Bitcoin was originally created in 2009 to serve as a currency outside the control central banks. Today, more than 6,800 different cryptocurrencies are trading across the world. The IMF has reported that the market capitalization of the cryptocurrency market nearly tripled between January and May 2021 to $2.5 trillion. 

At the federal level, little in the way of regulation specifically tailored to digital assets has been enacted.  Most states have addressed cryptocurrency directly, passing laws either promoting or restricting it (mostly in response to mining operations which burden local power grids). Where the federal regulation is currently impacting crypto markets is in its interpretation of digital assets as traditional assets and thus falling under the scope of existing laws.  Here, we will be looking at where existing federal regulations have absorbed crypto markets into their authority and to what degree.

Note that there is no uniform definition of “cryptocurrency,” sometimes referred to as virtual currency, digital assets, digital tokens, crypto assets or simply crypto, Federal Agencies use these terms interchangeably, but all refer to the same concept.

Securities Laws

The SEC has authority over ‘securities’ which include investment contracts, defined by the Supreme Court as “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.”[1]  This definition lead to the Howey Test which determines if a contract is an investment contract and thus under the purview of the SEC. 

Where crypto assets fall into this definition is with Initial Coin Offerings. ICO’s are just like Initial Public Offerings but in place of stock being offered, a digital token or coin is offered. This digital currency offered will be novel and specific to the company doing the ICO.  They often contain some utility related to the product or service that the company is offering (such as serving as the backbone to a decentralized network of wireless internet access points, Example here), or it may just represent a stake in the company or project.  The performance of the company is in someway linked to the price of the token and thus acts like a corresponding stock price.

These utility linked tokens run afoul with the Howey Test in its ‘expectation of profits derived from the managerial efforts of others.’  Bitcoin (which is not an ICO currency) is wholly decentralized, meaning that its price is not derived from the efforts a discernable group of people.  But while utility providing tokens use the same decentralized technology of the blockchain like Bitcoin, they are modified to be linked to the endeavors of the company offering them in order for their price is reflective of the performance of the company.  This linkage to the ‘efforts of others’ is what the SEC uses to claim that certain ICO’s fall under their authority.[2]

In October 2019, the SEC sued the company Telegram alleging that the company had raised $1.7 billion through the sale of GRAMS (the company’s cryptocurrency) in an ICO. The tokens they offered allowed customers of the messaging service a means of payment for goods and services within the Telegram ecosystem. The courts, using the Howey Test, found that GRAMS were securities and its ICO was not properly registered with the SEC.[3]

Tax Laws

In March 2014, the IRS defined all crypto assets as “property”, not currency.[4]  So like with all property, cryptocurrency owners will need to keep detailed records of purchases and sales, pay taxes on any gains made when trading the cryptocurrency into US currency or trading it for goods or services, and pay taxes on the fair market value of any mined cryptocurrency.    

This classification as property rather than a currency can become quite problematic for those who use cryptocurrency as a means of exchange. The IRS requires, on Form 8949, for each virtual currency transaction, the following information be disclosed:

1. a description of the amount and type of virtual currency sold,
2. the date acquired
3. the date sold
4. the amount of proceeds from the sale
5. the cost or basis
6. the amount of the gain or loss.

Someone using Bitcoin for numerous small purchases throughout the year would find this particularly burdensome and as the use of digital currency becomes more fluid for basic online transactions, this definition and its reporting requirements will become problematic and need to be addressed in the future.

Like-Kind Exchanges

Another issue with crypto taxation is the trade of one token for another and like-kind exchanges. The IRS permits investors to exchange real property used for business or held for investment purposes, for other business or investment property of the same type. These like-kind exchanges do not expose the taxpayer to taxes if the exchange netted them a gain.  In 2018 the IRS limited these exchanges to real property only, but prior to 2018 like-kind exchanges applied to all property.

The question then becomes whether trades from one crypto asset to another, that occurred prior to 2018, receive like-kind exchange protection.  The IRS has not issued any guidance on whether different cryptocurrencies are “property of like kind” that would qualify as a like-kind exchange. The taxation of transfers from one crypto asset to another would hinge on whether the IRS would consider two different crypto tokens are of like kind.  Experts have observed the similarity of this issue with exchanges of precious metal bullion and coins, being a currency in one respect and property in others. 

In 1982 the IRS stated, “Although the metals have some similar qualities and uses, silver and gold are intrinsically different metals and primarily are used in different ways. Silver is essentially an industrial commodity. Gold is primarily utilized as an investment in itself. An investment in one of the metals is fundamentally different from an investment in the other metal. Therefore, the silver bullion and the gold bullion are not property of like kind.”[5] 

Each cryptocurrency is not only different in name; the coding underlying their blockchain technologies are all different and engineered to serve some specific purpose. Given this, it is an easy logical induction that the IRS will conclude that pre-2018 cryptocurrency exchanges will not receive like-kind exchange protection.  But we will just have to wait and see for now.

If you have legal questions about crypto laws, contact Revision Legal at 231-714-0100.

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[1] SEC v. W.J. HoweyCo., 328 U.S. 293, 301 (1946)

[2] https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets

[3] https://www.zdnet.com/finance/blockchain/telegram-ordered-to-pay-over-620000-in-gram-cryptocurrency-lawsuit/#:~:text=The%20startup%20was%20sued%20in,Initial%20Coin%20Offering%20(ICO).

[4] https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions

[5] https://www.exeterco.com/1031_exchange_revenue_ruling_82_166