Blockchain in Review – Weeks of March 19th through March 30th, 2018

Below is a summary of some of the significant legal and regulatory actions that occurred over the past weeks. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.  Please visit our sister blog, FintechLegalReport, for the Fintech in Review – Weeks of March 19th through March 30th, 2018 portion.

U.S. Developments

Regulatory Updates

NFA Comments on CFTC’s Proposed Interpretation of “Actual Delivery”

On March 20, the National Futures Association (NFA) issued a letter to the Commodity Futures Trading Commission (CFTC) in which it provided its comments to the CFTC’s proposed interpretation of “actual delivery” in the context of virtual currency transactions subject to the Commodity Exchange Act (CEA) Section 2(c)(2)(D)(ii)(III)(aa), released on December 15, 2017.

The concept of “actual delivery” exists as an exception for retail commodity transactions under the Commodity Exchange Act (CEA) Section 2(c)(2)(D), a provision of the CEA intended to protect retail investors making a margined, leveraged, or otherwise financed purchase of a commodity. Transactions falling under this provision are treated as futures contracts and are subject to the full extent of the CFTC’s futures regime, unless an exception applies.  The “actual delivery” exception provides that a sale is excepted from this provision if the purchaser takes possession of the commodity within 28 days of the transaction, and the seller relinquishes all control over the commodity.[1]  The CFTC’s proposed interpretation of “actual delivery” puts the exception in the context of purchases of virtual currency.  The proposed interpretation sets forth two criteria necessary to establish “actual delivery” in a retail commodity transaction:

(1) a purchaser has the ability to (i) take possession and control of the entire quantity of the commodity (i.e., the virtual currency), and (ii) use it freely in commerce (both within and away from any particular platform) no later than 28 days from the date of the transaction; and

(2) the seller does not retain any interest in, or control over, any of the commodity at the expiration of 28 days from the date of the transaction.

The proposed interpretation additionally offered examples of when “actual delivery” would and would not be found to have occurred.

In its Comment Letter, the NFA proposed the following:

  1. Shortening of the 28-day period (a measure which would likely require action by Congress) on the basis that many virtual currency products are extremely volatile, offered for speculative investment purposes, and have attracted many retail investors;
  2. Clarification of the terms “depository,” “possession,” and “control” in the context of virtual currencies;
  3. Further consideration of the potential impact on certain virtual currency exchanges under the proposed interpretation of “actual delivery”–Specifically, exchanges that purchase virtual currencies for their own account and only allocate them to purchasers via internal bookkeeping entries. Under this model, the exchange collects large amounts of customer funds to buy and hold virtual currencies on behalf of the customers, although the purchases remain allocated in the public ledger as to the exchange, not the customer. Consequently, the NFA notes, those exchanges are not subject to the same level of regulatory scrutiny as other depositories, custodians, and intermediaries that hold customer funds in a similar fashion. The NFA expressed concern particularly in instances where a retail investor purchases virtual currency using a credit card or other leveraged means.

The CFTC’s proposal was open for public comment until March 20.  NFA Comment Letter 3.20.18

 OFAC Indicates That It May List Cryptocurrency Addresses on its Sanctions List

The Office of Foreign Assets Control (OFAC) of the U.S. Department of the Treasury released an FAQ on its website on March 19 indicating that it may add digital currency addresses to its Specially Designated Nationals (SDN) List to alert the public to those identifiers associated with a sanctioned person or entity who is otherwise on the SDN List.  The FAQ indicates that anyone who identifies a wallet address believed to be associated with a blocked individual should file a report with OFAC that includes the digital wallet address, ownership, and any other relevant information.  The field for digital currency addresses on OFAC’s SDN List would indicate the unique alphanumeric identifier and the digital currency stored in the wallet.  OFAC’s FAQ provided definitions of “virtual currency,” “digital currency,” “digital currency wallet” and “digital currency address” for the purposes of its sanctions program:

Virtual currency is a digital representation of value that functions as (i) a medium of exchange; (ii) a unit of account; and/or (iii) a store of value; is neither issued nor guaranteed by any jurisdiction; and does not have legal tender status in any jurisdiction.

Digital currency includes sovereign cryptocurrency, virtual currency (non-fiat), and a digital representation of fiat currency.

