Bates Research | 08-12-21
The Inevitability of Cryptocurrency Regulation: The Race to Establish a Regulatory Framework is On
With the U.S. Senate’s passage of the bipartisan infrastructure bill, which would impose the first reporting requirements on cryptocurrency transactions, more comprehensive regulation of the industry seems inevitable. As Bates reported in June, legislators, administrators and regulators were beginning to publicly advocate for government intervention to protect consumers and investors from price volatility and the fraud and money laundering that has proliferated across digital platforms. That urgency, expressed by officials at the Treasury Department, the Federal Reserve and the SEC, reflected early consideration of a framework for regulating cryptocurrency through crypto exchanges. It also elicited a note of caution from the former SEC Chair to make sure that any approach be grounded in “the principal objectives underpinning existing financial regulations: financial stability, deep and efficient funding markets across the spectrum of debt and equity, and the prevention of fraud and illicit activity.”
The newly passed Senate bill adds a more practical impetus for the inevitability of cryptocurrency regulation: IRS tax collection. If the bill becomes law, the new requirements are predicted by the Joint Committee on Taxation to generate $28 billion over the next decade, a sum to be used to offset the costs of the $1 billion infrastructure bill. Here we take a brief look at the cryptocurrency provisions in the Senate bill and consider some of the latest public statements by the SEC on regulating cryptocurrency.
The Senate Bill: Cryptocurrency and Taxes
The cryptocurrency provisions of the infrastructure bill impose reporting obligations on digital asset brokers for transactions on the sale of securities. As the key negotiator for the provision, Senator Rob Portman (R-OH), explained: the bill requires “crypto-brokers responsible for regularly providing any service effectuating transfers of digital assets like cryptocurrency, which for tax purposes means a sale on behalf of someone else, to issue a Form 1099-B to their customers in line with traditional assets like stocks and bonds.” In this regard, the bill is attempting to ensure tax collection on transactions that should already be taxed and therefore, it is not a provision to raise new taxes. (The purported $28 billion in estimated revenue over ten years is deemed a strengthening of existing tax compliance obligations.) The bill also requires—consistent with anti-money laundering regulations—the filing of reports with the IRS when crypto-assets are moved from an exchange and/or on transactions valued at more than $10,000.
The definition of “broker” was a source of controversy in the legislative debate. Industry concerns were raised on whether the broad category might apply to unintended players like software developers and crypto “miners.” In the end, the language remained unchanged. However, Senator Portman reiterated for the record that the definition was not meant to include “miners and stakers and others now or in the future who play a key role by validating transactions, or sellers of hardware or software for digital wallets, or node operators, or others who are not brokers.”
Deliberations around these cryptocurrency requirements now move to the House. If the bill becomes law in its current or reconciled versions, the IRS would issue regulations on implementation, and many of these issues, including the definition of broker and its exceptions, will likely be re-debated.
Securities and Exchange Commission Oversight
On August 3, 2021, SEC Chair Gary Gensler issued a public statement that went beyond his previous expressions on the general need for clarity in regulating cryptocurrency. His speech on “crypto’s intersection with national security” was a discourse on the rise of blockchain technology that has led to “a current asset class worth about $1.6 trillion, with 77 tokens worth at least $1 billion each and 1,600 with at least a $1 million market capitalization.”
Mr. Gensler painted a fearsome picture of the nature of these assets:
“Primarily, crypto assets provide digital, scarce vehicles for speculative investment. …These assets haven’t been used much as a unit of account…We also haven’t seen crypto used much as a medium of exchange. To the extent that it is used as such, it’s often to skirt our laws with respect to anti-money laundering, sanctions, and tax collection. It also can enable extortion via ransomware.”
He proceeded to identify the gaps in the regulation of these assets—gaps that put investors at risk. First, he raised issues around defining crypto tokens accurately to ensure proper registration. As securities requiring registration, these tokens would be subject to the full range of SEC rules on disclosure, oversight and enforcement designed to protect vulnerable investors. Second, he described the risk of crypto platforms that trade or loan cryptocurrency improperly. On this point, he was emphatic: “Make no mistake: to the extent that there are securities on these trading platforms, under our laws they have to register with the Commission… Make no mistake: If a lending platform is offering securities, it also falls into SEC jurisdiction.” Finally, he described the problem of widespread abuse of tokens by bad actors seeking to evade banking and financial systems including AML, tax compliance and sanctions.
Mr. Gensler went on to highlight how other products and services in the crypto space—stock tokens, stable coins (whose value is linked to an existing fiat currency, like the U.S. dollar) or other virtual products that provide exposure to underlying securities—fall within the SEC’s jurisdiction. He similarly argued that crypto trading platforms, lending platforms, and other “decentralized finance” (DeFi) platforms, cannot only implicate the securities laws, but might implicate the commodities laws and the banking laws as well. Mr. Gensler’s speech was unambiguous; it was a full-throated assertion of authority over cryptocurrency.
He finished with an appeal to legislators to provide “additional plenary authority to write rules for and attach guardrails to crypto trading and lending.”
The race to establish a cryptocurrency regulatory framework is on. The inclusion of language in the Senate infrastructure bill to ensure that the IRS will capture the tax receipts from cryptocurrency transactions is not only the first step in establishing a reporting compliance program, it is a first step toward tapping a deep well of potential revenue. While such reporting would have profound implications for FinCEN and anti-money laundering as well, the new law would ensure that Treasury (and the IRS in particular) has the authority to issue rules over the industry. SEC Chair Gensler’s speech at the Aspen Security forum presents the foundational arguments for SEC jurisdiction over cryptocurrency, to fulfill their mission of investor protection. That speech is only strengthened by a vigorous enforcement agenda which also serves to establish jurisdiction. Moving ahead, recent debates by Federal Reserve Board and Treasury Department officials over the issuance of a central bank digital currency (“CBDC”) and the need to regulate stable coins (more about those coming soon!) suggest that this will be the year when crypto starts to go mainstream. Bates will keep you apprised.
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