Introduction
Cryptocurrencies are digital or virtual currencies designed to work through a computer network, as a medium of exchange, without the involvement of any central authority (for example, bank or government) in any manner.
The regulatory focus on digital assets, such as cryptocurrencies, has increased exponentially over the past few years and is expected to continue this trend in the coming years. Blockchain lawyers play a crucial role in navigating the legal complexities of the cryptocurrency industry and ensuring compliance with relevant regulations. While the cryptocurrency industry only started in 2009, by 2019, this fintech industry had achieved over $55.3 billion in investments.
However, it is unfortunate that the laws related to cryptocurrencies, including cryptocurrency regulation in the US, have grown much slower. As per a report published by Chainalysis in 2022, only 10 countries are known for having the highest substantial rates of cryptocurrency adoption. These include China, Vietnam, Russia, the Philippines, Thailand, Ukraine, Brazil, India, Pakistan, and the United States. The regulatory focus on digital assets has increased exponentially over the past few years. It is expected to continue this trend in the coming years, including the implementation of crypto sanctions.”
Regulation Aspects in the Crypto Market
Regulatory bodies worldwide face the challenge of formulating rules that balance fostering innovation and ensuring consumer protection and market integrity within the cryptocurrency exchange. Here’s an insight into various segments of the crypto market and potential regulatory considerations:
- Utility tokens: Regulations could distinguish utility tokens based on their status as veiled securities and ensure compliance with consumer protection laws.
- Crypto exchanges and wallets: Regulatory focus could be on implementing robust AML (Anti-Money Laundering) and CTF (Counter-Terrorism Financing) measures, cybersecurity protocols, and consumer protection. SEC oversight may apply, with registered exchanges needing audit-compliant order books and adherence to strict rules on order execution.
- ICOs (Initial Coin Offerings): Similar to traditional IPOs, ICOs may face regulations focusing on disclosures, enhanced investor protection, and anti-fraud measures.
- NFTs (Non-Fungible Tokens): Regulations might cover provenance verification, intellectual property rights, and potential classification as securities for NFTs.
- Cryptocurrencies like Bitcoin: As a pioneer in the crypto realm, Bitcoin might be subject to regulations addressing its use as a currency or commodity.
- DAOs (Decentralized Autonomous Organizations): Addressing governance, legal liability, and potential registration as securities could be key regulatory considerations for DAOs.
- Stablecoins: Regulations might encompass reserve management, disclosure practices, and treating certain stablecoin exchanges as financial institutions, especially in light of concerns following the collapse of the Terra (UST) algorithmic stablecoin.
- Crypto lending and DeFi platforms: Regulations may involve licensing, consumer protection, and ensuring adherence to AML and CTF laws for decentralized finance platforms and crypto lending ventures.
- Crypto asset management: Regulatory compliance with securities laws and other financial regulations may be required for entities managing crypto assets on behalf of investors.
Cryptocurrency Cases in the US in 2023
In 2023, the cryptocurrency industry witnessed prominent scandals. Here’s a summary of some notable cases:
SEC v. Kraken – November 2023
The Securities and Exchange Commission (SEC) charged Payward Inc. and Payward Ventures Inc., collectively known as Kraken, for operating its crypto trading platform as an unregistered securities exchange, broker, dealer, and clearing agency. The complaint alleges that since at least September 2018, Kraken unlawfully facilitated the buying and selling of crypto asset securities, making hundreds of millions of dollars. The SEC claimed that Kraken operates as an exchange, broker, dealer, and clearing agency without the required registration, depriving investors of essential protections. The complaint outlined various alleged practices and risks associated with Kraken’s business model, including commingling customer funds and crypto assets. The SEC sought injunctive relief, disgorgement, and penalties.
SEC v. Woodbury and Holverson – September 2023
The Securities and Exchange Commission (SEC) charged Arline Woodbury and Joyce Holverson, promoters of the CoinDeal scheme, with fraudulent activities in a multi-million-dollar investment scheme. The CoinDeal scheme allegedly raised millions of dollars by making false claims of trillion-dollar returns through the sale of an anonymous blockchain technology. Woodbury and Holverson, acting as downstream promoters, formed their investor groups, raising over $3 million from hundreds of investors since January 2019. The SEC’s complaint accuses them of disseminating false and misleading statements, misappropriating investor funds for personal use, and violating various securities regulations. The SEC sought officer and director bars, disgorgement, penalties, and permanent injunctions against Woodbury and Holverson.
