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application of mlm through bit coins

Published on : July 2016
Author(s):Several

The Fueling of MLM through Bitcoin

Pragya Gianani; Shahed Abdul-Dayem; and Faraz Salat discuss the legal aspects surrounding multi-level marketing and usage of bitcoins.
 

Bitcoins MLM LawyersAny entrepreneur will tell you that the success or failure of a startup, business idea, or product depends on demand. Supply and demand are the basic driving forces of economies. But, when we think of a successful start-up idea, we recognize that success is almost entirely due to an entrepreneur’s initiative in fulfilling a demand that they recognized, closing the gap between consumers who require this service, and the aforementioned demand.

But what about successful business models that didn’t depend on demand generation, but demand creation?

Demand creation is the concept of 'creating what people love before they know they want it.' Essentially, drumming up excitement for a product or service people didn’t even know they wanted, and capitalizing off the buzz and magnetism which has been created from thin air.

Is that even possible? The CEOs of Netflix, Uber and Kindle would respond in the affirmative.

The founder of Netflix, Reed Hastings, found himself irritated by the late fees associated with renting DVDs from Blockbuster. He created a demand for DVD-by-mail that eradicated the need to travel to a physical shop in order to rent DVDs, and introduced a single-pay subscription system and CineMatch, an algorithm that recommended movies based on the consumer’s taste in television. Eventually, it became what we know as Netflix, as we know it today; a purely streaming website for an affordable price, with thousands upon thousands of TV and movie options. Did we need this? No. Was there an extensive demand for this commodity? No. Yet, here we are.

Bitcoins

We’ve seen the rise of Bitcoin over the past few years. In layman terms, Bitcoin is an electronic currency, not regulated by any authorities, providing users with perfect anonymity. Seems too good to be true, and yet, Satoshi Nakamoto single-handedly created this cryptocurrency. It is unnervingly easy to use, requiring only an internet connection and the software associated with Bitcoin mining. A person holds their Bitcoins in what is called an eWallet and exists solely on the internet. Essentially, any transaction involving Bitcoin would require absolutely no middlemen.

New Bitcoins are created in a process called 'mining,' which involves Bitcoin users’ computers attempting to solve a complex mathematical puzzle related to the current number of Bitcoins. Reuben Grinberg of Davis Polk compares it to finding the missing piece of a puzzle. Whomever finds the puzzle piece wins a certain number of Bitcoins, and the process starts all over again. Finding the Bitcoin solution involves an incredible amount of processing power, and so users often band together in 'pools' in order to find the solution and to earn Bitcoins more regularly.

Why would anybody be interested in this currency? What might have driven Satoshi Nakamoto to spend as much time as he did to develop it? Perhaps it was suspicions in regards to financial institutions and central banks like the US Federal Reserve. Perhaps people seeking privacy might find comfort in the anonymity afforded by Bitcoin transactions. As with gold, the idea is that the value of Bitcoin could survive some sort of cataclysm.

However Bitcoin is primarily unregulated in most jurisdictions, despite the volume of Bitcoin transactions taking place. It might be prudent to discover the possibility of potential regulation in the following important areas:

United States of America

Federal Tax Law

  • The IRS has decided to treat Bitcoins as property for taxation purposes.

Federal Anti-Money Laundering Laws

  • Because money laundering crimes often involve transactions processed by banks, the Bank Secrecy Act (BSA) has imposed many record-keeping requirements on banks and other financial institutions. Currently, Bitcoin exchanges and individuals and businesses that change Bitcoin into U.S. Dollars, or other foreign currency, must register with the Department of Treasury and comply with Bank Secrecy Act requirements.

Canada

In January 2014, the Department of Finance stated that Canada does not consider Bitcoin to be legal tender. Further, the Canadian Revenue Agency has announced that Bitcoin will be taxed in two ways:

  • Transactions for goods and services will be treated as a barter and taxed accordingly;
  • The profit made from buying or selling Bitcoin for speculative purposes could be considered income or capital and taxed as a security.

European Union

In early 2014 the EBA sent the European Commission and European Parliament guidelines for the regulation of digital currencies. The EBA instructed financial institutions to refrain from buying, holding, or selling digital currencies until these new rules are in place.

India

In December 2013 the Reserve Bank of India issued a warning about Bitcoin. This led to virtually all Bitcoin exchanges in the country choosing to suspend operations. One Bitcoin exchange reported having been raided by government officials, while another exchange said tax officials visited their premises to investigate how digital currencies could be managed and taxed.

