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. 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 to see that the laws related to cryptocurrency have grown at a much slower pace. 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.

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 was reportedly drowning 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’s seriously trying to regulate cryptocurrency for a greater financial landscape. The United States has tried doing the same as well.

Cryptocurrency regulation in the US

If you are considering investing in cryptocurrencies, the crypto regulation in the US might be the right place to start from. Crypto investments are always complemented with many questions, such as how the regulations 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 regulation – 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 the regulations can affect cryptocurrency prices. This is because the crypto regulation is extremely basic, allowing the government to expand or restrict it.

Usually, restrictive regulations 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 secured 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 the new law, 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).

This means that every centralized exchange, such as 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 regulations are expected to be implemented in the 2024 tax filing season. This means that any trades that you would be doing in 2023 shall be reported to the IRS in the following year.

Other US cryptocurrency regulations

While the Infrastructure and Investment Jobs Act was the first federal law to mention cryptocurrencies, there have been some noteworthy related regulations in the US.

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 law 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 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, it is always better to go forward with US exchanges such as Coinbase, Binance, Gate, Kraken, Coinmama, and eToro.

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:

1. It is an investment of money.
2. It is a common enterprise.
3. It is done with the expectation of profit.
4. 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 there has been no official clarification issued by SEC.

Regulations coming up in 2023

While the regulations mentioned above are already in place in the US, there are some upcoming regulations that are currently being discussed by policymakers, and that should be soon 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 important 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 as well, irrespective of whether you have immediately bought it back 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 new legislation comes in for this rule in 2023 or not.

Cryptocurrency banking and exchange regulations

The US agencies engaged in a ‘crypto sprint’ in 2022 to discuss further laws and regulations regulated to cryptocurrencies. Post the discussion, a roadmap was released for the potential areas wherein further research and new regulations 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, it is likely that 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. 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.”

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.

Frequently Asked Questions (FAQs)

Is it legal to use cryptocurrency in the US?

Yes, it is absolutely 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 a crypto regulation is introduced to start crypto financial services.

Conclusion

Cryptocurrency benefits are coupled with a regulatory framework, especially within the US jurisdiction. 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 the laws surrounding cryptocurrencies.

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.