CRYPTOCURRENCIES IN MODERN ESTATE PLANNING: THE CHALLENGES OF IDENTIFICATION, TAXATION, AND CRIMINAL LIABILITIES

September 10, 2022Articles, Criminal Liability, Estate Planning, Tax off
ABSTRACT

The explosive growth in ownership of cryptocurrencies in recent years has exposed the ever growing disconnect between legislation and social activity. What was once a novelty data file has become an increasingly frequent alternative to Fiat currencies with coins such as Bitcoin taking active roles in domestic and international economies and marketplaces. This comment seeks to provide tax experts and estate planning practitioners with a brief overview of the function cryptocurrencies, a summary of current asset identification for taxation purposes, and the potential for increased civil and criminal liability exemplified through a hypothetical. This comment focuses on current active law and does not discuss at length the possible implications of the multiple proposed cryptocurrency bills being put before the House and Senate of the United States as none have been passed into law.

Table of Contents

I. INTRODUCTION

The 21st century brought to life technological breakthroughs and challenges that no legal mind of the prior centuries could ever dream of. In the last thirty years, the clearest challenge to legal environment has been the innovation of, curation, and dissemination of information at lightning fast processing speeds. The legal community is left increasingly less capable of containing and defining advances in the digital space, such as cryptocurrency, though not for lack of effort. Current legal and regulatory landscapes remain significantly rooted in the traditional chronology of its own innovation and formulation, reliant on an archaic timeline consisting of months (if not years) of preparation to pass legislation. The law has yet to fully adapt to Moore’s Law when it comes to the speed at which technological advances are created and outdated.1 This makes most (if not all) efforts to legislate any current technology, rather than the underlying structures and principles thereof, largely ineffective by the time the legislation is passed.

In an industry where time is calculated by minutes, seconds, and fractions thereof, the law is behind by years, if not decades in language, understanding, and enforcement. As a result, practitioners2 who deal in technology within the United States must regularly consult guidance from relevant governing bodies such as the Federal Communications Commission (FCC), Federal Trade Commission (FTC), Internal Revenue Service (IRS), Office of Comptroller of the Currency (OCC), and Securities Exchange Commission (SEC) to determine what and when active legislation is applicable. Only then they reference applicable case law by state and federal courts to understand to what extent the legislative action and agency guidance has been applied in the past, effectively reducing their understanding to best guess and reasonable understanding when it comes to current technology and its application. As a result, practitioners concerned with ‘cutting edge’ technology rarely have any specific code or regulation to which they can refer. Instead, they must hope that they reasonably interpret the confusing patchwork that is the United States’ regulation of digital spaces.3

With the emergence of Cryptocurrencies, such as Bitcoin in 2018, reasonable reliance has become the lifeblood of a market that is standing witness to the forced marriage of regulation and common law, as the courts and agencies await passage of any one of no less than three proposed legislative actions. As of the final editing of this comment there are three active proposed cryptocurrencies bills in the United States4: S.4760 dubbed the “Digital Commodities Consumer Protection Act of 2022”4; H.R. 7614 known as the “Digital Commodities Exchange Act”5; and S. 4356 the “Lummis-Gillibrand Responsible Financial Innovation Act”.6 7 While all attempt to address what category of taxable asset cryptocurrencies fall under, they fail to properly cover the challenges of how to integrate cryptocurrencies into an estate plan or how their tax treatment is impacted by their underlying technology. Rather, they focus primarily on consumer protection, not the long-term complexities that arise out of owning cryptocurrencies and the blockchain technology that creates them. As “[b]lockchain is the tech[,] Bitcoin is merely the first mainstream manifestation of its potential.”8 The importance of understanding and appropriately regulating the technology behind cryptocurrencies cannot be empathized enough, and must eventually be adequately addressed in the grand scheme of society’s legal structures.

While the possible technological advances with blockchain are numerous, it is necessary to point out that there is, nevertheless, very real, blatant issues with their mass implementation. When it comes to using blockchain in the context of transactions, at what point are taxes due—and when due, how are they to be treated? While excellent for record keeping, lack of data portability between exchanges gives rise to issues of when and how cryptocurrency holdings are short or long term? How does a person or government agency determine the amount of loss to be deducted or gain to be taxed? These basic categorizations, thus far, have proved more complex than the IRS, OCC, and SEC would have you believe. When assessing instances of securities’ fraud, the process of creating and trading cryptocurrency on a whole shows gaps in the law (current and proposed), and the liabilities are still readily apparent.

The question presented is thus not simply if cryptocurrencies can be taxed, but how should the process involved in the creation of cryptocurrencies be taxed? Currently, all (non-cryptocurrency) transactions have an attachment of fees and taxes accompany transfers of assets. In the process of cryptocurrency creation there can be seven or more transfer points per unit created, depending on what definition of ‘transfer’ applies. If every stage is counted as a transfer, what other activities would unintentionally fall under the framework? Does the average person need to consider monitoring the value of the US dollar in their pocket and account for any gain/loss in the value on the world currency markets with each use? What entities would be responsible for tracking this? To whose wallet should those fees and taxes be sent? The proposed bills do not adequately answer these nor other fundamental questions.9 Furthermore, until the enacting date following the passage of one (or a combination thereof) of any of these bills, the patchwork of existing law cobbled together by IRS, SEC, OCC, and courts remains the controlling, albeit imperfect, applicable approach.

II. HOW TO IDENTIFY OWNERSHIP OF A CRYPTOCURRENCY WALLET

Traditionally, banks and government treasuries serve as funnel points in the economy. Treasuries control the ebb and flow of a currency’s availability, while the bank utilizes a singular, main ledger through which all monetary transactions of customers flow. This single ledger system is called a centralized ledger (also ‘general ledger’)10 due to the fact that all sources of inquiry about a customer’s available balance ultimately consult a singular ledger held by the customer’s bank. This allows the inquiring party to assume a significant amount of trust when checking good funds available in a customer’s account, which helps to minimize counterparty risk.11 With blockchain and cryptocurrencies, this ledger system is decentralized, which means every party involved not only with the transaction, but the processing of the blockchain, holds their own ledger.12 The architecture of this type of ledger removes the government and banks from the transaction sequence entirely, along with their ability to monitor and freeze assets. When assets are seized or frozen in a centralized ledger system, the singular ledger that is consulted renders an account, and all holdings within it, inaccessible to all parties seeking access to the account. To achieve the same ‘freeze out’ with blockchain’s decentralized ledger systems, every ledger that is involved in the blockchain process, not just the transaction, must be simultaneously frozen to prevent the individual from accessing their cryptocurrencies or other blockchain asset. While this immunity from freezes and seizures allows for greater control and access by the customer, which frees them from worry of crippling audits, it also requires a good-as-my-word honor system when it comes to asset disclosures and taxation.13

