Blockchain Week In Review

United States

IRS offers Tennessee couple tax refund over unsold staking rewards

Last week, in a closely watched federal court case in the U.S. District Court for the Middle District of Tennessee, the IRS offered a taxpayer who had paid tax on staking rewards a refund, but the taxpayer has reportedly rejected the offer.

The plaintiff, Joshua Jarrett, obtained certain cryptocurrency tokens by staking in 2019 and paid taxes on 8,876 tokens within the Tezos blockchain. “Staking” is a way of earning rewards for holding certain cryptocurrencies. It is a process of actively participating in transaction validation (similar to mining), and by verifying transactions in a blockchain network, the staker can earn passive income. Jarrett staked the 8,000 tokens and did not sell them through 2020. After paying income taxes on the tokens he staked, he sought a refund from the IRS, but the agency declined his request. Jarrett then decided to pursue his case in federal court, filing a complaint on May 26, 2021. The question before the district court was whether the receipt of staking rewards generates taxable income at the date the rewards are received. Jarrett argued that the government didn’t have the right to tax tokens he staked before the tokens were sold or exchanged. In court filings, Jarrett analogized his position to that of a baker who bakes a cake or an author who writes a novel before the baker or the author actually sells their creations.

On February 3rd, it was reported that the IRS offered to refund Jarrett’s money for the taxes paid on the staking rewards, but Jarrett rejected the offer. Unless a judge finally rules on whether tokens obtained in staking constitute taxable income, the matter may remain unsolved for other stakers in the future. Although a judicial opinion in this case may provide some much-needed clarity for stakers, the case could take years to litigate and is only binding precedent for taxpayers in the Middle District of Tennessee.

A trial is set for March 2023. The case is Jarrett v. United States, Case No. 3:21-cv-00419 (M.D. Tenn.).

Recent letters exchanged between Jarret’s counsel and the IRS can be found here.

The complaint can be read here.

U.S. Treasury warns of NFT money laundering in new report

Last week, the U.S. Treasury published a 40-page report in accordance with the Anti-Money Laundering Act of 2020, concluding in one section (Section VI – Emerging Digital Art Market) that there is some evidence to suggest high-value art is involved in money laundering. “[T]he emerging digital art market, such as the use of non-fungible tokens (NFTs), may present new risks, depending on the structure and market incentives,” the report said.

The report also warned of the possibility of wash trading with NFTs. “Furthermore, NFTs can be used to conduct self-laundering, where criminals may purchase an NFT with illicit funds and proceed to transact with themselves to create records of sales on the blockchain,” the report said. “The NFT could then be sold to an unwitting individual who would compensate the criminal with clean funds not tied to a prior crime.”

One example the report highlighted as a potential unsuspecting threat was the scenario of smart contracts that automatically distribute a royalty of every subsequent sale back to the artist. These smart contracts could, the report noted, “create an incentive to shape a marketplace where the work is traded repeatedly in a short period. While this can ensure that artists are compensated for their work past the first sale, the activity can pose [money laundering] vulnerabilities because the incentive to transact can potentially be higher than the incentive to verify the identity of the buyer of the work, or even can create a situation where it is not possible to conduct due diligence if transactions are conducted in rapid succession.”

The report recommended that the Treasury Department weigh the pros and cons of applying anti-money laundering and counter-terrorist financing rules to digital art market participants, including applying know-your-customer (KYC) and suspicious activity report rules. Other recommendations from the report include suggesting that the Treasury Department consider whether it should establish a transaction or sales volume threshold for reporting requirements, whether it should enact anti-money laundering rules for art sales, and whether high-value art should be regulated differently than low-value transactions.

The press release from the U.S. Treasury can be read here.

The report can be read here.


Justice Department arrests New York couple tied to billion-dollar Bitfinex hack

In a press release on Tuesday, the Justice Department announced that it had apprehended two New York individuals – a married couple, Ilya “Dutch” Lichtenstein and Heather Morgan, better known as “Razzlekhan,” her rapper alias.

In 2016, Bitfinex, a virtual currency exchange, was hacked. At the time of the hack, the stolen bitcoin was only worth approximately $71 million. Today, that price is over $5 billion. Law enforcement was able to seize over $4 billion of the $5 billion stolen in the hack. According to court documents, the New York couple allegedly conspired to launder the proceeds of 119,754 bitcoin that were stolen from Bitfinex and initiated over 2,000 transactions. Over the past several years, at least 25,000 of the stolen bitcoin had been transferred out of Lichenstein’s wallet via a complex money laundering process that ultimately routed the stolen funds into financial accounts controlled by the couple. The remaining 94,000 bitcoin remained in a wallet that was used by the couple to receive and store the illegal proceeds of the hack.