A digital currency wallet is a software application (or other mechanism) that provides a means for holding, storing, and transferring digital currency. A wallet holds the user’s digital currency addresses, which allow the user to receive digital currency, and private keys, which allow the user to transfer digital currency. […]

A digital currency address is an alphanumeric identifier that represents a potential destination for a digital currency transfer. A digital currency address is associated with a digital currency wallet.”

OFAC FAQs: Sanctions Compliance (See Questions on Virtual Currency, Paragraphs 559-563.)

IRS Issues Reminder to Taxpayers Regarding Virtual Currency

The Internal Revenue Service (IRS) issued a notice on March 23 in which it reminded taxpayers that income from virtual currency transactions is subject to federal tax regulation and must be reported on income tax returns. The Notice reiterated that the IRS treats virtual currency as property for federal tax purposes, meaning that the same general tax principles for other property apply equally to virtual currencies.  Among other points, the IRS noted the following:

  • A taxpayer who received virtual currency as payment for goods or services during the 2017 tax year must include the fair market value in U.S. dollars of the virtual currency at the time the payment was received.
  • If the fair market value of the property received was higher than the value of the virtual currency paid by the taxpayer, the taxpayer has a taxable gain. Conversely, if the FMV of the property received is lower than the value of the virtual currency paid, the taxpayer has incurred a loss.
  • Virtual currency paid by an employer is considered taxable wages. Additionally, virtual currency paid to an independent contractor in exchange for services is considered self-employment income.
  • Miners of virtual currency must report as gross income successfully mined cryptocurrency, the value of which is to be calculated in U.S. dollars as of the date of receipt.

For further discussion of the tax implications for virtual currency and additional information about IRS actions with respect to taxpayers, see Perkins Coie’s Virtual Currency Report: Urgent Tax Reporting Considerations for Virtual Currency Traders, Miners, and Anyone Contemplating Investment 3.26.18

IRS News Release 3.23.18

International Developments

G20 Calls for Recommendations for Cryptocurrency

Following several G20 meetings held March 20-21, international economic leaders issued a statement (“communiqué”) seeking proposed cryptocurrency regulations by July 2018. The first G20 meetings began in December 2017 as precursors to the G20 Summit, scheduled to take place November 30 – December 1, 2018 in Buenos Aires. The communiqué suggested agreement among the members that cryptocurrencies need to be examined across the world, but it stopped short of calling for a regulatory crackdown.  The members expressed a belief that the technological innovation underpinning cryptocurrencies is of great value to the worldwide financial system, but noted concerns about consumer and investor protection, risks of money laundering and funding terrorist activity, tax evasion, and volatility and stability of cryptocurrencies.  The communiqué took the position that cryptocurrencies should more appropriately be considered assets, not currency, and regulation should flow from that position.  Some countries, including Brazil and the UK, did not agree with that position, and asserted that cryptocurrencies would not be regulated according to such an approach. Reuters Article 3.19.18

Liechtenstein Proposes New FinTech Regulations

Prime Minister Adrian Hasler of Liechtenstein announced on March 21 at a Finance Forum in Vaduz that the government will introduce a bill in the summer of 2018 with proposed regulation for blockchain technology. The bill will provide legal and regulatory clarity for businesses developing distributed ledger technology (DLT), in addition to potential consumers of the technology, in an effort to attract FinTech innovation to the country.  More broadly, Liechtenstein has taken a lighter regulatory approach to blockchain technologies, including digital currencies, which are not currently subject to licensing requirements.  The Financial Market Authority of Liechtenstein has issued two formal statements related to digital currencies and ICOs FMA Digital Currency Statement 2.16.18; FMA ICO Statement 9.10.17, both of which are favorable to the industry in terms of taking a permissive approach to regulation and taxation of digital assets. Announcement 3.21.18

[1] CEA Section 2(c)(2)(D)(ii)(III)(aa)

Urgent Tax Reporting Considerations for Virtual Currency Traders, Miners, and Anyone Contemplating Investment

 As first published on Bloomberg’s Daily Tax Report.

Key Takeaways

  • The Internal Revenue Service is obtaining significant records about virtual currency holders
  • These records not only implicate taxpayers who sold virtual currency at a profit, but also anyone who bought, sold, sent, or received virtual currency
  • Exchanges of one virtual currency for another, mining of virtual currency, and receipt of units like Bitcoin Cash can create current tax obligations
  • These issues have criminal and civil implications, and IRS pressure will only increase

It is no secret that the value of many virtual currencies (in particular, cryptocurrencies such as Bitcoin) rose over the past year. The associated legal and tax challenges are less well-known but vitally important (at least for those looking to avoid potential criminal and civil penalties). As the April tax deadline fast approaches, one of the most notable issues affecting holders of virtual currency is their tax reporting obligations.

