6 Questions (and Answers) About How Regulators View Cryptocurrencies

Once considered a fringe technology, blockchain and cryptocurrencies have exploded into a global phenomenon with the potential of multi-billion-dollar implications for industries of all kinds.

Some experts estimate that there are more than 2,000 different cryptocurrencies on the market today with a total market capitalization north of $200 billion. The most famous is Bitcoin, but countless other cryptocurrencies are being invested in and traded around the globe.

The adoption of blockchains, the underlying technology that allows for the trustworthy exchange of cryptocurrencies, is also growing rapidly. It has applications in nearly every industry around the globe, from mobile payments to car insurance to supply chain management and even data security.

Because of this, cryptocurrencies continue to dominate news headlines. For example, China recently banned cryptocurrency trading. Also, Facebook launched its own blockchain-based cryptocurrency called Libra, and Cryptocurrency ATMs are even starting to pop up around the world.

Regulators and other governing agencies have started to take notice. On October 9, 2019, the Internal Revenue Service (IRS) issued updated guidance for individuals and businesses who engage in virtual currency transactions. The U.S. Securities and Exchange Commission (SEC) in 2018 shut down more than a dozen initial coin offerings (ICOs), a process that typically involves raising funds to help launch a new cryptocurrency. The Financial Crimes Enforcement Network (FinCEN) and the U.S. Department of Justice (DOJ) have also gotten involved by, among other things, launching task forces dedicated to detecting the use of these currencies and related technologies for illegal activities.

The increased regulatory spotlight on cryptocurrencies brings with it many questions for businesses and individuals attempting to leverage these groundbreaking technologies. While there have been a handful of prosecutions thus far providing some insight on the areas of concern for authorities, it is still unclear how exactly regulators will govern, restrict and monitor their use.

Just this past month, Buchanan Ingersoll & Rooney hosted a panel discussion in Miami, Florida, featuring some of the foremost experts on the subject. Here are six of the most pressing questions resulting from that discussion that individuals and companies interested in the cryptocurrency world may want to think about.

1. Why are investors interested in Bitcoin and other cryptocurrencies?

There are multiple facets of cryptocurrency technology currently attracting investors. Some businesses and other entities are seeking a financial security that is not backed by any central bank and thus is disconnected from the broader financial system. Others like the anonymity that Bitcoin and other cryptocurrencies provide. There are also many who believe the value of certain cryptocurrencies will rise and are seeking capital gains just like with any other investment. However, there are many considerations to take into account to ensure these investments are legal and otherwise compliant with existing regulations and the expectations of U.S. authorities.

2. Is there concrete guidance from the IRS on tax reporting around cryptocurrencies?

In the IRS’ initial guidance from 2014, the agency clearly tells taxpayers to treat cryptocurrency as  general property when it comes to filing taxes. Earlier this year, the IRS expanded on this initial guidance by issuing two new releases related to transactions involving virtual currency. For instance, transferring Bitcoins in a transaction that turns them into Bitcoin Cash, a spinoff of Bitcoin that is more easily used as a medium of exchange for commerce, has potential tax and reporting consequences. However, some investors and others interested in the cryptocurrency market have noted that the overall IRS guidance is unclear and/or insufficient in places and are seeking additional clarification from the agency. Whether or not we receive more clarity from the IRS in the near future is yet to be determined.

3. How will the IRS evolve its tax forms to account for the growing number of cryptocurrency investors?

Many individuals and businesses have questions relating to what information they need to report to the IRS in terms of their cryptocurrency assets. Up until now, most of those who have reported these assets to the IRS have done it voluntarily. The IRS anticipates (and has begun) updating tax forms to incorporate information pertaining to virtual currencies. However, despite the current limited guidance and outdated tax forms, failure to file due to lack of specific guidance is no defense if an individual or corporation is eventually audited.

4. What do investors in cryptocurrencies need to know about reporting their investments or capital gains?

Reporting capital gains to the IRS on cryptocurrency investments is similar to any other financial security. However, considering the limited guidance from the IRS thus far specific to virtual currencies, investors should be especially prudent in documenting the dates of any transactions, as well as the fair market value of the assets over the course of the investment. It is possible the IRS will begin scrutinizing these gains more than other assets, and investors must be able to substantiate the claims they make to the IRS with documentation.

5. What are ICOs, and why is the SEC interested in them?

An ICO is a process many cryptocurrency developers use to raise the funds necessary to launch a new virtual currency. Typically, the developer solicits funds from individuals who in return receive several coins of the new virtual currency. Unlike an initial public offering of stock, these individuals do not receive equity in any entity. Instead, they receive a select number of the new coins in the hopes that they will one day rise in value.

Recently, the SEC shut down the ICO of blockchain development company Block.one after the company had raised approximately $4 billion from outside investors. The SEC eventually settled with Block.one for $24 million dollars after finding that the company failed to register its ICO as a securities offering pursuant to the federal securities laws. Despite being based in the Cayman Islands, the U.S. had jurisdiction over the matter given the company’s operations in Virginia and its acceptance of ICO investments from U.S. investors. The SEC has likewise scrutinized many other ICOs in the past and has made it clear that it will continue to target such fundraising arrangements that fail to adhere to the requirements of U.S. securities laws.

6. What does the future hold for the regulation of cryptocurrencies?

With the introduction of many new financial securities, there is typically a period of time during which regulators attempt to figure out the details of the security, how it operates, how people and companies are using it and any potential areas of risk for fraudulent or criminal activity. Regulators and authorities are doing the same with cryptocurrencies and pursuing matters against those who fail to follow applicable laws and implement appropriate compliance safeguards. Regulators and authorities like FinCEN, the SEC, the DOJ, and the IRS are also working collaboratively to pursue violators. As these (and other) agencies become more sophisticated in their investigative methods and determine new ways to track potentially illicit activities, new regulations and enforcement actions will inevitably follow.