Currently, consumer control and self-monitoring of cryptocurrency is accomplished through wallets13 which play a fundamental role in the functionality of cryptocurrencies. Wallets are held on cryptocurrency exchanges and facilitate transfer, purchase, and sale of cryptocurrencies. They also serve as the means through which additional privacy measures can be added, such as double verification and increased data encryption.14 A wallet stores a user’s private key,15 which is a randomly generated sequence of numbers and letters that is only ever known to the user, and a public key,16 which contains some elements of a private key, but is primarily composed of random, mathematically generated numbers that represent each individual transaction. Public keys, along with their transactions, are displayed openly on the blockchain ledger of the traded cryptocurrency and serve as an unalterable history of origin for any single cryptocurrency unit while still protecting individual identity, such that at no point in time could a ‘John Doe’ be identified specifically as the owner of a cryptocurrency based on information on the blockchain ledger.17

This shielding of the owner’s identity18 in a transaction is called ‘pseudo-anonymity’, which is present at every step of a peer-to-peer19 cryptocurrency trade or through an exchange. To conceptualize pseudo-anonymity, imagine any account you hold where to identify who you are is done with the account ID number rather than your name, username, or email. Information about your account, such as amount of money in it, is the same but rather than identify the account and assets with belong to account holder Jane/John Doe, the available identity is facially void of any personal identifying information and is simply account holder ‘123456’. True identity can only be determined by cross reference to other information that eventually links the account to the name of its rightful holder. The appeal of cryptocurrencies’ double layered pseudo-anonymity (as both private and public keys provide pseudo-anonymity) is also a significant problem when it comes to traceability of ownership and management outside the digital space. In estate planning, ‘accountings’ of assets and funds that belong to an estate are often difficult enough to track with centralized ledger systems. This is especially so where you want to avoid commingling of funds.  With cryptocurrencies, despite their decentralized ledger format, it is nearly impossible to tell who has what without access to the wallet from the account holder’s end.  

This is to say that the biggest nightmare concerning cryptocurrencies and estate planning has yet to come to fruition. Currently, cases dealing with access, or lack thereof, to blockchain based digital assets are very limited. What caselaw there is does not paint the picture of an easy road ahead. Under 18 U.S.C. § 2701 (a portion of the Stored Communications Act “SCA”) it is unlawful for a party to intentionally access, or intentionally exceed authorization to a facility (such as an email or account on an exchange platform) that provides electronic communication services.20 In practical terms this means that unless a decedent grants express authorization to the executors of their estate, thereby granting them access to such information under their fiduciary duties, in a manner that complies with local laws, the fiduciaries of an estate cannot access so much as the decedent’s junk mail when trying to administer the estate.21 In context of cryptocurrencies this means a number of steps must be taken.

First and foremost, a testator or grantor must ensure that proper permissions are in place to allow the fiduciary party access to the relevant recovery emails, cellphones and other devices that partake in their multi-step verification process. This grants, at minimum, the fiduciary party the ability to recover lost passwords and usernames for various accounts held by the future decedent. Second, the documents must sufficiently identify what exchanges, wallets, and private keys were held and used by the future decedent, yet not in a manner that allows any other party (such as a beneficiary, filing clerk, or curious stranger at a public notary) to gain unauthorized or premature access to the accounts whereby they might remove any and all cryptocurrencies within it. As wallets hold the private keys and the private keys hold the cryptocurrencies, both function more like bearer bonds22 or a physical wallet—the one who holds it is presumed to own it, until proven otherwise. Evidence of this complication have appeared numerous times in the news, where cryptocurrency fortunes have been lost due to misplaced private keys which do not have a ‘forgot username’ option.23 Hence, many resources advise that private keys be written down and stored in a safe place,24 but in a world where the holder is the owner and where misplacing the physical is common, what is a practical mode of maintaining a cryptocurrency wallet as an asset of an estate once the holder dies?

A more traditional solution would be to store private keys in the same manner that many store their valuables—in a safe or security deposit box with limited the number of people who have access to it. Ideally, access would be granted strictly on a multi-party access basis, with at least two parties to be present and verified as having the proper authorization to access the contents of the safe or deposit box. For several reasons—many of which are well known to veterans of a wills and trusts class—even these best laid plans will often go to ruin if you wait long enough. Modernly, one could feasibly store the number on a USB drive, or in an encrypted file on their computer or phone, which appears a reliable solution, until one considers how often USB drives are lost or unintentionally wiped/corrupted, how often phones are stolen, and account passwords set to ‘remember me’ or auto fill logins. Furthermore, that increases the risk of a third party (such as a thief or repair person) coming across the private key, registering it to their own wallet on an exchange, and wiping it clean all within a short span. As wallets are specific to the issuing exchange, one wallet can hold multiple private keys, but because wallets cannot communicate from one exchange to another it generates a problem when it comes to calculating duration held and gain/loss taxation for cryptocurrencies.

The first taste of passed regulation for cryptocurrency exchanges on a federal level lies within the Infrastructure Investment and Jobs Act 2022 (the “2022 Jobs Act”), where a wide variety of reporting, verification and other policies and procedures across exchanges are to be required by law. While domestic exchanges aim to get ahead of the 2022 Jobs Act and have already begun implementing its required ‘Know Your Customer/Client’ policies,25 offering IRS tax reporting, exchanges based overseas, thus outside the jurisdiction of the United States, face no such obligation.26

As the application of these policy and procedures relies on the location and ethos of the exchange itself, a side-effect is that there is no current standardization of data transfers between exchanges. Thus, when cryptocurrencies from exchange A’s wallet are transferred to exchange B’s—but the owner of the cryptocurrencies is the same—exchange B reads the cryptocurrency as a new acquisition by the wallet holder and does not read any historical data. Therefore, exchange B ignores the fact that the account holder held the cryptocurrency in exchange A’s wallet for five years prior to the transfer. Meanwhile exchange A reads that their wallet no longer holds the cryptocurrency, as it was transferred to another wallet whose holder is ‘unknown’ (recall the double pseudo-anonymity effects of blockchain for all transactions) and would say that any gain/loss by the holder on those cryptocurrencies occurred on the date of transfer, despite the reality that only one owner exists; she simply moved her cryptocurrencies from exchange A to exchange B.

The informational chase this creates is analogous to the following: Johnny has spent his entire life (fifty plus years) building up his savings in a Wells Fargo account (“WF account”). For whatever reason, Johnny now wants to open an account with Chase (“C account”), and transfers some or all his life savings to the C account. Chase is unable to receive or understand the historical data from the WF account, but nevertheless, accepts the transfer of money. Instead of reading it as Johnny’s life savings built over fifty plus years (as the historical data from the WF account would convey), Chase interprets that Johnny has won the lottery or come into some good fortune and the lump sum of cash is brand new to not only Chase, but also Johnny. Meanwhile, Wells Fargo only knows Chase by the C account number and cannot see that it is a bank, let alone Chase. Understandably, Wells Fargo believes that Johnny has now paid or granted the transferred sum to a third party who is not Johnny as it cannot see Johnny holds the C account. Both banks report the transfer activity as they see it: Wells Fargo as Johnny giving an unknown person a large sum of money, and Chase as Johnny coming into a large sum of money from an unknown sender. Depending on the sum of money moved, Johnny could find himself on the wrong end of the Bank Secrecy Act (the “BSA”, 31 U.S.C. §§ 5311-5336) which, as a means of thwarting money laundering under the Racketeer Influenced and Corrupt Organizations Act (“RICO”, 18 U.S.C. §1961-1968), provides required banking information reporting, regulatory, and supervisory activity for transfers over set amounts. This means that the federal government, based on the pure numerical record before them (as no identifying information is provided, only numbers) may deem that Johnny is possibly part of a larger criminal enterprise given the amount transferred. While further investigation easily uncovers the misunderstanding, that does not change the fact that Johnny would nevertheless be facing an audit and possibly further investigation.