As noted in a March 23, 2018 press release on the issue, IR-2018-71, the IRS argues that the sale of all assets, including virtual currencies, must be reported on an individual’s federal income tax return. Based on its own review, the IRS argued that fewer than 1,000 taxpayers reported virtual currency sales on their tax returns between 2013 and 2015, for example. While virtual currencies were certainly less well-known three to five years ago than they are today, a court recently found the IRS argument persuasive enough to order disclosure of thousands of names and records.

Bought, Sold, Sent, or Received

As part of a federal summons enforcement proceeding in the U.S. District Court for the Northern District of California, the IRS will receive the names and personally identifiable information of more than 13,000 virtual currency account holders. This includes account holders who met or exceeded the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in 2013, 2014, or 2015. Notably, it does appear to exclude account holders who only bought and held Bitcoin during the 2013 through 2015 period, or those who received a Form 1099-K. While the recent proceedings involved Coinbase, the U.S.’s largest digital currency exchange, IRS demands for records will touch many more companies and users going forward.

Thus far, IRS demands for records are not limited to virtual currency sales or transactions that actually produced a profit in U.S. dollars. This goes to a broader consideration for virtual currency holders—transactions such as an exchange of one virtual currency for another are taxable events, and what triggers tax recordkeeping requirements may surprise some holders.

A taxpayer, for example, might use Bitcoin or Ethereum to acquire one of the many other virtual currency offerings that debut on a near-weekly basis. Under the law informally known as the 2017 Tax Cuts and Jobs Act, these exchanges must be reported to the IRS. If the virtual currency given up in the exchange is worth more than what was paid for it (or reported upon being mined), then income tax will be due from this exchange. In essence, exchanging one virtual currency for another is treated no different than a sale for U.S. tax purposes. The IRS will undoubtedly review tax returns to determine if these exchanges of virtual currency are being reported.

To date, the IRS has issued limited guidance on reporting exchanges of virtual currency. IRS Notice 2014-21, states that virtual currency should be treated as “property” for tax purposes. Because virtual currency is treated as property, not currency, there are several less-than-familiar scenarios in which an individual may be unaware that reporting is required. Specifically, miners and those who exchange one virtual currency for another have current reporting obligations, described further below.

Acquiring Virtual Currency and Mining

An individual can “mine” virtual currency by using their “computer resources to validate [virtual currency] transactions and maintain the public [virtual currency] transaction ledger.” IRS Notice 2014-21 (specifically referring to Bitcoin). A U.S. taxpayer must report as gross income the fair market value of the virtual currency that they obtain from mining.

In addition to having gross income to report, the IRS expects that an individual who mines as a trade or business will report and pay both income and self-employment taxes. This means that individuals mining virtual currencies may be liable for quarterly tax payments throughout the year, even if they have not sold any of the units they mined. It is essential for miners to maintain proper books and records to track income and expenses. Income is dependent on the value of the virtual currency the day it is discovered. Mining-related expenses for computer equipment and electricity can be very high and can be deductible for people conducting their mining operations as a business.

The timing of a miner’s virtual currency sale could also affect the character and tax rate of the sale proceeds. Proceeds from currency mined and held for over one year should be considered long-term gain, while currency held for less than one year is short-term gain (and typically has a higher tax rate). This is another reason why tracking the dates on which currency is obtained and then sold is critical.

No More Possibility of Like-Kind Exchanges

Like-kind exchanges are transactions that allow a person to exchange property for “like” property within six months without immediate tax implications. For sales prior to 2018, it is arguable that an exchange of one virtual currency for another (e.g., Bitcoin for Ethereum) could qualify as a non-taxable like-kind exchange. Beginning Jan. 1, 2018, Congress amended the like-kind exchange rules to no longer apply to virtual currency (or anything other than real property). Now, there is no question these virtual currency exchanges are recognition events. Because digital currency exchanges are not explicitly required to report these transactions to users on a Form 1099, this remains a trap for the unwary.

