🤿 Sunday Deep Dive: Cracking the Whip on Crypto

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Legal Operations
Industry Insights

The cryptocurrency boom may once have been nothing more than the futuristic ravings of your eccentric, tech-obsessed friend but now it’s real. The crypto market is worth over $3 trillion and adoption of the technology has risen 881% year-on-year. Authorities are hustling to catch up. China has banned all crypto-related transactions. Congress has proposed 18 crypto-related bills this year. And the U.S. Securities and Exchange Commission (SEC) Chair Gary Gensler is described as having launched a ‘war on crypto’.

Here’s what to watch for in the coming months.

The infrastructure bill row

On 5 November, the government passed a $1.2 trillion infrastructure bill. It includes two sections that have made the crypto industry unhappy.

The first requires crypto brokers to report more information about their activities to the IRS. Industry advocates have complained that brokers don’t have the information required to comply with the new rules because they can’t see into customer’s private ‘wallets’ and trades can happen outside of the exchange. There are also complaints that the definition of the word ‘broker’ is too broad. According to the wording of the bill, groups like crypto miners and software developers could be classified as brokers although they do not facilitate transactions and could not comply with the new law.

The second controversial section has to do with tax code 60501 to include digital. If you’ve ever seen a movie about money laundering or match fixing, you’ll know that cash payments of more than $10k have to be reported to the IRS (which is why the smart crooks bet $9999 at 10 different casinos). That’s tax code 60501. The new bill extends this tax code to include crypto payments. For many traders, the appeal of currencies like Bitcoin is that you don’t have to go through a bank or any other kind of financial institution. But banks are better set up to deal with tax requirements like 60501. The new law could undermine some of the defining features of the crypto movement.

The crypto community have not sat quietly and watched this happen. Campaigners Fight for the Future say their campaign to change the bill generated 40,000 calls to legislators and 10,000 tweets. The bill passed anyway and is due to come into play from January 2024. You can expect to see a continued push for changes.

The SEC wants crypto, dead or alive

The SEC Chair Gensler has described the cryptocurrency markets as the “wild West…rife with fraud, scams, and abuse.” Americans lost $80 million to crypto scams in the 6 months to April 2021. Gensler says he wants crypto platforms to register with the SEC in order to keep them in line. This is controversial but Gensler is determined. The SEC are suing Ripple, a crypto start-up valued at $10 billion, for failing to follow their rules.

New, trending products may appear to sidestep SEC regulations but it may not be long before they find themselves in the firing line. NFTs (Non-Fungible Tokens) are unique virtual tokens that can be used to represent physical assets, like art or sports memorabilia, or used digitally, for example as objects in games. The SEC has warned that some NFT traders may be breaking the law by assuming that regulations do not apply to these products.

Another trend that finds itself en route to legal trouble is DeFi (Decentralized Finance). DeFi describes a range of blockchain-based financial products such as loans and insurance that replaces middlemen like banks and insurance brokers with software. Currently DeFi is unregulated but the SEC has started cracking down on major players. Crypto exchange Coinbase has canceled a new product after a telling off from the SEC and Uniswap Labs, the developer of the world’s largest decentralized exchange, is under investigation.

DeFi is really challenging to regulate. It’s global, anonymous and doesn’t interact with any of the carefully managed structures that traditional financial products are connected to e.g. banks, the tax system. Authorities are likely to have their hands full working this one out.

Reigning in stablecoins

A recently published report, originally commissioned by Donald Trump, warns that a category of cryptocurrencies called stablecoin are a threat to users and the broader economy. Stablecoins are blockchain assets that are pegged to a reserve asset like gold or the US Dollar. If I created a stablecoin currency called LawTrades, for example, I could peg it to the Dollar and one LawTrades Coin would always be worth one USD. As the name suggests, the value of this kind of crypto is way more stable than currencies like Bitcoin which are known for being erratic.

Stablecoin has grown 500% in the last year and some experts predict we could soon be using it for our daily transactions. Regulators are worried that they are not as stable as they claim to be and the collapse of one stablecoin currency could be contagious.

Congress won’t pass any laws overnight but regulators are doing what they can to reign in stablecoin companies. Last month, Tether, the largest stablecoin, was fined $41 million for not having sufficient reserves to claim it was backed by US Dollars. You can expect to see regulators take more action in this area.

What does this mean for the industry?

Increased regulation could protect investors and allow the industry to thrive. It could prevent fraud and reduce the danger of a platform going bust or getting hacked. Clear rules and a clean image could also attract groups like banks and investment firms to crypto. On the other hand, too much regulation might scare crypto traders away to other countries. Most of them will want to keep trading in the US because there is plenty of money to be made here, but they’ll have to work with regulators to find solutions that work for everyone.

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