U.S. Regulatory Bodies and Cryptocurrencies: SEC, CFTC, IRS, FINCEN Outlook

U.S. Regulatory Bodies and Cryptocurrencies: SEC, CFTC, IRS, FINCEN Outlook

U.S. Regulatory Bodies and Cryptocurrencies: A Comprehensive Guide

The road to regulation for cryptocurrencies in the United States has been a long and rocky one. Disputes over the classification of the digital currencies as commodities or securities has created a long list of complications. Recent enforcement actions by regulators all over the country have compounded pressure within the new industry, creating a complicated situation and a difficult spot for those that possess cryptocurrencies.

But it isn’t just small regulators that have created problems for Bitcoin in 2018. The CFTC, or the U.S. Commodity Futures Trading Commission recently issued an official warning regarding virtual currencies. The document was poised to provide what the agency referred to as “regulatory clarity” for cryptocurrencies, stating that current deliberation is still underway, and that the commission’s staff will be working to provide “additional guidance.”

Though the document may not have included the full specifications necessary for complete regulatory action in the sector, the remarks certainly set the groundwork for a set of additional efforts to regulate which may happen in the coming years. In particular, it argued that there was a need for more surveillance on the market, increased CFTC coordination, stricter requirements for trader reporting, and risk management and governance protocols.

Despite this clear mark of governmental interest in increased regulatory scrutiny, there still doesn’t exist a clear and definitive definition-based framework for the regulation of cryptocurrencies in the United States. Furthermore, questions regarding the proper authority in charge of the regulation of this budding financial sector persist.

Most of the increased scrutiny comes in response to the problems caused by Initial Coin Offerings, also known as ICOs. These cryptocurrency crowdfunding methods are used by startup companies on the blockchain to provide the initial funds necessary to begin a new project. Typically, investors are promised returns based on the success of the project, or a stake in the product which will eventually be created following a successful campaign.

But ICOs are notorious for the regulatory issues which they help to cultivate. First, fraud is increasingly prevalent in this lawless sector. Hundreds of pump and dump schemes have minimized trust in the market, defrauding investors of millions of dollars that they initially put into the ICO for a company that doesn’t actually exist.

Additionally, the offerings are often a haven for sketchy business practices. Some businesses have been known to inflate the potential gain from investment, or to mislead investors on the nature of the product which they plan to eventually create.

Further complicating matters is the complex financial status of the ICOs. Though the complicated language surrounding the funding platforms often shroud the realities of what they’re offering, some analysts argue that ICOS are exchanges offering securities to eager investors. If this is the case, then the exchanges would fall under the regulatory authority of the SEC, or the Securities and Exchange Commission, and thus would be subject to its complex regulations for securities and commodities offerings.

But some companies within the world of cryptocurrencies have taken steps to secure a place in the evolving regulatory framework of the industry. In particular, Coinbase, a popular cryptocurrency wallet, began talks to obtain their own federal banking charter. This classification would be one of the first steps in the long road to governmental embrace of cryptocurrencies as an equivalent to traditional, fiat money.

But before this can happen and talks can transition into actualized progress, the United States government must fight to establish a clear regulatory and definitional framework for cryptocurrencies, Initial Coin Offerings, and blockchain technologies.

Typically, this right would likely come down to the power of the United States Congress. Congress holds the power to force regulatory agencies, including the CFTC and the SEC, to adhere to and enforce specific definitions and regulations on the industries that they are tasked with managing. In addition to creating a unified and binding framework, the involvement of the federal government would help to decide which agency is in charge of enforcing and regulating the evolving industry.

Unfortunately, the U.S. Congress has followed its normal strategy for responding to difficult situations: complete silence. The legislative branch has yet to come forward with a set of substantive bills on the subject. This means that the regulatory agencies of the U.S. financial sector, including the Security and Exchange Commission and the Commodity Futures Trading Commission, continue to squabble, releasing their own statements on how cryptocurrencies might fit into the existing legal framework for financial regulation.

This guide will provide a brief introduction into the regulatory agencies that are most pertinent to the evolving regulatory place of the new cryptocurrency sector.

The SEC Strategy: A Balanced Approach

The SEC is the regulatory authority tasked with regulating and evaluating securities transactions. They officially consider most cryptocurrencies to be securities, and argue that those companies which sell cryptocurrencies or allow the sale of them on their website must register as securities exchanges and follow the applicable laws associated with registration.

The primary historical basis for this classification comes from the Howey Test, a 70 year-old test to determine whether or not an entity classifies as a security or security exchange. The qualifications, according to the test, are clear. If an asset includes investment in a common venture, the potential expectation for profit, and the reliance on the efforts of the creators of a product, then it is a security.

But the agency’s view on cryptocurrencies is evolving all the time. In 2017, the commission opened up on their opinion regarding digital assets, saying that ICOs are “sometimes” to be considered exchanges, and that their coins are sometimes considered to be securities.

The SEC statement outlined that this classification means that cryptocurrencies are required to adhere to strict standards that are usually applied to securities. Another SEC statement this year expanded this strict application of existing laws to a variety of blockchain enterprises, including wallets and exchanges alike.