In the Matter of James Michael Wines – September 2023
The Securities and Exchange Commission (SEC) has settled charges against James Michael Wines for his involvement in a crypto asset securities offering that raised over $1.5 million from 30 investors in May 2021. Wines, a lawyer, participated in the drafting, review, and approval of a press release that falsely claimed commitments of over $50 million for the offering. The SEC’s order found that Wines violated Sections 17(a)(2) and (3) of the Securities Act of 1933. Wines consented to a cease-and-desist order and additional proceedings to determine appropriate disgorgement, prejudgment interest, or civil penalties without admitting or denying the findings.
SEC v. Hex et al. – July 2023
The Securities and Exchange Commission (SEC) charged Richard Heart, founder of Hex, with conducting unregistered offerings of crypto asset securities, raising over $1 billion. Heart is accused of misappropriating at least $12 million for luxury purchases. The complaint alleges unregistered offerings of Hex tokens and two additional offerings for PulseChain and PulseX tokens. Heart is accused of attempting to evade securities laws by framing transactions as “sacrifices” instead of investments. The SEC seeks injunctive relief, disgorgement, penalties, and other equitable relief.
The Controversy of Sam Bankman Fried
Sam Bankman Fried was once known as the face of cryptocurrency. The 30-year-old former billionaire founded the crypto exchange FTX (Futures Exchange), one of the world’s biggest cryptocurrency exchanges. He had an estimated worth of $16 billion and was at the peak of his career when the controversy started surrounding him.
In December 2022, Sam was arrested on wire fraud, securities fraud, and money laundering charges from the Bahamas. The US Securities and Exchange Commission has alleged that Sam defrauded crypto investors of FTX and raised $1.8 billion in equity. However, it was concealed that the amount was being diverted to Alameda by the company. FTX reportedly drowned in debt behind its deceptive image of being a top trading firm. This was why FTX’s customers’ deposits were misappropriated and used to pay for Alameda’s expenses and debts and make investments.
While Sam’s future is still dark, this controversy resulted in the government seriously trying to regulate cryptocurrency for a greater financial landscape. The United States has tried doing the same as well.
Potential Regulatory Frameworks for Cryptocurrencies in the US
The SEC possesses a diverse set of regulatory tools that can be customized to address the distinct characteristics and challenges presented by cryptocurrencies. Here are various regulatory approaches the SEC could consider for the crypto market:
- Cybersecurity Regulations: Implementing robust cybersecurity regulations for crypto platforms would play a crucial role in safeguarding against hacks and data breaches, given the digital nature of cryptocurrencies.
- Registration Requirements: Implementing mandatory registration for cryptocurrency exchanges and tokens could ensure compliance with disclosure, reporting, and operational standards akin to traditional financial entities.
- Global Regulatory Cooperation: Forming alliances with international regulatory bodies to create a coordinated regulatory framework could address cross-border crypto crimes and provide a cohesive approach across jurisdictions.
- Disclosure Standards: Establishing comprehensive disclosure standards would ensure that crypto enterprises provide investors with accurate information, including financial statements, business operations, and risks associated with the crypto assets they handle.
- Anti-Fraud and Price Manipulation Measures: Adopting stringent measures against fraud and manipulation, such as rules targeting practices like wash trading and pump-and-dump schemes, would fortify the integrity of crypto markets.
- AML and CTF Regulations: Collaborating with other regulatory bodies to enforce Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) regulations would address public security concerns related to cryptocurrencies.
- Market Surveillance: Deploying market surveillance tools to monitor trading activities would aid in the early detection of irregularities, maintaining a fair and transparent market ecosystem.
Cryptocurrency Regulation in the US
If you are considering investing in cryptocurrencies, the cryptocurrency regulation in the US might be the right place to start from. Crypto investments are always complemented with many questions, such as how cryptocurrency regulations in the US can affect you as an investor, how cryptocurrency prices would be affected, or if it is even legal to go ahead with crypto investments are not. This is the right place to get all your questions answered.
At the federal level, the following bodies are responsible for making the required cryptocurrency regulation in the US – the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Federal Trade Commission (FTC), the Treasury Department, through the Internal Revenue Service (IRS), the Office of the Comptroller of the Currency (OCC), and the Financial Crimes Enforcement Network (FinCEN). While these bodies have been highly engaged in bringing financial stability to the crypto market, no formal rule-making has occurred.
Cryptocurrency sales are only regulated if the sale constitutes a sale of a security under state or federal law or if the sale is considered a money transmission under state law, making the person a money services business (MSB) under Federal law. Further, CFTC has jurisdiction over market manipulation matters related to crypto assets, considered commodities.
