Regulatory Update

Crypto Rules Crackdown Looms for $150 Billion Stablecoin Market

Bloomberg Tax, August 15, 2022

Lawmakers in the US, the EU, the UK, Japan and others are considering rules that would overhaul the $150 billion sector. Several of these proposed restrictions are intended to bring issuers of the tokens -- which are cryptoassets designed to keep a one-to-one peg with a less volatile currency like the US dollar -- under the same financial regimes as payment providers.

More specifically, regulators want a say over the types of assets that stablecoin providers can use to fill their coffers, and are expected to require more detailed disclosures and fully-backed reserves. The changes could hurt some stablecoins, but already, providers are starting to adapt.

Stablecoins grew more popular as crypto adoption boomed, acting as a digital asset safe haven from volatile prices. They've attracted more scrutiny from authorities this year following the $40 billion collapse of stablecoin pair TerraUSD and Luna in May , which prompted concerns around the processes used to back different stablecoins. "The riskiness of a stablecoin fundamentally relies on what reserves it's backed by — in short, the greater the reserve, the lower the risk," said Sarah Kocianski, an independent fintech consultant. "Being able to accurately assess the riskiness of a stablecoin enables regulators to create appropriate rules, meaning companies' transparency around their reserves is vital."

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US Fed Opens Pathway for Crypto Banks to Tap Central Banking System

CoinDesk, August 15, 2022

The U.S. Federal Reserve said Monday it is publishing its final guidance for novel financial institutions to access its "master accounts," something these firms need to participate in the global payment system.

Monday's announcement would seemingly move the U.S. central bank one step closer to possibly allowing Wyoming special purpose depository institutions (SPDI), like Custodia (formerly Avanti) and Kraken Bank, access to these accounts so they would not need intermediary banks. The Fed first proposed guidance last year, opening up a request-for-comment process. Nearly 300 respondents filed comments, leading to a second public feedback process earlier this year.

In a statement, Fed Vice Chair Lael Brainard said, "The new guidelines provide a consistent and transparent process to evaluate requests for Federal Reserve accounts and access to payment services in order to support a safe, inclusive, and innovative payment system."

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Institutional Investors Are Increasingly Using Crypto Options Trading to Hedge Their Bets in Bear Market

CoinDesk, August 13, 2022

In the current bear market, crypto options trading has been a rare bright spot, building momentum even as crypto prices have plunged.

A number of crypto exchanges have noted rising trading volume after reaching lows earlier this year. Options strategies have figured prominently among institutional investors and even miners as they try to weather crypto's usual volatility and a downturn that could last for months, or longer, despite recent hopeful macroeconomic signs.

More recently, traders have been using the crypto options market to bet on ether (ETH) and hedge positions as the Ethereum blockchain's hotly anticipated Merge approaches. Panama-based derivatives platform Deribit, which is among the world's largest exchanges for crypto options trading volume, told CoinDesk demand is surging ahead of the Merge.

How fast crypto options trading evolves remains uncertain, even as firms add exposure and pinpoint the products and services that can help them manage risk. EDG CEO Chris Bae noted that miner and institutional platforms' use of derivative strategies remain in an early stage and that crypto options trading volumes "have yet to hit their j-curve when it comes to their adoption and growth."

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Tornado Cash's Sanctions Show Shift in Crypto Regulatory Focus

WSJ, August 12, 2022

The U.S. Treasury Department's decision to crack down on cryptocurrency platform Tornado Cash for allegedly being used to launder stolen funds—and the subsequent freezing of millions of dollars in assets by one of the largest U.S. stablecoins in compliance with the order—has prompted concerns of excessive government pressure from many crypto participants, particularly those in the decentralized finance sector.

The U.S. Treasury Department accused Tornado Cash, a so-called mixer platform that enables users to exchange cryptocurrencies with relative anonymity, of laundering billions of dollars in virtual currency, including $455 million allegedly stolen by North Korean hackers. The Treasury also identified and blacklisted dozens of wallet addresses associated with Tornado Cash. The sanctions block all property held by the platform under U.S. jurisdiction and bar U.S. companies and individuals from transacting business with it.

