BTC Is Not Bitcoin: Why It Matters to the SEC

SEC Chairman Gary Gensler recently reiterated the SEC’s long-standing position that, as far as they are concerned, Bitcoin is not a security, while most other digital assets are. Gensler didn’t say that BTC or BCH are not securities: he said that Bitcoin is not a security, especially thanks to the unique circumstances of its creation and issuance.

Which of course begs the question: what is the original Bitcoin? And where does Gensler’s assessment leave the many forks that have branched off from the original since its creation? Most importantly, why does any of this matter, legally or otherwise?

The term Bitcoin refers to a network and database protocol described and published under the pseudonym Satoshi Nakamoto in 2008. The system that follows this description is Bitcoin: any system that does not is not.

As Gensler acknowledged to NY Mag, Bitcoin is viewed differently than other digital asset networks because of its unique origin story. Satoshi Nakamoto issued all 21 million Bitcoins in January 2009, specifying a fixed algorithmic system that governs the circumstances under which coins are released, i.e. Proof-of-Work mining by nodes. No coins were pre-mined and Satoshi, the issuer, has no input into the release of these coins beyond the original design of the system. Once the entire issuance was complete, Satoshi was only able to get Bitcoin the same way everyone else was: by queuing and mining.

Perhaps most importantly, the protocol underlying Bitcoin was always designed to be fixed and not subject to revision (“Bitcoin’s nature is such that when version 0.1 was released, the core design was set in stone for the rest of its life,” wrote Satoshi Nakamoto in June 2010).

These circumstances matter because of how securities are defined: whether an offer of digital assets constitutes a security is subject to Howey test. Under Howeywill an offer be a security if:

• It is an investment of money
• The investment is made into a joint venture
• The investment is made with reasonable expectations of profit
• This expectation of profit is dependent on the efforts of others

The lack of a pre-mining from Satoshi is important, because courts have interpreted pre-mining as a signal to investors that the issuer “is motivated to work tirelessly to improve the value of its blockchain” for itself and buyers (see SEC v LBRY). In other words, it is taken as a sign that the investment was made with a reasonable expectation of profit depending on the efforts of the issuer. The algorithmic process that governs the release of coins without input from the original issue is important because under these circumstances there cannot be said to be any joint venture capable of investing: the nodes in the network act competitively.

The fact that the protocol is fixed is also important: constant revisions of the protocol require centralized control exercised by a defined group. Absent centralization of that kind, it is very difficult to argue that any kind of investment in Bitcoin was made with the expectation of profit depending on the efforts of others. Add to that control and not only is a given asset offering highly likely to constitute a security, but the developers are also likely to act as fiduciaries to those using their blockchains: see recent comments by the UK Court of Appeal in Tulip Trading v. Van der Laan and Ors or Angela Walch’s widely cited paper, “In Code(rs) We Trust: Software Developers as Fiduciaries in Public Blockchains”.

So when Gensler says that Bitcoin is not a security or refers to its unique history, this is what he is referring to. This was the legal nature of Bitcoin as it existed in 2009 and continues to exist in 2023 as Bitcoin SV.

Where does that leave BTC, BCH and similar knock-offs?

The term Bitcoin can only refer to a system that follows the white paper. Any deviation from the protocol described by Satoshi Nakamoto in that document is no longer Bitcoin, because the original Bitcoin protocol was designed to be fixed and not subject to revision. The fixed nature of the protocol is a key pillar in Bitcoin’s ability to serve as peer to peer electronic cash and its ability to serve the needs of businesses: a protocol that is fixed can be embraced and trusted by businesses and developers indefinitely, without the threat of regular changes to the basic protocol that threaten to break everything that depends on it. To illustrate, consider the TCP/IP protocol that governs the Internet: that protocol has remained steadfast since its inception, allowing the evolution and flourishing of the application layer above it. If the underlying TCP/IP protocol were subject to constant revision, the applications built on top would have to be modified or even discarded each time. If that were the case, the world would not be able to rely on e-mail, for example, as the indispensable communication platform it has been for decades. The same can be said about Bitcoin: a fixed and immutable underlying protocol is necessary if Bitcoin and all its possibilities are to be trusted in business and everyday life.

Despite all this, Satoshi’s decision to outsource development in 2010 has led to attempts to change the underlying protocol of Bitcoin. This happened despite Nakamoto remaining the custodian of the protocol and the issuer of all Bitcoin in existence. These changes have resulted in a number of “forks” away from the original protocol, and while such forks have attempted to retain (illegally, it turns out) the Bitcoin name, they are not Bitcoin.

Chief among these offshoots is BTC, or Bitcoin Core. This offshoot was created by the core of developers who took control of Bitcoin after Satoshi’s exit and implemented a series of centrally planned changes to the protocol that break from Bitcoin defined in the white paper.