At the moment, we don’t know whether cryptocurrency regulations in the US can affect cryptocurrency prices. This is because cryptocurrency regulation in the US is fundamental, allowing the government to expand or restrict it.
Usually, restrictive cryptocurrency regulations in the US are capable of negatively affecting cryptocurrency prices. However, luckily for investors, the US is not trying to restrict the crypto industry but instead trying to allow financial institutions to sell digital currencies.
Infrastructure Investment and Jobs Act
In November 2021, cryptocurrencies were mentioned for the first time in US legislation. It was in the Infrastructure Investment and Jobs Act, wherein a small set of crypto provisions had been added. Within these provisions, cryptocurrencies were called “digital assets” and “any digital representation of value which is recorded on a cryptographically secure distributed ledger or any similar technology as specified by the Secretary.” One of the provisions required digital asset brokers to report transactions worth more than $10,000 to the IRS.
According to this new cryptocurrency regulation in the US, any company or person that “transfers digital assets on behalf of another person” shall be referred to as a “broker.” This means that every centralized cryptocurrency exchange would require the issuance of Form 1099-B to each customer and the IRS (Internal Revenue Service).
For instance, every centralized exchange, including Coinbase, Kraken, Binance, etc., would require tracking every sale or purchase of cryptocurrencies that have been made using these platforms, along with information on what each user paid and how much profit or loss they made.
This is both good news and bad news for the investor. Good news because through Form 1099-B, there would be clarity on the profit or loss incurred from trades through these exchanges. However, bad news because a copy of this form shall also be shared with the IRS. Therefore, the authorities would become aware of your profits through crypto investments, making it liable for further tax applications.
It is important to note that these cryptocurrency regulations in the US are expected to be implemented in the 2024 tax filing season. Any trades you would be doing in 2023 shall be reported to the IRS in the following year.
Other Cryptocurrency Regulations in the US
While the Infrastructure and Investment Jobs Act was the first federal law to mention cryptocurrencies, some noteworthy related to cryptocurrency regulations in the US have been noteworthy.
For instance, in March 2013, the US Financial Crimes Enforcement Network (FinCEN) explained cryptocurrency exchanges to be “Money Services Businesses (MSBs)” that must keep documents proving the identity of their customers.
Since this cryptocurrency regulation in the US came into force, US cryptocurrency exchanges have been required to verify user identities before allowing them to trade in digital currency.
Therefore, any investor wanting to invest in cryptocurrencies through a US cryptocurrency exchange would be required to share the following details with the platform – name, address, phone number, a photograph of your ID, and a selfie. Not providing these details can result in not being able to access the platform altogether.
Further, being a US citizen or resident means you can only use US exchanges. Therefore, if you have a US IP address and try to use foreign exchange to invest in cryptocurrencies, you would be banned from trading or even opening an account. This is due to the FinCEN regulations.
Other security risks are also associated with using foreign exchanges in the US. Therefore, going forward with US exchanges such as Coinbase, Binance, Gate, Kraken, Coinmama, and eToro is always better.
SEC Crypto Regulations
The Security and Exchange Commission (SEC) regulates stocks and other securities in the US. The SEC has sometimes argued that cryptocurrencies are securities and hence, eligible to be governed by the SEC.
However, not all cryptocurrencies are necessarily securities. For instance, if a cryptocurrency has been generated through mining and is completely decentralized, it cannot be considered a security. However, in other cases, it is considered a security and would come within the purview of the SEC.
In case a cryptocurrency is proven to be a security, you require proper registration with the SEC, along with completing a bunch of paperwork for the same. This can result in extra costs for the developers and investors.
How to use the Howey Test?
To determine whether a cryptocurrency is a security or not, SEC uses the “Howey Test”. According to this test, a token shall be considered to be a security if:
- It is an investment of money.
- It is a common enterprise.
- It is done with the expectation of profit.
- It is to be derived from the efforts of others.
It is still unclear whether the same test is applied to cryptocurrencies as well, considering that no official clarification has been issued by SEC.
SEC v. CFTC Oversight of Digital Assets
A fierce turf war over regulatory oversight of cryptocurrency regulations in the USunfolded between the SEC and CFTC. While both agencies are involved, they have distinct areas of focus. The CFTC wields authority in regulating futures and derivatives trading of cryptocurrencies like Bitcoin, ensuring fair and transparent practices in these markets. On the other hand, the SEC concentrates its efforts on overseeing aspects such as initial coin offerings (ICOs) and decentralized finance (DeFi) platforms, aiming to protect investors and promote compliance within these emerging sectors. This clash of jurisdictions underscores the complex and evolving nature of cryptocurrency regulation as these agencies grapple to establish their roles in this rapidly expanding industry.
