by: Joshua Gayman
In 2014, the IRS brought some clarity to the implications of crypto as it relates to tax law. In the US, Crypto is considered virtual currency, which is classified as “property” under current tax law(1.). If you sell or exchange crypto, use it to pay for something, or “hodl” it for investment, there will be tax consequences that could result in monies owed to Uncle Sam. (2)
(In the US)If you receive crypto in exchange for sales, that is a taxable event. Since you have received “property,” which is NOT considered legal tender, you now also have a basis. If you later sell or even use that crypto to pay for something later, you could have another taxable event (if the value of the token has risen). Across countries, the tax classification, rules and rates vary.
It is very interesting that crypto is considered “property” when really it is a record of transfers or states. Nonetheless, the clarity did come from the IRS in 2014 after a 2013 case where online exchanges lost bitcoins to civil forfeiture after they failed to register with FinCEN under 18 U.S.C. § 1960, a statute that applies to forfeiture of real or personal property.”(3)
It is in the best interest of crypto exchanges to strictly follow AML and KYC compliance laws, as these laws help improve the user experience by reducing risk, since the exchange can then build detailed risk profiles and adjust their controls accordingly(4).
Even so, according to a getid.com article from January(2022), “At this time, crypto exchanges are not up to scratch with their AML policies. A recent study by Coinfirm(5) showed that 69% of the 216 crypto exchanges do not have “complete and transparent ” know-your-customer (KYC) procedures in place — An integral part of a robust AML program.”(6) In 2019, CipherTrace said that ⅓ of Crypto exchanges have little or no KYC.(7)
Currently, there are massive fines for failure to comply with AML laws, to the tune of approximately $2.2 billion in 2020. (8) Fincen can and has fined officers, executives, directors and employees.(31 U.S.C. 5321; 31 C.F.R. 1010.820)
In addition to fines and possible criminal penalties, FinCEN can also mandate a company to hire certain roles to be more compliant. KYC is critical to stay compliant with AML laws, as it is a process for determining customer risk.(4, 9)
Crypto is viewed in similar lenses to other financial industries with regards to AML, which has evolved since the Bank Secrecy Act in 1970.(10)
Eliminating manipulative trading practices is also key for Crypto exchanges in order to make the user experience worthwhile. Having an efficient KYC process in place is the best place to start. Many firms are even hiring KYC Executives to stay on top of things.(12) There are more firms coming into the space where exchanges can outsource some of the process, or double down on it.(13) Perhaps the best way to eliminate risk is to use sound decision making around the type of digital assets the exchange lists in the first place. Brand new assets in type or which don’t have a product behind them yet, for example, come with a much higher amount of risk than say Ethereum or Bitcoin.
Exchanges are increasingly worried about regulation. According to Robinhood CFO Jason Warnick, “We’re a highly regulated company in a highly regulated industry, and we think it’s important that we get a bit more clarity from regulators”(in a comment about high retail demand for crypto – 11)
The consequences for exchanges listing unregistered securities are largely unknown. Certainly, many unregistered securities have been listed. The infamous SEC vs Ripple case even led to Coinbase and other exchanges delisting XRP from their platforms. (14) Fines have been and will continue to be imposed. In August 2021, Poloniex agreed to pay more than $10m to settle damages with the SEC for operating an unregistered online crypto exchange. (15)
While the SEC has punished many violators of securities laws, they have yet to define exactly how digital assets fit into the space of securities. The SEC has stated numerous times that they do not want to restrict innovation. That being said, they also have a duty to protect the public, thus finding balance has been a daily challenge. Chairman Gensler has stated that he “fears a lack of oversight will ultimately hurt investors.” (16)
The SEC will punish exchanges for violating laws regarding selling unregistered securities, especially if fraudulent offerings are involved. In 2021, the SEC charged crypto exchange executives themselves over unregistered token sales involving fraud.(17)
As the SEC gets clear on how it wants to define securities with digital assets, the hammer could come down on many “naked swimmers.”
This article has been shared under the MIT creative commons license by its author.
References:
- https://www.irs.gov/irb/2014-16_IRB#NOT-2014-21)
- https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies
- https://www.bestlawyers.com/article/is-cryptocurrency-property/2106
- https://complyadvantage.com/insights/what-is-kyc-crypto-exhanges/
- https://www.coindesk.com/markets/2019/03/27/most-crypto-exchanges-still-dont-have-clear-kyc-policies-report/
- https://getid.com/aml-kyc-crypto-exchanges-wallets/
- https://www.coindesk.com/policy/2019/11/28/a-third-of-crypto-exchanges-have-little-or-no-kyc-says-ciphertrace/
- https://feedzai.com/blog/anti-money-laundering-aml-5-steps-to-avoid-fines/#:~:text=Last%20year%2C%20FinCEN%20issued%20its,door%20for%20severe%20personal%20liability.
- https://plaid.com/resources/banking/what-is-kyc/
- https://www.fincen.gov/history-anti-money-laundering-laws
- https://news.bitcoin.com/robinhood-listing-cryptocurrencies-important-clarity-from-regulators/
- https://in.indeed.com/Kyc-Executive-jobs?vjk=ece1c9fa82009126
- https://www.pymnts.com/authentication/2021/verifying-customers-at-speed-of-crypto-requires-aml-kyc-reset/
- https://www.sec.gov/news/press-release/2020-338
- https://www.sec.gov/news/press-release/2021-147
- https://www.marketwatch.com/story/a-lot-of-people-are-going-to-get-hurt-on-unregistered-crypto-exchanges-secs-gensler-says-11632243917
- https://www.theverge.com/2021/8/6/22613195/sec-cryptocurrency-blockchain-gensler-charge-illegal-fraud-tokens
