Many are proclaiming 2022 the year of crypto and it’s hard to argue against it. What began with Bitcoin in 2009 has now evolved into a thriving ecosystem of decentralized currencies and applications. Along the way, users and investors of all backgrounds have explored the various ways blockchain technology can simplify daily transactions and create a smart economy using our IoT. The edge of this expanding universe has yet to be found, but its rapid expansion has pushed crypto into the public eye and now the political system is grappling with the changes needed to both accommodate and regulate this system. Because of this legislative push Congress is considering a potential crypto trader tax and many anticipate that 2022 will cement crypto’s place in the political landscape.
As you might have guessed, a completely decentralized financial system surprisingly does not mesh with the government’s very centralized vision. For this reason, Congress’ $1.2 trillion Infrastructure plan included a provision to enforce new tax rules on crypto transactions as well as expanding reporting standards for digital assets. Ironically, the crypto tax provision is intended to reduce tax evasion – implying that crypto users are evading approximately $28 billion in taxes. But crypto advocates took offense to this potential crypto trader tax for a very different reason.
Crypto Trader Tax: Defining a “Broker”
The updated definition of a broker as “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person” is too broad because the definition did not exclude members of the crypto economy like miners, software developers, and stakers. As a result, they would have to file with the IRS to provide transaction details such as users’ names and addresses. In most cases it is impossible for miners and developers to even gather this information and some are worried even more blockchain applications could be affected by the added legal complexity.
In response, groups like The Electronic Frontier Foundation, the Coin Center, Fight for the Future, and the Blockchain Association have led a coordinated lobbying effort to alter this definition. Their campaign helped motivate the Wyden-Lummis-Toomey Infrastructure Bill Amendment created by Senators Cynthia Lummis (R-WY), Ron Wyden (D-OR), and Pat Toomey (R-PA).
The amendment would explicitly eliminate validators, protocol developers, as well as hardware and software makers from the bill’s ramifications. Yet, the White House came out in support of its more restrictive competitor, put forward by Sens. Portman, Warner, and Sinema. Ultimately, even this amendment was rejected due to “politics” – more specifically opposition from Sen. Richard Shelby, R-Ala because his unrelated defense amendment had been rejected.
Although the definition could still be loosened, the bill has already passed the Senate. But after recent negotiations fell flat, House Speaker Nancy Pelosi pushed the deadline for passing Biden’s infrastructure spending bill to October 31st which could be a trick or treat for crypto users depending on the final verdict.
Still, the pay-for-provision is ultimately unlikely to severely impact the crypto market because the definition is so broad even internet or telecom service providers could be affected – almost guaranteeing a legal battle. While the infrastructure bill could pass the House without an amendment to the broker definition, it will likely be corrected in a secondary process like what happened earlier to the defense bill.
In the grand scheme, this political battle symbolizes how regulatory efforts could undermine huge tenets of the crypto community and even digital privacy with some going as far as describing the shift as a step towards “mass surveillance”. Unfortunately this debate will likely get a lot worse before it gets better; but on a positive note, the provision is an undeniable sign that the government is finally taking crypto seriously.
As a result, federal bodies like the Treasury Department are racing to regulate the exponentially increasing crypto market but are struggling with how to approach regulation. The department has been meeting with industry participants since Treasury Secretary Janet Yellen recommended the department establish a regulatory framework for stablecoins. Now the Treasury is on track to issue a report outlining its framework for potential regulation.
The report will likely recommend stablecoin firms hold enough liquid assets to back up their currency’s value while touching on processes for creating new stablecoins, consumer protection, and security systems. In light of Solana’s 17 hour blockchain outage, the report could also discuss software requirements to make sure all networks are capable of handling large, simultaneous transactions.
Meanwhile, the most decisive voice – SEC Chair Gary Gensler – has tied his stance on crypto to that of investor protection saying, “we have a role as a nation to protect those investors against fraud.” Gensler is generally viewed as a hardliner when it comes to investor protection and market stability but has likened the $2.2 trillion crypto market to the wild west, rife with fraud, scams, and abuse.
During May’s Financial Industry Regulatory Authority’s annual conference, Gensler took it a step further saying that, “the investing public would benefit from more investor protection on the crypto exchanges”. Gensler has also brought Congress’ attention to his concerns saying, “these exchanges do not have a regulatory framework at the SEC or at our sister agency, the Commodity Futures Trading Commission” he added that without a market regulator for these crypto exchanges, there’s “no protection around fraud or manipulation”.
Yet, Gensler came under heavy criticism during a September Senate hearing, regarding the SEC’s ongoing battle with Coinbase. At the heart of the argument is a series of tweets from Coinbase’s CEO detailing how the SEC threatened to sue the exchange if it launched a product that allowed users to accrue interest by lending their coins.
Sen. John Kennedy: “The people and the companies that you regulate as chairman of the SEC, do you consider yourself to be their daddy?”
During the hearing, Sen. Toomey criticized Gensler’s approach, claiming that he was trying to regulate digital tokens through “enforcement” while pointing out the SEC’s lack of transparency in its process of classifying digital assets as securities.
The Future of Regulation
Despite the tug of war between policymakers and crypto advocates, the crypto community has long advocated for appropriate regulation although a crypto trader tax was likely not one of their first ideas. The lobbying effort that has occurred throughout this session demonstrates how organized and effective it could be if put to the task. As Elon Musk shared, it doesn’t seem possible to destroy crypto at this point but it is possible for governments to slow down its advancement.
Because it is an organic market fundamentally driven by its users, even if regulation comes into play it will likely serve as an obstacle rather than a fatal blow. As regulation is taken more seriously, the likelihood that crypto will be required to meet higher reporting standards is likely inevitable.
For example, President Biden’s proposed American Families Plan would require businesses’ cryptocurrency transactions valued at $10,000 or more be reported to the IRS. While this is only a small stab at government regulation, it’s worth noting that the IRS already considers crypto a form of property and is subject to taxation just like stocks or gold.
While the future of crypto is still unknown, the regulatory battle ahead is almost certain. However, crypto investors should not be worried. Even with regulation, the market will continue growing and the government’s interest in taxing crypto assets means it will be in the Fed’s best interest to keep crypto around. This is good news for crypto users who have been waiting for cryptocurrency to be taken seriously.
Yet the question remains, what impact regulation will have on cryptocurrency more generally. Overall, regulation could solve many of the problems associated with the decentralized system but on the other hand approaches like a crypto trader tax could easily stifle the creativity and growth that has allowed blockchain systems and cryptocurrencies to flourish. Finding the right balance is a process that will likely begin in earnest during 2022 but will take many years to perfect.
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