[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]



 
      BITCOIN: EXAMINING THE BENEFITS AND RISKS FOR SMALL BUSINESS

=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON SMALL BUSINESS
                             UNITED STATES
                        HOUSE OF REPRESENTATIVES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                               __________

                              HEARING HELD
                             APRIL 2, 2014

                               __________

                               [GRAPHIC] [TIFF OMITTED] TONGRESS.#13
                               

            Small Business Committee Document Number 113-064
              Available via the GPO Website: www.fdsys.gov


                                 ______

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                   HOUSE COMMITTEE ON SMALL BUSINESS

                     SAM GRAVES, Missouri, Chairman
                           STEVE CHABOT, Ohio
                            STEVE KING, Iowa
                         MIKE COFFMAN, Colorado
                      BLAINE LUETKEMEYER, Missouri
                     MICK MULVANEY, South Carolina
                         SCOTT TIPTON, Colorado
                   JAIME HERRERA BEUTLER, Washington
                        RICHARD HANNA, New York
                         TIM HUELSKAMP, Kansas
                       DAVID SCHWEIKERT, Arizona
                       KERRY BENTIVOLIO, Michigan
                        CHRIS COLLINS, New York
                        TOM RICE, South Carolina
               NYDIA VELAZQUEZ, New York, Ranking Member
                         KURT SCHRADER, Oregon
                        YVETTE CLARKE, New York
                          JUDY CHU, California
                        JANICE HAHN, California
                     DONALD PAYNE, JR., New Jersey
                          GRACE MENG, New York
                        BRAD SCHNEIDER, Illinois
                          RON BARBER, Arizona
                    ANN McLANE KUSTER, New Hampshire
                        PATRICK MURPHY, Florida

                      Lori Salley, Staff Director
                    Paul Sass, Deputy Staff Director
                      Barry Pineles, Chief Counsel
                  Michael Day, Minority Staff Director


                            C O N T E N T S

                           OPENING STATEMENTS

                                                                   Page
Hon. Scott Tipton................................................     1
Hon. Nydia Velazquez.............................................     2
Hon. Sam Graves..................................................     9

                               WITNESSES

Mr. Jerry Brito, Senior Research Fellow, Mercatus Center, George 
  Mason University, Arlington, VA................................     3
Mr. Adam White, Director of Business Development and Sales, 
  Coinbase, San Francisco, CA....................................     5
Mr. Mark Williams, Executive-in-Residence, Master Lecturer, 
  Boston University, School of Management, Boston, MA............     7
Mr. L. Michael Couvillion, Associate Professor of Economics, 
  Plymouth State University, College of Business Administration, 
  Plymouth, NH...................................................     9

                                APPENDIX

Prepared Statements:
    Mr. Jerry Brito, Senior Research Fellow, Mercatus Center, 
      George Mason University, Arlington, VA.....................    29
    Mr. Adam White, Director of Business Development and Sales, 
      Coinbase, San Francisco, CA................................    55
    Mr. Mark Williams, Executive-in-Residence, Master Lecturer, 
      Boston University, School of Management, Boston, MA........    57
Mr. L. Michael Couvillion, Associate Professor of Economics, 
  Plymouth State University, College of Business Administration, 
  Plymouth, NH...................................................    73
Questions for the Record:
    None.
Answers for the Record:
    None.
Additional Material for the Record:
    Journal of Accountancy.......................................    79


      BITCOIN: EXAMINING THE BENEFITS AND RISKS FOR SMALL BUSINESS

                              ----------                              


                        WEDNESDAY, APRIL 2, 2014

                  House of Representatives,
               Committee on Small Business,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 1:00 p.m., in Room 
2360, Rayburn House Office Building. Hon. Sam Graves [chairman 
of the Committee] presiding.
    Present: Representatives Graves, Chabot, Luetkemeyer, 
Mulvaney, Tipton, Hanna, Huelskamp, Schweikert, Velazquez, 
Clarke, Payne, Meng, and Mclane Kuster.
    Mr. TIPTON. [Presiding] Good afternoon. This hearing will 
come to order. Chairman Graves will be joining us shortly. I 
will fill in for him here in the interim.
    I would like to thank all of our witnesses for taking the 
time to be able to join us here today.
    To be able to gain an advantage in an increasingly 
competitive marketplace, small businesses are looking for 
innovative ways to be able to cut costs and be able to gain 
access to customers. One small way the businesses are doing 
this is through the use of cutting-edge technologies that can 
provide efficiencies, and Bitcoins may be one of these 
innovative technologies.
    Bitcoins are a form of virtual currency first introduced in 
2008 that allows users to exchange value digitally through the 
Internet. Despite not being backed by a government or holding 
any intrinsic value of their own, Bitcoins are growing as an 
alternative payment method. This hearing will examine the 
benefits and risks associated with Bitcoin as a payment system 
for all small businesses.
    While the origins of Bitcoin remain mysterious, it has 
grown rapidly in the last few years. Businesses choose to 
accept Bitcoin for many reasons, including to be at the 
forefront of new technology, to attract customers now using 
Bitcoin, to lower transaction fees from credit and debit cards, 
and to eliminate certain kinds of fraud.
    Despite these advantages, there are numerous risks that 
small businesses should consider before implementing a Bitcoin 
payment system. These risks include volatility of price, 
security and policy uncertainty. Further, recent developments 
in the Bitcoin industry have cast a shadow on its security and 
sustainability. Hacking attacks have led to the downfall of a 
leading Bitcoin exchange company, while its use for criminal 
activity has led to greater scrutiny by law enforcement and 
other federal and state banking regulators.
    We have invited a distinguished panel of experts who will 
explain what Bitcoin is, and we appreciate that, and how it 
operates, why it might be a good fit for small businesses and 
what the risks are associated with Bitcoin. We hope that by 
providing information about Bitcoin, small businesses will be 
in a better position to know whether adopting Bitcoin as a 
payment system might be a way for small businesses to be able 
to gain more customers. This hearing will also inform Members 
as we consider implications of policies affecting the use of 
virtual currencies.
    With that, I would again like to thank our distinguished 
panel of witnesses for joining us here today, and I now 
recognize the ranking member for her opening statement.
    Ms. VELAZQUEZ. Thank you, Mr. Chairman. Good afternoon, 
everyone, and thank you for being here today.
    American entrepreneurship is closely linked to technology 
called innovation. Whether it was the arrival of Google or 
Facebook, the widespread use of smartphone apps or cloud 
computing, our nation's entrepreneurs drive many technological 
developments. Not only do small firms help create new 
technologies that drive growth, but they often benefit from new 
systems and processes.
    The relatively recent arrival of digital currencies is one 
technology that presents significant opportunity. Just as the 
Internet has empowered entrepreneurs to reach new global 
markets and identify more efficient ways of doing business, 
digital currencies like Bitcoin can save small firms on 
transaction costs. For a small company accepting major credit 
cards, each card swipe can cost as much as one-quarter of a 
cent in addition to having to return 3 to 6 percent of sales 
total to the credit card company. Some credit card companies 
also charge businesses to join the network. By contrast, when 
utilizing Bitcoin, there is no cost of joining the network. 
Fees are less than 1 percent. For large retailers and big box 
stores, this cost may sound minor, but among small companies 
operating on thin margins, those expenditures are up. Moreover, 
should currencies like Bitcoin become widely utilized, they 
could create competitive pressure for conventional financial 
institutions to lower transaction fees in an effort to retain 
small business customers.
    Beyond allowing small firms to save on transaction costs, 
Bitcoins offer consumers other advantages. For customer seeking 
anonymity, Bitcoins provide more privacy than credit card 
transactions. Small firms are gradually recognizing the promise 
of accepting Bitcoins. In 2012, about 1,000 businesses used 
BitPay, the largest processor of Bitcoin payments. Today, more 
than 13,000 small businesses in the U.S. employ this service. 
While most are online sellers, one in five are traditional 
brick-and-mortar operations suggesting the technology is 
gaining broader acceptance.
    Although this growth sounds promising, a number of 
unanswered questions might be impeding small businesses' use of 
Bitcoins. Price fluctuation for Bitcoins create complications. 
Last spring, Bitcoin's dollar exchange rate rose sharply from 
$50 to $350 and then fell to $70. With swings like this, one 
has to wonder whether small businesses will find it difficult 
to continually price and reprice their products in order to 
ensure they receive fair compensation from customers.
    There are also security questions. Hacking incidents in 
2012 and 2013 endangered many users' Bitcoins. More recently, 
the bankruptcy of Mt. Gox, one of the largest Bitcoin 
exchanges, was followed by news that the company has lost 
hundreds of millions of dollars in Bitcoins. For small 
businesses to fully benefit from this currency, customers must 
be assured their money is safe and cannot be snatched out of 
cyberspace. It also remains to be seen how the IRS's recent 
ruling declaring Bitcoin a property as opposed to a currency 
will impact this technology growth.
    In all these areas, the Committee has an obligation to 
ensure small business interests are taking into account. We 
want small firms to benefit from this technology, but we must 
see to it that there are safeguards protecting them and their 
customers. Likewise, we must see that tax regulatory changes do 
not preclude the use of this currency.
    I expect today's hearing will help us learn about complex 
issues like this and assist the Committee as it addresses such 
matters going forward. In that regard, I would like to thank 
our witnesses for being here, and I yield the balance of my 
time.
    Mr. TIPTON. Thank you, Ms. Velazquez.
    If Committee members have an opening statement prepared, I 
ask that they submit it for the record.
    I would like to take a moment just to be able to explain 
our timing lights. You will each have five minutes for your 
testimony. The light will start out as green. When you get into 
the danger zone is when it moves to yellow. When it gets to the 
red, if you would conclude your statements at that time we 
would appreciate it.
    So again, thank you, gentlemen, for joining us this 
afternoon.
    Our first witness is Mr. Jerry Brito, senior research 
fellow at Mercatus Center at George Mason University. Mr. Brito 
focuses his research on technology, Internet policy, copyright, 
and regulatory process. Mr. Brito is the coauthor of Bitcoin: A 
Primer for Policymakers.
    Mr. Brito, thank you for being here, and I look forward to 
your testimony.

  STATEMENTS OF JERRY BRITO, SENIOR RESEARCH FELLOW, MERCATUS 
   CENTER, GEORGE MASON UNIVERSITY; ADAM WHITE, DIRECTOR OF 
   BUSINESS DEVELOPMENT AND SALES, COINBASE; MARK WILLIAMS, 
  EXECUTIVE-IN-RESIDENCE, MASTER LECTURER, BOSTON UNIVERSITY, 
    SCHOOL OF MANAGEMENT; L. MICHAEL COUVILLION, ASSOCIATE 
 PROFESSOR OF ECONOMICS, PLYMOUTH STATE UNIVERSITY, COLLEGE OF 
                    BUSINESS ADMINISTRATION

                    STATEMENT OF JERRY BRITO

    Mr. BRITO. Thank you. Thank you very much, Mr. Chairman, 
members of the Committee. Thank you for inviting me here today 
to comment on Bitcoin's use for small businesses.
    Virtual currencies and electronic payment systems are 
nothing new. They have existed for decades. So what is it about 
Bitcoin that makes it unique? Bitcoin is the world's first 
completely decentralized digital currency, and it is the 
decentralized part that makes it unique. Prior to Bitcoin's 
invention in 2009, online currencies or payment systems had to 
be managed by a central authority, whether it was Facebook 
issuing Facebook credits or PayPal ensuring that transactions 
between its customers were reconciled. However, by ingeniously 
solving some longstanding problems in computer science, Bitcoin 
for the first time makes possible electronic transactions that 
are person-to-person without the need for an intermediary 
between them, just like cash.
    This technical breakthrough presents both potential 
benefits and risks for consumers and small businesses. For 
example, because there is no central intermediary in Bitcoin 
transactions, fees associated with those transactions are 
relatively small. Small businesses accepting credit card 
payments often face fees of around 25 cents for each card swipe 
plus 2 to 4 percent of the transaction total. If you are a 
small margin business, those fees can really eat into your 
bottom-line. In contrast, businesses that use a merchant 
processor, like BitPay or Coinbase, pay fees of 1 percent or 
less on Bitcoin transactions. If you are a smaller margin 
business, that difference could mean doubling your profits.
    Another reason small businesses are attracted to Bitcoin is 
that, like cash, all transactions are final. And again, because 
there is no central intermediary, there is no third party that 
can reverse the transaction. This protects small businesses 
from chargeback fraud, which often results not just in the loss 
of a sale but also in penalty fees. And such friendly fraud 
accounts for 41 percent of all claims. And if a merchant has 1 
percent of their charges reversed as chargebacks, they can 
often be kicked out of the credit card networks, potentially 
ending their business.
    And finally, because Bitcoin is decentralized, businesses 
can now accept international payments that were not previously 
possible. There are over 50 countries that traditional payment 
processors do not serve, often because of high fraud rates. 
Because Bitcoin payments are global and final, doing business 
with consumers in those countries, especially in developing 
countries is now feasible.
    For consumers, the benefit Bitcoin presents is essentially 
choice. Wishing to encourage its use, merchants frequently 
offer discounts to customers who pay with Bitcoin. This means 
consumers will be able to choose to pay a little more and get 
the benefits of using a credit card, like fraud insurance and 
airline miles, or they can choose to pay a little less by using 
Bitcoin. For some price-sensitive consumers, this could be a 
very valuable choice.
    Of course, there are also risks associated with Bitcoin. 
Chief among these is Bitcoin's historic volatility. It has 
traded from a low of pennies when it was first introduced in 
2009, to a high of $1,200 last December, with wild short-term 
swings. However, there is nothing inherent in Bitcoin's design 
that naturally makes it so extremely volatile. Its extreme 
volatility is likely attributable to the fact that it is a new 
currency. Bitcoin is still an experiment, and it is still in 
the process of discovering a more stable price.
    Additionally, as a nascent currency, it is very thinly 
traded, and as a result, a single, large enough trade can 
affect the exchange price substantially. If Bitcoin's use 
continues to expand, potentially, we could expect to see 
extreme volatility subside. Additionally, derivatives that 
allow investors to bet against the price of Bitcoin will soon 
become available and this should help stabilize the price as 
well.
    The volatility risk is one that a small business faces if 
it accepts Bitcoins directly. It should be noted, however, that 
small businesses can use Bitcoin entirely as a payment system 
without ever holding Bitcoins. And in fact, this is what most 
small businesses do. Using a merchant service company like 
BitPay or Coinbase, merchants can denominate prices in dollars, 
not in Bitcoin, and denominate their prices in dollars, accept 
Bitcoins for payment at the current exchange rate, and then 
immediately convert those Bitcoins to dollars, never actually 
holding a Bitcoin.
    Security is another concern. Because Bitcoin is essentially 
digital cash, securing it is vitally important. There is no 
intermediary that can replace your Bitcoins if they are stolen. 
As we have seen, however, merchants need not hold Bitcoins, and 
as interest in Bitcoin expands, we are seeing a great deal of 
innovation and investment in secure consumer products. But, 
this still means that exchanges, merchant processors, and other 
new Bitcoin intermediaries will have to earn consumers' trust 
just as Visa and PayPal have.
    Like the Internet itself, Bitcoin has the potential to be a 
platform for the kind of permissionless innovation that has 
driven so much of the growth of our economy. And like all 
emerging technologies, Bitcoin also presents risks. The 
challenge for policymakers is to address those risks while 
doing no harm to the innovative potential of the technology.
    Thank you for your time, and I look forward to your 
questions.
    Mr. TIPTON. Thank you, sir.
    Our next witness is Adam White, Director of Business 
Development and Sales at Coinbase. Coinbase is a payment 
processing company for businesses interested in accepting 
Bitcoin. Prior to joining Coinbase, Mr. White served in the 
United States Air Force and was a test pilot for NASA before 
receiving his MBA from Harvard Business School.
    Appreciate you being here with us today, Mr. White, and 
look forward to your testimony.

