Crypto—Illegal Coin or Legal Tender?

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Crypto—Illegal Coin or Legal Tender?

After a summer slump, the crypto universe rallied in the third quarter, buoyed by improving sentiment. But global regulatory challenges persist and are inconsistent. Take Bitcoin, for example, which has seen exponential price growth in 2021: depending on where you operate in the world you could buy Bitcoin as an investment instrument, use it as a currency, or face penalties for illegal possession.

While many will still recall bitcoin’s early days as a conduit for illegal activities, in reality it is much easier to track activities on public block chains, while private banking activities remain largely hidden from scrutiny. According to the United Nations, 90% of money laundering goes undetected.

But crypto assets are still in their infancy, and governments around the world are working on ways to define, legalize, penalize and regulate more than 12,000 coins that are currently worth over $12 trillion.

Crypto and Banking

The United States continues to give no clear direction on crypto or digital assets. Last year, the decision by the Acting Office of the Comptroller of the Currency (OCC), Brian Brooks, that “banks and thrifts may provide custody services for crypto assets,” was applauded by markets. However, Brooks’ replacement, Acting Comptroller Michale Hsu, took a different stance this summer, stating that past crypto initiatives had not been done “in coordination with all stakeholders.”

The nomination for the Comptroller of the Currency (OCC) was one of the last open nominations for President Biden. And the President’s choice was not expected. Saule Omarova, currently a professor at Cornell Law School, has extremely progressive views, once stating she wanted to “end banking as we know it.” Omarova is not a fan of cryptocurrencies, and is critical of large banks entering the world of cryptocurrencies, for fear it would allow large firms to conduct trading activity out of sight from federal regulators. While her nomination will face heavy opposition by both moderate Democrats and Republicans, she has a strong Progressive following.

The direction the OCC takes on crypto could have strong repercussions for an industry that has already begun to custody these assets.

As crypto takes its place among major asset classes, the fifth largest bank in the United States, U.S. Bank, launched cryptocurrency custody services, limited to institutional investment managers with funds in the U.S. and the Cayman Islands. Services will extend to select coins, including Bitcoin, Bitcoin cash and Litecoin, with other coins potentially joining in the near future.

Who’s In Charge Anyway?

Are crypto coins commodities or a security? In the United States, the answer to that question will decide which regulatory agency will be responsible for overseeing crypto assets.

The SEC, regulator of investment assets, and the Commodity and Futures Trading Commission (CFTC), are currently at odds on the matter, with the heads of both agencies currently sparring.

Brian Quintenz, a Republican commissioner for the Commodity Futures Trading Commission (CFTC), tweeted ….the “ U.S. Securities and Exchange Commission (SEC) does not have jurisdiction over "pure commodities or their trading venues," including "crypto assets."

Securities and Exchange Commission (SEC) Chairman Gary Gensler said …. the rapid proliferation of cryptocurrencies and the investment products tied to them resembled the “wild west.”

Both Commissioners would like to have crypto assets under their regulatory regime, while others have pointed to the need for yet another regulator.

Are Coins Securities?

While the regulatory agency that oversees banks, the OCC, has taken steps to allow banks to custody crypto (although the actions were slightly rescinded), the overseer of the financial securities industry, the Securities and Exchange Commission (SEC), has taken a different stance.

When Gary Gensler was appointed the Chairman of the SEC, many in the crypto community were hopeful that his background—former MIT blockchain professor—would herald in easier times for the coins. That hasn’t happened.

At question are initial coin offerings, crypto exchanges and the actual coins themselves. The SEC has made clear moves over the first two, but continues to take an ambiguous approach to the actual coins. Recently it approved a crypto exchange-traded fund (ETF), however the ETF will invest in crypto exchanges, not the coins themselves. A decision on four ETFs that would invest in coins was delayed until the end of the year.

Taxing the Crypto Sector

At present, cryptocurrency is taxed as property in the United States. In other words, if you just buy and hold, you don’t have to pay any taxes. However, that may be about to change.

Similar to stocks, bonds and commodities, cryptocurrencies are taxed as securities and subject to a 30-day holding rule—which prohibits selling an investment for a loss and replacing it with the same or a "substantially identical" investment 30 days before or after the sale.

Prior to 2018, a crypto-to-crypto trade was considered a “like-kind exchange” under Section 1031 of the IRS tax code. But this was revised, and all purchases and sales of crypto need to be reported separately. Given the daunting challenge of reporting each transaction, many cryptocurrency investors have turned to offshore crypto exchanges for their transactions.

Cryptocurrencies are still in their infancy and offer a world of opportunities, yet challenges and risks abound. As policymakers try to decipher how to regulate and tax the coins, investors will need to keep on top of the latest headlines. In our next article, we’ll discuss crypto and cross-border taxes.

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