Crypto Industry Frustrated by Haphazard Regulation

In a parable from ancient India, six blind men touch different parts of an elephant, like its trunk, leg or tusk, and come up with wildly divergent ideas about what the animal is — a snake, for example, or a tree or a spear.

And so it is with regulators in the rapidly evolving crypto space, who are coming up with wildly divergent ideas about what it is and how to regulate it.

The tumult hit peak farce in a couple of televised congressional hearings in the winter and spring that the crypto crowd turned into memes.

(One of the hearings made J. Christopher Giancarlo, the chairman of the Commodities Futures Trading Commission, an overnight hero for his testimony calling for thoughtful regulation of cryptocurrencies, with some Reddit users calling for a Giancarlo coin.) But they haven’t produced clarity.

Asked to describe the current state of crypto regulation in the United States, Perianne Boring, president and founder of the Chamber of Digital Commerce, an industry group, said, “It’s unorganized and incredibly complicated, and it’s really putting the U.S. at risk of falling behind from an innovation and technology perspective. There are turf wars between the different regulatory agencies and turf wars between the feds and the states, and none of this is in the best interest of the U.S. or the blockchain technology industry.”

Two of the biggest issues that touch an alphabet soup of regulators are securities law and taxation.

Most pressing in the securities realm is the question of whether projects raising funds with cryptocurrencies like bitcoin or Ether should be subject to federal registration and disclosure requirements.

The fundraising mechanism, known as an initial coin offering, or ICO, has made it easier for entrepreneurs to raise large sums of money without the hassles of regulators, investor protections or accountants.

The coin offerings were inspired by initial public offerings, or IPOs, that companies use to sell stock to investors.

But unlike stock offerings, coin offerings are generally designed so that investors don’t get an ownership stake in the projects. If the coin does provide an ownership stake, the Securities and Exchange Commission has said, the companies must comply with all securities law. A few coins have done this, but most have tried to avoid it.

So complex has the securities question become that some law firms have decided they are no longer able to give guidance on whether a unit of cryptocurrency — or token — sold in an ICO would be deemed a security. (However, the SEC did recently clarify that Ether, in its current form, is not a security, though the agency sidestepped the question of whether its crowdsale constituted a securities offering.)Or they are advising that clients sell their tokens outside the United States. Another option would be to force token issuers to structure all their sales as securities offerings.

Two crypto unicorns, Coinbase and Circle, recently announced moves that would enable them to help customers buy and sell security tokens.

The state of Wyoming has addressed the issue by passing laws that carve out a new category of what crypto enthusiasts typically call “utility tokens.”

The Wyoming law stipulates such tokens cannot be marketed as investments, and the issuers need to make reasonable efforts to prevent buyers from buying tokens as an investment. While some experts say they believe the new Wyoming laws suggest a path forward, others are proposing self regulation.

In a recent speech, Brian Quintenz, a CFTC commissioner, proposed “a private cryptocurrency oversight body,” or self-regulatory organization.

Boring of the digital commerce chamber said, “It would have some oversight to a U.S. government agency or entity and congressional authority to levy fees and fines, and would have the actual teeth to be a regulator, but it would be an industry group.”

Donna Faulk-White, a spokeswoman at the CFTC, said in an email that in Giancarlo’s testimony on crypto assets to the Senate Banking Committee, he “expressed the view that policymakers should explore potential improvements to the existing patchwork approach to regulating spot markets for virtual currencies. Any such effort should be thoughtful and deliberative, however, which means that there is an opportunity for industry participants to develop standards that could inform policy discussions and benefit retail market participants.”

“We are not yet in a position to suggest or advocate for legislation, but the chairman would view proper, effective and balanced self-regulatory efforts favorably,” Faulk-White said.

Another area getting regulator’s attention is taxation. In late 2016, the Internal Revenue Service asserted that holders of crypto assets are evading taxes and asked for the data, even customer chat logs, on all of Coinbase’s users over three years, causing privacy advocates to protest. After a legal battle, in November 2017 a court restricted the order to customers who had more than $20,000 in annual transactions on the platform.

In an email, the IRS wrote, “The IRS generally does not discuss its ongoing compliance efforts to avoid providing assistance to those taxpayers trying to avoid their tax obligations.”