                    STATEMENT OF ADAM WHITE

    Mr. WHITE. Thank you, Mr. Chairman, Ranking Member 
Velazquez, and other members of the Committee, for the 
opportunity to appear here today.
    My name is Adam White. I am the Director of Business 
Development and Sales at Coinbase, a company founded in June 
2012, with the goal of making it easy for merchants and 
consumers to transact with the digital currency, Bitcoin. More 
than one million consumers use Coinbase as their digital 
wallet, and as of today, there are nearly 28,000 businesses 
that entrust Coinbase to accept Bitcoin payments on their 
behalf using our payment tools. These merchants include large 
enterprise-level businesses, such as Overstock.com and Big Fish 
Games, as well as tens of thousands of small businesses like 
Tealet, Tuft and Needle, and Mondo Cellars.
    Prior to my role at Coinbase, I served as a captain in the 
United States Air Force, and am a veteran of Operation Iraqi 
Freedom and Operation Enduring Freedom.
    I would like to begin today by outlining the inherent 
benefits of Bitcoin in commerce, namely the powerful prevention 
of fraud, the reduction of transaction fees, and the 
monetization of new markets, and how these benefits could be a 
positive influence on businesses of all sizes.
    Bitcoin enables individuals to push payments to merchants 
without having to share personally identifiable information 
that can be intercepted by criminals and used for fraudulent 
purposes. This irreversible nature of Bitcoin enables the 
abstraction of personal information and significantly reduces 
the risk of fraud, something that merchants, card processors, 
and banks spend billions of dollars per year combatting. With 
Bitcoin, for example, the target data breach that compromised 
40 million consumers' credit card information would not have 
been possible. Moreover, this irreversibility shields merchants 
from chargebacks. That is, the forced return of funds from a 
merchant to a customer's bank account and the cost associated 
with managing, defending, and preventing fraudulent chargeback 
claims.
    In response, many card issuers and merchants use fraud 
detection systems that are overly sensitive to trigger 
activities, especially in card-not-present transactions common 
online. Initial estimates suggest that some merchants turn away 
nearly 8 percent if incoming orders due to issues associated 
with suspicious activity. Many of these transactions, however, 
are, in fact, legitimate. Bitcoin prevents the need for risk 
algorithms and ensures merchants capture 100 percent of their 
customers' orders.
    Due to the powerful prevention of fraud and the reduction 
in the number of intermediaries required to process a payment, 
Bitcoin transactions are dramatically less expensive than 
traditional card-based payments. Merchants can reduce their 
electronic payment acceptance fees to less than 1 percent when 
accepting payment in Bitcoin. This is especially important for 
small businesses that sacrifice anywhere between 3 and 5 
percent of their revenues in card transaction fees. Businesses 
can use these savings to reinvest in their company or return 
them to consumers in the form of lower prices. Moreover, 
merchants are not subject to a fixed fee per transaction, 
enabling them to forgo minimum transaction limits and sell 
small ticket items profitably.
    Finally, Bitcoin provides the opportunity to monetize new 
markets by democratizing foreign exchange and enabling 
frictionless cross-border transactions that settle immediately. 
Many products and services are not available for sale in 
foreign countries because the business cannot manage the 
payment systems needed to support overseas commerce. Because of 
the borderless and global nature of Bitcoin, a Bitcoin payment 
made by a customer in New York looks identical to a merchant, 
as a Bitcoin payment made by a customer in London, Buenos Aires 
or Tokyo. There are no individual currency conversion fees 
associated with Bitcoin payments, so merchants can sell low 
margin items just as profitably abroad as they do domestically. 
The ability to easily begin accepting payments from customers 
around the world can open up whole new markets for merchants 
and significantly improve topline revenue.
    We see Bitcoin as an extremely powerful technology, and it 
is our goal to bring these efficiencies created by the Bitcoin 
network to the masses. We are encouraged to see the Committee's 
proactive examination into the topic of Bitcoin as it relates 
to small businesses, and I look forward to engaging in dialogue 
and answering any questions you may have.
    Mr. TIPTON. Thank you, Mr. White.
    Our next witness is Mark Williams, professor of Finance and 
Risk at the Boston University School of Management. Before 
joining the faculty at Boston University, Mr. Williams worked 
as a senior trading floor executive, bank trust officer and as 
a bank examiner for the Federal Reserve Bank. Mr. Williams 
holds an MBA from Boston University School of Business, and a 
B.S. from the University of Delaware.
    Welcome, Mr. Williams, and please begin.

                   STATEMENT OF MARK WILLIAMS

    Mr. WILLIAMS. Thank you. I am very happy to be here, and 
thank you for inviting me. In particular, I am very interested 
in Bitcoin, and the reason for that interest really stems from 
classroom discussions going back to 2011. At that point in 
time, prices were 35 cents, so it was more of a theoretical 
discussion, but very quickly within the classroom it moved from 
discussion to by 2012 when Bitcoin prices started to increase 
by over a dollar to actually homework assignments, and then 
eventually, these homework assignments turned into outright 
discussions and debate in the classroom. By 2013, the price of 
Bitcoin by January had increased actually to $13 a coin. Very 
quickly, in 2013, it escalated from $13 all the way up to 
$1,200. It was remarkable.
    But what was unusual about this price run-up at the peak in 
2013 was the fact that this was a 9,000 percent increase. 
Nowhere on this planet or any planet has there been that sort 
of price increase. And what that represented to the marketplace 
in particular is the fact that this was a unique product and a 
unique risk.
    So what I would like to do today is I would like to focus 
specifically not on the promised benefits of Bitcoin, because 
we have heard enough about that, but I would like to take my 
discipline in risk management, in particular, working on a 
commodity trading floor, and talk specifically about the risks 
that are associated with Bitcoin. In particular, I provided a 
30-page testimony which outlines 10 of the specific risks, what 
I consider to be the top risks associated with Bitcoin. But 
what I would like to do for the Committee right now is really 
focus on the top six risks. And I will leave this up for the 
discussion later.
    In particular, the first risk which is very important to 
look at for big businesses and for little businesses is that 
Bitcoin itself is not legal tender. And what I mean by that is 
the fact there is no legal precedence; that is, that 
individuals and corporations themselves have to accept Bitcoin. 
So as a result, it is a very voluntary commodity. So just as 
equally as we can turn a light off today, if the market decides 
they do not want to accept Bitcoin anymore, the value could 
drop to worthless. What is very interesting about that 
statement of worthless, we have seen Bitcoin drop already. 
Since its high in December, it has dropped by roughly 60 
percent. So clearly, this is not a currency. Currencies do not 
behave like this. But what this is is a high risk speculative 
commodity.
    Since December, what have we seen? We have seen daily price 
movements of up to 10 percent. Can you imagine having currency 
in your wallet that can move up or down by 10 percent? That 
would be hot currency. If you were worried about it dropping by 
10 percent, you would be selling it very quickly, getting it 
out of your wallet. If you thought it would appreciate, you 
would hoard it. And these characteristics are characteristics 
that you see in Bitcoin. Over 90 percent of Bitcoin is hoarded. 
What that means is only 10 percent of what is available trades.
    Increasingly, we have had changes within the marketplace. 
Last week, the IRS came out with a formal ruling and said 
Bitcoin is not currency. What it is, it is property. And what 
that means is it reduces the likelihood of people to use it to 
spend. It actually gives a disincentive. What it increases 
though is the incentive to hoard. So this is the opposite of 
what you want in a currency. Currencies, we collectively use 
currencies because currencies themselves provide us with the 
ability to buy things. A $100 bill has not value to us to put 
on the wall, but that $100 bill has value for us to buy art 
that we can then put on the wall. Bitcoin is unusual in that 
regard. The fascination, fixation of investors on Bitcoin is 
tied directly to it as a commodity, as something to speculate, 
not as something to use as a transactional currency.
    So what are some of the other risks? There is extreme price 
volatility that was discussed earlier as well, and with that 
extreme price volatility with daily movements of 10 percent, 
what that means to put it in perspective, Bitcoin is seven 
times more risky than gold, eight times more risky than the S&P 
500. In particular, it is 15 times more risky than the U.S. 
dollar. And just for fun I will throw this out. If you look at 
the Argentinian peso, Bitcoin is seven times more risky than 
the peso.
    So as you can see, this is not a currency, but this is a 
very risky commodity. But more importantly, when we think about 
businesses, businesses, your average business, they actually 
have profit margins of maybe 10 percent, 15 to be liberal. If 
you have a daily fluctuation of 10 percent, what that means is 
that profit margins can be evaporated within a period of days, 
and that is of concern.
    Two quick more risks that I will bring up to the Committee, 
and that is the asset bubble. Many noted economists have 
mentioned this asset bubble, and we have seen it actually since 
December start to implode. As I mentioned, the price dropped by 
60 percent. In addition, the number fifth risk is a growing 
concentration risk. We are seeing firms like Coinbase doing a 
nice job of trying to mitigate the market risk, but what is 
happening is they are moving the risk from let us say 20,000 or 
30,000 people to their balance sheet. So they are warehousing 
that risk and there is not a mature market for them to offload 
that risk. So we have concentrated risk on their books. They 
are thinly capitalized. They are a startup. There is no minimum 
capital requirement. So what should happen if one of these or 
both of these firms were to blow up? Then consumers, U.S. 
businesses would be impacted.
    And then finally, when we think about Bitcoin, there is 
Bitcoin tax which now is a risk. In a sense of using Bitcoin on 
a daily basis, deciding whether to pay, for example, employees 
or actually accepting it as currency, if you are having daily 
fluctuations of 10 percent, you can see capital gains very 
quickly.
    So I thank you for your patience.
    Mr. TIPTON. Gentlemen, if you would not mind, we apologize. 
Naturally, when we start, we get a vote called. And we want to 
make sure that our last witness has the appropriate amount of 
time and our folks are going to be able to listen. So we will 
go into recess, run over and vote. I believe it is going to be 
a short vote. And should be back in 20 minutes or so. Is that 
about right?
    So if you do not mind, I apologize, and certainly 
appreciate your patience.
    [Recess]
    Chairman GRAVES. We will go ahead and call the hearing back 
to order, and I now yield to Ranking Member Velazquez for her 
introduction.
    Ms. VELAZQUEZ. Thank you, Mr. Chairman.
    It is my pleasure to introduce Professor Michael 
Couvillion. Professor Couvillion is an associate professor of 
Economics at Plymouth State University's College of Business 
Administration. His current research includes asset allocation 
modeling and alternative investment vehicles such as Bitcoin. 
Additionally, he has worked with the Enterprise Center of 
Plymouth to educate local, small business owners in New 
Hampshire about the advantages and disadvantages of Bitcoin.
    Welcome, Professor.

