Headline: Cryptocurrency Regulation?

Senators Gillibrand and Lummis introduced a till to help regulate cryptocurrency transactions.

The Wild West was known that way because presence of law and order were thin on the ground, most of the time.  Land owners had to patrol their own property, sometimes the sheriff had to call together a posse (they still do this today, in some places.)  Point is that there was very little legislation affecting citizens in the Wild West, and very little in the way of protections for them either.  This is kind of how cryptocurrency is today.  There is no limit on how much money you could make and no limit on how much you might lose either.  Well, 2 Senators, from opposite sides of the aisle, are trying to change this.  Senators Lummis and Gillibrand have co-sponsored the Responsible Financial Innovation Act (RFIA).

OK, we’re back to the same question.   Is this tranche of cryptocurrency a security?

This is an important question because it helps decide which federal agency oversees it, and helps decide which pieces of legislation apply.  In the past, the Howey Test was applied, to see if something was a security or not.  Believe me when I say that there are thousands of pages of legal decisions based on this, but, fundamentally, there is a 4-part test.   The attributes examined are the following:

• The existence of an investment contract
• The formation of a common enterprise
• A promise of profits by the issuer
• The use of a third party to promote the offering

If the subject at issue fails any one of these 4 tests, then it is a commodity.  Interestingly, if it is a security and it’s some kind of cryptocurrency (like a virtual token) it is now called an ancillary asset.  If an ancillary asset is not decentralized enough, then they have to make semi-annual disclosures to the SEC.  But, in observance of the new pressures on the much smaller CFTC, the agency can now charge fees to help support them.

So, what else does the bill propose?

1.  $200 exclusion on your taxes if that cryptocurrency is used on goods and services.
2. Mining and staking profits would be taxable when they are realized.
3. The bill orders and investigation on using digital assets in retirement accounts.
4. Establishes that a DAO is a taxable business entity and now must be organized under the Laws of a state or foreign country.
5. The bill demands another set of  mandatory disclosures about the issuer of the currency, and how previous cryptocurrency experiences went for them.
6. The bill would set up a “sandbox” where cryptocurrency firms could try different products and approaches for a set period of time.

So, what else can you tell me about the bill?

The RFIA begins like any other bill, by providing definitions.   But, since digital assets are so new on the scene, it seems appropriate

Ancillary Assets. Ancillary assets in compliance with U.S. Securities and Exchange Commission (SEC) disclosures are considered commodities. Under the bill, an ancillary asset is an intangible asset provided to a person in connection with the purchase and sale of a security through an investment contract, as defined by the Howey test. This may include a digital asset that is used to facilitate the governance of a distributed ledger technology network or DAO.

Digital Asset: A natively electronic asset that grants economic, proprietary, or access powers and is recorded using cryptographically secured distributed ledger technology. Includes virtual currency and payment stablecoins, and may comprise other financial assets, such as ancillary assets and securities.

• Digital Asset Intermediary: A person who holds a license, registration, or other similar authorization as specified by the related legislature that may conduct market activities relating in digital assets. Includes a person who holds a license, registration, or other similar authorization under state or federal law that issues a payment stablecoin, but not a depository institution.
• Distributed Ledger Technology: A digital ledger or database that is maintained on multiple nodes using a consensus mechanism that facilitates a means for users to independently verify the recording and ordering of data or any similar analogue.
• Payment Stablecoin: A digital asset that is denominated or pegged to the value of legal tender or in the legal tender of a foreign country (excluding cases in which a foreign country has adopted virtual currency as legal tender).
• Smart Contract: Computer code deployed to a distributed ledger technology network that executes an instruction based on the occurrence or nonoccurrence of specified conditions. Includes taking possession or control of a digital asset and transferring the asset or issuing executable instructions for these actions.
• Virtual Currency: A digital asset that: (1) is used primarily as a medium of exchange, unit of account, store of value, or any combination of such functions, (2) is not legal tender, (3) does not derive value from or is backed by an underlying financial asset (except other digital assets). Includes a digital asset or the reasonable expectation or denominated or pegged value will be maintained and be available upon redemption from the issuer or other identified person, based solely on a smart contract.

So, is this legislation going to work well for the American people?

I think I would characterize this bill as a good first step.  But, I am rather confident that the cryptocurrency industry will work very hard to find the loopholes.  The industry has hired more than 200 officials and staff from the White House, Congress, Federal Reserve and political campaigns, according to the Tech Transparency Project. Meanwhile, crypto executives have contributed more than $30 million toward federal candidates and campaigns since the start of the 2020 election cycle, according to Federal Election Commission data. 

There is also a good deal of concern about whether or not the CFTC has the horsepower to do the regulation it would be mandated to do.  Many point to how small the CFTC is and how little budgetary authority they are granted, and ask whether or not they have the staff and other resources to do a good job.  Even though they would be empowered to take some fees, Wall Street lobbyists have been working diligently for decades in an attempt to keep this agency under-powered.  There is concern that the fees taken would not be sufficient to make up the shortfall.

There are additional fears that this bill could suffer a similar fate as others.   Just recently Senator Toomey (R-PA) sponsored a bill to enact rules related to stablecoins.  This legislation was stalled in Congress.

The Verdict

So, it would seem that we finish where we started.  “Currently, we just don’t have enough investor protection in crypto finance, issuance, trading, or lending,” Gensler told lawmakers in September. “Frankly, at this time, it’s more like the Wild West or the old world of ‘buyer beware’ that existed before the securities laws were enacted.”   Problem is, if the new sheriff in town doesn’t have the right deputies, and the right personal reputation, the bad guys will ride right over them.  I rather like the comparison to the Wild West, though, because it points us towards one of the only solutions that WILL work: personal responsibility.  In the Old West, if your mining stake turned out to be very profitable, you were very careful to find a reputable assayer and read your contracts VERY carefully to understand how much risk you had to take on.  I think that with cryptocurrency, these lessons are still relevant today.

REFERENCES

Lummis-Gillibrand crypto bill comprehensive but still creates division (cointelegraph.com)

Lummis-Gillibrand Bill Could Establish Cryptocurrency Regulation (natlawreview.com)

Bipartisan crypto regulatory overhaul would treat most digital assets as commodities under CFTC oversight (cnbc.com)

Key US Senators Introduce Crypto Bill Outlining Sweeping Plan for Future Rules (coindesk.com)

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REFERENCES

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.