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Market focus in Latin Lawyer Volume 14 Issue 2

At its best, bitcoin promises to cure Latin America of its most damaging ills, from high inflation and strict capital controls to poor access to banking; at its worst, it threatens to destabilise economies and facilitate crime. From regulation to money laundering, Vincent Manancourt takes a look at some of the key issues surrounding the mysterious digital currency in Latin America today.

Credit: Miha Perosa

Latin America has long been touted as a region that could benefit immensely from bitcoin. Of the top 10 countries the London School of Economics highlighted as having the highest potential for bitcoin adoption, four are in the region. Indeed, with strict capital controls, foreign exchange restrictions and high inflation blighting many of the region’s countries, it is clear why. Unlike national currency, which is created and backed by central banks, a main advantage of bitcoin is that it is free from government influence and governed by inviolable computer code allowing individuals to trade with each other. “Anything subject to financial codes could be disrupted by bitcoin without the need for intermediaries,” says Juan Pablo Cappello, founder of the Private Advising Group law firm in Miami, which accepts payments in bitcoin. But while some in Latin America may use the digital currency to cushion them from fluctuations in their local currencies, it is perhaps in the remittance industry where bitcoin has the greatest disruptive potential.

Remittances, which are the transfer of money by a foreign worker to their home country, play a significant role in the region’s economies and provide governments with a valuable source of foreign exchange. In 2013, remittances flowing into Latin America and the Caribbean totalled more than US$60 billion, far outstripping the US$8 billion the region receives annually in foreign aid. Yet a proportion of this money ends up in the hands of the remittance companies, such as MoneyGram and Western Union, who charge high fees for using their services. By allowing users to bypass the companies and transfer money across borders for much lower costs, bitcoin has forced many of these companies to re-evaluate their business models. Perhaps as a sign of things to come, in February More Money Transfers, a Latin American remittance company, struck a partnership with Bitex.la, a bitcoin exchange – a move many read as a sign the remittance industry is beginning to realise it must work with bitcoin, or else be superseded by it.

Some of the digital currency’s most fervent advocates go further still, predicting that bitcoin will not only replace money transferring services, but also national tender altogether, rendering intermediaries of any kind – from central banks to national borders – obsolete. But many within Latin America’s legal circles argue such predictions are wildly optimistic and, at best, premature. For a start, even agreeing on a legal definition for bitcoin has not proven easy. Many may use “digital currency” as a convenient short-hand to reflect bitcoin’s function as a medium of exchange, a unit of accounting and a store of value, but lawmakers and regulators argue such a definition is misleading. For them, currency is legal tender issued by a sovereign state, which bitcoin isn’t. Instead, they are more inclined to see it as an asset that investors buy and sell on the stock market; but that, too, misses the complexity of the technology. Consequently, attempts so far to regulate bitcoin by requiring companies involved in its exchange and development to apply for licences, as in New York state, have so far stopped short of defining bitcoin at all. “There is a discussion about whether to treat bitcoin as a currency or whether it should be treated as a security,” explains Nei Zelmanovits, a partner at Brazilian firm Machado, Meyer, Sendacz e Opice Advogados. “There are different consequences that derive from that. If it’s a currency you may be involved in foreign exchange regulations; if it is a security you will be dealing with security regulations.”

Regulation, regulation, regulation

While difficulties may persist in defining bitcoin, this has not stopped authorities across Latin America attempting to restrict its use. Bans in Bolivia and Ecuador have shown that, for all the disruptive potential of the digital currency, these central authorities still wield considerable power. Helena Suarez Margarido, a partner at HMO Advogados and co-founder of the Brazilian arm of the Bitcoin Foundation, believes that the immediate priority in encouraging the spread of the digital currency is preventing bitcoin from being banned elsewhere. To accomplish this, she advocates working with the authorities, rather than against them, to change their perception and educate them about bitcoin’s advantages. “If you listen to some people you’d think the whole point of bitcoin is to fight the power of the government,” she says. “We won’t get anywhere by portraying it like that. That’s why I try and de-politicise the issue and focus on bitcoin as a technology product instead.” This is a sentiment echoed by Bruno Balduccini, a partner at Brazil’sPinheiro Neto Advogados, who advises clients involved with bitcoin to work closely with regulators. “Bitcoin cannot exist in this completely decentralised and unregulated system,” he says. “It’s impossible. It becomes unsafe. At the end of the day you need regulation.”