Now, once a fiduciary party knows what cryptocurrency is held by an estate, what are they allowed to do with it? To what extent may they manage the wallet’s value, if at all? Given the volatility of cryptocurrencies, the knee jerk for many may be to liquidate the risk as soon as possible once the holder dies to avoid a sudden drop in value within the hour. Another response might be that it should be managed and maintained until the close of the estate. However, unlike securities or commodities, cryptocurrencies do not pay interest or dividends, so the only point of taxation is upon the gain/loss calculation at their point of sale. Now the question becomes, was this the original wallet or was it held elsewhere and transferred? If so, which wallet’s date of acquisition does the estate use? What if—like many services—the exchange purged (i.e. erased) accounts that have fallen into disuse? Do records of the years of prior holding in a discarded wallet proverbially go up in smoke? If the executor does not have access to all this information who do they contact? Do the regulations in the country where the wallet’s exchange is based apply or does the law of the country and state of where the holder died apply? This is all presuming the executor even knows of the wallet—it is entirely possible they are never even alerted to its existence.

Blockchain lovers would say this does not matter because the history of the transactions of all cryptocurrencies are available on the blockchain ledger. However, because only public keys are recorded on the blockchain ledger, when one user is transferring cryptocurrencies between their own wallets, the only way to access which public key transactions went with which private key is with access to the wallets—the blockchain itself reflects only that the public key 54658213 transferred “x” amount of cryptocurrency to public key 85492213.  It does not provide information such as: WF account transferred x amount to C account; nor Johnny’s Wells Fargo account transferred x amount to Johnny’s Chase account.

III. UNDERSTANDING THE CREATION AND FLOW OF CRYPTOCURRENCIES

For the living, a different problem presents: how does one treat cryptocurrencies, a digital asset under the 2022 Jobs Act, on their taxes and what reporting rules apply? When doing taxes and asked if they have or plan to partake in cryptocurrencies within the last twelve months or next twelve months, what is the penalty for not knowing and erroring in responding ‘no’ rather than ‘yes’? As with most cryptocurrency topics, the answer is more nuanced than the average person might think.

The reason for this is because of a step in a cryptocurrency’s creation called ‘mining’. Simplistically speaking, mining is the process of generating blocks along a cryptocurrency’s blockchain, where each new ‘block’ counts as a unit of that cryptocurrency.27 This term can be deceptive when thought of within its colloquial definition. At its core ‘mining’ of cryptocurrencies is effectively a ‘race’ (e.g. the process of digging) amongst computers to find a solution (e.g. the ‘valuable material’) to a mathematical question (e.g. the proverbial earth) with the reward for finding the solution (e.g. the miner’s fee for the time spent digging and finding the valuable material) being fractional amounts of the cryptocurrency being mined. Initially this could be accomplished with a basic home computer of the late 2000s; however, today entire server centers are dedicated solely to the purpose of ‘mining’. Regardless, this brief answer does not adequately cover the unique challenges of the process when it comes to the detailed nature of tax risk and liabilities.

As stated, the mining process starts with presentment of a mathematical problem across the mining network, which comprises a pool of networked computers that share processing power and connect individual ledgers via the internet. Once the problem is received the miners begin ‘mining’ for a solution, not necessarily the solution. Once one solution is found, it is shared across the network. While the first miner who solved it receives a reward,  the other computers verify the proposed solution to see if it is correct. Only 51% or more of the miners must concur with the solution for the block to be added to the blockchain, then the miners move onto the next problem. The 49% or less who do not reach the same solution, or who fail to verify it receive no reward though they may only fail to verify the solution because rather than rounding up five decimals out, as the 51% did, their program rounded down. This process repeats indefinitely and the speed at which it moves dictates how much of any given cryptocurrency is generated.28 Presently, the Bitcoin mining process creates roughly six Bitcoin per hour.29

A. KNOWING THE DIFFERENCE BETWEEN A CRYPTOCURRENCY’S HARD AND SOFT FORKS

During the mining process there can occur what are known as ‘forks’ when there is a significant (hard) change, or a minor (soft) change to the blockchain protocol.30 Generation of a new protocol (“hard fork”31) or update to the protocol code (“soft fork”32) results in replacement of the existing code for that blockchain by the fork. From the point of implementation onward a ‘fork’ is created where the new deviates from the old protocol. Forks are used to ensure that blockchains can continue to generate without becoming encumbered by their own original protocol or, in cases of ‘long’ blockchains, the size of the blocks.

The most notable difference between the types comes from implementation; soft forks do not need miners to take any proactive steps to update the existing protocol. Hard forks require some action by the miners to implement the new protocol and to proactively choose to continue mining the new chain. Thus, hard forks can result in some miners converting to the new fork while others continue mining the old. While adoption of the change is not required for hard forks, miners who stay with the old protocol will be unable to mine blocks that belong to the new protocol caused by the hard fork, so they will not be able to benefit from any implemented changes. The Ethereum (ETH) Classic Hack is an industry example of a hard fork.33 Opinions vary as to the risks associated with implantation of these forks. Certainly, soft forks, due to the passivity of their implementation, are most likely to see abuse or experience the most creative implementations (for better or worse).

The interplay of forks is relevant when considering whether cryptocurrencies ought to be treated as a security—or a commodity. Due to the manner and fanfare with which cryptocurrencies are launched, many have begun to consider them a security—ignoring the fact that in the economy they behave more like a commodity. This belief is further underscored by the current proposed bills, some of which seek to define cryptocurrencies as a security yet speak of a treatment and behavior that leans toward commodity.34 Likely the reason to treat them as a security is because when a new cryptocurrency protocol is first launched, it is called an initial coin offering (“ICO”)35 and mimics many characteristics of an initial public offering (“IPO”). Upon a successful launch, the cryptocurrency’s algorithm is released to mining networks and generates problems which the miners begin to ‘mine’.

