Is Regulation Bad For Crypto?

The crypto market, once thought of as the wild west of finance, is beginning to be tamed. The cryptocurrency market has grown to the point where regulators worldwide are taking notice and instituting regulations. Regulations vary widely from country to country, and in the U.S., they can vary from state to state. 

What are the pros and cons of regulation and crypto taxes? Are they needed?

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Is Cryptocurrency Regulated?

The types and extent of crypto regulation depend on where you live. In countries where the government wants to maintain tight control over its citizens, such as China, Russia or India, cryptocurrencies are heavily regulated or banned. In other countries like Singapore and Portugal, regulators and tax authorities have taken a soft stance on cryptocurrencies. These countries believe that the crypto ecosystem should be monitored to prevent illegal activities, but they also believe that cryptocurrency innovation shouldn’t be stifled by over regulation. 

Crypto regulation in the U.S. has been a bit foggy as no clear regulatory framework for certain aspects of cryptocurrency, like use of decentralized finance (DeFi) applications, has existed before November 2021. There isn’t even uniformity when it comes to classifying cryptocurrencies as an asset class. The U.S. Securities and Exchange Commission (SEC) typically views cryptocurrencies as securities; the Commodity Futures Trading Commission (CFTC) considers Bitcoin a commodity; the U.S. Treasury Department calls Bitcoin a currency; and the Internal Revenue Service (IRS) classifies cryptocurrencies as property. Crypto companies that operate in the U.S. would be significantly aided by more uniformity in how cryptocurrencies are classified. 

Currently, some cryptocurrency regulations in the United States exist, and more are in the works. The $1 trillion infrastructure bill recently passed by the House of Representatives was signed into law by President Biden on November 15, 2021. This bill contains a couple of cryptocurrency provisions that may significantly impact the U.S. crypto market, in both a good way and a bad way. 

The first provision requires companies that facilitate crypto trades to report tax information about those trades on a 1099-B form and send it to the IRS and the customer. This provision could be considered a good thing, as it could relieve some of the complicated tracking of trades that crypto investors must do. However, it could also become a nightmare for crypto investors who deal on multiple exchanges and keep most of their crypto in a self-custodied wallet. 

It would be possible for an investor to buy a cryptocurrency on 1 exchange, move it to their wallet, then at a later date transfer it to another exchange to sell it. In a case like this, it will be impossible for the exchange on which the crypto was sold to report the cost basis accurately. This scenario could lead to vastly overstated gains on 1099-B forms, requiring the investor to go back and attempt to sort out these inaccuracies themselves.

Another possible issue with this provision is the vague description of the word "broker," which could lead to not only crypto exchanges having to comply with the requirement but also miners, network validators and software developers. It is also unclear just how these regulations could impact DeFi. This provision could be especially bad for DeFi by imposing reporting requirements that would be difficult or impossible for decentralized applications (dApps) to report.

Another provision expands the section of the U.S. tax code 26 U.S. Code § 6050I to include digital assets. The change requires businesses and exchanges to report crypto transactions over $10,000 to the IRS. It states that businesses and exchanges must collect your personal information, including name, address and Social Security number and put that in reports. While this action doesn’t put a burden on the individual, it does raise questions about privacy. Also, it raises questions about how personal information will be protected. On the bright side, these provisions don’t take effect until 2024, so there is time to iron out issues. 

How Is Crypto Taxed?

As with crypto regulations, how and if they are taxed varies widely from country to country. At least 11 countries have no taxes on cryptocurrencies or very few instances where they would impose taxes. 

In the U.S., crypto taxes have been based on a 2014 IRS ruling that states they will be treated as capital assets, like stocks and bonds, rather than as a currency. So just like selling stocks or bonds, if you sell or exchange your crypto and realize a profit, you owe capital gains taxes on those profits. The amount that you owe also depends on how long you have held your crypto. Crypto sold for a profit after holding it for more than 365 days is taxed as long-term capital gains. On the other hand, if you held the crypto for less than 365 days and sold it for a profit, you owe short-term capital gains taxed at a higher rate.

Pros of Cryptocurrency Regulation

Regulations can be good or bad depending on the specifics of the regulation and the overall number of regulations. Some regulation is needed, but over-regulation could kill or limit innovation and growth in the crypto market. On the plus side, regulation expands the investor base by bringing more legitimacy to the crypto space. Legitimacy can increase institutional investment in cryptocurrencies by hedge funds and other institutions. 

Cons of Cryptocurrency Regulation 

One of the largest threats to cryptocurrency is over-regulation of the industry. This scenario could smother the continued growth of the crypto market. Also, regulations that put too many burdens on individual investors could cause many to not want to get involved with cryptocurrencies.

Where To Safely Buy Cryptocurrency

Several brokerages and exchanges where you can safely buy cryptocurrencies operate. Webull, eToro and Interactive Brokers (IBKR) are all solid choices. Of the 3, eToro offers the most extensive selection of altcoins, followed by Webull then IBKR. 

Coinbase Global Inc. (NASDAQ: COIN) is safe and provides a vast selection of cryptocurrencies. It is also an excellent choice for anyone new to crypto with its user-friendly platform. For those with a little more experience, Coinbase Pro offers a more sophisticated trading platform and a discount on trading fees.

Cryptocurrency Lawsuits

The SEC has not been shy when going after anyone it deems has violated regulations it has set for the cryptocurrency industry. On Dec. 22, 2020, the SEC announced that it had filed an action against Ripple Labs Inc., alleging that it had raised over $1.3 billion through an unregistered digital securities offering. The complaint alleges that Ripple Labs raised funds beginning in 2013 through the sale of XRP tokens to investors in the U.S. and around the world. 

Ripple is arguing that the SEC failed to give fair notice that it considered XRP a security. The defense team has also asserted that the SEC has not only failed to give fair notice on XRP but also for cryptocurrencies in general. Key to the defense's strategy is the deposition of former SEC Director of Corporation Finance William Hinman. In June 2018, Hinman gave a speech in which he said that Ethereum’s token Ether was not a security even though it was launched in an ICO. 

Reports surfaced on Sept. 4, 2021, that the SEC is investigating the decentralized exchange (DEX) Uniswap. According to the Wall Street Journal, which cited sources familiar with the investigation, the SEC will look into how investors interact with the exchange and how Uniswap is marketed. 

On Sept. 1, 2021, the SEC issued Coinbase a Wells Notice about its Lend program. The Wells Notice is the SEC's way of letting a company know it will sue them in court if it proceeds. The Coinbase Lend program would have allowed investors to lend their USD coins to Coinbase in return for a 4% yield. After considering their options, Coinbase decided not to launch the Lend program.

The concerning thing is that Coinbase had been interacting with the SEC for months regarding the program. After Coinbase officially announced the program in June, the SEC stated that it considered the Lend program to be a security. Despite numerous attempts by Coinbase to get the SEC to provide some explanation, the SEC refused. The SEC will only say that it assessed the Lend program through decades-old Supreme Court cases called Howey and Reves tests, but it will not provide additional details. 

It is concerning that the SEC uses 75- and 31-year-old cases to assess digital assets and refuses to give future clarity. 

Should Cryptocurrency Be Regulated?

Cryptocurrencies do need regulation, but regulators need to be careful not to stifle innovation or drive away investors with burdensome requirements. Having at least some regulations can help further legitimize the crypto space.

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