Crypto industry analysts say the sanctioning of protocols—essentially computer code—has become a key policy issue for the industry, which is increasingly concerned about the impact of broadening government intervention on the potential growth of crypto and the additional burden of compliance in a sector that sells itself on its privacy and decentralization.

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More Changes Are on the Way for Cryptocurrency Tax Reporting

Bloomberg Tax, August 12, 2022

Despite the setbacks, crypto is still huge—according to CoinMarket, the global crypto market cap is $1.1 trillion or more, depending on the day. That's about three times as much as the total amount of US corporate taxes expected to be collected in 2022.

Compared with those numbers, IRS collections from crypto have been unremarkable. In 2017, as part of an effort to obtain taxpayer information from Coinbase, US Magistrate Judge Jacqueline Scott Corley in San Francisco cited IRS claims that "only 800 to 900 taxpayers reported gains related to bitcoin in each of the relevant years and that more than 14,000 Coinbase users have either bought, sold, sent or received at least $20,000 worth of bitcoin in a given year." Judge Corley wrote that "[t]he IRS has a legitimate interest in investigating these taxpayers."

For the 2019 tax year, the agency announced a cryptocurrency compliance measure for taxpayers with a new question on Form 1040 at the top of Schedule 1: At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?

In 2020, the IRS moved the yes-or-no question to the front page of Form 1040 where it currently sits—with a tweak. It now reads: At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency? That means all taxpayers, even those without adjustments to income or other investments on Schedule 1, must answer a question about cryptocurrency use.

More changes are in store. While some platforms already provide information about gains and losses to taxpayers, the 2021 infrastructure law attempts to standardize reporting for tax purposes. The intent was to ensure that the IRS gets info and that crypto investors receive the same tax documents that stock traders receive. According to a 2021 letter from a group of senators, increased reporting would make it easier for taxpayers to "file their taxes more easily and promote higher compliance."

Form 1099-DA

While the IRS hasn't yet released a draft of the proposed form, we have some details. IRS CI Deputy Chief James Robnett confirmed this summer at the annual New York University School of Professional Studies Tax Controversy Forum that the IRS is working on the form—to be called Form 1099-DA (Digital Asset). The form will be used to report taxpayer cryptocurrency activity and will include the kind of information you'd traditionally see on Form 1099-B, like number and kind of assets, cost basis, fair market value, and holding period.

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What is the Future of Cryptocurrency Regulation?

BetaNews, August 11, 2022

Lawmakers are aiming to find a balance between regulation and crypto freedom. This is partly because, as it stands now, cybercriminals can take advantage of some of crypto's weaknesses. For example, cybercriminals often demand cryptocurrency payment when they launch a ransomware attack.

One piece of the infrastructure bill passed by Congress in 2021 requires cryptocurrency exchanges to report their transactions on 1099-B tax forms, just like a traditional broker would have to. Because this extra paperwork connects crypto transactions to individuals, the government will be better able to catch criminals capitalizing on crypto. This provision allows the government to keep track of what people earn from crypto so they can apprehend any individual trying to get away with tax evasion. It is set to take effect in 2023.

Regulation That Could Become Legislation

U.S. SEC Chair Gary Gensler suggests regulating crypto similarly to how traditional financial institutions are regulated and protected. Three possible options for crypto regulation that could come to pass in the future include expansion of the wash-sale rule, implementation of the de minimis rule, and regulation of stablecoins.

The Wash-Sale Rule

One way cryptocurrency could expand in the future is via the current wash-sale rule. The wash-sale rule currently applies to stocks and securities. It prohibits investors from claiming tax deductions on assets they claim at a loss, only to buy back the same securities or purchase substantially identical securities within 30 days of the deduction. This does not currently apply to cryptocurrency, meaning investors can claim deductions on cryptocurrency while holding it.

