More Crypto Regulation May Be Inevitable

The U.S. government has had a wary relationship with cryptocurrencies. Some countries, like Japan and Argentina, have detailed regulations for cryptocurrencies, but the United States has held the industry at more of an arm’s length.

The U.S. regulatory landscape also makes creating crypto regulation a little more complicated, said Jeremy Goss, partner at financial accounting firm FORVIS, LLP. Unlike some other countries where one centralized regulator handles everything, in the United States, different market participants are regulated by different regulatory bodies.

In the traditional financial industry, this includes specific banking regulators for banks, the Securities Exchange Commission and Commodity Futures Trading Commission for securities and derivatives markets, and the Financial Industry Regulatory Authority for broker-dealers. States also may have different regulations of their own, such as different money transmitter laws meant to prevent actions like money laundering. 

Because there are few existing regulations for the cryptocurrency industry, market participants like banks that want to get into the crypto industry have to make do by “slotting in” their approach to crypto into existing regulatory frameworks for traditional finance, Goss said. When making cash-to-crypto transactions, for example, companies may elect to follow all the different money transmitter laws passed by states — without any real reassurance that those same rules would apply to crypto.

“They’re in conversations with their regulators saying, ‘If we were to do this activity, is this how it would work under this regulation?’” Goss said. “And then their regulators may be like, ‘Well, we don’t want to tell you yes — but we also don’t want to tell you no.’ There’s a lot that’s just up in the air.”

Ultimately, Congress has to kick off the process of cryptocurrency regulation with legislation, assigning regulators to do the work of figuring out the detailed rules, Goss said. Creating the right regulations around an emerging market can be a delicate balancing act.

“They don’t want to stifle innovation,” Goss said. “But at the same time, they want it to be safe, and they want [regular] investors to be confident in what’s going on. So it’s push and pull — we’re right in the middle of all of it right now.”

Infrastructure Bill’s New Reporting Regulations 

U.S. regulations around cryptocurrencies first appeared around 2014, when the IRS classified cryptocurrencies not as a type of currency but as property, similar to gold, said Andrew Gordon, president and tax lawyer at Gordon Law Group. That designation is still true today and, as a result, cryptocurrency investors need to report it in their taxes as property.

In 2021, Congress passed the infrastructure bill, which includes provisions requiring cryptocurrency exchanges to report all transactions on their exchanges on 1099-B forms. Those are the same forms investors currently receive from brokerages like E-Trade and Robinhood during tax season, Gordon said. The idea is that by requiring cryptocurrency brokers to follow the same standard as traditional brokers, the government will be able to systematically track people’s earnings from crypto and prevent tax evasion.

That provision, when it takes effect in 2023, is also going to make it easier for the government to rein in and prosecute malicious hackers by explicitly linking crypto transactions to individuals. Cybercriminals regularly ask for payment in the form of cryptocurrencies when they launch ransomware attacks, which is when attackers lock out users from their own computer systems and extort payment in exchange for the key.

“The reality is that crypto is far from anonymous — in fact, the blockchain itself is an immutable ledger of activities.”

“There was, for many years, the false belief that crypto is anonymous,” Gordon said, which made it a popular currency for criminal activity. “The reality is that crypto is far from anonymous — in fact, the blockchain itself is an immutable ledger of activities.”

Blockchain technology is actually more pseudonymous, where the account holder’s corresponding ID isn’t explicitly tied to their identity in the outside world, but all their activity within the ledger is recorded and can be easily traced back to that ID.

“Time and time again, the government has shown that they’re able to trace through the blockchain and find people,” Gordon said. Take, for example, the arrest of the founder of the online black market the Silk Road back in 2013, where federal agents uncovered the identity of “Dread Pirate Roberts” and arrested him in a San Francisco public library.

When the law requiring cryptocurrency brokers to notify the IRS about crypto transactions takes effect, the task of tying blockchain activities to individuals is only going to get easier — especially because the government is currently able to do so even without this requirement.

“Historically, there was little to no reporting required,” Gordon said. “So now, the government is going to be armed with a ton of information, a treasure trove of information to trace transactions.”

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Possible Future Expansion of the Wash-Sale Rule

The Build Back Better plan proposed by President Biden that failed to pass the Senate in 2021 gives hints of another possible regulation coming in the future, Gordon said. In the plan, it was proposed that the wash-sale rule, which currently only explicitly applies to stocks and securities, would be amended to also cover cryptocurrencies. The wash-sale rule prevents investors from claiming a tax deduction on stocks or securities they sell at a loss if they buy back that same investment or a “substantially identical” one within a short period of time. 