               STATEMENT OF L. MICHAEL COUVILLION

    Mr. COUVILLION. Thank you very much. And thank you to 
members of the Committee for inviting me.
    I thought I would take a slightly different tact this 
afternoon and not discuss the nuts and bolts of Bitcoin because 
you have heard so many excellent comments about that before.
    My interest in Bitcoin started about three semesters ago 
when one of my best students wrote a research paper in a class 
on Bitcoin. He was a passionate advocate for Bitcoin, and he 
liked it so much he actually put $100 into Bitcoin. He would 
not tell me how many Bitcoins he bought except that it was well 
under $10. So the student has graduate and now I keep getting 
emails from him. ``Hey, check out the price of Bitcoin.'' 
Because he bought it, I think, about $8, and Bitcoin is worth 
about $450 right now. So he has got a very nice paper profit 
here.
    So he got me certainly thinking about Bitcoin in a way I 
had never thought about it before. And I began to become 
interested in Bitcoin and opened an account with Coinbase in 
May of last year. I have some data in my written remarks that 
come from that dataset, which is roughly about 10 months, so it 
is suggestive, it is recent, but it is by no means definitive.
    Some of the things I have learned I would like to share 
with the Committee. Coinbase charges a different price if you 
buy Bitcoin than they do if you sell Bitcoin. This is known as 
the bid-ask spread, very similar to the spreads on a NASDAQ 
stock let us say in the stock market. And just for a random 
day, which was March 28th--that is last week--the bid-ask 
spread for Coinbase was 17 basis points. That is about two-
tenths of one percent. By way of comparison, the Dow Jones 
Industrial Average at the same time had a bid-ask spread of 
about 45 basis points, twice as high, and the Standard and 
Poor's 500 had a bid-ask spread of 32 basis points. So on that 
day, compared to the stock markets, Coinbase's bid-ask spread 
was lower. In addition, I have taken a look at the trend in the 
bid-ask spread. The high is 164 basis points, the minimum is 
zero, and the average is 40. So that is where I got that data 
you will see on the spreadsheet.
    Also, the bid-ask spread has been steadily trending down 
over time and it is a significant trend. So that is important 
because bid-ask spreads are an excellent measure of the 
liquidity of any market. They also have to measure risk because 
if a market is very thinly traded, you will see much larger 
bid-ask spreads.
    Then, I took a look at the statistics for Bitcoin, asking 
what kind of distribution does it follow? And my conclusions 
are that the Bitcoin price return series, that is the 
percentage daily change, is 2P. It has too many small moves and 
not enough middling moves. It is also skewed heavily to the 
right and that causes a problem for using standard or 
traditional statistical analyses.
    Sorry, is my time up? No, okay.
    Also, I did a comparison of Bitcoin with three other 
invesmtents--short-term global interest rates, the dollar 
index, and the emerging markets currency index, and 
essentially, I found out that none of those models predict 
Bitcoin. Its price is in essence unpredictable. You cannot with 
any degree of accuracy project the price of Bitcoin more than 
just a few days in the future.
    Now, that is good if you are a small businessman, and the 
reason it is good is that because the average return to Bitcoin 
is positive--and remember, the price of Bitcoin has risen from 
about $85 last May to about $450 now. It is a bit seductive to 
a small business person because if you were to buy Bitcoin, you 
would see your Bitcoin increase in value. That is only because 
we have a bullish trend lately. The other thing that you will 
discover is that the number of daily moves are fewer than they 
should be at less than 10 percent.
    Now, Bitcoin investors, unfortunately, pay for that because 
while the number of 10 percent or more moves is less than it 
should be by approximately roughly 2 percent, if you look at 
the number of 15 percent moves, there are more than there 
should be. There is about 2 percent of the observations there 
and huge moves, which we call fat tails, there should be none. 
In the dataset there were six. Three were positive. Three were 
negative. But there were six price moves that would be 
completely unpredictable based on chance. So again, I would 
like to corroborate what your other witnesses have already told 
you, that Bitcoin is a very volatile currency.
    In terms of the other technical features, the problem with 
Bitcoin is that we cannot analyze it using the standard tools 
of finance because the underlying distributions simply does not 
fit our models. And that means it is hard if you are trying to 
use sophisticated techniques like value at risk or covariance 
matrices. It is hard to reach any conclusions that actually 
work. I realize that small businesses probably will not do 
that, but even large businesses will have difficulty with 
Bitcoin for that reason.
    I gave a small example of the cost comparison, and Bitcoin 
works at every level from $1 transactions all the way up to 
$10,000 transactions. Businesses can save money if they use 
Bitcoin, and that I believe is the single fact that is what is 
going to drive Bitcoin to a successful integration into the 
marketplace. So there is a slight advantage right there.
    Offsetting that, it is difficult for businesses to use 
Bitcoin because they first have to educate themselves and their 
employees, and then they have to educate at least some of their 
customers. And exactly how do you do a trade using Bitcoin? So 
there is a steep learning curve at first, but once you have 
managed to get your employees and your customers educated, then 
things go a whole lot more smoothly. That is a good role here 
for the government to encourage confident and detailed 
education on the part of the companies that do a large business 
in Bitcoin. Because it is so new, you have to educate consumers 
about that, and because there is so much risk, they also need 
to be clearly informed and disclosed that this is not an FDIC-
insured investment. It is not something that you would ever 
have invested in before. So I did want to make that point.
    Finally, I tried to forecast the price of Bitcoin, and my 
model suggests that the best predictor of the price of Bitcoin 
tomorrow is 99 percent of the price today plus $4.73. And that 
is because there is a positive trend in Bitcoin prices. And I 
have a graph that shows that basically in 46 days, the price of 
Bitcoin could be as low as zero or as high as $1,000. That is 
in 46 days. So it makes it problematic, and I believe that the 
market for Bitcoin will remain volatile at least for a while 
unless it achieves mainstream acceptance.
    So having said that, there are a couple of advantages of 
Bitcoin that have not been touched on previously, so I would 
like to mention them quickly. One is that somehow you can send 
a message using Bitcoin. There is a way where you could say 
thank you for your business or some other message like that. I 
have no idea technically how that happens. I just know that it 
is possible. So it represents a different way for customers and 
businesses to communicate with each other. I find that 
interesting, particularly if you are communicating across the 
ocean with customers who may be in many, many different parts 
of the world. That is a benefit there.
    The other shoe to drop, so to speak with Bitcoin, is the 
IRS and its announcement recently that they are going to begin 
to tax Bitcoin. A lot of people are very, very upset by that in 
the Bitcoin community because they view it as an announcement 
that came late.
    Chairman GRAVES. Time is expired.
    Mr. COUVILLION. Okay, thank you.
    Chairman GRAVES. I am now going to turn to questions, and I 
will let Mr. Hanna open them up.
    Mr. HANNA. Thank you.
    Mr. Couvillion, you undermine your own argument. The 
volatility alone proves that it is not a storage of value. Your 
conversation about the S&P or say pick a stock that is backed 
by a company with real assets that are in some way attachable, 
discernible, and measurable because you can go to their 
website, you can go to their annual reports, there are a 
thousand ways to figure out what it is you are buying when you 
buy a company, I find that completely not even relevant. This 
is about a storage of value that is reliable for people that 
they can use and go back to that is not volatile. As a matter 
of fact, any volatility at all that is more than the dollar 
depreciating over time or some other currency that fluctuates 
mildly is really, for me, a counterargument.
    But I want to ask Mr. Williams, why do we need an imaginary 
currency? What is there about this that benefits our society or 
the world at large? And in terms of the underground economy, 
what are the effects of this--why do we need an imaginary 
currency in talking about the underground economy?
    Mr. WILLIAMS. Great. So let me do it in reverse order, in 
regard to the underground economy, in particular. This is a 
potential tool which we have seen already because of Silk Road, 
to be used in nefarious ways. In essence, there are two aspects 
of Bitcoin that make it very dangerous in their wrong hands. 
And the one is the fact that it is anonymous. So that means 
whoever has it and controls it, owns it. So if you have an 
account and someone can hack it and grab that coin, not only 
does that criminal own it, but there is no way to trace down 
who took it and there is no way from a consumer standpoint to 
get it back. So in regard to the underground economy, that is 
one reason why it is a designer currency of choice. Now, it is 
unfortunate because Silk Road has sort of painted a very 
negative picture about virtual currencies.
    The second aspect of this sort of underworld of virtual 
currencies is the fact that Bitcoin also is not only anonymous 
but it is also irreversible. So once that transaction is done, 
it cannot be pulled back. So let us just say it is transferred 
by mistake to somebody. There is no way to get that back unless 
that person is generous and willing to do so. So that is of 
concern.
    Now, the first question you had, excellent question, and 
that really is what is the benefit? It is questionable in a 
sense that clearly I view the risks much greater at this point 
in time than the benefits. In regard to the price volatility, 
the fact that my colleague to my right can say within 46 days 
it could be worth zero. Currency is supposed to be used for 
transactional purposes to facilitate business. If you cannot 
count on currency, business will not be facilitated. What will 
happen is that will be hoarded and GDP will drop, employment 
will drop, and that is a negative thing for business.
    So what business needs is confidence in the currency that 
consumers are going to use. And it is not clear to me that 
confidence is there with Bitcoin.
    Mr. HANNA. Do you want a rebuttal, Mr. Brito?
    Mr. BRITO. Thank you. Actually, a couple things.
    I think there is a misperception that Bitcoin is completely 
anonymous. Bitcoin is not completely anonymous. Cash 
transactions on the other hand are completely anonymous. If I 
put a bike for sale on Craigslist and I get an email from 
somebody I do not know, we meet at a park, I give him cash----
    Mr. HANNA. But credit cards are not anonymous. I mean, they 
certainly do not have to be. I can trace them. Checks are not 
anonymous. And frankly, trading in dollars and not paying your 
taxes is actually illegal. So, I mean, there is nothing 
different about Bitcoin than me paying somebody in cash and 
them not declaring it.
    Mr. BRITO. So I was getting to that. Whereas, cash is 
completely anonymous, credit cards are completely identified. 
Credit card company knows who I am, who the merchant is, the 
time, the amount, all of that. Bitcoin is in the middle. It is 
between cash and credit cards. Because while there is a record 
captured of every transaction, the amount, we do not know who 
that is. Now, this is where the Bank Secrecy Act comes in, and 
companies like Coinbase are required to keep a record of all of 
their customers. And so, for example, I have an account with 
Coinbase. They know my name. If there was ever a subpoena 
related to a particular Bitcoin transaction, Coinbase could 
turn over my name.
    Mr. HANNA. But it requires a subpoena.
    Mr. BRITO. The same way with a credit card.
    Mr. HANNA. Thank you. Well, right, but credit cards are a 
lot. I got it.
    Thank you, Chairman.
    Chairman GRAVES. Ranking Member Velazquez?
    Ms. VELAZQUEZ. Thank you, Mr. Chairman.
    Professor Couvillion, last week Iceland announced that it 
will be releasing a variant of Bitcoin called Auroracoin. This 
is just one of many other cryptic currencies that exist in 
addition to Bitcoin. What makes these currencies so different 
from one another?
    Mr. COUVILLION. Thank you for the question.
    Bitcoin has what we economists call ``first mover 
advantage,'' because it was the first successful digital 
currency and because it has an overwhelming market share of, I 
believe, more than 90 percent. It will likely succeed simply 
because they were there first. There are many, many other 
different types of currencies, and most of them are variations 
on the same, but some offer a few different features than 
Bitcoin does.
    Ms. VELAZQUEZ. Do you think that the market can sustain 
numerous virtual currencies?
    Mr. COUVILLION. No. The parallel I would give is the time 
in the United States when banks printed their own currency 
before the Civil War and we saw ultimately the government had 
to then step in and create a national currency, the dollar. But 
that is a historical parallel. How good it is, I am not sure.
    Ms. VELAZQUEZ. Okay.
    Mr. COUVILLION. However, I do think we will see increasing 
use of Bitcoin very, very rapidly. I believe it is in the 
growth phase.
    Ms. VELAZQUEZ. Thank you.
    Mr. Williams, in your testimony, you indicate that the 
Bitcoin financial middlemen, who have multiple business lines, 
such as Coinbase, have an inherent conflict of interest. Can 
you please elaborate why you believe that this is the case?
    Mr. WILLIAMS. Sure. And that is a correct statement. The 
inherent conflict of interest with financial middlemen like 
Coinbase is on one hand they need to mitigate price risks for 
customers. So what they are interested in doing is being able 
to once they have the coin, is to sell at the highest price. 
But Coinbase also has another business line and that is selling 
Bitcoin to customers. Customers have an interest to buy at the 
lowest price, so just in those two business lines there is an 
inherent conflict of interest.
    Ms. VELAZQUEZ. What will regulatory oversight do to protect 
consumers in these cases?
    Mr. WILLIAMS. Right. I would say as regulation seeps into 
the industry pretty quickly, regulators will look at this and 
say we have to actually put a wall up with this conflict of 
interest. It is very significant and it needs to be taken care 
of.
    Ms. VELAZQUEZ. Mr. White, how would you respond to this 
criticism?
    Mr. WHITE. Thank you, Ranking Member Velazquez.
    First off, I would say at Coinbase we work very hard to 
make sure our pricing is completely transparent. So it is 
important to realize that we offer two prices. We offer a buy 
price and a sell price, and those are identical for both our 
merchant services as well as our consumers. So for our 
consumers that purchase Bitcoins and want to sell those 
Bitcoins, that is the exact same price that we offer to our 
merchants. So that bid-ask spread that Mr. Couvillion annotated 
was about 17 bps, 17 basis points. So we believe it is very 
small and a fair small price.
    There is also in the Bitcoin market, pricing is incredibly 
transparent. So there are a number of websites out there, one 
of which is Bitcoincharts.com where you can look at the price 
of Bitcoin across a number of the largest exchanges or 
brokerages and determine if whether or not the price you want 
to pay for a Bitcoin on Coinbase is fair or not. We are held, 
because of arbitrage, to seek that true price as close as 
possible.
    Ms. VELAZQUEZ. Okay. Mr. Brito, last week the IRS issued 
guidance that Bitcoin is to be traded as a property rather than 
currency for tax purposes. What effect will this have on the 
Bitcoin and the business ability to accept it as payment?
    Mr. BRITO. So, I will begin by saying that I am not a tax 
professional and you should consult one, but I can say the 
following. It is going to introduce some accounting headaches 
because every time that you dispose of a Bitcoin in a 
transaction, you might be subject to capital gains. What does 
this do for the person who is accepting it, which is your 
question? Maybe nothing. If they are a merchant accepting 
Bitcoins via Coinbase and they choose to never hold Bitcoins, 
they just take dollars, they really do not have to do anything 
with that. That is something that consumers or the person who 
is spending the Bitcoin is going to have to make that 
accounting.
    Now, it is interesting that the choice that the IRS faced 
was should the coin be treated for tax purposes as currency or 
as property. And from what I understand, if the choice had been 
property, it turns out that foreign currencies--sorry, if it 
had been treated as currency, foreign currency transactions 
have to account for a gain when you dispose of your foreign 
currency, just as if it was property. The only difference is 
that there is a de minimums exemption for currency of $200 per 
transaction. So in essence, if it had been treated as currency, 
any transaction under $200, you really did not have to worry 
about that accounting. We might hope to see that kind of de 
minimums exemption for property.
    Ms. VELAZQUEZ. Mr. Williams, would you care to comment on 
that question?
    Mr. WILLIAMS. Well, I view the blow last week with the IRS 
as devastating, in particular to Bitcoin. As I mentioned 
earlier, 90 percent of the coins are hoarded, so in that kind 
of economy, very few coins circulate. So that is not very 
liquid. We could look at bid-ask spread. That is only one 
measurement of liquidity. When we add now the IRS ruling last 
week, that increases and encourages consumers to horde more, 
not less. And as a result, that reduces liquidity even more. So 
it is very concerning. Being the leading financial market in 
the world, how we view this is extremely important, and it is 
going to set the tone for other nations as they try to regulate 
this currency as well.
    Ms. VELAZQUEZ. Thank you. Thank you, Mr. Chairman.
    Chairman GRAVES. Mr. Chabot?
    Mr. CHABOT. Thank you, Mr. Chairman.
    Just a couple questions. In February, CNN Money ran an 
article regarding the illegal website Silk Road, and it has 
come up a couple times already in this hearing, and its 
relationships with Bitcoins. In that they wrote, and I quote, 
``The Silk Road is primarily used to buy and sell drugs. 
Bitcoins are the only kind of currency accepted on the site 
because they are traded electronically and are difficult to 
trace to individuals,'' as has also been mentioned. That is a 
direct quote from the CNN Money Report.
    My question is this. If Bitcoin transactions are difficult 
to trace and also are irreversible, how do we prevent Bitcoins 
from facilitating criminal activity? And I would open that up 
to anybody who might like to address it.
    Mr. BRITO. So I think, again, by applying the Bank Secrecy 
Act and your customer rules to Bitcoin intermediaries, and that 
is something that FinCEN at the Treasury Department has already 
done and we are seeing these new intermediaries complying with 
those regulations.
    Second, I think it is a question for law enforcement and 
every time I have spoken to law enforcement, I have heard law 
enforcement testify, for example, last November's hearing 