Israel

In February 2014 the Bank of Israel issued a generic warning about the investment risks and dangers of fraud, money laundering, and terror financing that come with Bitcoin usage.

Australia

The Australian Tax Office (ATO) has stated that income and profits derived from Bitcoin transactions are taxable.

Let us look at the risks that a cryptocurrency carries, by using the legal framework of India specifically.

Statutory provisions in India that regulate the issuance, utilization and disposal of currencies (and money) are The Foreign Exchange Management Act, 1999, The Reserve Bank of India Act, 1934 and The Coinage Act, 1906.

Despite the fact that the terms ‘legal tender’ and ‘bank notes’ have not been clearly defined, the nature and characteristics of the terms have been determined according to the aforementioned statutes. Does Bitcoin, a virtual currency, come under the purview of the defined currency? If we apply the principle of express um facit cessare MLM Lawyerstacitum, virtual currency does not have any place in the ambit of the label ‘currency.’

Bitcoin transactions have been prone to security threats and hacks in the recent past; one instance being in early 2014 when hackers reportedly stole more than USD 5 million in virtual currency from Bitstamp, a major Bitcoin exchange. Cyber-thievery has increased gradually and significantly, with Bitcoins being a frequent target. Since the transactions are contained in the cyber environment, cyber security will be a long-standing concern. Due to a lack of confidence and insurance in Bitcoin, there is no sign of consumer protection in the Bitcoin community.  However, if Bitcoin exchanges and the use of Bitcoin were as widespread in the securities market, such security breaches may be construed as acts of cyber terrorism.

There are also several political and economic implications in the use of Bitcoin,ranging from government policies, to economic upturns and downturns, as well as illicit activities.

As most jurisdictions have not made any decision with regard the status and treatment of Bitcoin in the economy, one of the major dangers is that any government might declare it illegal, leaving the investors helpless without remedy. Further, there are very few nations which have passed legislation on the taxation of Bitcoin, however, it must be kept in mind that since Bitcoin is not a centralized currency, people are not likely to comply with regulations which require them to disclose their Bitcoin transactions.

Further, anonymous cryptocurrencies such as Bitcoin may be used to engage in illicit activities, not the least of which is drug trafficking. Silk Road was a website launched in June 2011 which sold illicit goods and services. An estimated of $1.9 million dollars’ worth of Bitcoin transactions per month were conducted, confirming that Bitcoin is fast becoming the first choice for those conducting illicit activities to shelter themselves from the scrutiny of the law.

Multi-level Marketing

Multi-level marketing (MLM) schemes are a form of network marketing characterized participants paying the company in return for:

1.      the right to sell a product, and

2.      the right to receive commissions in return for recruiting other participants into the program.

Perhaps the most renowned and long lasting MLM is the 1886 established California Perfume Company, renamed to 'Avon Products' in 1939. Avon made massive headway in yielding legitimacy to MLMs. It created demand women did not know they wanted yet - word-of-mouth business. In a time where women were increasingly entering the labor force, Avon used that to their advantage. Women were able to work and market according to their needs and schedules, allowing them time to look after their families while earning a commission.

The MLM industry was proceeding on a legitimate legal course until a proliferation of pyramid programs appeared on the scene in the 1970s. A promotion called 'Dare To Be Great' promoted by Glen W. Turner was one example. Like other pyramid schemes, the only 'commodity' that moved through this program was money. No viable goods or services, sold at fair market value, accompanied the recruiting activities. Virtually every state had residents who were impacted by this and other programs which officials successfully argued were mere 'headhunting' schemes.

The Federal Trade Commission (FTC) established the earliest guidelines regulating pyramids and other entrepreneurial chains and was highly critical of:

●       large membership fees;

●       programs in which distributors were misled as to the amount of commission they might reasonably earn; and

●       programs in which commissions were not based on the sale of product to the end consumer.

No legal ruling has had more impact on the direct sales industry than the landmark FTC v. Amway decision. (In the Matter of Amway.) In 1975, the FTC accused Amway of operating as an illegal pyramid. After four years of litigation, in 1979, Amway prevailed. An administrative law judge ruled that Amway's multi-level marketing program was a legitimate business opportunity as opposed to a pyramid scheme.