The agency hasn’t just been talk, either. February 2018 was a major month for the organization as they served subpoenas to hundreds of ICOs that were accused of selling “unregistered securities. The chairman of the SEC, Jay Clayton, expanded that the organizations had allegedly failed to comply with the securities laws which are applicable to their situation.

Additionally, the director of the SEC Division of Corporation Finance, William Hinman, expanded in a Congressional hearing that while the SEC has not banned Initial Coin Offerings entirely, they seek to implement a “balanced approach” to regulating decentralized currencies, citing the continued evolving nature of the industry as one reason for the lax stance.

Hinman also elaborated on the possibility that some ICOs are not securities, saying that in theory, some coins without a central minting authority could fall out of the regulatory jurisdiction of the Securities Exchange Commission.

The CFTC Strategy: Embrace Of Cryptocurrencies

By contrast to the harder approach from the Securities and Exchange Commission, the CFTC strives to embrace cryptocurrencies, choosing not to classify them as securities. Their leaders have successfully argued before New York judges that cryptocurrencies like Bitcoin are not securities because they are not backed by the government, and they don’t have liabilities attached to them.

The commissioner of the organization remarked that the tokens offered in cryptocurrency crowdfunding platforms could eventually transform from a security to something else—possibly even a commodity. If the currencies transformed into commodities, this could throw the currencies into an entirely new bracket of regulatory possibility.

The CFTC has also made a concerted effort to show their favorable leanings towards Bitcoin. The organization provided crypto-organization LedgerX with the ability to create a futures market for the investment of Bitcoin, one under the regulatory jurisdiction and blessing of the commission.

The head of the organization has his own reputation for supporting the development of cryptocurrency technology, even embracing the loving hashtag #cryptodad, a happy nod to the senior professional’s love for furthering the technology.

The CFTC has worked with the SEC on several cases, though. One hearing between the SEC and the CFTC concluded as the latter commended the former on their creation of an evolving paradigm for cryptocurrencies being traded. The agency stressed, however, that the best approach to regulating cryptocurrencies on the blockchain needs to be one that allows for maximum growth and innovation in the developing industry.

Financial Crimes Enforcement Network: It’s Complicated

This branch of the Treasury Department of the United States is tasked with pursuing matters of financial crime, including money laundering and non-securities legal violations. For the most part, their stance holds that tokens traded in Initial Coin Offerings are considered to be money, the equivalent to fiat currency in the traditional economic system.

This is important to the FinCen because it allows them to regulate financial crimes committed using cryptocurrencies in the very same way that they would investigate and respond to the same crimes committed using traditional forms of currency. Specifically, this means that the sales done during Initial Coin Offerings must adhere to money transmitter regulations put forth by the Bank Secrecy Act.

FinCen also finds that there is a certain level of variation in the Initial Coin Offerings that various agencies seek to regulate, saying that while some could be the charge of the SEC, others fall under the authority of the CFTC. This distinction has to do mainly with the different types of legal violations that can arise from not adhering to federal regulations on currency.

While the CFTC and the SEC deal with violations concerning securities, FinCen is in charge of exploring criminal violations not involving securities or commodities, including money laundering.

The IRS: Focus On Tax Regulations

The Internal Revenue Service is the agency responsible for tracking incomes and collecting taxes. Consequently, their goal in classifying currencies should be to maximize their ability to fit under clearly taxable income. This motivation is corroborated by the organization’s official stance on the digital currencies, with the IRS expanding that cryptocurrencies sold classify as properties.

When this sale happens, the IRS argues that the income attained must then qualify for a capital gains tax, a hefty tax typically levied on stock traders. The agency recognizes that paying taxes on cryptocurrencies is an increasingly complicated undertaking. To try to combat the confusion, the organization released a guide on how to file taxes on crypto-gains.

Despite their interest in making sure that Americans know how to file the complex taxes, the IRS is clearly targeting cryptocurrencies in an effort to ensure that Americans know that they are subject to the same tax earnings that other capital gains are.

The efforts thus far have not been effective. The agency was forced to release another memo on March 23rd urging U.S. cryptocurrency holders to included earnings from digital currencies when they file their annual income tax return.

But, in part because of the anonymous nature of cryptocurrencies stored on the blockchain’s public ledger, many people still do not pay their taxes on the currencies. In 2015, only 802 people included their profits and losses in their annual tax filings.

Office Of Foreign Assets Control: Block The Bad Guys’ Wallets

This office of the United States Treasury Department is responsible for the enforcement of sanctions on individuals posing a potential threat to U.S. security, both foreign and domestic. As such, their primary interest is in preventing the anonymous and decentralized currencies from facilitating threats to the United States, and to prevent it from being used to fund terrorist operations overseas.

The agency explained that U.S. citizens who are on a list of sanctioned individuals will have their wallets tracked and monitored. Furthermore, the organization specified that US persons who do business with addresses who are on the banned list will also face potential sanctions.

There are significant obstacles to this process, however. Obtaining the addresses to cryptocurrency wallets alone would be nearly impossible. The anonymity of the blockchain, as well as the decentralized nature of the storage of information which it enables, makes it nearly impossible to figure out who is behind what address.

Still, the United States government has been able to do something similar before. Leaks from March of 2018 revealed that the National Security Agency was able to obtain the personal information behind cryptocurrency wallets all over the world.