before the Homeland Security Committee, law enforcement has 
said that they are less concerned about virtual currencies 
being used for these illicit transactions online than they are 
about centralized virtual currencies or about cash, indeed. So 
I think it is a matter of law enforcement doing their job, and 
they say that they are up to the task, and it is a matter of 
enforcing our existing money laundering laws.
    Mr. CHABOT. Thank you.
    Would any of the other members like to address this? Mr. 
Williams?
    Mr. WILLIAMS. Well, I view the anonymous part of Bitcoin as 
actually being the Achilles heel. The fact it is anonymous, it 
makes it very dangerous, not only for criminal use for also for 
consumers. If these coins are stolen by criminals, they cannot 
be returned.
    Mr. CHABOT. Okay. Thank you.
    I will go on to another question. Of the number of 
businesses who sell their services or sell their products 
online, what percentage would you say--and I know it is 
difficult to know what it is for sure--but what percentage 
would you say of the businesses actually accept in some form 
Bitcoins for their items? Mr. White?
    Mr. WHITE. I will take that. So at Coinbase, we have 
roughly 28,000 merchants that use our payment tools as of 
today. What is interesting to note is the vast majority, and it 
is difficult to say with any certainty, but by and large 
probably 95 percent, if not more, are small businesses. And 
these are organizations or individuals that are confronted with 
high credit card fees, issues with chargebacks and financial 
risk they are just not prepared to handle. And Bitcoin enables 
them to bypass or avoid a lot of those issues.
    Mr. CHABOT. Let me ask you a question. When you say they 
are small businesses, is there a particular type of small 
business that they are in general?
    Mr. WHITE. Absolutely. So right now what we see is Bitcoin 
is an incredibly seamless experience when used online. So in 
line with payment options on a website, it is very simple. 
Using a Coinbase product, you can click out or you can check 
out in as simple as two clicks. The vast majority of these 
businesses are ecommerce facing companies where they sell their 
products online and accept Bitcoin as a form of payment just 
with PayPal or credit cards.
    Mr. CHABOT. Okay. Now, if you have 28,000 yourself with 
your company, how many others are out there? What percentage 
are we talking of the overall businesses on the Internet?
    Mr. WHITE. So between Coinbase and our competitors, my best 
guess would be there is roughly 50,000 businesses that are 
accepting----
    Mr. CHABOT. Altogether you mean?
    Mr. WHITE. Altogether here in the U.S. Correct.
    Mr. CHABOT. And out of how many are we talking about 
theoretically? Because I know it is pretty hard to know 
exactly. Whether it is 50,000 out of----
    Mr. WHITE. The vast majority are going to use a Bitcoin 
payment processor, like Coinbase, because they want to shield 
themselves.
    Mr. CHABOT. I am not asking that. I am asking the 50,000 
businesses that are actually utilizing Bitcoin now, out of a 
universe of how many businesses on the Internet are we talking 
about? If anybody else might know that----
    Mr. BRITO. I imagine it is a very small fraction of 
businesses, small businesses that accept Bitcoin. I imagine it 
is less than 1 percent.
    Mr. CHABOT. Would you agree with that, Mr. White?
    Mr. WHITE. I would agree.
    Mr. CHABOT. Less than 1 percent. And you would assume over 
time--I would assume you would hope that that would grow 
substantially over time?
    Mr. WHITE. We are seeing our merchant services grow at 
about 10 percent month over month.
    Mr. CHABOT. Okay. Are there online gambling businesses that 
are using this now? And are those any of your folks?
    Mr. WHITE. To the best of my knowledge there are. At 
Coinbase, we do not have the resources to ensure proper 
compliance with those online gambling organizations, so we do 
not provide Bitcoin payment processing services for them. But 
the thing with Bitcoin is you do not necessarily need to use a 
payment processor like Coinbase. An individual could create an 
online gambling site and accept Bitcoin directly, but that is 
not something at Coinbase we support.
    Mr. CHABOT. Okay, thank you. I see that my time is ready to 
expire so I will yield back. Thank you very much.
    Chairman GRAVES. Ms. Clarke?
    Ms. CLARKE. Thank you very much, Mr. Chairman. And I thank 
our panelists for coming and sharing their expertise with us 
today.
    My first question is to Mr. Brito. In your written 
testimony, you mention there is nothing inherent in Bitcoin's 
design that makes it naturally volatile. You attribute the 
current volatility to the fact that the currency is new and as 
such, thinly traded.
    My question is twofold. First, how is it that a currency 
backed by nothing more than market forces, and at the very 
least, without a central authority to intervene in price 
destabilization amongst other regulatory issues, that it is not 
inherently volatile. And then secondly, regarding your 
explanation on the current volatility, I have gathered from 
your written testimony that you believe time and increased 
trading and use will alleviate current volatility. A cynic 
might suggest that that was an oversimplification at best, or 
further, assumes that Bitcoin is an asset that can only 
appreciate, thus forcing stability. How is that unlike any of 
the previous bubbles we have seen inflate and pop over the 
course of the past 20 years?
    Mr. BRITO. Okay. I appreciate that question.
    So in my testimony, I think what I mentioned was that there 
is nothing inherent in Bitcoin's design that makes it extremely 
volatile. Extreme volatility. All currencies are volatile, and 
Bitcoin is certainly a deflationary currency by design. But 
this extreme volatility that we are seeing probably results 
from the fact that it is thinly traded. If Bitcoin's economy 
were to grow and it was much more widely traded, and if we 
began to see derivative products that allowed you to hedge 
against Bitcoin's volatility, we should see the volatility 
subside. Does that mean there would be no volatility? No. Is 
there a central bank that can intervene and basically introduce 
more money into the money supply to meet demands? No, there is 
none of that. So Bitcoin is still going to have a certain 
amount of volatility, but this extreme volatility is, I guess, 
what I am addressing.
    Does that mean that I see Bitcoin as only ever increasing 
in value? No. What I am saying is volatility, if Bitcoin's 
acceptance grows and it begins to be traded more, volatility 
will subside, but it does not mean that it will subside 
necessarily in an increasing fashion. It might just reach 
hopefully a stable range.
    Ms. CLARKE. Mr. Williams, did you want to comment on that?
    Mr. WILLIAMS. Yes, on a few things.
    So since Bitcoin was created in 2009 and started trading, 
the volatility the first year was 160 percent annualized. That 
is just unheard of. Since then it has dropped to 140 percent, 
so we are still in nosebleed territory. That is concerning.
    Structurally, there are three reasons why Bitcoin itself is 
so volatile. The first is the fact that it is hoarded, and that 
is, as I mentioned earlier, of concern because hoarding allows 
you to manipulate the price.
    The second part, which is very important, is the ownership 
structure itself is very small. With data that we know so far, 
at least looking at addresses, not knowing ownerships per se, 
we know that roughly 29 percent of Bitcoin is owned by 47 
people. So you can imagine if 47 people get in a room and say, 
``Hey, lets not sell,'' then that sets an artificial floor.
    A third thing, which is extremely important, is the fact 
that when we think about Bitcoin and what is happening here, is 
not only do we have sort of this scarcity of this commodity, 
and that is the third point, but it is scarce in a sense that 
by the year 2140, it maxes at 21 million. So in essence, if you 
create anything that has a scarcity and you hype up demand and 
you get enough people that think this is the next new, new 
thing, then you are going to see prices move and you are going 
to see high volatility.
    So those are the three structural things that have 
happened, specifically, that I view is why we have seen such 
extreme volatility. And up until last year, the space rocket 
went to the moon. This year it is coming back down to earth.
    Ms. CLARKE. So the second part to my question was do we see 
this as a bubble? Would you characterize it is such?
    Mr. WILLIAMS. Yes, I would. In December of 2013, I came out 
very strong adamantly saying that this was a bubble. We have 
also seen Alan Greenspan on December 4, 2013, come out and say 
it is a bubble. We saw actually Professor Shiller, a very well-
known economist from Yale who came out in January. And it was 
very interesting the way he described this bubble. He said, 
``It is not only a bubble, it is an amazing bubble.''
    More recently, we have also seen additional examples. We 
know bubbles have three phases--growth, maturity, and pop. And 
we are clearly seeing the pop phase right now.
    Ms. CLARKE. I am out of time, but I thank you gentlemen for 
your response.
    I yield back, Mr. Chairman.
    Chairman GRAVES. Mr. Mulvaney?
    Mr. MULVANEY. Sure, let us just continue right there.
    I guess, Mr. Williams, and this is not where I was going, 
but just to follow on your last comment, so what? So what if it 
is a bubble? It is a very small--I mean, this is not like it is 
the housing bubble. It is not like it is a real estate bubble. 
It is a very, very small piece of the economy. Right? So what 
if it is a bubble?
    Mr. WILLIAMS. Right. So let us go down that road. So if it 
is a bubble, then we have these 47 people that are harmed. 
There is roughly 1,000 people that own roughly 50 percent, so 
they are harmed. But it does not harm a greater population.
    Mr. MULVANEY. Okay.
    Mr. WILLIAMS. However, the problem with that logic is the 
fact that we are talking not about a manufacturer's 
manufacturing a good; we are talking about currency, which is 
the lifeblood of economies. We have to rely on currency and 
trust that currency to have effective business. So in essence, 
if the currency is flawed, then it impacts negatively our 
economy.
    Mr. MULVANEY. Right. But we just established that it is 
less than 1 percent of online trade, so, I mean, it is much to 
do about nothing in terms of the bubble. Right? It might be, it 
might not be, but I guess in my mind I am hard pressed to see 
why Congress would care if it is a bubble.
    But let us move on to a couple of other things before I get 
to my own questions.
    I had a chance to listen to some of the questions from Mr. 
Chabot, and my question to you, Mr. Brito, for example, would 
be Mr. Chabot was clearly concerned about its use, Bitcoin's 
use in illicit activity, whether it be drug sales, online 
gambling. Is it technologically possible and practically 
possible to make Bitcoin say as safe as the dollar when it 
comes to those types of transactions?
    Mr. BRITO. You are asking me if I was a criminal would I 
rather use a dollar or would I rather use a Bitcoin?
    Mr. MULVANEY. I guess so.
    Mr. BRITO. And the answer would be no. I mean, I have heard 
this from numerous law enforcement folks who told me you would 
be crazy to use a Bitcoin because there is a permanent record 
made of every Bitcoin transaction. And that is a record that 
could be accessed years from now to tie you back to a 
particular transaction. Is it your name? No, it is not your 
name. It is a pseudonym. It is a Bitcoin address. But there is 
a permanent record made of that transaction. And what we have 
seen with Silk Road, which is the example we all know of an 
online marketplace for drugs that use Bitcoins, is that the FBI 
successfully took down that website. And today, we are seeing 
one after another of the vendors on that website being arrested 
by the FBI.
    Mr. MULVANEY. Okay. Thank you.
    Let us get to my question then, which is the IRS decision, 
which Ms. Velazquez asked I thought some excellent questions 
about. Start with this, and I will ask everybody to check in on 
this very quickly because I really do not know where you folk 
stand on this, was it the right decision? Was the IRS decision 
to classify this as property and not currency the right 
decision? We will just go right down the aisle.
    Mr. Couvillion, do you want to start? And I will come back. 
Answer yes or no. We will come back and ask each of you why, 
but I am trying to get a sense of the panel.
    Mr. COUVILLION. No.
    Mr. MULVANEY. Okay.
    Mr. WILLIAMS. Yes.
    Mr. WHITE. I would say no.
    Mr. BRITO. Tentative yes.
    Mr. MULVANEY. Okay. Here is my question. I guess, because 
it looks like--which is a nice thing about having a good panel, 
you get different answers from everybody. It strikes me that it 
is a way to tax the Internet, is it not? Right now, we do not 
have taxes on most of the Internet sales, at least we talk 
about some of them. We are dealing with Main Street fairness 
and those types of things. It strikes me that this is a way to 
tax Internet trade. But if I cannot tax the transaction, I will 
tax the currency that is used to do it. So that is where I am 
coming from.
    Mr. White, you tell me why you think it is no. Mr. 
Williams, you tell me why you think it is yes.
    Mr. WHITE. Yes. So I think what was surprising was the 
misalignment between the regulators. Right? Because we had 
FinCEN come out last year and basically describe Bitcoin as a 
currency. They said companies like Coinbase that operate and 
provide Bitcoin services, please register as a money service 
business under FinCEN, and we followed that guidance.
    Mr. MULVANEY. You are doing that, right?
    Mr. WHITE. We are doing that. Absolutely.
    With the IRS's recent guidance that now Bitcoin is a 
property, there is a mismatch there between how do you exactly 
describe this asset class? How do you describe Bitcoin? At 
Coinbase, obviously, we are working with our counsel and 
working closely with the IRS to seek additional guidance 
because what we want to do is enable as burdenless as a process 
as possible for our users to be able to transact in Bitcoin. 
And right now with this guidance it makes buying a $2 cup of 
coffee nearly impossible without additional products and 
services to track that cost basis.
    Mr. MULVANEY. Mr. Williams, and maybe the chairman will let 
you go a little bit more, but if you could give us your answer 
as to why you think it was the right decision.
    Mr. WILLIAMS. Sure. Well, when we look at Bitcoin itself, 
it is not a currency. To be a currency, it has to be of store 
value, and see it is not of store value at all. It actually 
destroys value. Second, we know it is not stable.
    Mr. MULVANEY. I am sorry. I have to cut you off. Destroys 
value? If I bought it at a penny and it is worth $450, does 
that not create value? I am sorry, what do you mean it destroys 
value?
    Mr. WILLIAMS. Right, so with currency, for example, you 
want stability. So you want to be able to put it in your wallet 
and not think about it and then next week use it, not worry 
about the daily price moving.
    Mr. MULVANEY. I have no idea what the name of the currency 
is in Argentina or in Venezuela. Is it still a currency?
    Mr. WILLIAMS. Yes, it is. And earlier I referred to it. 
Bitcoin is seven times more risky than Argentinian peso.
    Mr. MULVANEY. And Venezuela is still a currency? I think 
you see my point is currency, you go through different phases. 
But go ahead. Finish your thought.
    Mr. WILLIAMS. Okay. So we will move on.
    So in regard to another measurement of a strong currency, 
and that is that it is stable, and we are seeing that there is 
volatility. So there is not stability in this currency. But 
most importantly, when we think about a currency, it needs to 
be liquid, and that is that you can get in and get out. And it 
is not very clear that you can get in and out at good 
execution.
    But let us move it over. So if it is not currency, what is 
it? And that is what the IRS is really helping with. In 
essence, the IRS is saying, okay, well, if it is not currency, 
what does it look like? Well, if we think about a commodity, 
right. A commodity is something that is mined. That is Bitcoin. 
A commodity is something in particular that actually is stored. 
It is something that is processed. It is something that is 
resold in the market, and it is something that actually has 
scarcity. Well, that sounds a lot like Bitcoin. So in essence, 
I see the IRS ruling as moving more towards commodity. At least 
it is calling it a product. So I think we are getting closer to 
the discussion we need to have about what is this.
    Mr. MULVANEY. Does Mr. White have a valid point about the 
misalignment? Why would he have to know his customer if he is 
dealing in a commodity and not a currency? To you, Mr. 
Williams. No, does Mr. White have a point? Is he right about 
the misalignment? One part of this government is treating it as 
currency and the other is not. He should not have to know his 
customer if he is only dealing in commodities; right?
    Mr. WILLIAMS. Right. So there is a lot of uncertainty about 
what it is.
    Mr. MULVANEY. Right.
    Mr. WILLIAMS. And so we saw that with the Treasury 
Department as it came in last year with this announcement with 
FinCEN, for example, and how they are working with money 
transmitters, and we are seeing with the IRS. The picture is 
getting clearer, but yet there is still a lot of uncertainty 
out there.
    Mr. MULVANEY. Thank you, gentlemen. I appreciate the time. 
I appreciate the chairman's indulgence in going over a little 
bit.
    Mr. LUETKEMEYER. There we go. Okay, Mr. Payne, five 
minutes.
    Mr. PAYNE. Thank you, Mr. Chairman.
    Mr. Mulvaney, the gentleman from South Carolina, was so 
thorough in his questions, he asked all of mine, so the 
indulgence for additional time probably cost me my questions. 
So I yield back.
    Mr. LUETKEMEYER. Mr. Payne, if you can think of anything in 
the meantime, let us know. I will be happy to get back to you.
    As we go through the discussions, a lot of times questions 
pop up and we want to make sure you have an opportunity to ask 
anything that may come up. But I understand. I was sitting here 
and I checked off all my questions. They were being asked as 
well.
    With that, Mr. Schweikert, you are up next. You have five 
minutes.
    Mr. SCHWEIKERT. Thank you, Mr. Chairman. And Mr. Payne just 
proved he is actually the smartest member of the Committee 
because brevity I think is a sign of being brilliant. And now I 
am going to break that.
    Okay. I want to actually sort of back up a little bit and 
have a conversation that is a little less transactional. And I 
do not mean to move almost ethereal. I sat on actually Monetary 
Policy a couple years ago, and I think we were one of the first 
meeting where part of it went off and we had the discussion of 
alternative currencies. And I almost am uncomfortable using the 
term alternative currency and more alternative units of value 
or acceptance and trade.
    What else is on the horizon? You know, Bitcoin appeared, 
what 2009? What else is out there? What other alternative 
exchanges of value do you see coming that are going to take 
advantage of the Internet universe? Because you and I can is 
there and come up if we really think it through, you know, 
tokens in a babysitting exchange are ultimately units of value 
in exchange. I mean, this is not--conceptually, it is not new. 
But with technology, what is next on the horizon?
    Mr. BRITO. So I think one thing that we have been doing 
here is focusing so much about Bitcoin being currency or being 
money, and I think that misses the point. Currency or money has 
three properties. Right? It is a medium of exchange, a store 