After executing search warrants on certain online accounts controlled by Lichenstein and Morgan, special agents were able to access files containing the private keys for digital wallets containing the stolen cryptocurrency. According to court documents, law enforcement was able to obtain the private keys because Lichenstein uploaded a list to a cloud storage and email provider that contained addresses for the wallet where the stolen Bitfinex’s funds were deposited, along with the private keys to access them. The files were encrypted when they were uploaded to the cloud, but after executing the search warrant, agents were able to decrypt the files and access the underlying wallet addresses and associated private keys. At the time of seizure, special agents recovered the 94,000 bitcoin, valued at over $4 billion today.

The criminal complaint alleges that Lichtenstein and Morgan employed numerous sophisticated laundering techniques, including using fictitious identities to set up online accounts; utilizing computer programs to automate transactions, a laundering technique that allows for many transactions to take place in a short period of time; depositing the stolen funds into accounts at a variety of virtual currency exchanges and darknet markets and then withdrawing the funds, which obfuscates the trail of the transaction history by breaking up the fund flow; converting bitcoin to other forms of virtual currency, including anonymity-enhanced virtual currency (AEC), in a practice known as “chain-hopping”; and using U.S.-based business accounts to legitimize their banking activity.

The DOJ said that people who lost bitcoin in the Bitfinex hack can request that the government return it to them.

The press release can be read here.

The complaint can be read here. The statement of facts can be read here.


House Financial Services Committee discusses stablecoin regulation

On Tuesday, the House Financial Services Committee held a hearing entitled “Digital Assets and the Future of Finance: The President’s Working Group on Financial Markets’ Report on Stablecoins.” The sole witness for the hearing was Treasury Under Secretary for Domestic Finance, Nellie Liang.

Chairwoman Rep. Maxine Waters (D-Calif.) started off the hearing, discussing potential risks of stablecoins for the economy and communities. “Investigations have shown that many of these so-called stablecoins are not in fact backed by full reserve assets. Moreover, due to the speculative trading, and the lack of investor protection, stablecoins could even threaten our financial stability,” she said.

Rep. Patrick McHenry (R-N.C.) spoke next, criticizing the President’s Working Group conclusions on stablecoin issuance, alleging that they did not take into account the full array of available policy options and existing regulations at the state and federal level. “We cannot regulate out of fear for the future. … Requiring stablecoins to only be issued by banks would be a major obstacle for us to continue to foster innovation within this nascent industry,” he said at the hearing.

Liang spoke next, noting the profound impact stablecoins have had on the financial system, specifically noting the policy concerns and financial system risks stablecoins pose on the U.S. Liang noted that neither money transmitter nor securities law requirements were designed to address payment system or concentration concerns associated with distributed ledger technology. Liang suggested that technology companies should not be allowed to issue cryptocurrencies as a payment instrument and that only insured depository institutions should be able to issue stablecoins.

Liang also said during the hearing that banking regulations would likely make stablecoins more stable and that variability would exist in the regulatory framework for stablecoin issuers based on the reserves for each stablecoin. For example, Liang said that stablecoin issuers that only issued stablecoins for payments would be subject to a different regime than a company that issued stablecoins for commercial loans.

Absent legislative clarity, Liang said that the Financial Stability Oversight Council would use its available tools to address any perceived increase in risk of stablecoins over the next year.

Re-watch the hearing here.


CFTC Chair Rostin asks Congress to provide agency to oversee crypto markets

On Wednesday, the Commodity Futures Trading Commission (CFTC) Chair Rostin Behnam addressed the U.S. Senate Committee on Agriculture, Nutrition, and Forestry. He told the committee that he believes the CFTC is best equipped to monitor trading, especially crypto spot markets. The CFTC already oversees derivatives markets such as bitcoin and ether futures, and the SEC oversees tokens believed to be securities, as well as stocks and funds.

“We are past the stage where digital assets and decentralized financial technologies are a research project, sandboxing what may come in the future. The issues are at the front and center of our thinking at the Commission in addition to our traditional regulatory, oversight and enforcement responsibilities,” Behnam said in introductory remarks. “The CFTC is well situated to play an increasingly central role in overseeing the cash digital asset commodity market.”

Chairman Behnam also requested that Congress not only grant the CFTC with additional oversight powers, but also fund the agency with an extra $100 million, which would go toward building up internal expertise as well as better enforcement mechanisms.

