who deal in the area of virtual currency,” a Bank of Israel official told TheMarker.

According to attorney Shiri Shaham, a specialist in banking law at the Yigal Arnon & Co. law firm, because there is no legislation in Israel today that addresses Bitcoin, in effect everything is permitted with respect to its use, until the laws are amended.

“Bitcoin brings with it a lot of innovation that has not existed until now,” she says, adding, “Consequently, it’s no wonder that it was not in the wherewithal of lawmakers in Israel and around the world to foresee this development and address it.”

Bitcoin transactions are essentially digital contracts between two computers transmitting data to each other through email, in a manner that maintains total anonymity for both parties. Bitcoins are stored on users’ computer hard drives, or in a digital wallet in the “cloud.” Transactions are effected by data transfer between computers, either online or using a USB key. Absent from the transactions are banks, credit-clearing

Bitcoin is transferred between users without the mediation of banks, or the government supervision this entails – supervision that has increased since the September 11 attacks. It can be used for massive transfers, making it very useful for money laundering purposes.

Most Bitcoin traders are merely engaging in speculation, trying to reap profits through the sharp fluctuations in the currency’s value. Just a year ago, one Bitcoin was worth $14, but on Wednesday its value reached $920.

But governments are worried about Bitcoin’s potential to be used for money laundering. Although it was launched in 2009, regulators around the world have yet to decide how to treat the currency and its market. This leaves banks, which are required by law to report suspected money-laundering transactions, in a bind regarding how they should treat clients who trade the virtual coin.

“Someone can hold several Bitcoin accounts under different names and trade it with himself [between the accounts] creating a ‘profit’ that was ostensibly made from trading with other people,” says a senior Justice Ministry official. “We also identified on the ‘Darknet,’ where people trade in illegal goods, that child pornography, drugs and more can be purchased with Bitcoin.”

According to the official, Bitcoin is not illegal but it is high-risk. Large amounts of money deposited into the banking system as the result of Bitcoin trading would be reported at each bank’s discretion to the Anti-Money Laundering Authority if the movement did not accord with the accountholder’s typical activity. The information would be stored in the agency’s database, the official says, and would only be acted on if other information about the user appeared suspicious. The bank could also limit the size of transactions for a specific account if had reason to suspect was being used to launder money or to finance terror. In fact, at some banks Bitcoin users have reported that their accounts were blocked after they conducted some trades in the currency.

Shaham’s colleague at Yigal Arnon, Guy Lachmann, says the laws of most Western countries, including Israel, define currency as the country’s legal tender, backing it as a valid means of payment within and outside its borders. “At this time, I don’t know a single country around the globe that recognizes Bitcoin as a legal tender, and therefore it should not be seen as a currency,” Lachmann says.

Some people, he says, view Bitcoin as a kind of tradable instrument like securities or futures options. However, he contends that it should be treated like a currency. “Bitcoin has become accepted as a form of payment among a large group of people in many countries,” he says. “Therefore, if we focus on the economic definition of money and not its political one, it should be seen as a currency.”

Shaham goes a step further, saying the government will not be able to prevent the use of Bitcoin. “I start from the assumption that there is nothing within the power of the Israeli lawmaker to prevent trading in Bitcoins, even it regulations prohibiting it are passed,” she says. “People who want to get their hands on Bitcoin will always succeed and it would be a pity if were to occur in the shadows and not under the supervision of the banking system.”

Shaham says Israel is too small a country to defy the global trend of Bitcoin use, but that it could regulate it and use technologies to minimize the dangers it entails.

“It seems to me that it would be a mistake on the part of the Bank of Israel to bury its head in the sand or, in the other direction, to adopt too conservative a position,” she says.

Another issue raised by Bitcoin is how to tax the profits generate from trading a currency not officially recognized by any country.

However, one thing seems clear. Bitcoin traders must report their trading income to tax authorities, says Tali Yaron-Eldar, a former income tax commissioner who now heads the law firm Yaron-Eldar, Paller Schwartz & Company.

A possible exception would be made for people who made a one-time purchase of Bitcoin, without intending to use it as an investment, and later sold it at a profit. In such a case, Yaron-Eldar says, the size of the purchase and sale, as well as how it was financed and the buyer’s expertise in buying speculative financial instruments would all be considered in determining any tax liability. However, she says that whether it is regarded as a currency or security, value-added tax would not apply to the purchase of Bitcoin.