The infrastructure bill that recently passed the U.S. Congress contains digital asset provisions designed to generate revenue and could hinder cryptocurrency growth and stifle innovation. The regulations require any party involved with the exchange of digital assets to register as a broker and report all cash payments exceeding $10,000 to the IRS.
Significant backlash from blockchain stakeholders has initiated debate regarding the bill’s definition of a "broker." The current definition requires developers, cryptocurrency startups and even miners to enact know your customer (KYC) measures.
In addition to the infrastructure bill, the SEC, providing little guidance, has shuttered Coinbase’s lending program with the threat of a lawsuit. The SEC has also proposed registration requirements for stablecoin issuers. Both these moves by the SEC have implications within DeFi as more regulations arise to minimize the decentralized nature of crypto.
One facet of the bill requiring attention is the new reporting standards laid out by the IRS. While myriad crypto funds/custodians already possess the capabilities to record and file transactions, experts are expecting difficulties tracking exchanges in the market. All crypto funds/custodians will need to ensure their technology and staff can maintain the records essential to ensuring that all transactions are being properly reported.
The SEC is continually enacting new rules and regulations that will make digital assets a more centralized market. Shutting down Coinbase’s lending program was a move toward a centralized future that exemplified the governing body’s increased desire for structure and providing utmost protection to the investor and ensuring lenders stay whole.
Crypto funds and custodians should acknowledge the possibility that the SEC could shut down other lending programs, or further expand their reach into the world of crypto products. Changes in the regulatory landscape have the potential to dramatically alter how custodians do business with their client firms and custodied assets.
Additionally, potential stablecoin regulation poses a serious concern to both custodians and market participants. Crypto funds and custodians should be cautious when choosing stablecoins and should closely examine both liquidity structures and regulatory adherence. Currently, the largest stablecoin is Tether, and the current controversy surrounding its backing could cast doubt on the credibility of similar products.
Historically, the IRS has classified digital assets as property with associated general property-tax-transaction principles. Cryptocurrency exchanges are not in the habit of producing 1099 tax reporting forms because, for now, the purchases or sales of digital assets are subject to income taxes.
The infrastructure bill’s digital asset reporting requirements aim to extract funds from digital asset holders who misreport or underreport their taxes by obligating cryptocurrency exchanges to produce Form 1099-Bs. However, unintended consequences due to opaque phrasing within the bill will also stifle innovation in the blockchain space by forcing wealth managers to produce 1099s when transmitting digital assets. Steep penalties from the IRS for each incorrect, incomplete or missed report of digital asset transactions may be a detriment to wealth managers handling digital assets at all. Wealth managers who choose to handle digital assets will need to ensure they have the necessary practices in place to accurately complete the new reporting requirements.
Even more alarming to the cryptocurrency ecosystem, the bill’s reporting requirements extend to all transfers of digital assets, regardless of there being a sale or exchange. The IRS will have the ability to trace all transfers of digital assets, creating a conflict between digital assets’ trademark security/privacy and protecting against the risks of failing to report necessary information regarding transactions.
Both the infrastructure bill and positioning of the SEC mark milestones that will alter the digital asset landscape. Regulators have been eagerly trying to catch up with the blockchain revolution, and these moves have elucidated their plans, setting the stage for what should be expected moving forward in the cryptocurrency space.
Advancements in economic operations lead to constant upheavals in the market. This has been true for hundreds of years and regulators are on constant watch. Today appears to be no different.
Amanda Bonello and Jessica Hillier are associates at Capco, a global technology and management consultancy specializing in driving digital transformation in the financial services industry.