The progression towards regulatory transparency for crypto assets in the US has been a slow one. Since FinCEN became the first federal regulator to release guidance for virtual currencies in 2013, we've seen various agencies slowly release tidbits of information.
Most recently, SEC Chairman Jay Clayton's remarks on Ether indicate that the SEC is taking a thoughtful (if somewhat backseat) approach to the regulation of crypto assets.
While this is no doubt good news, it casts into sharp relief the problematic reality for exchanges and token distributors: there is no comprehensive regulatory guidance.
A better way of saying that is that there is no guaranteed way for actors in the space to comply.
The lack of a cohesive regulatory approach is due to the number of federal agencies that need to weigh in. Blockchain is a technology that can be used for a wide variety of applications. As such, there are a number of regulatory bodies that will necessarily be involved depending on the function blockchain is used for.
The consensus that many existing tokens will be interpreted as securities has cast the SEC as the de facto leader in the push for a regulatory framework for crypto assets. In reality, there will be no meaningful solution until there is coordination between a group of regulatory bodies.
Let's take a look at who those regulators are.
FinCEN Draws First Blood
FinCEN (or Financial Crimes Enforcement Network) is a bureau of the United States Treasury tasked with the collection and analysis of information about financial transactions to prevent money laundering, terrorist financing, and other financial crimes.
FinCEN is the federal regulator responsible for administering the Bank Secrecy Act (BSA) of 1970, which requires US financial institutions to cooperate with the federal government to prevent the financial crimes listed above. I.e, most KYC/AML or internal compliance standards are established and regulated by FinCEN.
As it turns out, FinCEN was the first regulatory body to take any sort of official stance on digital assets. Back in 2013, FinCEN published their now famous (or infamous) "Guidance on Virtual Currency," which you can read here.
FinCEN's guidance was a watershed moment for an industry that was previously devoid of any regulation. The edict was of particular significance because it brought blockchain officially under the purview of federal regulation.
FinCEN's decision to label administrators and exchangers (although not users) of virtual currencies as money transmitters was equally as important. Much of the stringent and (arguably) disjointed regulatory US landscape can be traced back to this pivotal decision.
For the most part, FinCEN treats tokens traded in ICO's as money, allowing them to regulate financial crimes committed using cryptocurrencies in the same way they would respond to financial crimes committed with fiat currencies. In keeping with their guidance issued in 2013, this means that token issuances must adhere to money transmitter regulations pursuant to the BSA.
FinCEN's interpretation has driven exchanges operating in the crypto space to seek ATS registration, often through acquisitions. Coinbase's and Circle's acquisition of Venovate Marketplace Poloniex, respectively, are both attempts to buy the . Overstock's subsidiary tZERO was able to utilize an ATS Overstock acquired from a previous transaction.
In March of this year, FinCEN dealt a major regulatory blow to would be token issuers in a letter to Senator Ron Wyden (OR) indicating that ICOs must follow federal regulatory requirements for money transmitters. That means anyone planning a US based ICO should be aware that their organization is running the risk of prosecution for unlawful money transmission.
The SEC Strikes Takes a Backseat Approach
The SEC is an independent federal agency whose primary directive is to regulate and evaluate securities transactions. Much of the SEC's focus has been directed towards evaluating whether or not tokens issued in ICOs will be considered securities.
Issuers and regulators have looked to the Howey Test as a guide to determine the classification of tokens. The Howey Test is a 70 year-old test established by the Supreme Court that is often used to determine whether or not an instrument constitutes a security.
The four prongs of the Howey Test are not the only determinants used to render a decision on 'securitiness' of a token. 'Manner of Sale' has also been discussed by leaders in the space such as Joshua Ashley Klayman and Marco Santori as a factor that could influence the SEC's interpretation of a token's status.
The manner of sale refers to the messaging and intent of the issuer. Even if a token would not be considered a security, the token could may be considered a security IF the issuer promoted the token with explicit promises of returns.
The SEC appears to be taking, for lack of a better term, a 'wait and see' approach. Chairman Jay Clayton's recent statement about Ether and general guidance was a step in the right direction, but it was a far cry from a comprehensive regulatory framework or even a firm stance.