The wash-sale rule doesn’t currently apply to crypto, so investors holding cryptocurrencies could make use of the loophole to claim tax deductions on losses while still holding onto the currency. The Build Back Better plan was an attempt to make that change.

“I would assume in time that there’s going to be efforts again to close that loophole,” Gordon said. The proposed expansion of the wash-sale rule wasn’t the reason the Build Back Better plan failed to pass, so it’s likely that the proposal will appear again in future legislation.

Could There Be a De Minimis Tax Rule for Cryptocurrencies?

Another rule Gordon thinks will be implemented in the future is one that sets a minimum threshold for tax reporting, called a de minimis tax rule.

“There’s always rumblings about having a de minimis tax law, which means that you don’t have to pay taxes or report crypto transactions under a certain dollar amount,” he said.

Whenever cryptocurrency owners spend an amount of crypto — whether to purchase a boat or a cup of coffee — that transaction is considered a “sale” of the cryptocurrency, Gordon explained. As a result, investors need to calculate whether the price of the cryptocurrency at the time of the sale was higher or lower than the price when they acquired it for each instance they spend crypto, in order to use it for tax reporting.

“You’re going to have to calculate the gain or loss on that cup of coffee, which is a pain,” Gordon said. “No one wants to do it — and then it kind of bites people adopting and using crypto because you’ve got to calculate gain or losses on a $5 transaction.”

There’s currently a de minimis rule around discount bonds, allowing them to be taxed at the lower capital gains rate rather than the higher ordinary income rate under certain conditions when the discount is small enough. For cryptocurrencies, a de minimis rule might look like a law exempting lesser crypto transactions from tax reporting and therefore from calculating gains and losses in order to make the reporting process more manageable.

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Regulation of Stablecoins May Be An Early Step

When it comes to cryptocurrencies, there is one specific type that will likely see future regulation: stablecoin. Stablecoins are different from other types of cryptocurrencies because they are supposed to match the value of the U.S. dollar, with each stablecoin having a value of $1. Similar to how the U.S. dollar used to be pegged to gold, stablecoins are supposed to be “pegged” to the dollar to help give the currency more stability.

Stablecoins are often described as the “lifeblood” of the cryptocurrency ecosystem, Goss said. They allow crypto investors to quickly and easily exchange cryptocurrencies like Bitcoin for the value of the dollar without directly using the dollar. Without stablecoins, investors may have to wait days for the transfer between dollars and cryptocurrencies to go through the traditional financial banking systems.

There are many different stablecoin cryptocurrencies, including tether, USD Coin and TerraUSD, which uses the cryptocurrency token Luna. Different types of stablecoins are pegged to the dollar in different ways, with many stablecoin issuers claiming to hold dollars or assets that equal the total volume of stablecoins issued. 

Some stablecoin companies, like USD Coin’s issuer, voluntarily invite independent accounting firms to attest that the company has what they consider to be sufficient assets to back up the stablecoin’s value, Goss said. Other stablecoins use an “algorithmic” method to automatically encourage buying and selling of coins to regulate their value relative to the dollar. But cryptocurrencies being unregulated still means there is no way to guarantee whether there are enough assets — or any assets — backing up the stablecoins, Gordon said.

“There’s no transparency, there’s no audits, there’s no regulation — it’s just the belief that what they’re saying is true.”

“I can create a website called the Gordon Coin and tell everyone that I’m going to put one dollar in the account for every dollar that someone buys of the token,” he said. “There’s no transparency, there’s no audits, there’s no regulation — it’s just the belief that what they’re saying is true.”

Just recently, the value of TerraUSD’s Luna coin fell to less than a thousandths of a dollar, illustrating how some stablecoins may not be that stable.

These developments make it more likely that regulations will come for stablecoins, which the government had already indicated it was interested in regulating. In April, the Biden Administration proposed that stablecoin issuers be subjected to some of the same regulatory requirements as banks.

It’s hard to predict what the eventual regulations would be, but Gordon said some examples of what could one day be required is that stablecoins are subject to audits to ensure their assets and holdings, that they are required to hold their assets in U.S. banks or that they be FDIC insured.

Ultimately, Goss said, regulators are focused on creating rules that will maintain the health of the broader financial system, safeguard the emerging market from hackers and loss of assets, and prevent market manipulation.