value, and it is a unit of account. Now, Bitcoin probably is 
not good at all of those three, certainly not right now. As Mr. 
Williams so eloquently put forth, it is not a good unit of 
account. I certainly would not want my mortgage or my salary 
denominated in Bitcoin, and it is not a good store value 
because of its volatility. But what about medium of exchange? 
Is it a good medium of exchange? And I think with the 50,000 
merchants, usually all small businesses that are accepting 
Bitcoin today, are telling us that this is a very good medium 
of exchange.
    Mr. SCHWEIKERT. My question was what is next on the 
horizon?
    Mr. BRITO. Okay. So jumping from there.
    Mr. SCHWEIKERT. Is there Bitcoin 2? Is there someone that 
is going to take a million bucks of gold and say I am going to 
produce an electronic currency that has a gold peg? What else 
is next?
    Mr. BRITO. So I think the next thing we are going to see is 
that because Bitcoin at base is simply a ledger that keeps 
track of value being transacted, there is no reason why a 
Bitcoin has to represent only a dollar. A Bitcoin could also 
represent anything else. An ounce of gold, a share of stock, a 
car.
    Mr. SCHWEIKERT. So you could see a generation----
    Mr. BRITO. Commodities markets based on Bitcoins.
    Mr. SCHWEIKERT. I want to bounce to Mr. White. The 
question, what is next on the horizon?
    Mr. WHITE. That is a great question. We see Bitcoin as more 
than just a payment network in digital currency. This is the 
first application of Bitcoin as the protocol. The core 
technological problem that was solved here has never been 
solved before, and that is the ability to prove and transfer 
ownership without the need of a trusted third party.
    Mr. SCHWEIKERT. Okay. So is there the next generation on 
the horizon?
    Mr. WHITE. Exactly. So Mr. Brito said that you can attach 
this one satoshi, the smallest amount of a Bitcoin worth much 
less than a fraction of a penny to an asset or a stock. So in 
essence, you could provide this ability to trade assets. You 
could also use it as a date timestamp to prove ownership of an 
idea using the blockchain, which is this universally 
distributed ledger that no one central body controls.
    Mr. SCHWEIKERT. Okay. Mr. Williams, that sort of concept, 
what is next on the horizon in this concept?
    Mr. WILLIAMS. Well, if you open the door and you call it a 
currency, then that is a real slippery slope.
    Mr. SCHWEIKERT. You know of my preference of value of 
exchange.
    Mr. WILLIAMS. Okay. So if we slam that door shut, then it 
is not a nationless currency. Then you have more control. And 
then what is it? Well, it is a payment system. How is it 
different than ACH? And the question is, well, it is definitely 
much more sophisticated. ACH happened. This payment system in 
the 1970s, the Fed had a lot of influence over that system, but 
it still remains to be an efficient system. So all of a sudden 
you have focus now on the payment benefits of Bitcoin, and then 
you have competition within that payment system. And we have a 
discussion no longer about currency.
    Mr. SCHWEIKERT. Do you see something else on the horizon 
that takes this technology that goes to the next level?
    Mr. WILLIAMS. Right. So then----
    Mr. SCHWEIKERT. Or a commodity pegged to such electronic 
currency or something else?
    Mr. WILLIAMS. Right. So yes, I do. What we will see is more 
asset classes that can be pushed through this payment system.
    Mr. SCHWEIKERT. Okay. And Mr. Couvillion, and my mother's 
maiden name, please, the same question. What else is next on 
the horizon?
    Mr. COUVILLION. In terms of the next thing on the horizon 
that I think the Committee might be interested in taking a look 
at, there are at least three serious proposals to get approval 
to launch Bitcoin-based exchange traded funds, commonly called 
ETFs, such as the diamonds, the spiders, the NASDAQ cubes. 
There are more than 400 others. If they do get approval to 
launch these Bitcoin ETFs, it may be possible by the end of 
this year, if you have a self-directed IRA, to put in effect 
Bitcoin into your individual retirement.
    Mr. SCHWEIKERT. Or hold a Bitcoin denominated?
    Mr. COUVILLION. Exactly.
    Mr. SCHWEIKERT. In other words, you would look at it just 
in the reverse.
    Mr. COUVILLION. Exactly. And I am not sure that that is a 
wise idea.
    Mr. SCHWEIKERT. Mr. Chairman, I know I am a little over 
time, but there is a fascinating philosophical debate 
underlying here for those of you who are followers of sort of 
monetary policy. Mr. Williams just spoke, a nationless currency 
or value of exchange. I am not sure that is a bad thing. And in 
many ways we have had it forever. I mean, a gold peg contract. 
But also something of Bitcoin, yes, it is a challenge to being 
a reserve currency but the benefits we gain as a country being 
the reserve currency is we have minimal transaction costs; 
correct?
    Mr. COUVILLION. Yes.
    Mr. SCHWEIKERT. And if all of a sudden there is another 
medium of exchange that no longer has that transaction cost 
spiff benefit, it also becomes a threat to becoming the reserve 
currency.
    Let us start with Mr. Williams, just because you and I seem 
to be the farthest outliers from each other. Tell me where I am 
wrong on both those premises.
    Mr. WILLIAMS. Well, you say what is wrong with a nationless 
currency. So we are back--you opened that door that we shut I 
thought earlier, and that was it cannot be a currency.
    Mr. SCHWEIKERT. Then that is why we were--Mr. Williams, 
that is why we were reusing the term ``value of exchange''; 
correct?
    Mr. WILLIAMS. All right. So now if this is a value of 
exchange, then it will not compete with nation currency, such 
as the U.S. dollar.
    E: Well, the fact of the matter is any type of exchange, 
whether I am willing to exchange diamonds or gold or anything 
else, ultimately is--has inflationary, disinflationary effects 
on exchanges of value and commodities and other things.
    So, and first, let us go through my couple of questions. 
Let us try these.
    Threat to reserve currency if it becomes an efficient means 
of avoiding the exchange cost. Yes? No?
    Mr. WILLIAMS. I do not view it as a threat because of this 
high volatility that we see.
    Mr. SCHWEIKERT. Okay. But if you and I are sitting here a 
decade from now and there is ETFs and others, assuming this 
concept even survives that long, that volatility would 
ultimately be squeezed away because of the amount of 
participation. Because would you agree that much of the 
volatility today is because of how thin the market is?
    Mr. WILLIAMS. Right. So I would disagree with that. There 
is structural problems and it has less to do with the fact of 
how thinly it is traded. It is actually how it is structured.
    So good question though in regard to looking forward what 
could happen. A competition within currencies. That is what we 
have in the global financial markets. Sometimes the dollar is 
stronger, sometimes it is weaker against other currencies. So 
if this could ever gain that status, then it would be in the 
mix and be competitive.
    Mr. SCHWEIKERT. But what becomes fascinating there in 
monetary policy is all of a sudden you would have a currency 
without intervention from a central bank which becomes a 
fascinating--you actually have an honest peg of value compared 
to--let us be completely honest--pegs of value of currency, 
nation currency that do have a certain level of intervention, 
and therefore, manipulation.
    Mr. WILLIAMS. So I am going to stir it up a little bit. I 
have made this statement before. So with the U.S. dollar, we 
have central bankers in the monetary policy you have spoken 
about and they determine how much of the money supply increases 
or decreases to spur economic growth for our businesses. If we 
go to a Bitcoin-type currency, then the new central bankers is 
the computer program itself and those miners that mine it. So 
the question is not that central bankers go away but they just 
are different people.
    Mr. SCHWEIKERT. Yeah. And now you are heading in the 
direction I was hoping to have the conversation. I am sorry. I 
told you it was going to get slightly ethereal.
    Do we let--Mr. Brito----
    Mr. BRITO. Yes.
    Mr. SCHWEIKERT.--had one comment and then I thank you. You 
have been very patient with my ramblings.
    Mr. BRITO. I will simply say that this is something that 
Milton Friedman proposed that we should replace humans at a 
board determining the money supply with a computer that had a 
set of rules and simply determined the money supply based on 
the algorithm. The thing about Milton Friedman's proposal is 
that the computer, you can always go in and reprogram it. A 
human could always go in and reprogram it with a currency like 
Bitcoin or another currency. Once you set the algorithm in 
place and you have a wide diversity of miners and others 
running that program, it becomes virtually impossible to 
change. That algorithm change the money supply.
    Mr. SCHWEIKERT. Mr. Chairman, I am one that believes by the 
end of this decade I will see another type of alternative value 
of exchange here, but will we have some collective or others 
that attach some reserve value or a peg of value or something 
of that which may deal with the stability issue, but it does 
actually start to become both a threat to a country like ours 
where we carry a large deficit and we use certain monetary 
policy, inflationary policies and others to be able to value 
back those future payments. But in many ways you are seeing I 
think the tip of an iceberg of a fascinating discussion.
    Thank you, Mr. Chairman.
    Mr. TIPTON. As you can see, Mr. Schweikert is a very, very 
thoughtful member of our Committee.
    Let us go for round two. If anybody has any extra 
questions, we will go through those. We will start with Ms. 
Clarke.
    Ms. CLARKE. Thank you, Mr. Chairman. I do have one final 
question for Mr. Brito.
    Mr. Brito, you mentioned that one-quarter of Americans who 
are unbanked and underbanked could look to Bitcoin as an 
important new option, and a good number of these unbanked and 
underbanked individuals are one step away from absolute 
financial calamity. How would Bitcoin be an effective buttress 
against the calamity given its valuation swings?
    Mr. BRITO. So I said it could potentially be seen as a new 
option for the unbanked and the underbanked. So the unbanked 
and the underbanked traditionally, they do not have bank 
accounts. They do not have credit cards. They use Payday loans. 
They have to buy prepaid cards. With something like Bitcoin, it 
allows for them to have electronic transactions and perhaps at 
a much cheaper cost. Right? So if you are going to a merchant 
that is giving you a discount because you are using Bitcoin, 
you can do that.
    Is that going to happen tomorrow? No, I do not think that 
is going to happen tomorrow. But the beauty of Bitcoin is it is 
an experiment and its potential is huge. So I think what we 
need to do is allow the experiment to go on. Today, state 
regulators are coming up with regulations that are consumer 
protection regulations and make sure the Bitcoin businesses are 
well capitalized, comply with disclosure, et cetera, et cetera. 
We need to make sure that those rules are consistent and clear 
so that we can have these products potentially become available 
to these consumers. Is it available today? No. But if we take 
the view that the risks just outweigh the benefits at all 
points, and we should not even think about this thing, then we 
are going to--in order to avoid the risks, you are going to 
give up all the potential benefits, and that would be a real 
shame.
    Ms. CLARKE. Thank you, Mr. Brito. Thank you, Mr. Chairman. 
Thank the panelists today. I yield back.
    Mr. TIPTON. Thank you.
    Mr. Mulvaney, do you have any second questions?
    Mr. MULVANEY. Sure, real briefly.
    Continue there, Mr. Brito. In terms of allowing this 
experiment to run its course, how damaging is the IRS decision?
    Mr. BRITO. So earlier you asked me if I thought the IRS 
decision was right or wrong, and I said tentatively yes. Let me 
tell you why. The IRS only had a choice between designating it 
a currency or property. Those were its two choices given to it 
by Congress. And so between those two, I think Mr. Williams is 
right, technically it looked at the thing and it looks more 
like property. So technically, they probably made the correct 
decision that was available to it.
    Now, it does create this problem that Mr. White was 
alluding to, where potentially now if you want to buy a cup of 
coffee you have to calculate your capital gains. Some folks 
think it should have been treated as a currency because if it 
were currency, then there is a $200 de minimums exemption. 
Right? So if you are buying something under $200, you do not 
have to worry about capital gains. Perhaps it is something that 
Congress should consider having that kind of exemption for 
property or perhaps creating a new category for virtual 
currencies to allow the kind of entrepreneurship and 
development that might get these products out to the world.
    Mr. MULVANEY. My staffers mentioned something, again, I 
know a little bit about Bitcoin, mostly on account of the 
presentation you made to the Monetary Policy and Trade 
Subcommittee on Financial Services. But I do not know that much 
about it. My staffers are telling that Germany has classified 
it in a very special way as a private currency. Is that an 
option that might be available to us? Is that something that 
makes sense?
    Mr. BRITO. So I am not a tax expert, as I mentioned before, 
so I am not 100 percent on that. I could look into that.
    Mr. MULVANEY. Mr. Williams, are you familiar with that at 
all? No?
    Mr. WILLIAMS. No. I am not a tax expert either.
    Mr. MULVANEY. Gotcha. And again, Mr. Chairman, so what I am 
hearing is it is classified as something else in other 
countries, so maybe Mr. Brito is onto something that it is not 
currency and it is not property. It is something new. Perhaps 
not too surprising in this 21st century that we have new types 
of things. So it is something we will take a look at.
    Thank you, gentlemen, very much. It is very enlightening.
    Mr. LUETKEMEYER. Yes, Mr. Couvillion, you have a comment?
    Mr. COUVILLION. Yes, I do. I would like to read a very 
short statement from Alistair Nevius, who is the Journal of 
Accountancy's editor-in-chief for tax matters.
    ``The IRS warns that taxpayers who treated virtual 
currencies inconsistently with the notice before the date the 
notice was issued will not get penalty relief unless they can 
establish that their underpayment or failure to properly file 
information returns was due to reasonable cause. Many people 
believe that because the IRS announcement came out three weeks 
before income tax forms are due and because many taxpayers have 
already filed their income tax returns, everyone, at least for 
this year, should be able to use the reasonable cause.''
    Mr. MULVANEY. Mr. Chairman, if I may, Mr. Couvillion, if I 
may interrupt, there is no way to do that, is there? What you 
have just read to us says the IRS expects you to treat it--to 
have been treating it as property from the beginning of time 
and that if you filed, I guess, last year or if you have 
already filed this year, they expect you to pay taxes on it as 
if it was property. Does small business have the ability to do 
that? Have they been tracking it as property this whole time or 
have they been treating it as currency?
    Mr. COUVILLION. It can be done. You can go back and audit, 
but it is not something anybody thought we would ever have to 
do two years ago, three years ago, and so it creates a huge 
paperwork burden. Technology can help, but especially this 
year, many people think it is simply unfair to expect taxpayers 
to amend their returns at this late date because the IRS just 
issued this ruling.
    Mr. LUETKEMEYER. Mr. Brito, not to interrupt, did you not 
mention a while ago that every single Bitcoin transaction is 
documented so that there would be the ability then, even to buy 
a cup of coffee, be able to go back and recreate a record for 
an individual's transactions over the course of a year to see 
whether they gained or lost or whatever?
    Mr. BRITO. Sure. And I also think that the tax consequences 
for this year for consumers, or at least I should say the 
compliance costs are not going to be huge simply because most--
the folks who are today holding and spending Bitcoins, it is 
not your grandma. It is not your average Joe. It is people who 
know what they are investing in, what they are doing. And they 
have known that there was going to be a tax--an IRS guidance 
coming out soon. And so they have probably filed for 
extensions, so they are not filing on April 15th. They are 
probably doing that in September. And even if that is the case, 
the IRS is probably not going to audit you for very small 
transactions. It is going to be if you have--if you are not 
declaring capital gains on $20,000 worth of Bitcoin.
    Mr. TIPTON. The rules document the database of 
transactions.
    Mr. BRITO. The transactions, it is available to anyone. It 
is online. You can download it. Anybody can download it at any 
moment.
    Mr. TIPTON. So the IRS has full access to this document or 
this database?
    Mr. BRITO. This database. Yes.
    Mr. TIPTON. Okay.
    Mr. Mulvaney, do you have any other follow ups?
    Ms. Herrera, would you like to ask any questions?
    Okay. I do not have very many. I just have one or two. With 
regards to hedging Bitcoins, you mentioned a while ago, Mr. 
Brito, they do not do that yet. Is that correct?
    Mr. BRITO. So there are no--to my knowledge, there are no 
options or exchange traded futures or options available on 
Bitcoin. There are some companies today, some exchanges today 
that are looking to get CFTC approval to offer those. But I 
think Mr. White probably could speak more to how Coinbase might 
be hedging.
    Mr. LUETKEMEYER. So if they are looking to start hedging, 
would that make it a currency then or would that make it a 
commodity?
    Mr. BRITO. I do not think the fact that you are hedging 
against a value of something, that alone does not speak to 
whether it is a commodity or currency.
    Mr. LUETKEMEYER. Okay. Very good. I have no other further 
questions. I certainly enjoyed the conversation here. It is 
certainly thought-provoking to see something like this. I think 
Mr. Schweikert is kind of also on the cusp here of some things. 
Is this today's currency and 10 years from now there is going 
to be another Bitcoin 2 or some other entity out there, 
whatever it is called, that will be a new method of transfer of 
payment. You know, who knows? I think as our economies continue 
to evolve and trade continues to take place, people are going 
to find ways to trade. From the beginning of time we have been 
bartering and trading. And so today's world is no different. We 
just use currency right now as a traditional way of transacting 
trades, but that being said, I come from rural Missouri. There 
is still a lot of bartering that goes on where I live. You 
trade this for that and the IRS never knows anything about it.
    So with that, as we close the hearing, I would like to 
again thank all the witnesses for being here and thank you for 
sharing your expertise, both with the members of this Committee 
and the small business community. I believe that today's 
discussion provides valuable information about the benefits and 
risks associated with Bitcoin and other virtual currencies as 
the government further examines this alternative payment 
system.
    With that, I ask unanimous consent that members have five 
legislative days to submit statements and supporting materials 
for the record.
    Without objection, so ordered.
    This hearing is now adjourned. Thank you very much.
    [Whereupon, at 3:08 p.m., the Committee was adjourned.]