If Congress did grant the CFTC jurisdiction to oversee crypto markets, then it would potentially blur the line with the SEC’s jurisdiction. “The most noticeable gap is what constitutes a security and what constitutes a commodity,” Chairman Benham said during the hearing, adding that “at its core, we are a market regulator … we would build up expertise in places we need it.”

In addition to making an appearance before Congress, Chairman Behnam also filed a document with answers to a series of questions from the Senate Agriculture Committee, reiterating the same argument he made during the hearing.

“In my opinion, there are important principles missing from the current regulatory framework applicable to digital asset markets that we see in other federally regulated markets, particularly ones that primarily cater to retail investors,” Behnam wrote in the document. “A federal regulatory regime may ensure that certain safeguards are in place to address the risks to individual investors, market integrity and systemic stability. Those safeguards could include pre-trade and post-trade transparency and uniform standards around settlement, data reporting, cyber security and leverage.”

Read the testimony of Chairman Benham here.

Re-watch the hearing here.


Avanti Bank is one step closer to a master account

On Wednesday, Wyoming-based cryptocurrency bank, Avanti, received a routing number issued by the American Bankers Association (ABA). This is a key milestone in the process to receive a Fed account, since routing numbers are used to identify banks or checks and other transactional purposes and are issued only to federal- or state-chartered financial institutions that are also eligible to have a Fed account.

Avanti’s ABA routing number is listed in the publicly available ABA Routing Number Directory, as shown below.

Bank Name Address City State Zip Code Routing Number
Avanti Financial Group (Head Office) 2120 Carey Ave, Ste 300 Cheyenne Wyoming 82001 107007605

Caitlin Long, the founder and CEO of Avanti, said she is “optimistic that the Fed will grant its applications for a master account and membership. Avanti meets or exceeds the legal and prudential regulation requirements, and has been purpose-built to create a safe and sound bridge between the US dollar financial system and digital assets,” said Long in a statement to CoinDesk.

A number of Wyoming Special Purpose Depository Institutions (SPDIs), including Avanti and Kraken, have long sought master accounts with the Federal Reserve. Any bank that has such a master account is eligible to deposit funds at the Federal Reserve and access the global payments system. However, it’s not yet clear that the Federal Reserve has concluded that special purpose depository institutions (SPDIs) meet the definition of “depository banks” eligible for master accounts. Receiving a routing number does not unconditionally lead to a Federal Reserve master account.


U.S. lawmakers reintroduce bill to provide tax relief for small crypto transactions

Last week, a bipartisan group of U.S. House representatives reintroduced a bill that would exempt consumers from paying taxes on crypto payments of less than $200. It is dubbed the “Virtual Currency Tax Fairness Act” and, if enacted into law, would amend the IRS’s tax code to simplify tax burdens on daily crypto users who must now report even the smallest capital gains.

“Virtual currency has evolved rapidly in the past few years with more opportunities to use it in our everyday lives,” Rep. Suzan DelBene (D-Wash.) said in the announcement. “The U.S. must stay on top of these changes and ensure that our tax code evolves with our use of virtual currency.”

Read the announcement from Rep. DelBene here.

The text of the bill can be found here.


Arizona crypto bill

Last week, Arizona state Senator Wendy Rogers introduced a bill that would make bitcoin legal tender in the state of Arizona. The bill seeks to amend the list of accepted legal tender to include bitcoin, which means the cryptocurrency would be accepted for the payment of debt, public charges, taxes, and other dues.

The bill must not only pass the state senate and house before Gov. Doug Ducey could sign it into law, but also must pass constitutional muster, which is questionable considering that the U.S. Constitution does not allow individual states to create their own legal tender.

Last September, El Salvador made bitcoin legal tender alongside the U.S. dollar. El Salvador remains the only county in the world that has made cryptocurrency an official currency.

The text of the bill can be found here.


Bipartisan crypto bill would allow TN to invest in crypto and NFTs

A bill introduced last week by Representative Jason Powell of Nashville would allow Tennessee counties and municipalities in the state to invest in cryptocurrencies and NFTs. The bill merely adds permissible investments to the “Authorized Investments” statutes in the Tennessee code, which detail specific investment choices available to county governments and limitations on the maturity for the various investments.

The bill was introduced on February 2nd and was assigned to the Finance, Ways, and Means Subcommittee on February 9th. The next step is for the bill to be referred to the House Committee on Calendar and Rules and then placed on the calendar for discussion by the House Chamber.

