Multiple Studies Analyze Recent Cryptocurrency Market Trends
By: Robert A. Musiala Jr.
A recently issued report from the Blockchain Transparency Institute analyzed high-volume bitcoin “trading pairs” on various cryptocurrency exchanges and found “clear evidence of wash trading” on 22 of 25 exchanges analyzed. A bitcoin “trading pair” is an exchange of bitcoin for another type of cryptocurrency (or vice versa), and “wash trading” is a form of market manipulation where an investor simultaneously buys and sells the same financial instrument to create artificial market activity. The report claims to have identified four different “bot strategies” used to artificially inflate bitcoin trading pair volumes via wash trading on cryptocurrency exchanges. According to the report, over 80 percent of the top bitcoin trading pairs volume reported by CoinMarketCap is wash traded, with most of the trading pairs having actual volume under 1 percent of their reported volume.
Another recent report analyzed website traffic on the most frequently used cryptocurrency exchanges and found that many cryptocurrency exchanges with low website traffic report high transaction volumes. According to the report, this indicates that some cryptocurrency exchanges may be artificially inflating the dollar value of transactions processed on their platforms. Cryptocurrency market manipulation is also the topic of a recently published research paper co-authored by professors from four different universities that provides a detailed examination of “pump and dump” schemes in the cryptocurrency markets. The report’s findings suggest that such schemes are “widespread and often quite profitable.”
According to a recent Bloomberg article, a large U.S. hedge fund acknowledged emerging contingencies related to initial coin offerings (ICOs) by citing the risk that a significant percentage of ICOs it had invested in may be found in violation of U.S. securities laws. An analysis published Dec. 17 found rising outflows of Ethereum (ETH) from wallets reportedly controlled by ICO projects, with over 400,000 ETH moving out of ICO team wallets over a 30-day period. Another recently released analysis found that of the over 460 million “public key” addresses on the bitcoin blockchain, only about 172 million were “economically relevant” in that they are “controlled by people or services who currently own bitcoin,” with the remaining 63 percent of addresses used only temporarily to facilitate transactions.
Another apparent trend, reported by Diar, found that institutional bitcoin trading appears to be shifting away from traditional exchanges in favor of over-the-counter markets. Finally, the University of Cambridge has released its 2nd Global Cryptoasset Benchmarking Study, which “gathers survey data from more than 180 cryptoasset companies and individuals, covering 47 countries across five world regions” and provides analysis focused on mining, exchange, storage and payments. In one notable finding, the study reports that in the first three quarters of 2018, the number of ID-verified cryptocurrency users almost doubled, increasing from 18 million to 35 million.
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Stablecoins, “Trading Pairs” and Other Developments in Cryptocurrency Payments
By: Robert A. Musiala Jr.
In recent developments in cryptocurrency payments, according to reports, the PAX stablecoin, which is backed 1:1 by U.S. dollars, recently exceeded $5 billion in transaction volume in just over three months of its September launch. Another recently launched stablecoin, USD Coin, has been added by the cryptocurrency exchange Binance as a “trading pair” option for six different cryptocurrencies.
This week, Coinbase began allowing its retail customers to trade bitcoin in “trading pairs,” where bitcoin is exchanged for another type of cryptocurrency. Coinbase also recently announced that its U.S. customers now will be able to withdraw cash balances to their accounts at a major U.S. internet payment processor. And startup OpenNode recently announced that it has closed a seed-funding round from a major U.S. venture capital firm to develop a new bitcoin payment processing system for merchants that want to accept bitcoin as payment.
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Threat Update: Ransomware, Crypto-mining Malware, BTMs and ICO Fraud Schemes
By: Shea M. Leitch
Scammers recently delivered messages to various targets threatening to detonate explosive devices carried by an unidentified “mercenary” unless the targets paid a $20,000 ransom to a bitcoin wallet by the end of the business day. The sender(s) targeted individuals in geographically dispersed English-speaking countries, such as the U.S., Canada and New Zealand. Authorities in these jurisdictions have reported that no explosives were actually found.
