Since blockchain technology and cryptocurrency are catching on quickly, laws and regulations have a long way to go to catch up. This includes tax regulations and money transmission laws.
For example, token sales have interesting tax implications — where the token is not a security, the proceeds of the sale will generally constitute some form of revenue, deferred revenue as one example (for more on token sales, click here for Part 1 of this series about securities laws).
Tax regulations you need to be aware of
A successful token issuer could be left with a substantial tax bill following a sale, so companies considering such token sales should consider their available options to mitigate the tax burden. This could include organizing the company in, and conducting the sale from, a jurisdiction with more favorable tax rates. For example, organizing an Ethereum-based sale in Switzerland allows the company to benefit from their lower corporate tax rates.
Additionally, the IRS currently classifies bitcoin, Ethereum, and other cryptocurrencies as “property”, not as currency. This means that individuals and organizations receiving, holding, or otherwise transacting in cryptocurrency are required to account for fluctuations in value. What could this look like? If a company receives $1,000 worth of bitcoin for their product, but exchanges the bitcoin into USD after the bitcoin has appreciated 50 percent, then the company will have to report $500 in capital gains, in addition to any tax burden from the sale.
Money transmission laws might also apply
Some owners of cryptocurrency may be surprised that laws covering money transmission could apply to them. These rules and regulations generally apply when an intermediary is involved in moving money (or something else of value) between two unrelated people. Money transmitters are companies like Western Union, PayPal and Square. The Financial Crimes Enforcement Network (FinCEN) — a division of the Treasury Department — has issued administrative guidance that suggests that many blockchain and cryptocurrency applications may be money transmission.
First, some background:
- An “exchanger” is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.
- An “administrator” is someone engaged as a business in issuing a virtual currency and putting it into circulation, with the authority to redeem or withdraw it from circulation.
In 2013, FinCEN stated that an “administrator” or “exchanger” whom:
(1) accepts and transmits a convertible virtual currency, or
(2) buys or sells convertible virtual currency for any reason
is a money transmitter unless a limitation to or exemption from the definition applies.
FinCEN also said that someone who “creates units of [cryptocurrency] and sells those units to another person for real currency or its equivalent is … a money transmitter. In addition, a person is… a money transmitter if the person accepts [cryptocurrency] from one person and transmits it to another person as part of the acceptance and transfer of… value that substitutes for currency.”
Almost every state has a comparable regulatory regime designed to protect the average citizen when otherwise unregulated financial service providers control consumers’ funds. Many states are also adopting legislation that specifically governs cryptocurrency. The BitLicense in New York, which requires licenses for certain cryptocurrency-related businesses to operate in the state, is one example.
So what does all this mean?
This overview of potential legal issues that arise in connection with blockchain initiatives, particularly token sales, is by no means exhaustive. Many other areas of law may be implicated, including digital signature laws, commodities and derivatives regulations, and other industry-specific regulations. And, this only captures U.S. law; jurisdictions around the world are being even more active in regulating these emerging technology’s applications. China recently banned all token sales, as well as the ability to operate a cryptocurrency exchange. Many jurisdictions are declaring that all token sales are securities issuances.
Each blockchain company or initiative, especially those involving the issuance, administration or exchange of cryptocurrencies or other digitized assets, must first consider which laws, rules and regulations could apply. They should also keep their eyes open for new laws which could be offered at any time. And, especially if they operate overseas, they should pay close attention to the various restrictions and prohibitions around the world.
Attorney Austin Mills leads the Blockchain and Cryptocurrency Group at Morris, Manning & Martin, LLP. The group is also holding a “Beyond Blockchain 101” event on Nov. 13 for those who want to learn more.