The text of the bill can be found here.



El Salvador downgraded by Fitch weeks before Bitcoin bond issue

Ratings agency, Fitch, downgraded El Salvador’s long-term foreign-currency issuer default rating (IDR) to CCC from B- just weeks before the country starts issuing its bitcoin bond. In a television appearance last week, Finance Minister Alejandro Zelaya said the initial $1 billion bitcoin bond issue will take place between March 15th and March 20th. The bond is to be launched on Liquid, a bitcoin-based service created by Blockstream, and will have a 6.5% coupon. By using Liquid, investors can participate in the bond with as little as $100. “Bonds will comply with all financial market regulations,” Zelaya stated. “All [know-your-customer] requirements will be met, all due diligence will be done.”

Despite these assurances from Finance Minister Zelaya, shortly after Zelaya’s television appearance, Fitch downgraded El Salvador’s IDR from B- to CCC, which reflects, according to Fitch, “heightened financing risks stemming from increased reliance on short-term debt, an USD800 million Eurobond repayment due in January 2023, a still-high fiscal deficit, limited scope for additional local market financing, uncertain access to additional multilateral funding and external market financing given high borrowing costs.” Fitch also noted that El Salvador faces a financing gap of $1.2 billion in 2022, which is expected to rise to $2.5 billion in 2023.

Fitch’s downgrade adds to the headwinds El Salvador is already experiencing regarding its adoption of cryptocurrency. Last July, Moody’s lowered El Salvador’s foreign-currency issuer and senior unsecured ratings to Caa1 from B3, citing El Salvador’s plan to adopt bitcoin as legal tender as reason for the downgrade. In September last year, El Salvador became the first country to allow consumers to use bitcoin in all transactions alongside the U.S. dollar.

At the end of January, the International Monetary Fund (IMF) urged El Salvador to reverse its decision to make bitcoin legal tender, stressing that it would be difficult for El Salvador to get a loan from IMF. The IMF “urged the authorities to narrow the scope of the Bitcoin law by removing Bitcoin’s legal tender status. Some Directors also expressed concern over the risks associated with issuing Bitcoin-backed bonds.”


Zambia’s central bank exploring CBDC

On Wednesday last week, the Bank of Zambia announced that it was exploring a potential central bank digital currency (CBDC) and expects to complete its research by the fourth quarter 2022. “The results of the research will form part of the input in the policy considerations on whether to introduce a central bank digital currency in Zambia,” Nkatya Kabwe, acting assistant director of communications at the Bank of Zambia, told Bloomberg. This announcement comes on the heels of the Bank’s warning last month on the use of cryptocurrencies, saying that “the general public should therefore fully understand and be aware of the risks associated with the use of cryptocurrencies,” which, according to the warning, include money laundering, financing activities of terrorism, and general consumer protection risks.

Last week, International Monetary Fund (IMF) Directory Kristalina Georgieva said in a speech that over 100 countries were actively researching CBDCs. One of the motivations for this research is the concern that demand for fiat currencies will drop should citizens begin transacting with private cryptocurrencies or CBDCs issued from other countries.


Russia introduces crypto bill to parliament

Last week, the Russian government stated that it intends to regulate cryptocurrencies, dispelling some of the concerns that Russia would outright ban cryptocurrencies. Russia has a population of over 144 million with over 12 million cryptocurrency accounts holding approximately 2 trillion rubles ($26.7 billion USD) worth of crypto, according to the document accompanying Russia’s announcement. “The purpose of the regulation is to integrate the mechanism for the circulation of digital currencies into the financial system and ensure control over cash flows in the circuit of credit institutions,” said the statement.

According to a press release yesterday, the bill was presented on February 18th to the Russian parliament. The press release highlights the policy split with the Bank of Russia, which opposes regulation and advocates for an outright ban on cryptocurrency trading and mining. In the press release, the Ministry of Finance said the objections of the Bank of Russia “will be considered in the further work on this bill where they don’t contradict the Ministry of Finance approach.”

Under the proposed bill, cryptocurrencies will only be considered solely as investment vehicles. The use of crypto in daily transactions of goods and services will be prohibited. Additionally, the bill will require that any purchase or sale of cryptocurrency will only be possible if the client is identified: “Deposit and withdrawal of cryptocurrency from the client to the operator and vice versa will be possible only through banks using a bank account. Thus, customer identification will be carried out both by operators when accepting customers for service, and by banks when opening a bank account.”

The official text of the bill is not yet available in the online database for legislative documents.