Where Bitcoin and MLM meet

Multi Level Marketing LawyersThe sale of Bitcoin in and of itself is no more a vehicle for MLM than the sale of any currency, stand alone. Bitcoin MLMs work like other MLMs of a similar nature. For example, one Bitcoin MLM may be one which sells Bitcoin mining hardware and additional educational materials to consumers for a price, from which they may earn a commission by selling Bitcoin mining hardware and educational materials to others. Given the online nature of Bitcoin, it is not even required that one have the hardware they own in their physical possession. Companies can and have providing cloud/remote Bitcoin mining services.

The most notable case of Bitcoin used in an MLM scheme is that of GAW Miner/Zenminer, who are currently being sued by Securities and Exchange Commission (SEC) on account of their fraudulent conduct in selling hardware to mine Bitcoin.

The scheme first began with Mr. Garza’s business which purchased virtual currency mining equipment from overseas manufacturers and resold them to customers. Later, he began to offer a service known as 'Hardware Hosted Mining.' In short this process consisted of GAW Minder would host the computer hardware in their own data centers, for a fee, as opposed to shipping out the equipment, but allowed users direct and complete access over their equipment remotely, over the internet. This sort of trade between the seller of the scheme, and the user later became known as 'Cloud Hosted Mining'.

From August 2014 until the end of that same year, Zenminers LLC, under GAW Miners LLC, sold contracts to over 10,000 investors. These contracts, they claimed, represented a share in the profit from using computer power to mine virtual currency. The returns cloud miners received of these shares were in the form of 'Hashlets,' a system the corporation claimed would earn a reward based on the number of virtual currency units one had mined.

Eventually, the company sold more Hashlets worth of computing power than had existed in their computer centers. The computer equipment they claimed to be selling often did not exist in their data centers, or did not back up the number of Hashlets the company claimed had been sold. The company earned approximately $19 million in this way.

This, the suit claims, misrepresented the amount of computer power associated with the packages investors had purchased, and were hence fraudulent. Further it is claimed that the company did not provide adequate information to the customers as to the sustainability of the Hashlets they mined, nor the basis by which Hashlets were derived.

Customers’ computing power was being neglected, and any choice they believed they were given through the ZenCloud interface was not accurate. Customers became disgruntled as they realize the options they were being sold had no effect.

Implications

Despite the risks involved with Bitcoin MLMs, there are perceived perks to such affairs. One of the reasons there has been a surge in Bitcoin exchange is that the practice is not regulated by any body; there is no centralization of this currency which is so easily exchanged. However, the demand creation for Bitcoin using Multi-Level Marketing may influence banks into treating Bitcoin as a currency which can be exchanged for physical money. This would allow for Bitcoin to be more easily regulated, defeating several features of the currency, though this is not a likely outcome.

Another perk of Bitcoin is the anonymity it affords its users. Any centralization, or even the use of cloud-hosted Bitcoin MLM, negates either the initial anonymity of an individual, or the entire concept in itself. Regardless, Grinberg claims that anonymity is not complete in Bitcoin transactions as they are at present: 'It's possible that using statistical techniques and information that's publicly available [on the blockchain] you could find out a great deal about Bitcoin users.' Further, bitcoin users who reveal information to third parties, either a Bitcoin eWallet provider, or through joining pools to mine Bitcoins, are compromising their identities.

Conclusion

Engaging in Bitcoin may be risky in itself, but its marriage with Multi-Level Marketing could potentially prove disastrous if misapplied. The regulatory concerns are paramount. The possibilities for exploitation of security flaws, crime opportunities, and of potential customers are numerous. The aforementioned positive implications are not minute, but, it still seems like regulation is a necessary concern of all jurisdictions if the rise of Bitcoin MLMs continues. The legal complexity of the creation of such businesses has led to a scramble for a legitimate solution.

Perhaps the most important consideration is one of accountability. The product involved in this process is a purely economical one, there is nothing tangible to it. As has been presented in the case law, the merging of Bitcoins in MLM companies has led to the lessening of accountability, especially in regards to cloud hosted Bitcoin mining schemes. It is difficult to hold companies accountable for the acts they commit, because there seems to be very little legal precedence for situations that require justice. The most fundamental problem is the lack of confidence that the public entrusts to virtual currencies. Modern states need to found trust in its market should it introduce a formal regulation for virtual currency.

Technology is a double-edged sword. While the law on Bitcoin in various jurisdiction is the need of the hour, it’s also important to note that needless laws will merely serve to complicate business transactions and restrict opportunities. The government must critically engage with the Bitcoin community. Eminent economists such as George Stigler and Avinash Dixit have emphasized the need for intelligent and dynamic regulations rather than a ‘one-size-fits-all’ measure.