In 2021, President Biden proposed expanding the wash-sale rule to include cryptocurrency as part of his Build Back Better plan. The plan failed to pass the Senate, but not because of the proposed expansion of the wash-sale rule. It will likely continue to show up in legislation again – and possibly get passed.

De Minimis Tax Rule

Another possible area for regulation is the implementation of the de minimis tax rule. Under this rule, investors do not have to report their crypto transactions or pay taxes on crypto under a certain dollar amount.

Stablecoin Regulation

An entirely possible solution that could take place in the near future is the regulation of stablecoins. Stablecoins are easy to trade because each one has a value of $1. However, because cryptocurrency and stablecoin are not regulated, it is difficult to guarantee their stability. For example, in May 2022, the stablecoin Terra Luna dropped from its $1 amount, resulting in a crash of its cryptocurrency, Luna. Crashes like these encourage federal regulators to continue pushing for crypto regulation. They believe investors and the public could benefit from added stability in the cryptocurrency industry, citing different benefits.

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Tornado Cash Crackdown Shows Limits of Regulating Cryptocurrency Services

WSJ, August 11, 2022

The U.S. sanctioning of a prominent cryptocurrency platform this week exposed technical gaps in the government's ability to prevent criminals, national adversaries and extremist groups from using the services to launder money and finance their operations, analysts said.

Among the central challenges: Cryptocurrency platforms are increasingly run by computer code distributed across computers around the world, rather than by individuals facilitating transactions, analysts said.

The Treasury Department on Monday imposed sanctions against Tornado Cash, a popular cryptocurrency platform known as a mixer because it blends funds from different users and redistributes them, obscuring their origin. The Treasury Department accused Tornado Cash of laundering billions of dollars in virtual currency, including $455 million allegedly stolen by North Korean hackers. As part of the penalties, officials blocked all property held by the exchange under U.S. jurisdiction and barred U.S. companies and individuals from transacting with it.

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Issues Crypto Should Watch For in the Tornado Cash Sanctions

CoinDesk (Opinion), August 11, 2022

OFAC sanctioning Tornado Cash presents fascinating new questions about crypto's role in nuclear weapons proliferation. Tornado Cash got sanctioned, hedge funds might soon have to report their crypto holdings and we haven't even had a chance to look at the latest push to give the CFTC spot market oversight.

Something I've been hearing a lot recently from lawyers and regulatory-adjacent folks is that the Treasury Department's Office of Foreign Asset Control (OFAC) is one of the few federal agencies you absolutely do not want to mess with. Whereas anyone can fight a Securities and Exchange Commission lawsuit or duke it out in court against the Department of Justice, OFAC can go hard.

Tornado Cash developer Roman Semenov told Bloomberg News in March that it would be "technically impossible" to enforce sanctions against decentralized protocols like the privacy mixer he helped build. The fallout was swift: Circle immediately froze about $70,000 worth of its USDC stablecoin on Tornado, crypto exchange dYdX blocked accounts that may have once interacted with Tornado, GitHub suspended not only Tornado's account but also Semenov's and now everyone's trying to determine what constitutes an interaction with a sanctioned address.

Tornado Cash is a protocol, one that was open source to boot and built on a decentralized framework. Unlike when OFAC sanctioned, another mixer, Tornado doesn't exactly have a business to shut down. It has a governance token. The token holders are responsible for voting to accept or reject various possible forks and whatnot. If those holders are not beholden to U.S. sanctions (i.e., they're not U.S. persons or they feel really really confident in their privacy setup) they may feel more comfortable continuing to operate business as usual.

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The Future of Crypto Regulation: Highlights from the Brookings Event

The Brookings Institution, August 11, 2022

Brookings's Center on Regulation and Markets and the Hutchins Center on Fiscal and Monetary Policy recently hosted "The future of crypto regulation," keynoted by Commodity Futures Trading Commission (CFTC) Chairman Rostin Behnam. Benham's keynote was followed by a discussion with experts representing an array of perspectives, including that of regulatory agencies, academia, and industry. Here are five takeaways from the event, which you can watch in its entirety here.