In addition to so-called crypto-ransomware, another emerging threat are bitcoin ATMs (BTMs), which according to a recent report are spreading quickly and may pose high risks of money laundering. Perhaps the most pervasive current threat is crypto-mining malware, which, according to a new Threats Report from McAfee Labs, has increased 4,000 percent over the past year.
Financial regulators in France and Belgium have sought to minimize the impact of cryptocurrency fraud on investors, each blacklisting a number of crypto-related investment websites this week and warning against unauthorized or fraudulent ICOs. The Belgian Financial Services and Markets Authority announcement contained a blunt warning to investors.
“The principle remains the same: they offer you an investment they claim is secure, easy and very lucrative. They try to inspire confidence by assuring you that you don’t need to be an expert in cryptocurrencies in order to invest in them. They claim to have specialists who will manage your investments for you. You are told that your funds can be withdrawn at any time or that they are guaranteed. In the end, the result is always the same: the victims find themselves unable to recover their money!” (Emphasis in the original)
Greece’s high court issued a ruling this week affirming a lower court’s decision to extradite to France Alexander Vinnik, who is accused of laundering up to $4 billion through the now-defunct cryptocurrency exchange BTC-e. Russia has also sought Vinnik’s extradition. Vinnik’s legal representatives have expressed the belief that his extradition to France will result in his eventual extradition to the United States to face charges of fraud, identity theft, money laundering and a number of other crimes related to his alleged operation of the BTC-e cryptocurrency exchange.
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Blockchain Enterprise Developments in France, Spain and South Korea
By: Simone O. Otenaike
According to a recent report, French officials plan to invest about $569 million in state-level blockchain projects over the next three years. In the same report, officials expressed a desire to create a more bitcoin-mining-friendly environment in France. Despite these potential initiatives, the country’s commitment to the blockchain and cryptocurrency industries seems tenuous – just last month, France’s central bank failed to endorse a plan involving the sale of bitcoin at thousands of tobacco kiosks. Meanwhile, Spanish renewable energy company ACCIONA Energía launched the GREENCHAIN project, which will use a blockchain platform to track the supply chain of renewable energy from five wind and hydro facilities in Spain to four corporate customers in Portugal in real time. According to reports, ACCIONA Energía will be the first entity in Spain and Portugal to trace renewable energy through blockchain technology and allow clients to certify from any location in the world that 100 percent of the energy supplied is green.
In South Korea, the Ministry of Science, ICT and Future Planning and the Ministry of Oceans and Fisheries announced plans to launch its maritime blockchain pilot project, which will promote efficiency in the country’s container shipping industry. The port-logistics pilot will run for one year out of the Port of Busan, the country’s largest port, and the fifth-busiest container port worldwide. The pilot is part of the South Korean government’s overall strategy to raise $204 million for blockchain technology by 2022.
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UK Issues Cryptocurrency Guidance; US Issues Remain
By: Roger M. Brown and Nicholas C. Mowbray
This week, the U.K. tax authorities (HMRC) published guidance on the taxation of cryptoassets. The guidance states that HMRC does not view such cryptoassets as currency or money – which aligns the HMRC view with the general U.K. regulatory position. The guidance identifies three types of cryptoassets:
— Exchange tokens (including bitcoin and other cryptocurrencies)
— Utility tokens
— Security tokens
The guidance notes that labels do not control; rather, the functionality and substance do. The guidance focuses on the taxation of exchange tokens while noting that it also provides a beginning discussion point for rules that may ultimately be developed for the other types of tokens.
The guidance states that, in the vast majority of cases, individuals hold cryptoassets as a personal investment and hence will be liable to pay capital gains tax on any profits arising when they dispose of their cryptoassets. Only in exceptional circumstances would HMRC expect individuals to buy and sell cryptoassets with such frequency, organization and sophistication that the activity amounted to a financial trade – the profits of which would be subject to income tax rather than capital gains tax.