Like with IPOs, the lead up to an ICO involves supporters of the new cryptocurrency protocol actively seeking to build excitement: why this new cryptocurrency is different, why it should be bought, why it is a worthy investment, and how the protocol —which has yet to be written in some instances—can accomplish a new feat provided the group seeking the funds receives the right amount in combination of time and venture capital. Pitches such as ‘more secure’ begin to appear along with other key buzz words. However, to claim more security is a bit of a misrepresentation, as blockchain technology is still whole-number-based encryption.36 Because of this all cryptocurrencies have a finite number of times any protocol can be solved, and that ‘cap’ sets the maximum supply capacity for how many coins can be mined overall.37 Thus, one cryptocurrency does not differ that greatly from another, and typically the only factors that vary across cryptocurrencies are total cap amounts, size of the mining reward, and how frequently it can be mined (i.e. at what speed). While some of these can be altered by hard or soft forks, all cryptocurrency protocol creators share the same lack of ability to control which protocols miners mine. The decision of what to mine is firmly rooted in the value of the cryptocurrency the miners are being rewarded with and feeds into the issues of volatility of cryptocurrency value. If a cryptocurrency becomes worthless, miners will cease mining the protocol and shift to more profitable cryptocurrencies, regardless of whether the cap has been reached or not.38 At no point during this decision process do the miners communicate with the writers of the protocol, nor the holders of the declining cryptocurrency. Nor do they need to, because no party involved in cryptocurrency has authority or power over the action of the other involved parties. In comparison, recognized valid fiat money39 generally must be printed through a central treasury. The decision about how much is printed or released/issued into the economy and when naturally involves at least authorization by one supervisory party over the treasury; more commonly it requires any number of combinations of political and financial institutions and may or may not involve a national or central bank.

That is why understanding the cryptocurrency creation process is imperative when assessing what regulatory structure should be used for valuation of cryptocurrencies. Regardless of how cryptocurrency is treated, its hard-wired autonomy is unheard of in traditional currencies, securities, or commodities, so the problems it poses have not been faced outside the mostly abandoned barter style economic system.

Currently, the consensus in the U.S. is that taxation valuation triggers at the point where cryptocurrencies convert to some form of fiat money. Initially, this made sense, until, due to lack of federal regulation and structures, states began adopting cryptocurrencies as alternative cash flows in the economy. There, residents may use cryptocurrencies instead of USD to pay for rent, food, gas, and even state taxes.40 In such cases, where does the point of taxation valuation begin? By its fickle value nature, a cryptocurrency that is worth $300.00 at noon could be worth $3.00 by 12:01 then $450.00 by 12:15 and $1000.00 by midnight. When should the valuation be determined? When is cryptocurrency used—when paid (noon) or when it is due (e.g. 5pm PST on the first)? If the cryptocurrency used is now half the USD value it was at noon does the renter now owe a portion of rent that was in full earlier? What if it doubles in value? Does the landlord owe back any excess?41 Furthermore because cryptocurrency markets do not ‘open’ nor ‘close’, trading occurs at the same rate cryptocurrencies are mined—continuously and at all hours, which only adds to the volatility.

B. CLASSIFYING CRYPTOCURRENCIES AS SECURITIES

To head off risk of rampant fraud within the cryptocurrency marketplace, U.S. courts have allowed failed ICO suits (where the cryptocurrency protocol fails to launch) under the Securities Act of 1933 (“the Act”) to grant standing and cause for relief under 15 U.S.C. §§ 771(a)(1) and 12(a)(1). These sections grant a right of private civil action against any person offering or selling an unregistered security in violation of § 5 of the Act, as well as those who fail to satisfy § 77e of the Act.42  Post ICO, there are several issues that stem from treating cryptocurrencies as securities, most of which are rooted in the very way cryptocurrencies are created and function.

Unlike securities, there is no centralized authority in cryptocurrencies that issues or regulates their creation. Nor is there any centralized agency, such as a bank, that possess a ledger that provides a comprehensive list of the private keys as they relate to wallets and public keys. While public keys have been reverse engineered to reveal a private key, the resources required to do so are often only deployed in ransomware situations.43 Also, gaining access to private keys (reverse engineering aside) requires compliance with several other rules, laws, and regulations due to the digitally stored and financial nature of cryptocurrencies. At minimum, this means both the SCA and BSA must be considered when fulfilling requirements for applications of warrants or other compelled disclosure tools, which apply before the question of whether a cryptocurrency qualifies as a ‘registered security’ under § 77e(a).44

To qualify as a registered security, an issuer must provide an effective registration statement as defined under 15 U.S.C. § 77b(a)(8) and (under § 77f) “any amendment thereto and any report, document, or memorandum filed as part of such statement of incorporation.” § 77f also lists how securities must be registered with the SEC and accompanied by associated fees.45 As cryptocurrencies are mined both simultaneously and individually across a large network of miners, they cannot be ‘issued in bulk’ as is common with securities that seek approval for a set amount from which they issue securities as time passes. For traditional securities that practice allows for the biggest ‘bang for the buck’ when it comes to fees, as only one issuing entity creates the security. As cryptocurrencies have no central entity, just miners who work on the digital protocol which itself is merely a mathematical problem, there is no controlling company or entity. While ‘caps’ for cryptocurrencies offers a proposed total maximum number of a given cryptocurrency, that cap may never be reached or may be changed later through utilization of a hard fork. As it stands, cryptocurrencies are not registered at all. Therefore, who would pay registration fees? Is it the author of the protocol? The miner? The supporter? The holder? How would that party pay registration for previously created cryptocurrencies? What happens when the fees are not paid?  Do any of them have a fiduciary duty to the holders? Members of the marketplace writ large? Or just the exchange upon which it was purchased?

While these questions create eternal job security for some members of an oversight agency, the practical aspect would render it a veritable nightmare when applied across all cryptocurrency blockchains that span a global network.46 Not to mention, because some of the largest mining servers are based abroad, such as in China, Iceland, the Netherlands, Russia, and Switzerland, jurisdictional authority of the supervisory agency would be grossly exceeded.47

The legislative gymnastics required to apply current securities law to cryptocurrencies does not end there. Issuance of securities is often sought as a means of securing funding by an issuing entity. The phrase ‘going public’ and ‘IPO’ has become a layman’s term for the process of an entity issuing its registered securities to make them available in the relevant public marketplace. Under § 77e(a) these issuers need not be American to release securities, but the plain language of the Act requires the issuing entity to have some representative who holds the authority to file and sign a registration certificate. This can be some combination of controllers, executive officers, principal executive officers, accounting officers, or any combination of several other positions—the title is less important than the authority over the securities in the eyes of the Act. This is perfectly applicable to companies and other formally organized entities where such positions are commonplace and part of the requirements for their founding. However, no such positions are required, nor needed, to create a cryptocurrency.

A cryptocurrency only needs a party capable of writing a protocol that is then shared with miners; with the right artificial intelligence this protocol author need not even be human.48 Generally, traditional securities convey some level of control or ownership over the issuing entity, even if only in terms of the entity’s debt. Comparatively, possession of a cryptocurrency conveys nothing to its holder other than the mere possession of the numbers that compose the cryptocurrency. Lack of asset backing is the reason a cryptocurrency’s worth is solely derived from its popular public opinion, which causes the high volatility that cryptocurrencies are known for.