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Written Statement to U.S. House of Representatives Committee on 
                         Small Business

    Thank you Chairman Graves and members of the House 
Committee on Small Business for the opportunity to appear here 
today.

    My name is Adam White and I'm the Director of Business 
Development and Sales at Coinbase, a company founded in June 
2012 with the goal of making it easy for merchants and 
consumers to transact with the digital currency, bitcoin. More 
than 1 million consumers use Coinbase as their bitcoin wallet, 
and as of today, there are more than 27,000 businesses that 
entrust Coinbase to accept bitcoin payments on their behalf 
using our payment tools. These merchants include large, 
enterprise-level businesses such as Overstock.com and Big Fish 
Games, as well as a myriad of small businesses like Tealet, 
Tuft & Needle, and Mondo Cellars.

    Prior to my role at Coinbase, I served as a Captain in the 
United States Air Force and am a veteran of Operation Iraqi 
Freedom and Operation Enduring Freedom. I also worked briefly 
as a consultant at Bain & Company and a product manager at 
Activision Blizzard after completing my MBA at Harvard Business 
School.

    I'd like to begin today by outlining the inherent benefits 
of Bitcoin in commerce--namely the elimination of fraud, 
reduction of transaction fees, and monetization of new 
markets--and how these benefits can be a positive influence on 
businesses of all sizes.

    Bitcoin enables individuals to push payments to merchants 
without having to share personally identifiable information 
that can be intercepted by criminals and used for fraudulent 
purposes. This push functionality gives Bitcoin a unique 
characteristic that eliminates the risk of fraud, something 
that merchants, card processors, and banks spend billions of 
dollars per year combatting. With Bitcoin, for example, the 
Target data breach that comprised over 70 million consumers' 
credit card information would not have been possible.

    Additionally, many card issuers use fraud detection systems 
that are overly sensitive to trigger activities for card-not-
present transactions. Initial estimates suggest that some 
merchants turn away nearly eight percent of incoming orders due 
to suspicious activity, many of which could, in fact, be 
legitimate. Bitcoin payments are irreversible, so fraudulent 
charges are prevented from occurring, and as a result, 
merchants do not bear the risk and cost associated with these 
false declines.

    Due to the elimination of fraud, Bitcoin transactions are 
dramatically less expensive than traditional card based 
payments. Merchants can reduce their electronic payments 
acceptance fees to less than 1% when accepting payment in 
bitcoin. This is especially important for small businesses that 
sacrifice anywhere between 3-5% of their revenues in card 
transaction fees. Businesses can use these savings to reinvest 
in their company or pass them on to consumers in the form of 
lower prices. Moreover, merchants are not faced with a fixed 
fee per transaction, enabling them to forgo minimum transaction 
limits and sell small ticket items profitability.

    Finally, Bitcoin democratizes foreign exchange and enables 
frictionless, cross-border transactions that settle 
immediately. Many products and services are not available for 
sale in foreign countries solely because the business cannot 
manage the payments systems needed to support overseas 
commerce. Because of the borderless and global nature of 
Bitcoin, a bitcoin payment made by customer in New York looks 
identical to a merchant as a bitcoin payment made by a customer 
in London, Buenos Aires, or Tokyo. Moreover, there are no 
international currency conversion fees associated with bitcoin 
payments so merchants can sell low margin items just as 
profitably abroad as they do domestically. The ability to 
easily begin accepting payments from customers around the world 
can open up whole new markets for merchants, and significantly 
improve top-line revenue.

    We see Bitcoin as an extremely powerful technology, and it 
is our goal to bring the efficiencies created by the Bitcoin 
network to the masses. We are encouraged to see the Committee's 
proactive examination into the topic of bitcoin as it relates 
to small businesses, and I look forward to engaging in dialogue 
and answering any questions you may have.
                   Testimony of Mark T. Williams \1\

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    \1\ Mark T. Williams has only a de minimis financial interest in 
Bitcoin and no direct investment in Bitcoin-related startups.
---------------------------------------------------------------------------

       Banking Specialist, Commodities and Risk Management Expert


                  Boston University Finance Department


                    To U.S. House of Representatives


                      Committee on Small Business


                             April 2, 2014


                                Hearing


      Bitcoin: Examining the Benefits and Risks for Small Business


                     Rayburn House Office Building,


                          Washington, DC 20515


    Introduction

    Good afternoon Chairman Sam Graves and other distinguished 
committee members. My name is Mark Williams and for the last 12 
years I have been on the Finance faculty of Boston University 
where I have specialized in banking, capital markets and risk 
management related matters. In 2010, I wrote Uncontrolled Risk, 
a book about the fall of Lehman Brothers and what caused the 
2008 real estate asset bubble www.uncontrolledrisk.com. Prior 
to my academic career, I was a senior executive for a Boston-
based commodity-trading firm and have worked as a field 
examiner for the Federal Reserve Bank in San Francisco and 
Boston. On occasion, I have also been a consultant to small 
businesses.

    Through my academic and work experiences I have gained a 
strong understanding of how the capital markets function, the 
role of currency, how businesses operate and how unaddressed 
risks can result in financial harm. For the last 18 months, I 
have closely studied, researched, and more recently written on 
Bitcoin, its structure and its highly-risky nature.

    I appreciate the opportunity to testify today and I view 
this committee room as an extension of the Boston University 
classroom. My interest and fascination with Bitcoin started in 
2011. Initially it was part of an in-class lecture, later a 
homework assignment, and ultimately, morphed into a full 
classroom debate. At that time, Bitcoin was trading for 32 
cents. Over the last three years, this pseudo currency has 
taken on a life of its own. In 2013 its speculative value 
increased from $13 to a market high of $1,200.

    Most Recent Events

    One month or even one week in the Bitcoin world can be 
equivalent to a decade in other markets. The price risk 
associated with Bitcoin is extreme and unlike any other 
volatile community. Despite the dramatic rise in 2013, prices 
have not been a one-way space rocket to the moon. Since 
November 2013, Bitcoin has slid by over 60 percent to $462.\2\ 
China's decision on December 5, 2013 to prohibit its banks and 
money transmitters from accepting Bitcoin was the pin that has 
begun to prick the Bitcoin Bubble.\3\ On this date, the world's 
second largest economy warned that virtual currencies carry 
substantial risk.\4\ Other market disruptions have occurred. On 
January 19, 2014 Alibaba, the Chinese equivalent of Amazon 
stopped accepting Bitcoin. Two weeks later, Charlie Shrem, the 
Vice Chairman of the Bitcoin Foundation, located a stone throw 
from these Chambers, was indicted by the FBI for money 
laundering. Then on February 6, 2014, Russia declared the use 
of Bitcoin illegal stating that the Ruble was the sole official 
currency. That same week, Mt Gox of Japan, formerly the world's 
largest Bitcoin exchange, accounting for 80 percent of trading 
volume, announced it had been hacked, and later disclosed 
customer losses of more than $400 million. The other two major 
exchanges, Bitstamp, located in Slovenia and BTCe, located in 
Bulgaria, were also impacted by this attack. The scale and 
scope of the Mt Gox virtual-bank heist further rattled market 
confidence, raising new questions about safety and the need for 
basic consumer protection standards. In February, cyber hackers 
broke into Silk Road, the defunct deep-web purveyor of illegal 
goods and services, stealing over $2.7 million worth of e-
coins, proving that criminals can also steal from criminals.
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    \2\ Market price of $462 on March 30, 2014 ($738/$1,200) = 62 
percent.
    \3\ On December 4, 2013, former Federal Reserve Bank Chairman Alan 
Greenspan indicated publically that Bitcoin was a bubble.
    \4\ China on December 5, 2013 declared that Bitcoin was not a 
virtual currency but a virtual commodity.

    On March 11, 2014, the U.S. Financial Industry Regulatory 
Authority released a stern warning to investors about the 
dangers of buying and using virtual currencies. Shortly after, 
on March 24, 2014, the Internal Revenue Service dealt a further 
blow to Bitcoin, ruling it is not a foreign currency but should 
be taxed as property. This IRS ruling gives investors with a 
low-cost basis an added incentive to hoard coins instead of 
using them for transactional purposes. This further diminishes 
the already low level of market liquidity. Casting more doubt 
on the prospects of Bitcoin, on March 14, 2014, famed investor 
Warren Buffett stated ``Stay away. Bitcoin is a mirage.'' His 
comments supported remarks made by Charlie Munger, Vice 
Chairman of Bershire Hathaway a year earlier, when Munger 
declared Bitcoin ``rat poison.'' \5\ Despite these significant 
market disruptions, scandals and pessimistic comments made by 
well-respected investors, Bitcoin promoters continue to trumpet 
the virtues of this volatile, nationless and anonymous 
currency. Some advocates have declared this period as the 
Bitcoin Revolution (2000s), equivalent to the early stages of 
the internet (1990s). Although I do not view Bitcoin as ``rat 
poison,'' this virtual currency does pose significant risks to 
small business owners. These risks need to be carefully 
evaluated before deciding whether or not to venture into these 
new, uncharted waters.
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    \5\ Stated on Fox Business May 6, 2013.