On the flip side, industry players complain that crypto assets are taxed as property, subject to capital gains tax, rather than as a currency, which is subject to ordinary income tax. To pay capital gains tax, users would have to record the dollar exchange rates for when they acquired their cryptocurrency and when they disposed of it — even for transactions in which, say, bitcoin was used to pay for coffee.

Boring said this had hampered the adoption of cryptocurrencies as payment for goods and services.

“If those taxes didn’t exist where you have to report the valuation on every transaction, we would see a huge amount of activity and people using cryptocurrencies for payment,” she said.

The chamber says cryptocurrencies and crypto assets should be taxed as an alternative to currency in the form of sales tax and income tax. Another blockchain advocacy group, Coin Center, supports a minimum exemption on transactions below $600 and also suggests that the IRS make it easy for crypto exchanges to “give a right kind of reporting to their customers so they can easily report what they owe,” said Jerry Brito, the executive director.

ICO issuers also are unhappy with taxation. While some regulators say the tokens that issuers release are securities, the issuers don’t necessarily get the tax benefit that a company having an initial public offering would receive.

“You’ve got the SEC saying that things may be securities, but then your tax treatment isn’t treating you as though it’s a security,” said Joshua Ashley Klayman of law firm Klayman LLC. “Your tax treatment is as though it’s property, so you’ve got the onerousness of something potentially being a security, but you don’t get the benefit from a tax perspective.”

Among the many remaining regulatory issues surrounding crypto assets, are state and federal regulations. To operate nationwide, many crypto startups need to obtain what are called money transmission licenses from 53 states and territories.

“There is still today, in March 2018, not one company that has been able to get money transmitter licenses across the entire United States,” Boring said. “It is a complete regulatory failure and breakdown.”

Brito of Coin Center said going state by state was expensive, time-consuming and somewhat outdated for the internet era. Adding in the federal agencies, startups are required to deal with more than 60 regulators for the money transmission issue alone.

“The state-by-state money transmission licensing regime makes no sense in a world where you have internet companies that are providing services not just on a national scale but a global scale,” he said. “It makes no sense to regulate them locality by locality, so we think a federal solution would be better.”

“Good actors are trying to comply,” Klayman said. “If good actors can’t figure out how to comply, and feel safe about complying, then they’re going to consider avoiding the U.S. for their transactions.”

By Laura Shin

While the United States is dealing with thorny regulatory issues over cryptocurrencies, some jurisdictions abroad have more clarity, though global consensus is far-off.

Group of 20 meetings in the spring about blockchain regulation did not yield much except a recognition that crypto assets are not merely currencies and a July deadline for the organization’s first step toward regulation. The International Monetary Fund recently highlighted the utility of crypto assets, while also cautioning that, depending on how large they grow, they could someday pose risks to financial stability.

Some jurisdictions are further ahead than others, though the tacks they are taking vary widely. John Collins, an affiliate with the Berkman Klein Center at Harvard University and former head of policy for Coinbase, said one of the strictest, and most opaque, is China, which has banned crypto exchanges and so-called initial coin offerings. More welcoming are Switzerland, Singapore and Britain.

Switzerland is home to the “Crypto Valley” near Zug, where a number of crypto startups — including Xapo and Shapeshift and teams behind initial coin offerings, such as Ethereum and Tezos — are based. Regulators there have deemed that storing a customer’s crypto assets does not qualify as taking deposits, so such companies do not require banking licenses, freeing startups from the requirements to obtain one.

Additionally, the Swiss financial market regulator Finma released principles-based guidelines that would be applied case by case as opposed to prescriptive rules. It also designated a category called utility token, which are not considered securities. Some Chinese companies are moving to Switzerland, which is a hot spot for ICOs; Geneva has even created a guide for token issuers.

“Switzerland is already developing into a leading hub, and I think that will be even more the case in the future,” said Olga Feldmeier, chief executive of Zug-based SmartValor.

Britain and Singapore have also been lauded by crypto startups for their regulatory environment, which enables companies to experiment under relaxed regulation and licensing requirements.

But these progressive approaches are not the norm.

“There has been a hesitancy on the part of these regulators to regulate because they don’t want to grant these businesses a seal of approval,” Collins said. “The fear on the part of the industry at this point shouldn’t be that there’s a crackdown, but that they’ll be ignored because no one is going to take them seriously. And if no one takes them seriously, and they still can’t get bank accounts, that’s a problem.”