Under a securities approach, cryptocurrencies have limited legal precedent, appearing almost exclusively in circumstances of fraudulent conduct regarding a failed ICO.49 U.S. courts have shoehorned cryptocurrencies into the Howey Test to confer satisfactory standing upon the defrauded in actions seeking promoter liability under the Act. There is undoubtedly a genuine interest in heading off a new wave of fraudulent behavior, but to say a cryptocurrency is a security under the Howey Test is akin to saying a bet placed on a racehorse is a security. Thanks to the ease of issuance, it is increasingly common for individuals and companies to issue their own digital assets in the form of NFTs or cryptocurrencies (in the form of a token50 or coin51)52 as a means of securing funds. This allows them to effectively bet that they can obtain funding without losing any ownership or control over their endeavor. While betting on an increase in values is a characteristic of a security, it is the sole characteristic of most cryptocurrencies. Absent express written agreements or embedded smart contracts53 cryptocurrencies convey zero ownership interest in the issuing party,54 only granting a right to the increase or decrease of the cryptocurrency’s value rather than any profit or growth the issuing company achieves.55

The Howey Test is a “flexible rather than a static principle, […] that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits,”56 with emphasis on the “economic realities underlying a transaction and not on the name appended thereto”,57 such that “[f]orm should be disregarded for substance.”58 While clearly applicable to IPOs and traditional security offerings, cryptocurrencies lack fundamental IPO elements.59 Even for failed ICOs the courts arguably stretch and generalize the existing language of both the Howey Test and the Act to cram cryptocurrency into the shoes of securities regulations.

Under the Howey Test, a ‘security’ must be (i) an investment of money (ii) in a common enterprise (iii) with the expectation of profits to be derived solely from the efforts of others. When looking at the initial similarities between ICOs and IPOs, it is easy to see why the courts would want to adapt the Howey Test to cryptocurrencies. As with traditional securities, the launch of a cryptocurrency protocol takes both time and money. Time to write the protocol and money for marketing and ‘buzz building’ around the upcoming cryptocurrency to establish any value above absolute zero.60 At that point the parties involved in the ICO significantly mimic or mirror the kind of behaviors that lead up to IPOs (populating the cryptocurrency investor marketplace61 with prospectuses and ads). The courts are not wrong to believe that this conduct should be held to the same standard as those involved in traditional IPOs, but the problems begin post-IPO in valuation and investment.

i. THE HOWIE TEST PRONG 1: AN INVESTMENT OF MONEY

Public policy has a long-standing interest in curbing fraudulent and misleading information. However, when the value of something is solely dependent on popular public opinion, how can one control what conduct is fraudulent or misleading? Which parties should be held responsible for their conduct? What determines who qualifies? Role in the cryptocurrency’s creation or follower count?62 Unlike IPOs that are backed by an issuing entity, when it comes to cryptocurrencies there is no company to ‘check in on’ or hold accountable. There is no company performance, services, nor goods, and those creating it—the miners—are servers, not people. Furthermore, no one entity ever owns nor ‘operates’ the cryptocurrency and its miners. Instead, it is held en masse by parties around the world in an array of locations and jurisdictions.

Regarding solicitations for investors in ICOs, U.S. courts concluded that when a plaintiff shows “horizontal commonality” in which the “fortunes of each investor in a pool of investors” are interconnected, shared, or pooled with one another and tied to the success of the venture overall, the first Howey prong is satisfied.63 Traditionally, investment in IPOs and the issuing security are based on a valuation of the issuing entity. No matter how big or small, rich or bankrupt, an entity reflects some level of asset valuation. It may comprise only office furniture or a work provided lunch, but an accounting of assets will always find some residual assignment of monetary value. The value might not be particularly high, and may not be worth the effort of cashing, but may still be assigned to a tangible object. Even at the lowest of valuations a company with any kind of asset backing will typically be able to derive an absolute scrap value for their assets.64 This ability to retain tangible assets for potential liquidation grants some level of assurance when it comes to the valuation of a security and weighs on assessment risks of gain/loss. At the end of the day, a holder of a security will still hold some fraction of a tangible value.

Comparatively, cryptocurrencies are a pure waste product, like fruit. Fruit is diverse in supply, demand, and value and has the capacity to be as varied both in flavor and types as cryptocurrencies. What holds true for all fruits is that once rotten, its value effectively becomes nil and generally results in the holder abandoning it by throwing it away. Some holders might retain it in the desperate hope that perhaps, at the right time, place, and condition, the rotten mass might yield something of value, but until then its value is absolute zero. The same holds true for cryptocurrencies; unless being actively used and traded, they become a waste product that a holder must abandon or retain.65 So, when does that loss become realized?

These ‘dead’ cryptocurrencies are not tied to a company. They belong to a protocol that has fallen out of fashion yet might one day have a use or value again. Effectively a ‘dead’ cryptocurrency is akin to losing change in your couch—you cannot use it, but you can still ‘have’ it. Without the ability to trade a ‘dead’ cryptocurrency there can be no real realization of loss, as is the case with liquidations and company wind-ups or mergers wherein the company withdraws its securities from the marketplace. There, a loss can be noted by reporting it on IRS tax forms. However, if the holder did not sell at a loss, the held cryptocurrencies are simply worth nothing but the holder can still retain the cryptocurrencies. If the held cryptocurrency regains value after a declared loss, how is the gain noted or the loss reversed?

While money can be collected for an ICO, unlike an IPO there is no return consideration. Investments in ICOs are more of a collective fund for buying lottery tickets than an investment in some grand project or enterprise. Where is the enterprise in cryptocurrency? The only purpose it currently serves is that of an alternative to fiat currencies to avoid centralized systems. Further, it is a product that is exclusively created through passive processes66 to yield a series of numbers whose value could depend on the latest tweet.

ii. THE HOWIE TEST PRONG 2: IN A COMMON ENTERPRISE

Securities normally render some level of control or dominion over the issuer, or their debt, to the holder of that security. This can be in the form of preferred stocks, liquidation options, voting preferences, and so on, as deemed by the classification of the security in question. Since 2004, the courts have held that a security consists of “the ‘touchstone’ of an investment contract [which is] ‘the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others….”67 In traditional security environments these efforts are human based, be they a promoter’s involvement leading up to a public offering or managerial guidance of a hedge fund manager.

For cryptocurrencies there is no such classifications, control, nor power of dominion over the issuer, because the issuer (i.e. the miner) is a computational server, not a human being. To say a holder of cryptocurrency should have any influence on the miner is to say that any party in possession of a physical security certificate should have influence over the printer that printed the security. It can be done, but the impracticality immediately defeats the purpose.