The most radical of these early changes was the SegWit update in 2017, which took the extraordinary step of removing digital signatures from Bitcoin transactions and putting them in a separate data structure to (ostensibly) help Bitcoin scale alongside an ever-increasing number of transactions without increasing the block size limit. In reality, this didn’t help scaling at all (the so-called “problem” of scaling is little more than a myth, as demonstrated by the original vision for Bitcoin scaling perfectly without any hard cap on the block size) and only served the developers in charge , as it pushed users of the network off-chain and towards the Lightning Network, a second-tier commercial solution owned by the same developers.

The change was a radical departure from Bitcoin: the white paper makes it clear both that signatures are an integral part of the system and that Bitcoin was always meant to scale on-chain via a fixed protocol. Moving data off-chain in an attempt to scale is to some extent defeating the purpose of Bitcoin, which is to create a system of secure peer to peer electronic cash that is public. Moving this data to a layer 2 network is a solution to an entirely self-inflicted problem (imposing an arbitrary block size) with the added benefit (to some) of hiding the authors of transactions made with Bitcoin.

Each significant deviation from that protocol has two related effects: the chain “forks” so that the newly changed protocol splits from the original Bitcoin protocol, and a new coin issue is created based on the new protocol in which the new coins are “airdropped” to holders of the original. So, for example, when the SegWit update created a fork and split from Bitcoin, every Bitcoin holder was dropped the new, covertly issued BTC coin. Lawyer and technology commentator Zeming Gao said it best in his recent article, “Even BTC is a Security According to the Howey Test”:

“Any time the actual underlying blockchain changes the base protocol that not only affects transactions, but also affects the automated one-sided contract originally offered by Satoshi, the coin is no longer the original coin. From that point on, any coin that continues on the changed blockchain in effect a new coin offered under a new contract.Furthermore, the continuous issuance of new tokens to miners is also under a new mining contract that is different from the original one-sided contract offered by Satoshi to miners.This makes the reissued tokens and the new tokens of both a security, collectively or separately, even though the original bitcoin was a non-security. It does not matter what name or ticker it has, nor what market price it receives. This is because the market is not the fact finder of this matter; it simply agree according to what information it was fed, and at that In this case, they were fed misleading information.”

The main implication here is that just as these changes depart from the original definition of Bitcoin, they branch from the original, SEC-compliant issuance. In other words, none of the factors that made Bitcoin not a security apply to the forks. The consequence is that these subsequent issues constitute illegal, unregistered securities offerings. Which means that at any moment these systems could be hit by an SEC enforcement action that killed LBRY and XRP.

There’s another gigantic reason why this should matter to anyone holding one of these forks: the taxman. BSV is the continuation of the original protocol, but the likes of BCH and BTC are forks. Whenever a chain undergoes a hard fork in response to network changes, the forked coin is sent to all holders of the original. This airdrop is considered income by the IRS and is therefore taxable as such. This position was explicitly confirmed by the IRS in 2014 via Notice 2014-21. Which means that holders of Bitcoin at the time it was split into BTC (August 2017) and BCH (November 2018) owe income tax on the coins that the fork entails:

“A hard fork occurs when a cryptocurrency undergoes a protocol change that results in a permanent diversion from the old distributed ledger. This can result in the creation of a new cryptocurrency on a new distributed ledger in addition to the older cryptocurrency on the old distributed ledger. If your cryptocurrency went through a hard fork, but you did not receive any new cryptocurrency, either through an airdrop (a distribution of cryptocurrency to multiple taxpayer distributed ledger addresses) or some other form of transfer, you do not have taxable income.”

Even if they ignore the concerns of the SEC and IRS, those responsible for these drastic deviations from the Bitcoin protocol and continued misuse of the Bitcoin name are discovering that their actions have profound legal consequences. A number of individuals and entities that have used the Bitcoin name to market these unrelated products have been hit with rejection claims in the UK potentially worth billions: those being sued include the individual developers of BTC, but also those members of the broader ecosystem that enables abuse of the Bitcoin name: companies like Coinbase and Kraken, which continually promote BTC as Bitcoin despite BTC having little or no resemblance to the system described in the white paper. The developers are also discovering that their exercise of centralized control over their knock-off protocols has huge legal ramifications: they may well be proven to owe fiduciary duties to those who use their networks, which would compel them to, among other things, return access to the stolen digital assets to their rightful owners.

Hijacking the original Bitcoin and turning it into something else must have seemed like no big deal, but as Gensler and the flood of lawsuits these hijackers are now facing show, such actions have serious legal consequences.

See: The Future World with Blockchain

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