Is The Looming Bitcoin ‘Hard Fork’ Illegal?
As the Bitcoin community struggles to reach a broad consensus over how to expand the blockchain’s block size, thus allowing Bitcoin to scale, a pro-Bitcoin attorney has sounded an important alarm: any hard fork of Bitcoin may be illegal, and furthermore, exposes the developers of the newer code to substantial liability.
“The creators of the new software face potential liability and criminal sanctions if they are deemed administrators unless they register with the Feds,” according to Daniel Friedberg, a principal at the law firm of Riddell Williams PS in Seattle. Furthermore, “the implementation of a ‘hard fork’ would require exchanges to differentiate between bitcoin and ‘Bitcoin Classic’ or ‘Bitcoin XT’ Bitcoin, as its customers would inherently have rights to either one or the other.”
In a recent article on his law firm’s web site, Friedberg points out several legal issues with the looming hard fork – a situation where two incompatible versions of the underlying Bitcoin software coexist until a consensus of miners (transaction processors) switch from the old to new version, thus rendering the old version obsolete.
Bitcoin Developers Become Money Services Businesses
The first issue: the potential liability of the software developers working on Bitcoin Classic or Bitcoin XT, two contenders for the new fork of the Bitcoin platform code. “Unlike Satoshi, the mysterious creator of the original Bitcoin software who has remained anonymous and therefore outside the reach of law enforcement, the developers of both Bitcoin Classic and Bitcoin XT are publicly named,” Friedberg explains. As a result, “the creators of Bitcoin Classic or Bitcoin XT who are deemed administrators would need to register with FinCEN [the US Treasury’s Financial Crimes Enforcement Network] as a Money Service Business (MSB). Failure to register can result in imprisonment of not more than 5 years, as well as civil penalties.”
This regulatory requirement also throws a wrench into the near-anonymity that Bitcoin users currently enjoy. “An MSB is required to maintain effective anti-money laundering (AML) programs, recordkeeping, and reporting of suspicious activities,” Friedberg continues. “In order to do so, the MSB must know who its customers are.”
AML regulations already require Bitcoin exchanges to know the identities of Bitcoin users. However, in the case of the upcoming hard fork, Bitcoin developers must maintain this information as well to the extent they are deemed administrators as a result of controlling the resulting new currency. “These requirements would require the replacement Bitcoin protocol to maintain the personal identifying information of its users,” Friedberg explains. “The adherence to such requirements will be a large deviation from the current Bitcoin protocol which does not maintain personally identifiable information about its users.”
‘Old’ vs. ‘New’ Bitcoin: Legal Morass
Perhaps the more serious legal issue with the upcoming hard fork results from the fact that it creates two different kinds of Bitcoin, and furthermore, forces owners of the older type to switch to its replacement.
Friedberg points out the problems with such a move. “The implementation of a ‘hard fork’ would require exchanges to differentiate between Bitcoin and ‘Bitcoin Classic’ or ‘Bitcoin XT’ Bitcoin, as its customers would inherently have rights to either one or the other,” Friedberg says. “Exchanges could not mix or intermingle the two, as each has its own rights. In addition, the market price of each coin would likely differ, complicating the decision-making of investors and users.”
The result: Bitcoin exchanges would open themselves up to both criminal and civil liability. “To the extent that a recipient of Bitcoin expects normal Bitcoin but instead receives ‘Bitcoin Classic’ or ‘Bitcoin XT’ virtual currency due to the actions of a miner, that recipient could argue that the actions of the miner resulted in a dispossession” – ‘dispossession’ being legalese for ‘theft.’
Predictably, the Bitcoin community is generally in disagreement with Friedberg’s legal conclusions. “Anyone who knows what they are doing and uses an updated wallet will clearly know the difference between coins in both forks,” states Redditor klondike_barz (most Bitcoin enthusiasts prefer to remain anonymous). “This is like saying that someone might sue you for giving them USD when they expected Canadian dollars.”
However, not all Bitcoin community commenters on Reddit take the same perspective. “An exchange backing a larger block fork that winds up on the losing side would be dead-to-rights guilty of outright fraud for selling fake coins,” admits jphamlore in the same discussion.
This commenter also references the ‘double your money’ problem I discussed in my previous article on Bitcoin: “There have been threats that such a fork could be attacked by double-spending and rendered worthless,” contrary to the opinion of klondike_barz.
Will Bitcoin Survive the Hard Fork?
It’s difficult to say at this point in time whether Bitcoin will be able to survive a hard fork to Bitcoin Classic – or any other solution to the block size problem the community may come up with, for that matter.
Certainly, developers of any new fork may register as MSBs to avoid personal liability. How to resolve the problem with ‘old’ vs. ‘new’ Bitcoin, however, is less clear.
One thing is certain however: Bitcoin’s days operating at the periphery of the law are numbered.
This article was updated to reflect Friedberg’s clarification that not every hard fork requires registration – only those where the creators are deemed to be administrators by virtue of exercising control over the resulting currency.
Disagree with this article? Feel free to comment – but illegal attacks on Forbes or the author’s web sites will be reported to the authorities and dealt with to the full extent of the law. Intellyx advises companies on their digital transformation initiatives and helps vendors communicate their agility stories. As of the time of writing, none of the organizations mentioned in this article are Intellyx customers. Image credit: Daniel Friedberg, Antana.