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BlackRock Launches a Private Trust to Give Clients Exposure to Spot Bitcoin

CNBC, August 11, 2022

BlackRock has launched a private trust offering institutional clients in the U.S. direct exposure to bitcoin.

The largest asset manager in the world revealed the new product in a blog post Thursday, though it was light on detail.

"Despite the steep downturn in the digital asset market, we are still seeing substantial interest from some institutional clients in how to efficiently and cost-effectively access these assets using our technology and product capabilities," the company said in the post. "Bitcoin is the oldest, largest, and most liquid cryptoasset, and is currently the primary subject of interest from our clients within the cryptoasset space," the post continued.

Thursday's news is the latest in BlackRock's foray into crypto. The company, which has about $8.5 trillion in assets under management, announced recently a partnership with Coinbase that allows its institutional clients to buy crypto, beginning with bitcoin. This also comes amid frustration by new institutional investors in the market keen to see the Securities and Exchange Commission approve a spot bitcoin exchange-traded fund. So far, only bitcoin futures ETFs have been approved.

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Regulators Weigh Asking Hedge Funds to Report Crypto Exposure

WSJ, August 10, 2022

The Securities and Exchange Commission issued a proposal Wednesday that would require large hedge funds to report their cryptocurrency exposure through a confidential filing known as Form PF.
Created after the 2008 financial crisis, Form PF was designed to help regulators spot bubbles and other potential stability risks in the otherwise opaque ecosystem of private funds that manage money for wealthy individuals and institutions.

The rule proposed Wednesday would add "digital assets" as a new asset class on Form PF and define the term. It requests comments on whether funds should report detailed information about the cryptocurrencies they hold, such as identifying them by name or describing their characteristics.

In the proposal, SEC staff noted that many hedge funds have been formed recently to invest in crypto, while some existing hedge funds have begun adding it to their portfolios.

Read more here.

News Articles

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Shiba Inu, Dogecoin Jump as Risk-On Behavior Returns to Crypto Markets

CoinDesk, August 15, 2022

Meme tokens shiba inu (SHIB) and dogecoin (DOGE) gained over 15% in the past 24 hours as risk-on behavior returned to crypto markets.

The rally came as ether (ETH) broke the $2,000 level on Sunday night ahead of the network's Merge event expected in September. Bitcoin (BTC) rose to over $25,000 for the first time since June.

SHIB rose as much as 30%, while DOGE gained 15%, before a price reversal in European morning hours as investors took profits. DOGE entered the top ten cryptocurrencies by market capitalization with a total valuation of just over $10 billion, ahead of Polkadot's DOT token.

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Applying Anti-Money Laundering Practices To NFT Market

Law360, August 15, 2022

The current "crypto winter" and related collapse of certain fintech projects and digital assets has resulted in widespread losses and has exposed risks and vulnerabilities within the digital asset landscape.

A number of recent controversies in the NFT space have led some to draw comparisons between NFTs that are digital collectibles and the high-value art market, which has historically been fraught with issues of money laundering and other illicit activities.

The sheer speed at which NFT sales are transacted, paired with the purported anonymity of the digital marketplace, renders the NFT space ripe for illicit activity. Bad actors can purchase an NFT from themselves and sell it at a loss to another account under their control to avoid paying taxes on the sale. Criminals can make laundered funds appear as legitimate funds generated from an NFT sale.

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Crypto Lender Celsius On Pace to Run Out of Cash by October

CoinDesk, August 15, 2022

Celsius Network, the crypto lender that filed for bankruptcy in July, appears to be in even worse financial straits than previously signaled.

A new court filing Monday from Kirkland & Ellis, a law firm the crypto lender hired to lead its restructuring efforts, included financial projections that Celsius will run out of cash by October.

The filing, submitted to the U.S. Bankruptcy Court for the Southern District of New York in advance of an upcoming hearing, also stated that the crypto lender holds $2.8 billion less in crypto than it owes to depositors.