It is possible that the SEC will take a step back and simply let the courts have the final say on the status of crypto assets. Given the high levels of fraud in the ICO realm, it's almost inevitable that courts will begin to see an inflow of class action lawsuits.
In order to render a verdict, courts will by necessity take a stance on the status of crypto assets. Perhaps the legal status of crypto assets will come not from a federal regulator, but from our judicial system.
FINRA Keeps an Open Mind
FINRA (or Financial Industry Regulatory Authority) is a private group and self-regulatory organization for the financial services industry. They are a member organization whose edict is to regulate and provide transparency into member brokerage firms and exchange markets.
As the primary regulator for liquidity providers in today's financial ecosystem, their participation has been a highly sought after badge of credibility in the crypto space. There have been market makers and broker dealers operating in the crypto space such as Genesis Trading that have become members, and there is a great deal of push to increase that number.
For the most part, FINRA has taken a cautious but open approach to crypto assets. FINRA has recognized the need for liquidity in the burgeoning market as well as regulation and transparency. They have tentatively accepted several new member whose activities are concentrated in crypto assets.
Recently, FINRA sent a memo to its member organizations asking them to report any and all activities related to digital assets. While not unexpected, this is a positive indicator that the organization is taking the need for regulation in the crypto market seriously.
The CFTC Opens its Arms
The CFTC (or Commodity Futures Trading Commission is an independent federal agency created in 1974 to regulate futures and options markets. Their mandate is primarily to keep markets open, transparent, and free of fraud pursuant to the Commodities Exchange Act (CEA) of 1936.
The CFTC has arguably been the most accepting of all the federal regulatory agencies that touch crypto assets. Chairman Christopher Giancarlo reassured investors back in February when he spoke positively on the subject of digital assets at a Senate Banking Committee.
Giancarlo stated, among other things, that "We owe it to this new generation to respect their enthusiasm for virtual currencies, with a thoughtful and balance response, and not a dismissive one."
In the same hearing, Giancarlo espoused an opinion that ran counter to the Jamie Dimon 'blockchain not bitcoin' narrative, indicating a nuanced understanding of the space as well as a desire to listen.
In May, the CFTC published explicit guidance for crypto assets to exchanges and clearinghouses registered with the CFTC. The report covers what the CFTC interprets the majority of crypto assets as (commodities), in addition to what kinds of trading activities fall under its jurisdiction, what types of activities require approval, and how other agency’s jurisdictional interpretations interact with its own.
The IRS Doesn't Surprise Anyone
It's not exactly a secret that people don't like the IRS. It's not too difficult to believe given that their primary responsibility is to separate Americans from between 20% and 40% of their annual income.
If anyone was hoping for a progressive taxation approach to crypto assets, they were sadly disappointed. Given the IRS' mandate, it should come as no surprise that their objective for crypto assets is to classify them in a way that most closely aligns with a status of taxable income.
The IRS has (by and large) interpreted crypto assets as a form of property subject to capital gains tax. The issue with this decision is that not every sale of a crypto asset represents a conversion into fiat currency (as would be the case in the sale of a stock or financial instrument).
Some people do transact in crypto with expectation of an exchange of goods or services. Unfortunately, the IRS has chosen to not make the distinction between "cashing out" and exchanging goods. For instance, say you wanted to buy a car with bitcoin. The IRS doesn't care if you sell your bitcoin for cash and buy the car or if you buy the car directly with bitcoin - they take the view that you are cashing out of a digital asset.
The annonymity inherent to most cryptocurrencies has made tracking difficult. Indeed, the IRS (and any other government agency, for that matter) can only track transactions that happen at the exchange level. Users to conduct peer-to-peer exchanges can not be traced, and therefore can't be taxed.
The statistics reflect the difficulty of the task. In 2015, only 802 people filed profits and losses on the sale of digital assets on their returns. The IRS has since published a series of guidelines on how to file gains realized on the sale of crypto assets, the latest (and most comprehensive) of which came on March 23rd of this year.