In the realm ofcryptocurrency regulations in the US, both the SEC and CFTC have been vigorously pursuing enforcement actions against cryptocurrencies falling within their respective perceived jurisdictions. At the heart of this conflict lies a crucial question:
- How should cryptocurrencies be categorized; as commodities or securities? This classification carries substantial implications, as the CFTC holds the power to regulate commodities, while the SEC exercises jurisdiction over securities.
The regulatory powers of the CFTC in commodity trading have certain limitations, with its authority over spot trading of commodities being more restricted. However, the CFTC has broad regulatory powers in the futures market, establishing rules for participants, exchanges, and intermediaries. When it comes to cryptocurrency regulations in the US, the CFTC’s jurisdiction may not extend to investors who primarily buy cryptocurrencies through apps. Nevertheless, the agency can investigate and prosecute instances of fraud or manipulation related to cryptocurrencies.
The CFTC has recognized Bitcoin as a commodity, while the SEC acknowledges that Bitcoin and Ethereum are not considered securities, posing a challenge for the SEC as these cryptocurrencies serve as influential models for other digital assets. This means that if cryptocurrencies like Bitcoin and Ethereum are not classified as securities, they fall outside the SEC’s regulatory scope.
In view of the disagreements, during a Senate Agriculture Committee hearing, CFTC Chair Rostin Benham asserted that specific digital assets, such as Ethereum and stablecoins, should be classified as commodities, thereby granting the CFTC jurisdiction over their derivatives and underlying markets. In contrast, SEC Chair Gary Gensler advocated for Congress to provide the SEC with expanded control over cryptocurrencies. The discord between the two agencies prompted discussions during a hearing led by Subcommittee Chair Rep. French Hill, emphasizing the urgency to resolve the regulatory conflict between the SEC and CFTC. Additionally, lawmakers also deliberated on the allocation of regulatory authority between the two agencies concerning digital assets. Former CFTC chief Timothy Massad proposed the establishment of a mutually regulated self-regulatory organization to govern cryptocurrency regulation in the US, involving both the SEC and CFTC.
Cryptocurrency Regulations in the US Coming Up in 2023
While the regulations mentioned above are already in place in the US, there are some upcoming cryptocurrency regulations in the US that are currently being discussed by policymakers, and that should soon be implemented in the US.
Wash sales
The ‘Wash Sale Rule’ is applied to stocks, mutual funds, and other securities under the current tax regime of the US. According to this rule, if you sell a security/stock at a loss and then repurchase the same security/stock at a lowered price, the loss cannot be deducted from your current year’s taxes.
However, it is essential to note that under IRS regulations, cryptocurrencies are considered property, not investments. Therefore, the wash sale rule is currently not applicable to cryptocurrencies. Therefore, if your cryptocurrency falls in value, and you sell it at a loss, it is possible to claim such a loss on your taxes, irrespective of whether you have immediately repurchased it at a lower price. This is a loophole currently in the regime, and many policymakers are not happy with its existence, so they want to pass legislation to tackle this issue.
The Build Back Better Act 2021 does contain language capable of making the wash sale rule applicable to cryptocurrencies. However, the Act has failed to pass the US Senate, and hence, the loophole still exists.
It is yet to be seen whether any new cryptocurrency regulation in the US will come in for this rule in 2023.
Cryptocurrency banking and exchange regulations
The US agencies engaged in a ‘crypto sprint’ in 2022 to discuss further laws and cryptocurrency regulation in the US. Post the discussion, a roadmap was released for the potential areas wherein further research and new cryptocurrency regulations in the US are possible. Some of the topics include:
- Bank custody of crypto-assets
- Stablecoin issuance
- Holding crypto as a balance sheet rules
- Crypto-asset sales by banks and financial service companies
- Crypto as collateral for bank loans
From these discussion points, likely, the US government will soon legalize the sale of cryptocurrencies by banks. The Biden administration had recently proposed the stablecoin (a type of cryptocurrency) legislation and the possibility of a digital dollar in communication with the central bank. Therefore, 2023 might be the year to welcome proper legislation.
This change is capable of leading to a boom in the cryptocurrency market. This is something that potential investors must keep an eye on.
New accounting and disclosure requirements
On 14th December 2022, the Financial Accounting Standards Board discussed new accounting and disclosure requirements that shall be required to be fulfilled by entities holding cryptocurrency assets, considering the cryptocurrency regulations in the US. Following an agenda consultation with the investors, these shall be expected to be disclosed within the financial statements.