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    U.S. Small Business - Market Innovation

    Small businesses fuel growth. Decisions by owners have 
broad impact. Presently, U.S. small business accounts for over 
half of private sector gross domestic product and employment. 
Since the 1970s, small businesses provide 55 percent of all 
jobs and 66 percent of all net new jobs. Businesses that are 
willing to adopt and utilize new technology, such as virtual 
currencies, may gain a distinct competitive advantage (e.g., 
cost savings, increased sales) over their competitors. However, 
blindly adopting technology without understanding the full risk 
implications can be hazardous to a company's financial health. 
Bitcoin is an example of new technology that has clear promise, 
but also poses a multitude of risks for both businesses and 
consumers.

    In my testimony today I will not focus on the promise of 
virtual currencies as I will leave that to the other hearing 
witnesses. Instead my focus will be on the significant and 
currently unaddressed risks associated with Bitcoin. Sound 
business and regulatory decisions can only be made when these 
identified risks and promised benefits are examined, and 
weighed against each other in the light of day.

    Once the facts are fully laid out, my hope is to leave this 
Committee with one simple question to ponder: what net 
benefits, if any, does Bitcoin actually provide to legitimate 
U.S. small businesses?

    How Risky is Bitcoin to Small Businesses?

    This question is best summarized by looking at the 
disclosure statement provided by Coinbase, a San Francisco 
based money transmitter who is servicing an increasing number 
of the nation's small businesses. As part of the new account 
set-up process, Coinbase describes Bitcoin as a virtual 
currency that could drop to the price of zero. In order to 
fully assess the risks of Bitcoin, small business owners should 
take note of this particularly revealing disclosure prior to 
deciding whether or not to accept Bitcoin. Indeed, if the U.S. 
dollar carried a similar risk disclaimer, how many small 
business owners would be willing to use the greenback to 
conduct commerce?

    The 10 Major Risks for U.S. Small Businesses

    In determining whether to accept Bitcoin when selling goods 
and services or for meeting payroll or paying vendors, small 
business owners need to first assess these 10 major risks. If 
this panoply of risk is not fully understood or controlled, it 
has the potential of exposing a business to greater earnings 
uncertainty, losses and fraud.

    These 10 major risks are discussed below.

    1. Bitcoin Is Not Legal Tender

    Small businesses need to clearly understand that Bitcoin is 
not legal tender. It is not created or supported by a 
sovereign--it is nationless. Unlike the U.S. dollar, there are 
no laws that require businesses or individuals to accept 
Bitcoin to settle private or public debts. Bitcoin is also not 
backed by taxing power, ability to assemble an army, assets or 
other natural resources customarily owned or controlled by 
nation states. In contrast to legal tender, the use of Bitcoin 
is limited to those willing to accept it. Presently the group 
of Bitcoin users is minuscule relative to the U.S. population 
(1 million out of 317 million). Globally, these numbers are 
even smaller. If businesses or individuals suddenly decide not 
to accept it, Bitcoin will become worthless.

    Extreme Price Risk

    Since inception, Bitcoin has experienced extreme annual 
price volatility topping 140 percent.\6\ Bitcoin is 7 times 
more risky than gold and 8 times more risky than the S&P 500. 
Compared to currencies it is 7 times more risky than the 
unstable Argentinian Peso and 15 times more risky than the U.S. 
dollar. As a result, it could be argued that small businesses 
that blindly accept Bitcoin are not actually in commerce but 
are in the high-risk speculative trading business. In contrast 
to small businesses, a Wall Street trading company might be 
willing to assume the triple-digit price risk posed by Bitcoin 
but only with experienced staff, sophisticated systems, strong 
controls and a large balance sheet to buffer against daily 
price swings.
---------------------------------------------------------------------------
    \6\ In 2009, annual volatility was approximately 160 percent. Using 
price data from 2010 forward from Mt Gox, Bitstamp and BTCe, annual 
volatility through 2014 was approximately 140 percent.
[GRAPHIC] [TIFF OMITTED] T7403.027

    In a single day, it is not uncommon for Bitcoin prices to 
move by 10 percent. At current price levels, Bitcoin can drop 
by $50 or more in a single day. In December 2013, in a 48-hour 
period, Bitcoin plummeted by 50 percent. Since the November 
2013 market peak, Bitcoin prices have dropped by over 60 
percent. On February 14, 2014, during a flash crash, one block 
of 6,000 coins fell, in seconds, by over 80 percent to $102 
before rebounding.\7\
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    \7\ Prices plunged on the BTCe to $102 before rebounding to over 
$600.

    3. Extreme Price Movements Can Quickly Erase Company Profit 
---------------------------------------------------------------------------
Margins

    The profit margins of U.S. small businesses are dependent 
on numerous factors including the nature of the industry, 
competition, location, number of employees, technology 
employed, cost of capital and level of management skill and 
experience. Although net profit margins can be 10 percent or 
less, more profitable companies earn margins in the 15 to 20 
percent range. Examples of higher profit margin professions 
include CPAs, chiropractors, and dentists, lawyers, portfolio 
managers and optometrists.\8\
---------------------------------------------------------------------------
    \8\ Nelson, Brett, The Most Profitable Small Businesses, Forbes, 
February 10, 2011.

    Given that the daily price movement of Bitcoin can be as 
high as 10 percent, a small business owner who accepts this 
form of payment could see profit margins reduced or completely 
---------------------------------------------------------------------------
erased in a matter of days.

    4. Bitcoin is an Asset Bubble in the Process of Deflating

    Small business owners need to be cognizant of the fact that 
Bitcoin prices were only $13 at the start of 2013 and could 
easily drop to the same low level in the near future. In an 
efficient capital market, capital flows to its highest and best 
use as investors seek a tradeoff between desired risk and 
desired return. When investors receive timely, accurate and 
transparent information, the likelihood of an asset bubble is 
diminished. However, even in efficient and well-developed 
financial market, it is not uncommon to experience bubbles 
(e.g., Dotcom 2000, Real Estate 2007).

[GRAPHIC] [TIFF OMITTED] T7403.028

    All asset bubbles are similar in that they have three 
phases: growth, maturity and pop. However, not all asset 
bubbles see prices collapse during the final phase; sometimes 
prices deflate over an extended period allowing investors to 
experience lower losses and softer landings. Bitcoin entered 
the growth stage in 2011, the maturity stage in 2013 and now is 
in the pop stage. Since December 2013 rapid price swings 
continue to demand that owners watch prices on a daily and even 
hourly basis. If small business owners are willing to accept 
Bitcoin they need to stay vigilant in monitoring the high 
probability of a pronounced price collapse.

    In December 2013, when prices were still over $1,000, I 
indicated that Bitcoin could drop to $10 or below (http://
cognoscenti.wbur.org/2013/12/05/bitcoin-currency-mark-t-
williams). This prediction was based on several observations 
including the underlying option value of this new and uncertain 
technology, price level at the start of 2013 and the percentage 
price drop associated with the 1637 Tulip Mania Bubble \9\. On 
January 24, 2014, Nobel prize-winner economist Robert Shiller 
stated ``it is a bubble, there is no question about it... it's 
just an amazing example of a bubble.'' As articulated by 
Coinbase, as part of its new customer disclosure statement, 
business owners have to be prepared for the chance that Bitcoin 
prices could drop to zero.
---------------------------------------------------------------------------
    \9\ The price dropped once the bubble burst was 99 percent.

    5. Growing Concentration and Bankruptcy Risk to Financial 
---------------------------------------------------------------------------
Middlemen

    Increasingly, small businesses, in an effort to avoid the 
extreme price risk of Bitcoin, are using the risk-mitigation 
services of Coinbase and BitPay. However, in relying on these 
startups, there is a growing exposure to concentration and 
bankruptcy risk.

    Both Coinbase and BitPay, as financial middlemen, accept 
price risk for a fee and allow businesses to receive their most 
preferred currency. Merchants are given a fixed Bitcoin 
conversion rate linked to a window of time. For example, BitPay 
provides a locked price quote for only 15 minutes. The fee for 
basic entry level service is 1 percent of transaction 
value.\10\ Customers pay in Bitcoin but merchants can elect to 
receive U.S. dollars. Extreme daily price swings have created a 
niche for Coinbase and BitPay but also have created a 
potentially dangerous level of industry concentration risk. It 
is important to note that Coinbase and BitPay do not eliminate 
overall Bitcoin price risk but simply warehouse this risk on 
their books. This is of particular concern given that these two 
fledgling firms are lightly regulated, thinly capitalized, and 
not required to operate with minimum capital requirements. 
Without these important safeguards, it is uncertain what this 
price mitigation guarantee is really worth? Adding to this 
concentration risk, no derivatives market exists to off-load 
this significant risk.
---------------------------------------------------------------------------
    \10\ BitPay has a four tier customer structure with fees ranging as 
low as 1 percent of transaction value to monthly fees of up to $3,000 
for extremely large transactions.

    As the number of small business customers increases, the 
amount of Bitcoin price-risk retained by these financial 
middlemen will also grow. For Coinbase or BitPay, a single-day 
price drop of 20 percent or a prolonged price decline on a 
large enough Bitcoin position could be financially 
devastating.\11\
---------------------------------------------------------------------------
    \11\ Since December 2013, there have been several days where daily 
intra and inter-day price movements have exceeded 10 percent, 
increasing to 15, 20 percent or more.

    Coinbase also has multiple business lines that present an 
inherent conflict of interest. In offering price-risk 
mitigation and Bitcoin-for-sale services, Coinbase has an 
economic incentive to sell Bitcoin at the highest market price 
while customers have an economic incentive to buy Bitcoin at 
the lowest market price. Without strong regulatory oversight it 
is unclear how Coinbase effectively balances this duel and 
---------------------------------------------------------------------------
conflicted loyalty.

    If these financial middlemen were to declare bankruptcy, no 
longer able to honor their obligations, and accounts receivable 
owed to merchants were not paid, such a scenario could be 
extremely costly.

    6. Bitcoin Exchange Bankruptcy Risk

    Business owners can also sell coins and open e-wallets 
through Bitcoin exchanges. Since Mt Gox trading was halted on 
February 7, 2014, and its subsequent bankruptcy two weeks 
later, the bulk of Bitcoin trading has been concentrated in the 
hands of two exchanges: Bitstamp and BTCe. To sell on these 
exchanges, U.S. small businesses must send instructions and 
trust that their requests will be honored. These exchanges 
operate under no regulation and are outside of the reach of 
U.S. regulators. With no regulatory oversight, it is not 
unusual for certain well connected buyers and sellers to gain 
preferential treatment in terms of price execution. Front-
running is not uncommon.\12\ In a weak corporate governance 
environment are customer funds adequately protected from 
internal or external fraud? In this ``wild-west'' atmosphere 
many exchanges have failed. It is estimated that of the 40 
Bitcoin exchanges that have been started since the inception of 
Bitcoin, almost half (18) have failed.\13\ When exchanges 
close, customers tend to lose everything. In November 2013, 
GBL, based in Hong Kong, closed its doors, costing investors 
over $4 million. In December 2013, the European Banking 
Authority also warned of the dangers of other exchanges failing 
and of the lack of investor protection laws. Should one or both 
of these exchanges go into bankruptcy, small businesses that 
store e-coins on either of these exchanges could experience 
substantial financial exposure.
---------------------------------------------------------------------------
    \12\ Practice of a self-interested firm executing trades in its own 
account after having advanced market information, sometimes trading at 
the detriment of the customer positions.
    \13\ Moore, Tyler, Christin, Nicolas, Beware the Middleman: 
Empirical Analysis of Bitcoin-Exchange Risk, 2013.

---------------------------------------------------------------------------
    7. Bitcoin Use Can Trigger Significant Tax Risk

    Unlike legal tender, Bitcoin has been designated for tax 
purposes as property. This distinction is significant. Unlike 
legal tender, when accepting Bitcoin, business owners can be 
subject to additional taxes associated with the gains--the 
difference in value on date received versus value on date sold.

    On March 25, 2014, IRS issued a ruling that clarified the 
tax treatment of Bitcoin but, in doing so, created greater 
uncertainty about the e-coin's future. Bitcoin is now taxed as 
property and not as foreign currency. Any gains in Bitcoin 
value is taxed as ordinary income (as high as 39.6 percent) or 
at the capital gains (20 percent) tax rate. Given the high 
price run-up of Bitcoin during 2013, there are significant tax 
considerations which also influence the level of hoarding 
versus spending. If an e-coin was purchased for $250 and it now 
trades for $500, the owner is going to be less motivated to use 
it for transactional currency purposes, especially if doing so 
would trigger an additional tax event. For holders of Bitcoin, 
this IRS ruling reduces the incentive to use e-coins for 
transactional purposes, reducing transaction flow, market 
liquidity and price stability. Prior to this ruling, over 90 
percent of e-coins were hoarded. It is highly plausible this 
tax ruling will encourage even more hoarding.

    Small business owners are now confronted with several other 
tax risks. If they decide to accept and retain Bitcoin, they 
will need to keep records of the market price on the day 
received and sold. Any increase in value from that date forward 
would be subject to income tax. If a merchant decided to pay 
its employees in Bitcoin, the firm also needs to withhold the 
required employment tax in U.S. dollars. Companies that pay 
employees in Bitcoin are also subjecting staff to increased tax 
risk should coins appreciate in value or if prices drop. Such a 
policy, given Bitcoin's extreme daily price volatility, would 
unfairly penalize employees.

    8. Transaction Fraud Risk - Double Spending

    Under Bitcoin protocol all new transactions are validated 
through the blockchain, a public ledger that is independently 
verified every 10 minutes. Validation is done to avoid a 
situation where a customer is able to fraudulently double-spend 
this e-coin. However, this 10 minute window poses potential 
risk should two businesses be paid with the same Bitcoin. If a 
double-spending incident occurred during this time gap, the 
last merchant to report the transaction would have little 
recourse to collect on this payment.\14\ That merchant would 
then lose the value of the product or services sold. If the 
customer had used a credit card and not Bitcoin to commit the 
fraud, the business would have had recourse through the credit 
card company. One way merchants can attempt to mitigate this 
risk is by waiting until a full validation is completed before 
permitting customers to receive goods or services.
---------------------------------------------------------------------------
    \14\ Although the Bitcoin community has indicated that double-
spending events are rare, and controls against it are strong, merchants 
still need to be prepared should such fraud be committed.

---------------------------------------------------------------------------
    9. Bitcoin Slow Transaction Speed Increases Credit Risk

    Credit cards such as Visa and MasterCard have higher 
upfront charges for small businesses; however, the transaction 
speed of the credit card network is superior to the existing 
transaction speed of Bitcoin. At point-of-sale, it still 
remains faster and more convenient for customers to swipe a 
card or input the card number on an internet e-commerce site 
than it is to use Bitcoin. The process of copying and pasting 
an e-coin alphanumeric string into another program and waiting 
for the confirmation is cumbersome and time-consuming. 
Merchants are also much more accustomed to receiving a point-
of-sale credit card authorization and receipt within seconds of 
sale. With Bitcoin, merchants remain exposed if they deliver 
product or services before payment confirmation is fully 
verified.

