Loyola University Chicago School of Law, JD 2023
Despite last-ditch efforts by lobbyists for the crypto community, controversial new cryptocurrency tax requirementsburied in the massive bipartisan infrastructure bill that passed the US Senate in early August will likely remain unaltered by the House which has committed to vote on the $1 trillion dollar bill by September 27, 2021. The new reporting rules are sending ripples of concern through the cryptocurrency industry and even have some national-security officials worried that their breadth and overreach will only succeed in pushing illicit activities and actors further underground. Overly aggressive regulations risk forcing illegal activity “deeper into anonymizing methods and corners of the internet that would make it more difficult for law enforcement,” according to Jeremy Sheridan, assistant director of the U.S. Secret Service’s investigations office. Moreover, overregulation could also have a chilling effect on domestic innovation and result in the U.S. falling behind other countries that adopt laws and regulations that are more favorable to new technologies. “The U.S. has to make a decision if it wants to be a center of. . . transformational technology that can bring more people into the financial ecosystem. . . [or] get left behind,” said Sigal Mandelker, a former undersecretary for terrorism and financial intelligence in the Treasury Department. Mandelker is now with a private venture capital firm which invests in the crypto markets.
Under the new provisions, brokers who handle cryptocurrency transactions will be required to report their customers’ trading gains to the Internal Revenue Service (IRS) in addition to names and addresses of the transacting parties. However, the term “broker” is vaguely defined and potentially could be used to ensnare miners and developers of crypto hardware and software. Despite assurances from the Treasury Department that it will issue guidance on the rules in the future to provide for appropriate exemptions, critics argue these promises are not enough.
Some companies which are obvious targets of the new reporting rules, such as Coinbase, a leading crypto exchange, have been busy preparing for the anticipated increase in regulatory scrutiny. Coinbase announced in mid-August that it had built up a $4 billion dollar war chest to weather not only the stricter regulatory regime, but also any possible cyberattacks and other risks that have yet to be defined. Coinbase went public through a direct listing in April of this year, and the company has profited from the recent growth in trading by individual investors, earning $1.61 billion during the second quarter, up from $32 million just a year earlier.
Other agencies are attempting to develop their own regulatory frameworks.
Increased regulation of the cryptocurrency industry is also being considered by a number of other federal agencies. Specifically, the Securities and Exchange Commission (SEC) has been active in enforcement. In December 2020, the SEC filed suit against Ripple Labs and two of its executives, accusing the company of raising more than $1.3 billion in unregistered securities offerings through the sale of the cryptocurrency XRP. The lawsuit is considered an important test case of the SEC’s approach to the regulation of cryptocurrencies. The agency is also reviewing several applications for Bitcoin exchange-traded funds (ETFs). The Chairman of the SEC, Gary Gensler, recently signaled that the agency might be willing to approve ETFs that are structured under the more stringent rules of the Investment Act of 1940, a federal statute with investor protections which normally applies to mutual funds.
On December 23, 2020, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) proposed new reporting rules on un-hosted digital wallet transactions, believing such rules could be an important tool in preventing illicit money laundering. However, the rules received such a strong reaction from the cryptocurrency community that the comment period was extended for an additional sixty days. Further action on the rules then stalled due to the regulatory freeze imposed by the Biden administration in January 2021.
Despite the increasing popularity of cryptocurrencies and digital assets, the federal regulatory framework that exists today is largely outdated. Current regulations are insufficient to fully address the myriad of innovations that have been created and continue to be created using blockchain technology. Moreover, the government’s response to date has been piecemeal and reactive in nature. Building a new framework is a formidable task and will take time, but the various agencies involved—SEC, IRS, Treasury, FinCEN, and the Commodities Futures Trading Commission—must set aside their jurisdictional disputes and work together to create a cohesive and workable system. The pace of innovation does not appear to be slowing down any time soon, and participants in the burgeoning cryptocurrency industry deserve certainty regarding their regulatory obligations.