Further, the Securities and Exchange Commission had delivered letters to companies to engage their opinion on the disclosure requirements since “the need to address crypto asset market developments in their filings generally, including in their business descriptions, risk factors and management’s discussion and analysis” in line with the evolving cryptocurrency regulations in the US.
While it is yet to be seen how stringent the disclosure requirements are for cryptocurrency transactions, the rules are expected to be released in 2023 only.
Who is Affected by the Cryptocurrency Regulations in the US?
There are notable differences between cryptocurrency regulations in the US and other countries, primarily because digital assets are subject to the oversight of various regulatory authorities based on their specific characteristics. Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) obligations are applicable to entities categorized as “financial institutions” under the Bank Secrecy Act (BSA). This classification encompasses a range of entities, including money services businesses, securities brokers/dealers, futures commission merchants, introducing brokers in commodities, and mutual funds, among others. These entities are subject to AML/CFT requirements outlined by the BSA.
In 2019, the Financial Crimes Enforcement Network (FinCEN) issued guidance outlining the application of the Bank Secrecy Act (BSA) to various business models involving the transmission of digital assets, specifically convertible virtual currencies (CVCs). Consequently, the following business models may fall under cryptocurrency regulation in the US within specific circumstances, including; Peer-to-peer (P2P) exchangers; Multiple-signature wallet providers; hosted wallet providers; Operators of Convertible Virtual Currency (CVC) kiosks that accept and transmit value; Payment processing services involving CVC money transmission and Decentralized Applications (DApps) performing money transmission; providers of anonymizing services for CVCs; and CVC money transmission conducted by internet casinos or individuals involved in the gambling business that do not meet the regulatory definitions of a casino, gambling casino, or card club but accept and transmit value denominated in CVC.
Furthermore, the Anti-Money Laundering Act (AMLA) made amendments to the Bank Secrecy Act (BSA) in 2021. These amendments expanded the scope of “financial institutions” to encompass “value that substitutes for currency.” Consequently, the definition of financial institutions now includes, among others: businesses engaged in the exchange of currency, funds, or value that substitutes for currency or funds; and Individuals or entities conducting the business of transmitting currency, funds, or value that substitutes for currency. This includes those involved in informal money transfer systems or networks facilitating money transfers domestically or internationally outside of traditional financial institutions.
Therefore, if any activity involving digital assets falls within these definitions, it will be subject to regulatory oversight as a regulated activity.
How to Stay Compliant?
Companies involved in digital currencies must adhere to the Bank Secrecy Act (BSA) and register with FinCEN, SEC, and CFTC, depending on the nature of the assets. They are also obligated to comply with cryptocurrency regulations in the US.
Regulated businesses in the US must perform a risk assessment to determine their vulnerability to money laundering activities and develop an Anti-Money Laundering (AML) program based on the assessment results. The AML program should be appropriate in size and scope, encompassing policies, procedures, internal controls, independent compliance testing, designated personnel responsible for implementation and monitoring, and ongoing training for relevant individuals.
Additionally, these companies should establish protocols for recordkeeping, reporting, and submitting suspicious activity reports. Furthermore, they are required to implement a Customer Identification Program (CIP) as part of the cryptocurrency regulation in the US introduced by the USA PATRIOT Act in 2003, aiming to combat money laundering and terrorism financing. The CIP mandates certain businesses to verify customer identities during onboarding and transactions.
Frequently Asked Questions
Is it legal to use cryptocurrency in the US?
Yes, it is legal to use, buy and possess cryptocurrency in the US.
Do US banks accept cryptocurrency?
As of now, NO. You cannot purchase or exchange any cryptocurrency due to the lack of a regulatory framework on cryptocurrencies in the US. However, the situation might change soon if cryptocurrency regulation in the US is introduced to start crypto financial services.
Conclusion
Cryptocurrency benefits are coupled with cryptocurrency regulations in the US. Therefore, it becomes imperative to conduct proper due diligence before indulging in the development of or investment in cryptocurrencies. Especially considering the increasing attachment of cryptocurrencies to the centralized exchange and the increased need for disclosures and transparency, there are many pitfalls to avoid when investing in cryptocurrency. Hence, always keep yourself updated with cryptocurrency regulations in the US.
To help you in the process, LegaMart is always there to provide its helping hands with its experienced team of lawyers. Please visit LegaMart’s homepage to make use of our customized services.
To learn more about the crypto industry, check out this article:
NFT Law and the Future of the Crypto Market – The Rise and Rise of NFTs
The remarkable growth of cryptocurrencies has had its share of consequences as well. One such scandalous consequence was the arrest of FTX’s Sam Bankman Fried.
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