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Crypto Org Eyes Legal Challenge To Tornado Cash Sanctions

Law360, August 15, 2022

The U.S. Department of the Treasury overstepped by sanctioning certain addresses associated with cryptocurrency mixing service Tornado Cash, a cryptocurrency policy group argued Monday, warning that it may pursue an administrative or legal challenge.

The Treasury's Office of Foreign Assets Control wrongly sanctioned several cryptocurrency addresses that aren't individuals or entities, but rather house computer code, advocacy group Coin Center said. Coin Center argued that the move creates due process concerns and implicates First Amendment rights.

"How can it be proper to add to the sanctions list not a person, or a person's property, but instead an automated protocol not under anyone's control?" the statement said.

The group said it's seeking to "engage" OFAC and is exploring a court challenge to the designation.

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Public Pension Systems Join Those Stung by Crypto Crash

WSJ, August 14, 2022

Among the investors who bet on cryptocurrency over the past year are pension funds that manage public workers' retirement savings. Now those funds are navigating the crash.

A Quebec pension fund made a $150 million equity investment in Celsius Network LLC last fall. In July, the cryptocurrency lender filed for bankruptcy protection.
A $5 billion retirement fund serving Houston firefighters said last October it had put $25 million into bitcoin and ether. Since that announcement, both cryptocurrencies have fallen by more than 50%.

"Of course we would have preferred otherwise," Houston Firefighters' Relief and Retirement Fund investment chief Ajit Singh said in an email. But "volatility and large swings are expected."

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Crypto Insurance Policies 'Popping Up' to Meet Frenetic Demand

Bloomberg Tax, August 12, 2022

Companies this year are scrambling to obtain cryptocurrency insurance as a hedge against catastrophic losses, paying dearly for relatively limited protection as they venture into the world of high-risk, high-reward digital assets.

"We're seeing crypto risk and coverage inquiries from all kinds of companies," said Jackie Quintal, a director at insurance broker Marsh McLennan. "Crypto is popping up all across financial services, tech, fintech, and other parts of the economy."

Demand now far outstrips supply—less than 2% of crypto-related risks are currently insured, said Edin Imsirovic, associate director at insurance credit rating agency AM Best—so those willing to sell policies can command rates several times those of traditional coverage.

Read more here.

Ethereum Just Pulled Off Its Final Test Run Ahead of One of the Most Important Events in Crypto

CNBC, August 10, 2022

Ethereum, the second-largest cryptocurrency by market value, just ran a final dress rehearsal ahead of a years-awaited upgrade that's been billed as one of the most important events in the history of crypto.

Since its creation almost a decade ago, ethereum has been mined through a so-called proof-of-work model. It involves complex math equations that massive numbers of machines race to solve, and it requires an abundance of energy. Bitcoin mining follows a similar process.

Ethereum has been working to shift to a new model for securing the network called proof of stake. Rather than relying on energy-intensive mining, the new method requires users to leverage their existing cache of ether as a means to verify transactions and mint tokens. It uses far less power and is expected to translate into faster transactions.

Read more here.

FTC Probes BitMart Breach, Marking First Crypto Case (Correct)

Bloomberg Tax, August 10, 2022

The Federal Trade Commission is investigating the operators of the BitMart cryptocurrency exchange over a December 2021 hack that led to consumer losses between $150 million and $200 million -- marking the agency's first known probe into crypto markets.

The investigation was disclosed Wednesday in an FTC order denying a bid by BitMart operators Bachi.Tech Corporation and Spread Technologies LLC to block the agency's efforts to compel them to turn over information. The companies had argued that the FTC's document request was overly broad and that some of the information was located overseas.

The FTC also said it was investigating whether the BitMart operators were complying with another federal law that requires financial institutions to safeguard sensitive customer data.

If the agency finds that the companies misled users about its cybersecurity protections or didn't comply with financial-services laws, it can impose fines and put them under a consent decree ordering them to change their practices.

Read more here.

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