Distributions to Holders

On Aug. 1, 2017, Bitcoin Cash emerged after a hard fork in the Bitcoin blockchain. Many who held Bitcoin on August 1, automatically became owners of Bitcoin Cash coins as a result. There also have been dividend-like distributions of one type of virtual currency to holders of another type. From a taxpayer’s perspective, these types of transactions could be treated in similar fashion to stock-splits or dividends or even another alternative, depending on the facts and how the IRS construes these events. This creates yet another question of when and what amounts must be reported.

Conclusion

The broad takeaway is that U.S. taxpayers who have held any virtual currency should be very wary of government scrutiny. U.S. taxpayers under investigation or those who believe they sold, exchanged, or sent virtual currency through any exchange or medium should consider their options with great care to minimize exposure to criminal liability and civil penalties. With limited IRS guidance currently available, it is in taxpayers’ best interest to establish a clear reporting plan as soon as possible.

Blockchain in Review, February 19th – March 16th

Below is a summary of some of the significant legal and regulatory actions that occurred over the past weeks. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.

U.S. Developments

Regulatory Updates

House Financial Services Committee Holds Hearing on Cryptocurrencies and ICOs
On March 14, 2018, the House Financial Services Committee Subcommittee on Capital Markets, Securities, and Investment held a hearing entitled “Examining Cryptocurrencies and ICO Markets.” The one-panel hearing included the following witnesses: (1) Dr. Chris Brummer (Professor of Law, Georgetown University Law Center), (2) Mr. Mike Lempres (Chief Legal and Risk Officer, Coinbase), (3) Mr. Robert Rosenblum (Partner, Wilson Sonsini Goodrich & Rosati), and (4) Mr. Peter Van Valkenburgh (Director of Research, Coin Center). The subcommittee conducted an overview of the cryptocurrency and Initial Coin Offering (ICO) markets, which have been growing rapidly. The hearing was intended to examine the economic efficiencies and potential capital formation opportunities that cryptocurrencies and ICOs potentially offer to businesses and investors. In the hearing, Continue Reading

FinCEN Is Watching ICOs for BSA Violations

In a recently published letter to the Senate Finance Committee, FinCEN confirmed that when an ICO token is a “convertible virtual currency,” administrators or exchangers of the token would be “money transmitters” under existing FinCEN regulations and interpretations.

Under the Bank Secrecy Act (BSA), a money transmitter must register with FinCEN as a money services business (MSB) and implement a risk-based anti-money-laundering (AML) compliance program. Pursuant to the BSA and its implementing regulations, an appropriate AML compliance program will include certain mechanisms for meeting the MSB’s transaction monitoring, reporting, and recordkeeping obligations—obligations that, in effect, require the MSB to know your customer. FinCEN’s letter to the Senate Finance Committee indicates that the agency is closely monitoring ICO tokens, as well as the developers and trading platforms that are issuing and exchanging ICO tokens, for BSA violations and trends or risks of associated money laundering, terrorist financing, and other financial crimes. Continue Reading

White Paper – Smart Contracts: Revisiting Use Cases and Key Legal Issues

We are pleased to release an updated edition of our smart contracts white paper, originally published in May 2017.   The updated white paper surveys the current academic and industry landscape related to smart contracts, and discusses the key legal issues surrounding smart contract applications. Authors of the white paper are Dax Hansen, Partner and Chair of the Blockchain and Digital Currency and Fintech industry groups, Carla Reyes, Visiting Assistant Professor of Law at the Stetson University College of Law and Faculty Associate, Berkman Klein Center for Internet & Society at Harvard University, and Laurie Rosini, Associate with the Blockchain and Digital Currency industry group.

The paper consists of four sections:

  • Updated introduction to DLT-based smart contracts;
  • A review of current academic and industry literature on smart contracts, which includes industry initiatives such as the Accord Project, OpenLaw, the Stanford Computable Contracts Initiative and the Smart Contract Alliance, and State legislative efforts related to smart contracts;
  • Emerging use cases touching on different legal regimes; and
  • Updated risk mitigation checklist for businesses developing applications using smart contracts.

Click here to download the updated white paper.

Blockchain Week In Review, February 5th – 16th

Below is a summary of some of the significant legal and regulatory actions that occurred over the past week. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.