 

 

 Andrew Ittleman, Bruno Balduccini, Juan Pablo Cappello and Bruno Pineda

Lacking a fixed definition means regulatory and tax issues around bitcoin have abounded. For instance, as an asset, bitcoin would be subject to capital gains tax, but as currency, it would not. Then there is the small matter of foreign exchange. Many Latin American countries impose restrictions on inbound and outbound transactions, meaning that while buying and selling bitcoin as an asset is currently legal, transferring it between jurisdictions without using traditional foreign exchange methods runs the risk of falling foul of these laws. “Basically, if you use bitcoin as an asset to transfer money abroad without entering into a foreign exchange transaction with the bank, then this could be considered illegal,” says Balduccini.

Latin American regulators are uncertain of how to proceed. Some have moved to ban bitcoin entirely. Others, such as those in Argentina and Brazil, are playing a waiting game, watching to see how matters play out elsewhere before committing to any regulation themselves. Everywhere, suspicion abounds, says Julio Vieito, a partner at Argentina’s Abeledo Gottheil Abogados. “The authorities are very wary of virtual currencies because they could be used on the black market or for money laundering.” Central banks in Brazil, Argentina and Colombia have issued statements warning against bitcoin usage, and there are predictions Venezuela will follow Bolivia and Ecuador’s lead and ban it outright. And while there have been encouraging signs in Brazil, where the federal senate has commissioned a study on how to regulate bitcoin, it is clear that a definitive stance on regulation is a long way off.

Many believe, however, that it is only a matter of time before this situation changes. “At the moment there is a limited number of bitcoin users,” says Ricardo Higashitani, a partner at Brazil’s KLA-Koury Lopes Advogados. “But when that number increases, specific regulation will probably start to be introduced.” In the meantime, regulatory uncertainty in the region is holding back bitcoin’s development there, thinks Cappello. “Companies understand that regulation is unstable in Latin America. They have no framework from which to hang their hat, so a lot of those operating in the region actually go through places like Singapore and the Netherlands, which have put regulations in place to encourage bitcoin companies to set up shop in their countries,” he says. A case in point is Bitex.la, which though based in Argentina, is incorporated in Netherlands to mitigate the risk it faces by being an early entrant to an unregulated market. At the time of its launching, the exchange’s chief operating officer said that Bitex.la did not yet want to be at “the whim of the regulators” in Latin America.

Instead, regulators across the region are looking to the northern hemisphere to see how their counterparts in the US deal with bitcoin before tackling the issue themselves. But it seems confusion reigns stateside too. “All the different agencies in the US have taken their own position with respect to bitcoin,” says Andrew Ittleman, a founding partner at Fuerst Ittleman David & Joseph, PL in Miami, which also accepts payment in the digital currency. “The Internal Revenue Service has come out and said that bitcoin is property and will be taxed accordingly. Other federal bodies may regulate it as a security or as a futures contract.”

The federal anti-money laundering body, FinCEN, has also weighed into the debate, saying that it will regulate bitcoin as money and treat bitcoin exchanges as money transmitters. According to guidance published by FinCEN, companies that exchange bitcoin for other currencies will be required to implement anti-money laundering programmes. These programmes require that companies know the identity of their customers, have designated compliance officers and submit to audit by federal agencies. This is a move to try and combat some of the money laundering issues surrounding the digital currency. These issues arise because transactions in bitcoin are done on an anonymous basis – the fear is that this presents an opportunity for the network to be used for nefarious purposes. An added worry is that compliance measures currently in place are not sophisticated enough. “Bitcoin transactions are not processed using the usual channels, so they are not subject to specific compliance or controls,” says Renato Schermann Ximenes De Melo, a partner at Brazil’s Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados. “As negotiations occur outside the banking system, the origin of funds and identity of parts remain unrevealed.”