HMRC specifically notes that it does not consider the buying and selling of cryptoassets to be the same as gambling – the proceeds of which would be tax-free. This is a clear change of position from their March 2014 guidance, which stated “depending on the facts, a transaction may be so highly speculative that it is not taxable or any losses relievable. For example gambling or betting wins are not taxable.”
Under the U.K. guidance, cryptoassets received from mining or from airdrops may be subject to income tax on receipt, depending upon the nature of the activity giving rise to the receipt. Cryptoassets received as earnings from employment are treated as “money’s worth” and are therefore subject to income tax and national insurance contributions.
The U.K. guidance raises questions that are similar to those that must be addressed from a U.S. tax perspective when transactions in cryptocurrency occur. Some of these questions focus on:
– The proper category of property in which to place tokens
– Which types of transactions give rise to taxable gains or deductible losses
– The applicable rate at which to tax gains
– Application of employment compensation rules to cryptoassets (or rights therein), including when there are conditions of continued employment associated with the retention of such rights
– Treatment of cryptocurrency or tokens received in exchange for performing some activity (e.g., mining, social actions, validating)
– Actions that give rise to a taxable gain (or loss) when cryptocurrency is disposed of, as well as planning opportunities that can defer taxable gains
– Tax treatment of forks – both hard and soft
– Record keeping and reporting
In the absence of comprehensive guidance in the U.S. on cryptocurrency issues, taxpayers will borrow from other areas in doing their best to comply with their tax obligations – while identifying opportunities to optimize their tax situations when applicable doctrines permit.
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The U.S. discussion above was provided by Roger Brown and Nicholas Mowbray of Baker Hostetler LLP. The U.K. discussion above was provided by Darren Oswick of Simmons & Simmons, LLP.
Monetizing Positions in Cryptoassets Without Triggering Taxable Gain or Loss
By: Roger M. Brown and Heather K. P. Fincher
Strategies still exist to monetize a position in crypto without triggering current taxable gain or loss, as a recent case shows: Estate of McKelvey v. Commissioner (906 F.3d 26, 2nd Cir. 2018).
Many people historically have sought to diversify their crypto holdings by exchanging one cryptoasset for another. Some people sought to avoid recognition of taxable income by taking the position that the exchange of cryptocurrencies was exempt from current taxation under the “like kind exchange” rules. However, that’s no longer possible, due to 2017 tax law changes.
Nevertheless, a number of common law doctrines continue to exist that permit current monetization without current taxable income. One example is illustrated by the transaction undertaken by the founder of the Monster.com website, Andrew McKelvey (McKelvey). McKelvey had substantial appreciation in his shares, and he sought to monetize that value without triggering current taxable gain by entering into variable prepaid forward contracts (VPFCs).
Under VPFCs, a buyer of the shares agrees to make an upfront payment for the right to receive at a future date a maximum amount of the designated assets or their cash equivalent. The exact number to be delivered, however, would be determined by a minimum price and a maximum price that limit the amount of property to be delivered in the future.
As security for performance, the buyer gives the seller cash up front, effectively “monetizing” the shares upfront. In turn, the seller receives the maximum amount of assets at a future date that the buyer may have to deliver. Custodians can be involved to minimize performance and execution risks.
The IRS did not take issue with the fact that the VPFCs of McKelvey were effective in allowing the taxpayer to monetize his position. Rather, the IRS said that McKelvey’s modification of the VPFCs by extending their settlement dates shortly before delivery was effectively an event that triggered taxable gain. The appellate court agreed.
As trading activity in cryptoassets increases, taxpayers seek to monetize positions without triggering taxable gains or losses. Traders also seek to enter into different forms of “long” and “short” positions to profit from market movements. VPFCs are among the established tools that can be used to achieve these goals in the crypto space – just like they have been for other asset classes.