U.S. Developments

Regulatory Updates

CFTC Chairman Gives Testimony Before the U.S. Senate Agriculture, Nutrition, and Forestry Committee
On February 15, 2018, Chairman J. Christopher Giancarlo of the Commodity Futures Trading Commission (“CFTC”) provided testimony related to the CFTC’s plans to regulate virtual currencies and how this new technology impacts the agricultural markets before the United States Senate Agriculture, Nutrition, and Forestry Committee.  Specifically, Chairman Giancarlo quoted Chairman of the Securities & Exchange Commission (“SEC”) Jay Clayton to support the argument that “virtual currency presents complex challenges for regulators.”  Giancarlo outlined that the CFTC’s work on virtual currencies is being guided by six broad elements: “(1) staff competency; (2) consumer education; (3) interagency cooperation; (4) exercise of authority; (5) strong enforcement; and (6) heightened review of virtual currency product self-certifications.” As part of satisfying these elements, the CFTC has introduced LabCFTC, issued an “unprecedented amount of public educational materials on virtual currencies,” and collaborated with the SEC, state banking regulators, the IRS, and the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) to ensure that the regulators are aware of the CFTC’s approach towards virtual currencies.  Chairman Giancarlo noted that while the CFTC has determined that virtual currencies such as Bitcoin meet the definition of “commodity,” it has concluded that Continue Reading

Open Session of the U.S. Senate’s Committee on Banking, Housing and Urban Affairs Hears Joint Testimony from Heads of the SEC, CFTC

On February 6, 2018, the United States Senate Committee on Banking, Housing and Urban Affairs conducted a hearing entitled “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission.” Hearing. The Chairman of the U.S. Securities and Exchange Commission (SEC), Jay Clayton, and the Chairman of the U.S. Commodity Futures Trading Commission (CFTC), J. Christopher Giancarlo, provided testimony. Read a full article summarizing the key takeaways from the written testimonies and the testimony and questions on our sister blog, The Fintech Report.

Blockchain Week in Review January 20th – February 2nd

Below is a summary of some of the significant legal and regulatory actions that occurred over the past week. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.

U.S. Developments

Regulatory Updates

CFTC and SEC Chairmen Publish Joint Op-Ed
Following a joint meeting last month, SEC Chairman Jay Clayton and CFTC Chairman J. Christopher Giancarlo published a joint op-ed in the Wall Street Journal reaffirming both agencies’ mutual commitment to stricter enforcement in the distributed ledger and cryptocurrency industry.  Chairmen Clayton and Giancarlo wrote that they will continue to monitor initial coin offerings (ICOs) and continue to crackdown on unregistered sales of coins deemed to be securities, in addition to fraudulent and other criminal activities. See WSJ 1.24.18

In a sign of continued collaboration, SEC Chairman Clayton and CFTC Chairman Giancarlo will testify on the topic of cryptocurrency regulation before the Senate Committee on Banking, Housing, and Urban Affairs. The hearing is scheduled on February 6 at 10:00am ET.  The live cast of the hearing can be accessed here: Banking.Senate.gov  See Coindesk 1.31.18

Congress Holds Fintech Hearing
The U.S. House of Representatives Subcommittee on Financial Institutions and Consumer Credit held a hearing this week to discuss consumer protection in the context of Fintech innovation.  The hearing focused on addressing Continue Reading

Blockchain Week in Review January 8th – January 19th

Below is a summary of some of the significant legal and regulatory actions that occurred over the past week. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.

U.S. Developments

Regulatory Updates

CFTC and SEC Enforcement Directors Issue Joint Statement Regarding Virtual Currency Enforcement Actions
This morning, the Enforcement Director of the U.S. Commodity Futures Trading Commission (“CFTC”), James McDonald, and the Enforcement Co-Directors of the U.S. Securities and Exchange Commission (“SEC”), Stephanie Avakian and Steven Peikin issued a joint statement addressing virtual currency enforcement actions (collectively “the Agencies”).  In the statement, Continue Reading

CFTC Flexes Its Regulatory Muscle in a Case Involving a Virtual Currency

Just like the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) is actively policing the virtual currency market.  On January 24, 2018, the CFTC announced an enforcement action against two individuals and a company, My Big Coin Pay, Inc., for fraudulently offering the sale of a “fully functioning” virtual currency. Press Release, CFTC Charges Randall Crater, Mark Gillespie, and My Big Coin Pay, Inc. with Fraud and Misappropriation in Ongoing Virtual Currency Scam (Jan. 24, 2018), http://www.cftc.gov/PressRoom/PressReleases/pr7678-18Continue Reading

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