One feasible stretch of promotor liability and its accompanying fiduciary duties could be made to encapsulate parties involved in a cryptocurrency’s ICO because they hold the ability to control and hold dominion over the protocol, until it is launched. However, by their very nature cryptocurrencies require minimal to no human oversight once launched. Even when there is human influence, the impact is severely restricted due to the decentralized system of blockchain and passive mining process. Thus, post-ICO, cryptocurrency founders have no more control over the miners than they do the wind. At the best of times, there may be a programmer who institutes a hard or soft fork to make a cryptocurrency more favorable or appealing to the miners to keep them mining that protocol, but at no point can miners be compelled to mine a specific protocol. However, it is also possible that a cryptocurrency will never have nor need a hard or soft fork.

The most glaring aspect that results in lack of control over a cryptocurrency is that anyone with access to the internet can become a miner. All a miner needs is an internet connection and a computational device that can compute the protocol in question. An entire industry is developing from the desire of people and governments alike to earn ‘passive income’ through cryptocurrency mining simply by obtaining mining-capable hardware, starting it up, logging it onto the internet and walking away. Applying the precedent and mindset of securities to a market that is so fundamentally freeform insinuates that the SEC instills a right in American holders to control other parties and their hardware regardless of global jurisdictions and governments.68

The ready availability and participation of miners also brings up another question: for those paid in cryptocurrencies for mining, not trading, what taxes apply? What liabilities? How do they calculate a gain/loss when they created the asset? How is jurisdiction decided? Is income tax calculated solely on cryptocurrencies converted, or also cryptocurrencies rewarded?69 What write-offs can miners apply? Are they independent contractors? Can they form a company to trigger pass-through taxation?

Because the courts want to treat cryptocurrencies as a security, taxation only triggers—in theory—at the point of conversion to fiat when a gain/loss can be calculated. However, as cryptocurrencies grow in popularity within the fiat marketplaces, this trigger point is increasingly less common and at times never materializes.

 Nothing like the mining process exists for securities. Even for treasury bonds the U.S. Treasury Department has ultimate dominion and control over how many have been issued. Applying the securities’ concept of enterprise to cryptocurrencies and the mining process not only creates more headaches than solutions, but also begins to imply control and dominion where none could nor should exist. Absurdly, under the proposed logic, holders of a U.S. dollar could declare, by virtue of holding that dollar, they can now exercise influence over the U.S. Treasury Department. In a global cloud computing network, where does the enterprise start and stop when miners can mine multiple cryptocurrencies? U.S. courts have yet to address these questions, even when compared to another global network—the internet—enterprise has been limited to the domain or platform of the owning entity.70 Cryptocurrency protocols do not own anything. Miners can be solely dedicated to one cryptocurrency or none as their money is best made by mining as many cryptocurrencies as possible as fast as possible.

iii. THE HOWIE TEST PRONG 3: FOR EXPECTATION OF PROFITS TO BE DERIVED SOLELY FROM THE EFFORTS OF OTHERS

How to differentiate expectation of profits deriving from the cryptocurrency’s creation from the cryptocurrency’s valuation based on the efforts of others has yet to be answered by a court.71 It is also difficult to say to what extent either type of profit is derived from efforts of others when it comes to cryptocurrencies. For IPOs it is easy to define the efforts of promoters and other interested parties who partook in the initial ramp up and valuation. With cryptocurrency it is more nuanced, due in no small part to the mining process and public aspect of it is worth. Courts must be careful in how they craft their analysis as to when investors have been “led to expect profits solely from the efforts of the promoter”72 as inevitably they risk of roping in more parties than they bargained for. In the Second Circuit, “solely” is not a literal limitation and the courts are to consider under all circumstances the scheme being promoted and whether it was primarily an investment or not.28

While a reasonable approach in the business world, it ignores the fact that in the world of cryptocurrencies promoters cannot only be an indefinite term, but it can apply to almost anyone dealing with cryptocurrencies. By mining the currency miners promote its supply; in accepting it as a form of payment governments and business owners endorse its demand; by talking about and openly discussing it a layperson could be responsible for the rise or fall of value depending on who and how many are listening. Where does the role of promoter start and stop?73

Copyright law widely recognizes the fact that that some level of human involvement must be present for a copyright to apply, which prevents a completely computer-generated thing, tangle or not, from obtaining copyright protection.74 A similar approach could be applied to cryptocurrencies at least with respect to miners. While this would not resolve the issue of where the lines exist for forks, it would at least categorize miners as a party who neither enjoys protections nor risks the liabilities of their human counterparts. For the human aspect of cryptocurrency involvement, current case law is largely unhelpful regarding post-ICO circumstances due to its focus on pre-ICO/ICO misconduct and fraud cases. This leaves the legal community with an incomplete scope of promotor liability, rendering general post-ICO liability a mystery, especially regarding where lines for promoter liability should be drawn, as the very nature and fluctuation of cryptocurrencies make it difficult to gauge at any one point in time which parties are dealing in which cryptocurrency. Should promoter liability apply post-ICO to the average YouTuber who talks about their latest cryptocurrency purchase? Or the barista telling a customer the same? With creation of and access to cryptocurrencies so widespread it is unlikely a court would want to imply liability whenever cryptocurrency is discussed.

By ignoring these fundamental aspects of how cryptocurrencies are created, function and derive their value, current case law unintentionally awards cryptocurrencies the benefits of securities without all the risk and expense of regulation. Such application of law will only encourage companies to abandon securities in favor of launching their own cryptocurrencies, allowing unfettered access to funds without securitization of value and without loss of control over the company. Depending on what their endeavor is, they may never need to convert their cryptocurrency to fiat, thus enjoying the benefits of a high valuation tax free. Last time the United States opened the door to highly volatile cash flows such as this was the 1920s, which ultimately led to the crash of October, 1928, which in the first place birthed the Act.

As flexible as the principles of Howey Test may be, and as convenient as it is to apply securities law to cryptocurrencies, doing so undermines the Act and related legislation. Even if there was some way to make cryptocurrencies satisfy the Howey Test, from a functional perspective there are still fundamental issues with the application of securities law to cryptocurrencies.

C. NOTABLE COMPLICATIONS IN TREATING CRYPTOCURRENCIES AS SECURITIES

Blockchain’s inherent anonymity poses a problem as to the ownership registration of securities law. Unlike commodities, securities are registered to the holder and the issuer. Often there is also a middleman who retains the security as the holder’s agent or as the seller for the issuer. While all these parties could hold stable private keys, the blockchain of the cryptocurrency in question will only ever show the transactionally generated public keys. Absent reverse engineering, the public keys are not facially traceable to a given private key. While this anonymity makes cryptocurrencies popular, monitoring the holdings of private keys (legally) is the greatest burden associated with cryptocurrencies. Coupled with cryptocurrency decentralization, even if a private key is known the holdings remain un-freezable without dominance over the mining process.

Even if there were a way to create a central cryptocurrency registry, it would be a colossus to maintain and would require regular manual and automatic updates to whatever AI was employed to monitor all public keys transactions while simultaneously decoding what private keys and cryptocurrencies are involved in every transaction. Those who would argue this is doable—citing how banks can monitor high volumes of transactions—ignore that this is only possible because of the banks’ centralized ledger system.