    On the existing Bitcoin network, only 7 transactions per 
second can be processed compared to 2,000 transactions on the 
credit card network.\15\ If the number of Bitcoin transactions 
on the existing network continues to grow, and if the network 
is not accordingly scaled up, small businesses accepting 
Bitcoin could see transaction time lengthened and payment 
verification slowed. Although inconvenient for customers, to 
mitigate this risk, merchants may need to have customers wait 
until a transaction can be completely verified.
---------------------------------------------------------------------------
    \15\ Bitcoin advocates claim that in the future the Bitcoin payment 
network will be much quicker than the existing credit card network. 
However in 2014, transaction processing time for Bitcoin remains much 
slower as measured in time to confirmation.

    BitPay, a virtual currency payment facilitator provides 
small businesses with three speed setting to help manage the 
Bitcoin payment confirmation process. At the fastest speed, 
merchants assume total credit risk if they deliver the product 
in advance of receiving a completely verified payment 
confirmation. For small transactions like candy, coffee and 
newspapers this concern may be minimal. For larger 
transactions, the concern for credit risk may take precedence 
over customer inconvenience. This is especially true before 
retail customers are allowed to take possession of merchandise 
---------------------------------------------------------------------------
or a product is shipped from an internet-based enterprise.

    10. Risk of E-Wallet Theft Remains High

    Small business owners that decide to accept Bitcoin have to 
create an e-wallet, and determine whether to store it on one's 
own personal computer hard drive or relying on a third-party 
vendor such as Blockchain or Coinbase. Third-party vendors that 
create and hold e-wallets perform a deposit-type function. 
However, unlike banks, these vendors lack regulatory oversight, 
minimum capital standards and don't provide consumer protection 
against loss or theft. Once created, e-wallets generate a 
public and private key. Small businesses need to have strong 
controls in place around the storage of e-wallets and of the 
private key.\16\ This is particularly important given that 
Bitcoin is an anonymous currency that is irreversible once 
transferred.\17\ Bitcoin features make it an ideal target for 
cyber criminals. If an e-wallet is hacked and coins stolen or 
transferred by mistake, they are lost forever. If a computer is 
infected with a virus, it could wipe out the hard drive and the 
stored value of all e-coins.
---------------------------------------------------------------------------
    \16\ Some businesses to gain maximum control have taken paper 
copies of private keys and placed then in locked boxes, E-wallets can 
also be taken off line. This control technique is called storage.
    \17\ These secrecy features also raise the question of what 
business need these benefits unless they have something they want to 
hide.

    Relying on third-party vendors also has it drawbacks, as it 
requires confidence that adequate controls are in place to 
minimize the likelihood of cyber-attacks or internal employee 
fraud. It is not uncommon for e-wallet service providers to go 
out of business. This was evidenced by the dramatic and costly 
Mt Gox bankruptcy in February 2014. Last month, Flexcoin, a 
Bitcoin e-wallet bank, based in Canada also folded after being 
---------------------------------------------------------------------------
hit by a devastating cyber-attack.

    Background

    a) Forms of Payment

    Forms of payment in commerce have evolved over many 
centuries including barter, shells, crude metal coins, precious 
metal coins, leather money, paper money, wampum, gold, gold-
backed dollars, charge plates, checks, wires, credit cards, 
debit cards and prepaid cards. Each manifestation has occurred 
in response to consumer demand for more convenient ways to 
conduct commerce. In the process, businesses have expanded and 
financially benefited.

    Virtual currencies, Bitcoin in particular, are being 
presented as the newest attempt at payment innovation. Bitcoin 
promoters claim it is a safer, faster and cheaper form of 
payment than existing forms including credit cards. These 
claims have yet to be fully proven.

    b) Facilitating Commerce

    It is widely known that businesses can increase sales by 
expanding the availability of customer payment options. Credit 
cards remain the primary form of payment used by consumers when 
entering brick and mortar businesses or when shopping online. 
Unlike cash or debit cards, credit cards facilitate greater 
purchasing by delivering a fast, short-term loan to consumers. 
In a cash only economy, businesses would not sell as many 
products or services, and profits would fall. Credit cards also 
increase impulse buying. To encourage even greater purchasing, 
some credit card companies establish reward programs, enhance 
product warranties and provide free loss/damage insurance on 
products purchased. In addition to credit cards, PayPal makes 
it convenient for customers by providing the option of quickly 
transferring money from either personal bank accounts or credit 
cards.\18\ PayPal has made significant inroads into e-commerce, 
now representing 18 percent of the market or $315.3 million in 
daily payment activity.
---------------------------------------------------------------------------
    \18\ The predecessor company to PayPal was founded in December 
1999. On October 3, 2002, PayPal became a wholly owned subsidiary of 
eBay.

    The cost of processing plastic is higher and small 
businesses attempt to manage higher fees especially on smaller 
purchased items by imposing credit card minimums or by 
establishing a cash or credit card price. The average cost of 
credit card transactions to merchants ranges from 2 to 3 
percent. In the last year, small businesses have also gained 
greater relief from credit card fees. Since January 27, 2013, 
U.S. merchants have been permitted to pass on to consumers a 
surcharge when using a credit card. Presently, few merchants 
---------------------------------------------------------------------------
have exercised this right.

    Small businesses have also received meaningful fee relief 
when accepting debit cards. Since the Dodd Frank Act and with 
the adoption of the Durbin Amendment, per-swipe fees have 
dropped by about 50 percent to 21 cents. This cost savings of 
an estimated $8 billion per year has been advantageous to small 
business.

    c) Credit Cards Fees Come With Merchant Benefits

    Credit cards have fees but with these fees come services 
and benefits to both merchants and customers. Consumers using 
credit cards are more likely to spend than those who only have 
cash. Business owners at point-of-sale receive instantaneous 
assurance that a card is valid and its owner has sufficient 
funds available to make a purchase. Credit card companies also 
work with merchants to reduce the change of fraudulent 
purchases. Consumer sales are increased through the use of 
loyalty program, enhanced guarantees and damage insurance. As a 
financial middleman, credit card companies also handle dispute 
resolution, gathering facts from merchants and customers. The 
chargeback protection (disputed purchases) also increases the 
likelihood of credit card use and thus a greater number of 
purchases.

    d) Evolving Payment Landscape - Business Transactions

    Currently, two-thirds of all point-of-sales transactions in 
the U.S. are completed either with credit, debit or gift cards. 
A little over twenty-five percent of sales are completed with 
cash and this rate is projected to decline to only 23 percent 
by 2017.\19\ Technology continues to make it easier for 
merchants to accept credit card transactions as older swipe 
machines and dedicated phone lines continue to disappear. 
Innovative firms such as Square, WePay and PayPal are making it 
more convenient to accept plastic or to make bank account 
direct transfers.
---------------------------------------------------------------------------
    \19\ Javelin Strategy & Research 2012.

    There is also significant growth in the use of prepaid 
cards. In 2013, Starbucks reported that one-third of the 
company's U.S. sales or $2.5 billion was conducted through this 
payment method. Annually, over $65 billion in U.S. sales is 
conducted through prepaid cards. This convenient and 
inexpensive payment method is projected to double in consumer 
---------------------------------------------------------------------------
use in the next two years.

    Most Small Businesses Don't Accept Credit Cards

    Internet commerce continues to grow rapidly where the 
preferred payment methods are either credit card or the use of 
PayPal-type services. In 2013, U.S. E-commerce sales increased 
by 17.22 percent to $380.6 billion accounting for 6 percent of 
total sales. Despite this market trend, more than half (55%) of 
the nation's 27 million small businesses do not accept credit 
cards.\20\ Some businesses argue that credit card-related fees 
(2 to 3%) or PayPal fees (2.2. to 2.9%) remain too high, while 
other small companies prefer cash over the transparency and 
reporting requirements associated with the use of credit cards.
---------------------------------------------------------------------------
    \20\ McClue, TJ., Why Don't More Small Businesses Accept Credit 
Cards, Forbes, August 16, 2013.

    Cash-only businesses also increase the chance for tax 
under-reporting. The Internal Revenue Service estimated that 
under-reporting by small businesses represents about $140 
billion in annual uncollected taxes. It is also estimated that 
56 percent of sole proprietors' cash receipts are not disclosed 
for tax purposes. Since 2012, the IRS has devoted more 
resources to address tax under-reporting by small 
businesses.\21\
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    \21\ IRS requires payment processors to annually file form 1099-k, 
a record of system transaction history.

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    Why Small Businesses Might Utilize Bitcoin?

    There are two major reasons why U.S. small businesses might 
either accept Bitcoin as payment and/or use it for paying 
employees, and vendors:

    1. Illegitimate Purposes - Silk Road, the deep web purveyor 
of drugs, guns and prostitution, accepted payment only in 
Bitcoin. The FBI shutdown Silk Road in October of 2013. The 
Silk Road Case elevated public awareness of Bitcoin as the 
designer currency of choice for the criminally-inclined. The 
anonymous nature of Bitcoin and the fact that transactions are 
irreversible, make it an ideal way for criminals to launder 
money, buy illicit goods and avoid taxation with little chance 
of detection.

    Legitimate Purposes

          a. Gain Marketing Exposure - Bitcoin has gained 
        increased media attention. As a result, more small 
        businesses view accepting Bitcoin as a way to gain 
        market exposure. Posting a sign on a door front, on a 
        website or gaining local media coverage increases free 
        advertising and brand awareness. For example, Grass 
        Hill Alpacas, a Massachusetts lama farm and purveyor of 
        wool socks, has gained considerable visibility being an 
        early acceptor of Bitcoin.

          b. Reduce Transaction Costs and Gain New Customers - 
        Bitcoin represents a new possibly less expensive, 
        private payment form to sell goods and services and 
        possibly expanding sales by reaching new customers.

    How do Small Businesses Obtain Bitcoin?

    There are four legitimate ways businesses can obtain 
Bitcoin:

    1. Buying through an exchange (BTCe) or money transmitter 
(e.g., Coinbase)

    2. Accepting as a form of payment for goods and services

    3. Receiving as a gift

    4. Mining coins

    To obtain Bitcoin, assuming there is no interest in mining 
coins, businesses first have to setup e-wallets, either through 
third-party vendors (e.g., Blockchain) or by storing them on 
the hard drive of a personal computer, which then allows for 
the receiving and sending of coins.

    Additional Background

    There are over 190 virtual currencies traded in the 
marketplace totaling $6.5 billion in stated value. http://
coinmarketcap.com/mineable.html. Of these traded e-currencies, 
Bitcoin, is the dominant player representing about $6 billion 
or 92 percent of this total stated value.

    In 2009, a programmer by the pseudonym Satoushi Nakamoto 
\22\ supposedly designed Bitcoin, a computer generated 
``virtual currency'' produced by solving progressively complex 
mathematical equations.\23\ The code-protocol for Bitcoin is 
open source, allowing it to be easily viewed, commented on and 
if a majority of programmers agree, changes are adopted. In 
this regard, Bitcoin is very transparent.\24\ Bitcoin, the 
pseudo currency and Bitcoin, the low-cost payment system, are 
dependent on each other and are inseparable. Bitcoin is the 
locomotive while the payment system is the track that allows it 
to move back and forth. The Bitcoin infrastructure is 
decentralized and based on a peer-to-peer structure. 
Individuals in a multitude of locations, using powerful 
computers to solve pre-determined equations, authenticate e-
coins and help keep a general ledger of ongoing transactions. A 
continuous blockchain is used and maintained to record Bitcoin 
ownership. New transactions are authenticated every ten 
minutes. Unlike in credit card transactions, the peer-to-peer 
network was designed to eliminate the need for the financial 
middleman or the associated fees. These individuals verify 
transactions and provide the backbone control to ensure that e-
coins are authentic and are not double-spent. As a reward for 
their efforts, they earn blocks of e-coins. This process is 
referred to as mining and those that do it are called miners. 
Interestingly, using such terminology also gives the false 
impression that something of tangible value is being created 
such as gold being mined out of the ground. Some enthusiasts 
have claimed that Bitcoin is gold for geeks. Initially, the 
entry-level barrier to become a miner was low. Overtime, this 
barrier has risen and those who are already mining have a 
competitive advantage and greater market power.
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    \22\ In March, Newsweek presented facts in an attempt to prove the 
founder in Dorian S. Nakamoto who currently lives east of Los Angeles. 
When confronted by reporters, Mr. Nakamoto denied having any connection 
with the creation of Bitcoin.
    \23\ Bitcoin has not been recognized by any of the G20 countries as 
meeting the definition of currency as it lacks price stability and does 
not provide a stable store of value. As a result it is a speculative 
virtual commodity with no tangible value.
    \24\ The Bitcoin community has argued that this open source 
unregulated peer-to-peer approach is a strong control as it allows a 
large community of computer scientists, software engineers and 
cryptologists to watch over the system and insure its integrity.

    At first miners were rewarded with 50 coins per block. 
Initially Bitcoin prices were in pennies. More recently, a 
block is equal to 25 coins. The block/coin ratio will continue 
to halve as time goes on. It takes approximately 10 minutes to 
mine a block and approximately 4,000 new e-coins are generated 
globally per day. Currently over 12.3 million Bitcoins have 
been minted and by year 2140, the 21 million limit will be 
reached. A preset quantity limitation creates scarcity which 
puts upward pressure on price. This is especially true as long 
as new investors can be recruited to buy newly minted e-coins. 
Although commodity scarcity is dictated by predetermined rules, 
it is unclear what mechanism or controls are in place to 
guarantee that rules will be followed and that incentives to 
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cheat the system will be eliminated.

    Theoretically, the Bitcoin mining and authenticity process 
is decentralized, keeping collusion between miners to a 
minimum.\25\ As new e-coins are minted they are added to the 
blockchain and when trades occur, existing e-coins are 
authenticated against this blockchain. As more Bitcoins are 
mined, the blockchain grows longer in complexity and the 
verification time increases. In February 2014, a series of 
cyber-attacks occurred on the Bitcoin infrastructure, targeting 
three of the largest exchanges, resulting in significant 
trading disruption. While the integrity of the blockchain 
remained intact, several third-party vendors were significantly 
impacted. Mt Gox eventually filed bankruptcy and the other two 
largest exchanges, Bitstamp and BTCe were immobilized for a 
week. During this attack, markets and Bitcoin prices suffered.
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    \25\ However, in practice, as prices have skyrocketed, there has 
been a greater economic incentive for miners to band together in 
pursuit of increased profits. As a result, this remains a clear 
weakness in the Bitcoin infrastructure.

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