Israel said on Wednesday it was considering regulation of Bitcoin and warned citizens that using such decentralized virtual currencies was risky.
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As a virtual currency, Bitcoin is passed between two parties digitally and can be traded on exchanges for real-world currencies. Its value fluctuates according to user demand but it is not backed by any government or central bank.
Supporters of Bitcoin are drawn to its decentralized platform and say it is here to stay. Detractors call it a bubble and expect it to be forgotten in a year or two.
However, it has proved increasingly popular and governments and regulators around the world have been searching for the best way to respond.
Israel, home to pioneering firms in high-tech fields such as cryptography, has emerged as a Bitcoin hotspot, prompting central bank governor Karnit Flug to convene a meeting this week with other regulators, including those for capital markets, taxes, securities and money laundering and terror financing.
"It was agreed to continue to examine various perspectives related to the use of, and trade in, virtual currencies," the authorities said in a joint statement on Wednesday.
"These perspectives include possible macro effects, their legal standing, their regulation, money laundering and terror financing risks, taxation and consumer protection."
The statement was a rare coordinated move by the Bank of Israel, the Capital Market, Insurance and Savings Department, the Israel Tax Authority, the Israel Securities Authority, and the Israel Money Laundering and Terror Financing Prohibition Authority.
They said the Israeli public should be aware that Bitcoin is unsupervised, is not legal tender and presents fertile ground for fraudulent activities. At the same time, such transactions are anonymous and often hard to trace, they added.
The statement put Israel in line with warnings already issued in the United States, Canada and the European Union.
Not everyone shares the skepticism of the regulators, however.
"[The statement] a collection of well known warnings but it ignores the need to take care of regulating the market," Attorney Ohad Maimon, the head of the banking and financial department at law firm Yuval Levy & Co.
"Trading in virtual currencies has existed for a long time already and the regulators must give a practical response to the burning issues for both the traders and for the banking system, and not to issue a collection of warnings that have nothing new in them," he said. This is a real lost opportunity to create an appropriate legislative and regulatory framework for issuing and regulating virtual currencies."
"This anonymity is liable to be exploited for criminal activity, including money laundering, financing illegal activities and financing terrorism," the statement said.
"Law enforcement authorities are therefore likely to close trading platforms in virtual currencies which are used for illegitimate activities, by preventing access or use of customers' capital, which would likely be held by those platforms," the statement added.
Other governments have also issued warnings on the use of Bitcoin and New York's financial regulator revealed plans this month to govern virtual currency firms in the state in order to protect consumers and combat money laundering.
At least two dozen Israeli startups have popped up in the past year with a view to creating tools that will allow Bitcoin to be used in almost any kind of transaction - from buying shoes to issuing company stock.
In recent weeks, Bitcoin was hit by attacks from unknown computer hackers that led to problems at two exchanges. They had to temporarily halt withdrawals by customers who stored Bitcoins in digital wallets provided by the exchanges.
This week, a Bitcoin is worth about $635, down from around the $1,000 mark in late 2013. However, it was worth only about $150 as recently as last September.
Guide to the risks of Bitcoin
1. Virtual currency is not legal tender: Virtual currencies are not issued by a central bank, and are not backed by a central bank which guarantees the nominal value of currency it issues and acts to maintain confidence in it. In addition, they are not legal tender in Israel, and there is no requirement to accept them as payment for any asset or service, or as repayment of a loan.
2. Risk management by financial institutions: As the use of virtual currencies enables their anonymous transfer, in many cases evading the need to use financial institutions that are subject to an anti-money laundering and terror financing prohibition regime, this is activity with high risk in terms of money laundering and terror financing. Financial institutions must take this into account within the framework of their risk management policy, including with regard to reporting to the Israel Money Laundering Authority.
3. Fraud and deceit: The unique characteristics of virtual currencies are liable to present fertile ground for fraudulent activities, such as Ponzi schemes. Fraud of this type, and others, are expressed in, among other things, the use of technology, innovative products, and rapid growth of industries in order to draw in additional people to invest their funds, with the understanding that potential investors tend to be less suspicious due to a lack of familiarity with what is being offered, and their trust in the promise of the innovation offered to them. Transactions in decentralized virtual currencies cannot be cancelled, and from the moment a sale takes place, the value paid can no longer be returned. Therefore, their use as means of payment is exposed to fraud such as not supplying the product or service, in which after payment is transferred, the supplier or service provider does not provide anything in return.
4. High volatility: The value of virtual currencies such as Bitcoin is given to especially high volatility. The value of a Bitcoin, for example, increased sharply over a specific period, but it is also liable to sharply decline rapidly, as has already happened. Such volatility impacts on both investors in the virtual currencies as well as on those who wish to use them as means of payment, whether as a customer or as a supplier.
5. Use in criminal activities, including money laundering and terror financing: Transactions using decentralized virtual currencies are open and are conducted directly via peer-to-peer networks. However, the sides in a transaction remain anonymous, which often makes it difficult to trace them. This anonymity is liable to be exploited for criminal activity, including money laundering, financing illegal activities, and financing terrorism. Law enforcement authorities are likely to close trading platforms in virtual currencies which are used for illegitimate activities, by preventing access or use of customers’ capital, which would likely be held by those platforms.
6. Robbery: Virtual currencies are generally stored on computers or smart phones, and there have been cases reported of hacking into computers and stealing large sums of Bitcoins. In addition, their loss or a forgotten password is liable to lead to the absolute loss of the value stored on the computer or phone.
7. Loss of money in trading platforms: Virtual currencies can be purchased directly from someone who holds them, through a trading exchange or via conversion services. These trading exchanges and conversion services generally do not operate under a designated license or relevant oversight. In several cases these entities ceased their operation due to a breach by third party, and the value of the virtual currency held there disappeared. Such services expose their users to a wide range of additional risks resulting from operational instability, information security failures, and lack of regulatory certainty which characterizes their operations.
8. Lack of supervision over trade: Trade in virtual currencies is not supervised by any government authority. It should be noted that Israeli traders in Bitcoins and similar products who are listed as currency service providers at the Ministry of Finance, are not listed there with regard to trade in virtual currencies, but only to related activities. The Israel Securities Authority does not oversee trading in Bitcoin or similar products or in securities for which they serve as their underlying assets.