With cryptocurrency the monitoring would have to be for every ledger, hosted independently on a global network. To put it in terms of the current system, this ledger monitoring would require:

  • Monitor all global de-identified financial data;75
  • Access and monitor the ledger of every bank around the world (including ledgers for every branch, atm, employee computer, etc.)
  •  Access and monitor the ledger of every separate individual and business account (and variety of);
  •  Contemporaneously trace every transaction of each ledger;
  • Decode and reverse de-identify76 all accounts while cross referencing the transactions and account balances all at once.

Comparatively, in the centralized system all transactions move through a main, singular, ledger which all parties consult when partaking in a transaction with the account holder. Ultimately a monitoring system like this is a bigger risk than reward, even for Federal and State governments.

These considerations precede concerns for the impact of hard and soft forks to a cryptocurrency’s blockchain. Both alter the actual protocol moving forward from the point of initiation—particularly hard forks which inhibit a miner’s ability to mine the old protocols once they switch. Hard forks are akin to Company A acquiring Company B, and as a result ceasing to issue and support all Company A and B stocks, instead supporting stock AB, all without consulting any holder of the prior stocks and offering no option to exchange or buy back the previously issued stocks. Due to the impact on the mining rate (which in turn affects the supply and value of the cryptocurrency), surely if a cryptocurrency is a security, then cryptocurrency holders should have some rights under the Act to control what forks a miner implements. Even when a fork is welcome, would it signify a stock reissue or issuance of a new class thereof? A new round of securities? An injection of venture capital funding? How do voting rights work (or lack thereof) regarding the implantation (or not) of a fork? How would its outcome be enforced?77

What of soft forks? Given that miners do not need to take any action for implementation, should holders of the cryptocurrency be able to vote on their implementation? Soft forks change the protocol in a way that is analogous to a company changing—without vote or approval—stock dividends. It can change not only the date of when ‘dividends’ are paid, but it could also change the amount to be paid for ‘dividends’. 

Currently, the case law and legislation are silent on these issues. While it may be the situation of waiting for the ‘right case’ to make it through the courts, there is a greater policy interest to begin issuing advisory comments—as the OCC has been doing over the course of the last year—to get all parties ready for coming legislation.

D. CLASSIFYING CRYPTOCURRENCIES AS COMMODITIES

For now, treating cryptocurrencies as commodities is functionally the best course of action, and is reflected in one of the latest bills for cryptocurrency regulation.78 As with the regulatory structure of securities, cryptocurrencies do not seamlessly integrate into the existing commodities’ controls. Yet, because cryptocurrencies function more like commodities, at least it resolves the issues of control and dominion over an issuing entity. At base level, commodities are a good used in commerce that is interchangeable with other goods of the same type—a commodity is also often the product of another good or service.79 Holding a commodity does not render any form of ownership stake or control over the issuing entity. Just a buying gold does not convey a share of interest or ownership in the gold mine, purchasing a cryptocurrency does not vest any ownership interest in the miner, holder, or blockchain of the cryptocurrency.

The issuance of commodities is also regulated differently than securities. Using a centralized ledger, commodities trading can be overseen by the exchanges. Structured more like a farmer’s market, miners and other commodity providers can ‘set up shop’ with the sole purpose of trading their products, and interest in future production or value thereof. This can be through a collaborative effort, or by individual registered suppliers. By comparison, the securities market is more like a specialty shop; its purpose revolves around valuation and raising of funds for a particular company to lure interest primarily based on promise of future benefits, such as dividends. While the securities market can only offer alternative securities, the commodity market more readily offers a wider variety of investment types, as well as a better arena for cross product exchange.80 The versatility of cryptocurrencies has made them more of a ‘farmers’ market’ application where they can be held (like unripe fruit) as their value appreciates, then easily sold or exchanged (once ripe) for goods and services beyond alternative cryptocurrencies of the same type (such as gas, pet grooming, and other purchases).

As with commodities, cryptocurrency supply is determined by the number of producers and estimated supply. Just as wheat supply depends on farmers, cryptocurrencies depend on miners to generate supply. While a third party may create the protocol the miners use, without miners it is little more than an unplanted seed. Without a miner to mine the protocol there will be no supply of that cryptocurrency. Creators of a protocol can also be miners of that cryptocurrency; however, lesser mined cryptocurrencies run the risk of not being popular enough within the cryptocurrency marketplace to garner value or use for outward trades.81 82 For securities, cryptocurrencies, and commodities, value is ultimately determined at the intersection of supply and demand at the exact point of sale. Unlike securities, because commodities and cryptocurrencies can have an absolute zero value there often is no issue as to residual value or rights (i.e. no liquidation terms, rights or equivalents). The lack of a residuary value found in commodities and cryptocurrencies does little to stop the demand for either and is part of the reason why currencies can be seen as a commodity sub-type rather than as a security.

Also, issues surrounding agency jurisdiction are solved, as fiat currencies already qualify as commodities. In sharing the classification, any cryptocurrency that is exchanged or transferred via interstate commerce lines (which includes the internet)83 can fall under both the Commodity Exchange Act (the “CEA”)84 and the OCC,85 which primarily oversees federal banks and issues guidance accordingly, or as proposed by at least one of the bills currently up for consideration, under the Commodities Futures Trading Commission (“CFTC”).86

 Due to the popularity of cryptocurrencies (such as Bitcoin) there is a growing push—and acceptance—for cryptocurrencies to be an alternative to fiat. With uses ranging from high end luxury retailers to gas stations, cryptocurrencies are becoming common place, which allows them to function like a currency within the fiat marketplace. Tesla will not sell a buyer a car for x number of Apple stock unless it is converted to funds in the form of currency, but they will sell a car for Bitcoin. The fact that it can be used for minor purchases as well furthers the argument that cryptocurrencies serve the same economic function as a virtual fiat currency, albeit one that has no physical counterpart. The proliferation of cryptocurrencies and their application into the economy has created a desire to establish stablecoins.87 These would function more like a digital variation of the once gold backed U.S. dollar or silver based British Pound Sterling.

