By Paul Weiss contributors
As diverse businesses from Overstock.com to Google’s parent company Alphabet increasingly use and express growing interest in using virtual currencies, the legal and regulatory landscape for those currencies has become increasingly complex. Indeed, various regulators have yet to agree on what to call these blockchain-based financial devices. They might be securities, commodities or something else entirely, with SEC Chairman Jay Clayton suggesting in a letter in March of 2019 that the applicable legal definition can change based on how cryptocurrencies are used and transacted.
We provide this overview of the regulatory landscape to alert companies to the legal implications of venturing into this uncertain terrain. This article does not discuss non-cryptocurrency blockchain business enterprises, which are built on the same basic technology but serve a different function.
International cryptocurrency regulations are widely divergent. Interested countries tend to adopt one of three regulatory approaches: (i) rigid restrictions or even outright prohibition; (ii) cautious development; and (iii) facilitation and encouragement.
India and China have taken the approach of strictly regulating or prohibiting cryptocurrency and related activities. In 2017, an Indian government committee advised lawmakers to close crypto merchants and other active dealers. And, in 2018, the Reserve Bank of India prohibited banks from providing services to individuals or business that deal with cryptocurrencies. This action was recently criticized by the Supreme Court of India, though no ruling has been issued.
China similarly blocked all foreign crypto exchanges in 2018. Financial institutions have been advised not to accept digital currency for retail transactions. China’s National Development and Reform Commission also banned cryptocurrency mining earlier this year. Even more recently, China passed a law broadly aimed at regulating cryptography-related activities, which may hold further implications for cryptocurrency-specific activities in its practical application and enforcement. The law takes effect on January 1, 2020.
Many European states have adopted an approach similar to the United States, which generally permits cryptocurrency activities with regulation and restriction. In the United Kingdom, cryptocurrencies have been widely adopted, though they are not considered legal tender. France is also generally viewed as being favorable towards cryptocurrency and passed a law in 2018 that creates a legal framework for cryptocurrency service providers and initial coin offerings (ICOs). And the German Federal Financial Supervisory Authority classifies cryptocurrencies as “units of account,” usable for payment purposes.
Outside Europe, the Canadian government regulates cryptocurrency under existing anti-money laundering and counter-terrorism laws, and also requires certain types of firms to register. Banks are prohibited from opening cryptocurrency accounts, but otherwise generally seem to embrace cryptocurrency activities. In Australia, the Reserve Bank of Australia generally permits the use of digital currency, and the government treats bitcoin like regular currency, exempted from double taxation.
Facilitation and Encouragement
Some countries are actively encouraging cryptocurrency activity. Switzerland incentivizes cryptocurrency business and transactions, offering tax exemptions and low rates for crypto-based ventures. In Japan, the nation’s Financial Services Agency has adopted a registration mechanism to facilitate cryptocurrency trading platforms. Over 100 businesses have obtained or expressed interest in platform licenses. And in Singapore, the government has issued guidelines providing for the issuance of ICOs pursuant to Singapore’s Securities and Futures Act, and put in place a regulatory framework for promoting regulated payment services that explicitly incorporates cryptocurrency in 2018.
U.S. Federal Regulations
Federal regulations that govern cryptocurrency do not apply uniformly and are often inconsistent in their application. Some also conflict with state and international regulations, creating problems of application and jurisdictional authority.
The U.S. Securities and Exchange Commission has indicated that it will regulate cryptocurrency markets, treating many tokens as securities. In an August interview, SEC Commissioner Jay Clayton indicated that he had no intention of changing laws governing securities regulation to include or exclude digital assets. While Clayton indicated that not all cryptocurrencies should be considered securities, he also stated that many Initial Coin Offerings would likely be required to register or prove an exemption.
Treasury Department Monitoring
The Financial Crimes Enforcement Network of the U.S. Department of the Treasury has promulgated guidance making clear that cryptocurrency is covered by the Bank Secrecy Act and other regulations relating to money service businesses.
For tax purposes, the Internal Revenue Service treats cryptocurrency as property, subjecting it to capital gains tax treatment, according to guidance published by the Global Legal Group. In October, the IRS issued additional guidance related to the treatment of crypto “hard forks” and “airdrops.” Illustrating the complexity of cryptocurrency tax treatment, the IRS also provided additional guidance for parties holding virtual currency as a capital asset.
The U.S. Commodity Futures Trading Commission (CFTC), the official government agency that regulates the U.S. derivatives market, and the National Futures Association, the industry’s self-regulating organization, have adopted rules governing funds that invest in cryptocurrencies, according to the Global Legal Group report. Relevant regulations require fund managers to register as Commodity Trading Advisors and Commodity Pool Operators with both organizations.
While the U.S. Congress has yet to enact any legislation specifically to address cryptocurrency, numerous cryptocurrency-specific pieces of legislation have been introduced. There have been at least five bills introduced so far in 2019. While congressional intervention may eventually bring some harmony to the area, Congress’ current indications of interest, without concrete action, only create further unpredictability.
State Laws and Regulations
Several states, including New York, California and Texas, regulate the exchange of cryptocurrency. Regulations range from restrictive to progressive. New York oversees a regulatory regime known as BitLicense, which imposes strict disclosure and consumer-protection requirements on businesses engaged in the provision of cryptocurrency services. Wyoming, in contrast, has made efforts to become a “crypto valley,” encouraging investment in the state and passing legislation to classify cryptocurrency as money. Other states are currently exploring steps by which to exert control over the cryptocurrency ecosystem.
Companies moving into the cryptocurrency space—developing, offering, purchasing, investing in, or accepting cryptocurrency as a medium of exchange—must account for the concerns raised here in their regulatory compliance programs, and stay abreast of future developments accompanying a growing and increasingly regulated market.
*This article was a joint collaboration of Christopher Boehning, Roberto Gonzalez, Jeh Johnson, Jonathan Kanter, Claudine Meredith-Goujon, Lorin Reisner, Jeannie Rhee, Richard Tarlowe and Steven Herzog.