by Jennifer R. Bagosy
Bitcoin (BTC) is a new and unique form of currency that is entirely electronic in nature. Once perceived to be the domain of criminal enterprises, it is accepted by a number of technology companies—and, now, even some law firms. Because attorneys are bound by ethical rules governing fees and handling of client funds, Bitcoin raises novel issues for lawyers and firms who are eager to “keep up with the times” while avoiding ethical pitfalls.
What Is Bitcoin and How Does It Work?
According to www.bitcoin.org, Bitcoin is an online currency that was created by an anonymous developer (using the pseudonym “Satoshi Nakamoto”) in 2009. Like gold or other precious metals, Bitcoins are “mined” by enterprising people who, instead of digging with picks and shovels, dig with specialized hardware and software. See Bitcoin (2009), http://www.bitcoin.org. Miners then use those tools to securely process others’ transactions by solving complex mathematical puzzles online. Miners will sometimes receive new Bitcoins as a “reward” for their services. Id. As one federal court explained in the context of a securities fraud case, “Bitcoin was designed to reduce transaction costs, and allows users to work together to validate transactions by creating a public record of the chain of custody of each Bitcoin.” SEC v. Shavers, No. 4:13-cv-416, 2013 U.S. Dist. LEXIS 110018, at *2 (E.D. Tex. Aug. 6, 2013) (citing Derek A. Dion, I’ll Gladly Trade You Two Bits on Tuesday for a Byte Today: Bitcoin, Regulating Fraud in the E-Conomy of Hacker-Cash, U. Ill. J.L. Tech & Pol’y 165, 167 (2013)). Bitcoin’s value—like the value of gold—arises solely from a common belief that it has value.
Bitcoins exist on a decentralized peer-to-peer network, much like the Internet itself. The Bitcoin software is in the public domain, so anyone with the skill to do so can review the code and create his or her own version of the software. When Bitcoins are generated through mining, they are placed in the user’s online “Bitcoin Wallet” and can be used to buy goods and services from businesses and individuals who accept Bitcoin. See supra Bitcoin. However, Bitcoin has other key features that make it very different from other methods of payment.
First, the value of Bitcoin is highly volatile. In January 2013, one Bitcoin was worth about $13. By December 4, 2013, the price had skyrocketed to $1,061 per Bitcoin. See Kenneth Rapoza, Bitcoin $10,000?, Forbes Online (Dec. 4, 2013), http://www.forbes.com/sites/kenrapoza/2013/12/04/the-bitcoin-bubble/. By April 15, 2014, the value had dropped to $500 per Bitcoin. See Bitcoin Exchange Rate (2014), www.bitcoinexchangerate.org.
Second, Bitcoin transactions are “largely anonymous.” Andrew Strickler, Law Firms Jump on Bitcoin Bandwagon with Virtual Fees, Law360 (Jan. 6, 2014, 9:58PM), http://www.law360.com/articles/498830/law-firms-jump-on-bitcoin-bandwagon-with-virtual-fees. As such, in the past, Bitcoin has been a favored currency of money launderers and traders in black market goods. In 2013, the federal government shut down the Silk Road, an online marketplace that sold drugs and other illicit items, and seized more than $28 million worth of Bitcoins. Id.
Third, there are differences in the transactions themselves. Bitcoin transaction fees are often lower than fees for credit card payments or wire transfers. Transactions can take up to ten minutes to confirm due to the work the miners perform to verify the Bitcoin’s chain of custody. Also, if an error is made, the parties are out of luck—Bitcoin transactions are irreversible. See supra Bitcoin.
Fourth, Bitcoins residing in your “wallet” operate very differently than cash in a bank. Bitcoins are not tracked on a central system. There are no monthly statements reflecting your Bitcoin balance. Bitcoins are not FDIC insured, nor are they protected by the same anti-theft measures that banks offer for debit and credit cards. If Bitcoins are hacked and stolen, or if the security key to the wallet is “lost”—which can happen, for example, if the computer on which the wallet resided was attacked by a virus or inadvertently thrown away—your Bitcoins are simply gone from your account and from circulation, forever. See Kelly Phillips Erb, From Treasure to Trash: Man Tosses Out Bitcoin Wallet on Hard Drive Worth $9 Million, Forbes Online (Nov. 30, 2013), http://www.forbes.com/sites/kellyphillipserb/2013/11/30/from-treasure-to-trash-man-tosses-out-bitcoin-wallet-on-hard-drive-worth-9-million/; see supra Bitcoin. In February, MtGox, a major Bitcoin exchange, filed for bankruptcy after losing approximately 850,000 Bitcoins to hackers. MtGox Finds 200,000 Missing Bitcoins in Old Wallet, BBC News Online (March 20, 2014), http://www.bbc.com/news/technology-26677291. Then, in March, MtGox “found” approximately 200,000 of the Bitcoins it had claimed were stolen in an “old digital wallet” dating to 2011. Id. In short, losing the hardware containing a Bitcoin wallet or its security key is like taking cash and setting it on fire.
Fifth, Bitcoins are almost entirely unregulated. See supra Shavers at *2. In January 2014, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) issued guidance that neither Bitcoin miners who do not exchange their Bitcoins for dollars, nor investors holding Bitcoins, are “money service businesses,” and as such, they do not need to comply with money laundering regulations. Miners are covered by the regulations only if they sell the Bitcoins they produce to others for cash, or if they create derivative products to sell to others. Evan Weinberger, Bitcoin Miners Exempt from Money Laundering Rules, US Says, Law360 (Jan. 31, 2014, 1:54PM); Application of FinCEN’s Regulations to Virtual Currency Mining Operations, FIN-2014-R001 (Jan. 30, 2014) available at http://www.fincen.gov/news_room/rp/rulings/pdf/FIN-2014-R001.pdf; Application of FinCEN’s Regulations to Virtual Currency Software Development and Certain Investment Activity, FIN-2014-R002 (Jan. 31, 2014) available at http://www.fincen.gov/news_room/rp/rulings/pdf/FIN-2014-R002.pdf.
