Is Virtual Currency worth the Risk? was published by JD Supra on 11/6/18.
We have read that Virtual Currency (VC) is a “speculative asset” that under certain circumstances may be used to pay for goods or services or be held for investment; and that its sale, exchange or use has tax consequences that may result in a tax liability. Regulatory and Governmental Agencies are concerned about “risks” related to VC and the “retail investor”. VCs can be targeted by hackers and fraudsters and the “retail investor” may not necessarily understand the product.
Originally, Satoshi Nakamoto (the name used by the unknown person or people who developed Bitcoin), stated that “what is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers”. VC has met this criterion as evidenced by the fact that it is a “peer to peer” platform; meaning that there are no intermediaries. No middlemen or a central bank authority is required for a transaction to occur. It is a system for electronic transactions without the “traditional reliance on trust”.
VC investors are Currently Investing without Clarity
Different interpretations from the main US Regulating Agencies can place confusing compliance burdens on VC investors. There is a lack of clarity regarding which Government Agency(s) has the final word with respect to the treatment of VC as four of them have different regulatory interpretations:
- IRS: For federal tax purposes, VC treated as property. A taxpayer who receives VC as payment for goods or services must, in computing gross income, include the fair market value of the VC, measured in U.S. dollars, as of the date that the virtual currency was received. The basis of VC that a taxpayer receives as payment for goods is the fair market value of the VC in U.S. dollars as of the date of receipt. If the fair market value of property received in exchange for VC exceeds the taxpayer’s adjusted basis of the VC, the taxpayer has taxable gain. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer; which means that buying a cup of coffee with Bitcoin is cumbersome for a Taxpayer because it can trigger capital gain reporting. There is a Bill under way in the House of Representatives that is proposing to exempt $600 worth of VC transactions.
- FinCEN: Investors in VC utilize the services of on-line “secure” platforms for buying, selling, transferring, and storing VC. The providers of these services are known as web-wallets (Coinbase is an example). They are required to register and operate as Money Service Businesses (MSB) by the Financial Crimes Enforcement Network (FinCEN). MSB’s that operate in the U.S. are regulated by the states. This means that while web-wallets are not subjected to direct oversight of the Securities Exchange Commission (SEC), MSB’s are required to keep records and file reports on certain transactions to FinCEN by Bank Secrecy Act (BSA) regulations.
- SEC: On March 7, 2018, the SEC stated that “Online trading platforms have become a popular way investors can buy and sell digital assets” and that “a number of these platforms provide a mechanism for trading assets that meet the definition of a “security” under the federal securities laws. If a platform offers trading of digital assets that are securities and operates as an “exchange,” as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange”
- CFTC: The US Commodity Futures Trading Commission has stated over the last three years that VC is a “commodity” and should be regulated by the CFTC.
What does this mean?
This is confusing and complex without clear guidance because each of these Agencies have different interpretations:
- For the IRS: VC is property
- For FinCEN: VC falls under a Money Service Business and VC exchange platforms must register with FinCEN
- For the SEC: VC is a security
- For the CFTC: VC is a commodity
The CFTC is the only Regulatory Agency that has “limited” oversight over VC in the US. The CFTC is “limited” to only overseeing: when VC is used in a derivatives contract, or if there is fraud or manipulation involving a VC traded in interstate commerce. The CFTC states that “while VC can provide benefits, VC is largely unregulated and:
- Is commonly targeted by hackers and fraudsters
- Has no assurance of recourse if stolen
- Involves e-wallets or storage that present cybersecurity risks
- Carries speculative risk plus fraud and manipulation risks”
Don’t be a Victim of your own Making
If VC is property, securities are property, and commodities are property, and all the agencies have overlapping authority. Given the uncertainty of where exactly in the regulatory landscape VC falls, all VC holders must proceed with caution. There is no universal clarity regarding reporting obligations, enforcement, governance and definition of VC. How are VC holders expected to comply when there is no roadmap? Is VC to be treated as property, as currency, as a security or as a commodity? VC holders ought to consult with a specialized tax consultant and stay on top of regulatory news as the regulatory landscape continues to shift.