 

 

 Helena Suarez Margarido, Julio Vieito, Nei Zelmanovits and Renato Schermann Ximenes De Melo

Others think the link between illicit activity and bitcoin has been overstated. “It’s basically the only press it gets,” says Suarez, referring to publicity surrounding online black markets, such as the now-defunct Silk Road, where illicit goods and services are bought and sold using bitcoin. Cappello agrees: “No one talks about all the illegal things done with dollar bills. Why blame bitcoin, when you could blame the greenback for everything bad that happens with US$100 bills? There’s nothing inherently evil about bitcoin.” Here, again, lawyers believe the answer is to work closely with regulators and legislators to try to allay money laundering and terrorism financing fears to ensure that bitcoin is not banned before it can even get off the ground. The authorities need reassurance that, to a certain extent, bitcoin can be reined in. Balduccini admits that this will not be easy. “There are some characteristics of bitcoin that you can’t get rid of. So the challenge is to come to some kind of compromise with the regulators that will not kill the essence of the product,” he says. In particular, the decentralised nature of the technology is considered sacrosanct by enthusiasts, yet they may have to accept some centralisation if bitcoin is to flourish. There are suggestions that if the bitcoin exchanges are willing to be subjected to some kind of regulatory oversight, regulators are more likely to play ball.

Creative disruption

Regulatory and money laundering issues aside, it is undeniable bitcoin has the potential to improve many aspects of life – especially in Latin America. “The potential of bitcoin in Latin America is tremendous,” says Ittleman. “It can be so much more disruptive there than in Europe and the US because the need is so much more acute. At a basic level, many of the countries are either subject to strict currency controls, have worthless currency or both.” Another factor in bitcoin’s favour is that a large proportion of Latin Americans do not have bank accounts. As a consequence, many have migrated cash to electronic systems such as prepaid cards on phones, which, unlike bank accounts, are ubiquitous in the region. Central banks, realising that a large portion of the economy is not being supervised, have started to bring some of these financial instruments under scrutiny. Bitcoin could be used in much the same way, with no need for bank accounts and the onerous bureaucracy needed to open them in many countries. There is also hope that nascent regulation used for these electronic money systems could be used as a precursor for any legal framework for bitcoin.

Another compelling case for bitcoin in Latin America is the role it could play in facilitating international trade. Companies, especially in Venezuela and Argentina, face a difficult and time-consuming process to access dollars if they want to pay for products to be shipped into the region. “Bitcoin has the potential, when fully mobilised, to eliminate all of that,” says Ittleman. Bitcoin could also provide more security for US companies wanting to trade with the region. US manufacturers such as Apple or Dell, for instance, currently prefer not to sell directly to Latin American retailers because they are not willing to take the risk that local suppliers will be unable to pay because of local currency volatility. Instead they sell to distributers, mainly based in Miami, who absorb the risk for them. But with the latest developments to the bitcoin technology, the blockchain, these kinds of transactions could be effectively risk-free. “With trade you could use these things called smart contracts,” says Ittleman. “So you could have Apple selling directly to a Latin American vendor, who deposits a certain amount of bitcoin into the blockchain using one of these smart contracts. The blockchain will then only release the computer parts to the vendor and the bitcoin to Apple once all the conditions of the contract are met.”

Bitcoin’s role as a tonic for Latin America’s currency troubles is in jeopardy, however. As Bruno Pineda, a partner at Ecuador’s Pérez Bustamante & Ponce Abogados, puts it: “A handful of Latin American countries have already banned it.” Others are more optimistic, and feel that once bitcoin is in the public sphere, it will be difficult to turn back the tide; even if more bans follow, there is a limit to how effective they will be. “Governments have a choice: to ban bitcoin, and start a kind of war on drugs, or to embrace it, which will allow them to regulate it and tax it properly,” says Ittleman. If nothing else, says Cappello, bitcoin will force the established players in the financial services space to be more innovative and offer better choice to customers. And if there’s something that no one can argue with, it’s the potential the digital currency has to disrupt established systems. As Cappello says: “If you take a step back from all the issues surrounding it, from a technological perspective, bitcoin is one of the great innovations of the past 2,000 years.”