How Do I Avoid Ethical Pitfalls Arising From Bitcoin?
A number of small law firms and at least two large international firms now accept Bitcoins as payment for legal fees. Typically, firms who have made this move have done so because they have clients in the technology industry who transact business in Bitcoins. Yet accepting payments from clients or third parties in Bitcoins raises certain unique ethical issues any attorney or firm considering accepting Bitcoins should examine.
Fluctuating Bitcoin Value and Payment Arrangements
Because Bitcoins are so volatile, it is important to keep track of the value of a Bitcoin in dollars as of the date the fees are paid for services rendered. Ideally, the engagement letter should state the attorneys’ fees in dollars rather than in Bitcoins in order to avoid California Rule of Professional Conduct (“Rule”) 4-200’s prohibition on unconscionable fees. An arrangement that the client would pay one Bitcoin per hour for an attorney’s services could mean that the client is paying $500 per hour one month, and $1000 per hour the next, which the client could contend is unconscionable. An engagement letter that states that the attorney’s fee is $500 an hour, which the client may pay in dollars or Bitcoins, would assign the risk of keeping the Bitcoins to the client. The client would still have to pay $500 an hour even if the value of his Bitcoins dropped, but he would also reap the gains if the Bitcoins’ value increased.
Bitcoin’s volatility should also be addressed upfront in the engagement agreement if the client is to pay in advance. If the client pays $200,000 up front for fees and/or costs in Bitcoins, and the attorney is to draw from that amount each month, the attorney should make certain the client knows if she plans to convert the Bitcoins to cash, for example, to keep in a trust account. See, e.g., Rule 4-100(A) (advances for costs and expenses should be placed in a client trust account); Baranowski v. State Bar, 24 Cal. 3d 153, 163-64 (1979) (finding that while attorneys must place advanced costs and expenses in a trust account, there is no requirement that advanced legal fees be kept in that manner); see also The State Bar of California Standing Committee on Professional Responsibility and Conduct (“COPRAC”), Formal Opinion 2007-172 (stating that attorneys may accept payment by credit card for earned and advanced fees, but not for advanced costs because these must be placed in a trust account).
A Bitcoin wallet is not a bank account, as described earlier, nor is it physically located in any particular jurisdiction. Therefore, in order to comply with Rule 4-100(A), a lawyer accepting Bitcoins from a client to hold in trust must immediately convert them to cash and place them in a bank account in California or in another jurisdiction as the Rule requires. There are also practical reasons why the attorney should tell the client in advance (preferably in writing) that she needs to convert the Bitcoins to cash upon receipt. If she does not disclose this intention, the client may expect that the Bitcoins will be kept as Bitcoins, and may become upset if the value of the Bitcoins increases substantially while the cash in the trust account increases only by the amount of interest earned.
Third Party Payors
Any time a client arranges for a third party to pay the client’s attorneys’ fees, the attorney must keep in mind her obligations under California Rule of Professional Conduct 3-310(F). This rule prohibits an attorney from accepting payment from a third party unless the arrangement would not interfere with the attorney’s independence or relationship with her client, the client’s confidential information is protected, and the client provides informed written consent.
Although there may be ways for tech-savvy people to discover the identities of Bitcoin buyers and sellers, Bitcoin as developed is virtually anonymous. Therefore, an attorney should take extra precautions to confirm the identity of the person paying. One potential way to obtain this information is by using a Bitcoin payment processing service that requires disclosure of the users’ identities. Bitpay (www.bitpay.com) claims to provide such a service. (It also claims to eliminate volatility risk by maintaining consistent exchange rates.) At least one Kansas law firm uses Bitpay to process Bitcoin transactions. Brianne Pfannenstiel, KC Law Firm Bets on the Future of Bitcoin, Kansas City Business Journal, (Dec. 11, 2013, 2:35PM), http://www.bizjournals.com/kansascity/news/2013/12/11/kc-law-firm-bets-on-the-future-of.html?page=all.
Also, as is the case with any method of payment, an attorney should ensure that the client understands that any third party advancing legal fees on his behalf will receive the remainder if there are funds left in the trust account at the end of the engagement. COPRAC Formal Opinion No. 2013-187.
Bitcoin Wallet Security
Any attorney opting to receive client payments in Bitcoin must take extra precautions to protect her Bitcoin wallet. There is no bank to reimburse Bitcoins if a hacker steals them, nor is there an IT department to help users who have forgotten their passwords. Once lost, Bitcoins are gone forever. As a result, one attorney whose firm accepts Bitcoin payments keeps the wallet and passwords on a “military grade” flash drive that he carries with him at all times. Strickler, Andrew, Law Firms Jump on Bitcoin Bandwagon with Virtual Fees, Law360 (Jan. 6, 2014, 9:58PM). Regardless of the hardware used, backing up the contents and security keys and passwords associated with Bitcoin wallets is essential.
Although Bitcoin is no longer just for smugglers and is rapidly becoming a legitimate form of currency, its unique features warrant additional precautions by any attorney wishing to participate in this aspect of twenty-first century technology.
Jennifer R. Bagosy is an associate attorney with Morgan, Lewis & Bockius LLP. She focuses her practice on securities litigation, general commercial litigation, and has experience in professional liability litigation. She is also the Secretary of the OCBA’s Professionalism & Ethics Committee. Jennifer may be contacted at firstname.lastname@example.org.