Though the CEA’s structure allows the sidestepping of the issues discussed in treating cryptocurrencies as a security, it nevertheless faces the hurdle of cryptocurrencies’ anonymous nature and decentralized structure. Under the CEA, commodity sellers (or producers if they sell directly) must be registered; while this eases the need to account for each individual cryptocurrency wallet, it brings up a different issue regarding the miners and exchanges. Some miners are within the U.S., but significant numbers exist outside U.S. borders. At first, this may not seem problematic, but an issue arises from the ability to control and monitor a given commodity’s value based on its supply from its sellers/producers. In the past, the U.S. government has controlled crop supply by promoting or limiting specific crops, generally via payment incentives. To replicate this for cryptocurrencies the U.S. government would need to institute practices where it buys ‘excess’ cryptocurrencies that flood the market, and under mines cryptocurrencies by paying miners to refrain or by investing in its own miners to attempt to control the market.88 While ideal for holders, such policies are less favorable for the U.S. government who, as the holders of excess cryptocurrencies, can be stuck as easily with a shortfall as a windfall.

i. THE JURISDICTIONAL AND IDENTIFICATION ISSUES OF MINERS AND EXCHANGES

The main issue with current commodity law lies in the basics of civil procedure: who are the parties and what is the jurisdiction? Significant numbers of cryptocurrency trades happen overseas.89 While some large exchanges such as Binance and Coinbase90 are based in the U.S., others, such as Kucoin,91 are not. Because only exchanges and miners based within the U.S. would fall under U.S. regulations, it is possible that any attempt to enforce regulatory controls could simply push the cryptocurrency market overseas. In an era of increasing consumer awareness about data and privacy rights this opens a door to new problems as financial privacy and consumer protection acts such as the Graham-Leach-Bliley Act (the “BLBA”) and Know Your Customer (“KYC”) policies would not apply to overseas exchanges or miners.92

KYC policies typically require the exchange to collect certain data where the user is making an account.93 Under the 2022 Jobs Act § 80603(a) a clarification was made as to the definition of ‘Brokers’ under 26 U.S.C. § 6045 (the Internal Revenue Code of 1986) to currently read as ‘every person’ not ‘any other person’ and under § 6045(g)(3) to add the following: “[…] unless provided otherwise by the Secretary, the term ‘digital asset’ means any digital representation of value which is recorded on any cryptographically secured distributed ledger or any similar technology as specified by the secretary.” Under the new definitions, the CEA and OCC are allowed to enforce the filing of forms required under 26 U.S.C. § 6050I by cryptocurrency exchanges despite the fact they do not meet the financial institution threshold required under

§ 6050I.94 By ignoring the financial institution requirement, any person, including exchanges and retailers, who receive $10,000.00 USD95 in cash—or its digital equivalent such as Bitcoin or other another cryptocurrency—must report the transaction to the IRS. The significance of this expansion is that it also implicates other legislation that uses the same threshold (such as RICO, discussed later) and it fully encapsulates U.S.-based cryptocurrency exchanges within the language of § 6045, subjecting them to IRS reporting requirements by 2024 as laid out by IRS approved KYC policies.

Though some exchanges have preemptively adopted KYC policies, such as Robinhood Crypto,96 the Jobs Act will require cryptocurrency exchanges to implement such policies as part of the required generation and submission of IRS form 1099B to both the users and IRS. This allows a better—though imperfect—way of monitoring U.S.-based trades. Exchanges (and miners) who are not U.S.-based are only required to follow their native jurisdiction’s laws and regulations. Thus, only an email address may suffice to establish an account on these foreign exchanges.97 This leaves the user to determine what is or is not reported to the IRS—assuming they report at all. Without the ‘dual’ reporting of the Jobs Act, the IRS—contrary to urban legend—has very limited if any means of knowing what a person holds in an overseas cryptocurrency account.98

The inherent identifiable data limitation within cryptocurrencies restricts not only the actions a government can take, but also how much information can be gathered about a holder of cryptocurrencies. Current technology does allow for reverse engineering of de-identified data;99 however, it is not feasible to reverse engineer every key (public and private) associated with every transaction.100 With KYC policies there is some ability to back track a wallet through the exchanges without reverse engineering due to the significant data the KYC collects about the holder. However, where only an email is linked to a private key the ability to identify and capture the holder is more complicated, especially where the cryptocurrency could be laundered throughout the cryptocurrency eco-system in a matter of seconds.

IV. USING CRYPTOCURRENCIES AS A MEDIUM OF ASSET TRANSFER

The push for stablecoins is increasing and their treatment should not mirror that of other cryptocurrencies. This is due to a stablecoin’s value being based on tangible assets (such as gold or silver) or a commodity. This type of backing limits the volatility that plagues other cryptocurrencies, while the use of blockchain and mining process prevents stablecoins from merely becoming a digital version of their fiat counterparts, yet still behaving more like a digital fiat currency than other cryptocurrencies. Stablecoins act, behave, and serve the purpose of currency yet offer more efficient digitalization process that allows quick and easy movement of funds thanks to the lack of clearinghouses, which are present in all centralized systems.

Based on the preliminary uses (actual and proposed) for stablecoins their primary purpose is limited to financial transactions within a walled garden101 in which the stablecoin is converted seamlessly to local fiat once at its destination. Given their popularity with established institutions it is likely that stablecoins will at some point become part of outward facing transactions (i.e. from one company to another) in public global and local economies. Currently, stablecoins are best characterized as a new way of digitizing assets and currencies in a manner already being done rather than as a separate and unique challenge. Though stablecoins may face similar issues of traceability, the connection to a tangible asset is the very reason for their growing popularity, particularly amongst institutions that already primarily deal in currency, security, and commodity exchange markets.

Another blockchain creation are Non-fungible Tokens (NFTs), which fall under the ever-widening definition of digital assets.102 Hailed as being a unique, individual, one of a kind ‘piece of art’, the generation of an NFT image utilizes a different algorithmic process than cryptocurrencies, but similarly, is a passive, computer-generated product. As with cryptocurrencies, it relies on blockchain for its transactional record keeping and derives its value from public opinion. As with some cryptocurrencies,103 NFTs integrate smart contracts, predominately terms of service agreements and use restrictions, into their units. While addressing such differences here goes well beyond the purpose of this comment, it is important to recognize guidance is lacking as to how the terms of service agreements may affect the ownership aspect of digital assets and tax liabilities thereof.

A. ABILITY OF A LAYMAN TO LOAN OUT THEIR CRYPTOCURRENCIES

Due to the functionality of cryptocurrencies, it is not uncommon for them to be loaned. However, because their valuation is strictly limited to at-the-moment value, interest calculations can be challenging. Is the interest rate based on the five Bitcoin worth $1500.00 USD at the time it was loaned? Or is it based on the $2000.00 USD those five Bitcoin were worth when the borrower was able to convert to fiat? Is it the same five Bitcoin that the lender loaned out or five different Bitcoin that the loanee had and returned to satisfy the debt? What if it never converts to fiat thus simply stays a cryptocurrency and interacts with the fiat market? What if the lender is paid back in fiat instead of Bitcoin? Which loan valuation applies when the lent cryptocurrency declines following the loan?

As current case law heavily favors suits deriving from the lack of value a cryptocurrency has, not determining changes in value, these questions are unanswered. Additionally, any reporting regarding these loans to the IRS is entirely voluntary—especially when it comes to peer-to-peer transactions104 which are not facilitated through an exchange. Currently, exchanges may chose to adopt KYC policies, and IRS reporting, as a best business practice. However, this does not resolve the issue that data from one exchange does not port to another. When a holder ‘switches’ from one exchange to another for trades their new exchange does not receive any of their historical data regarding their cryptocurrency holdings without use of third parties. This complicates the investment perspective of cryptocurrencies unnecessarily and is an area only recently being addressed by the capitalistic drive of third-party providers.

Another challenge cryptocurrencies pose is that the legislation makes for limited to no accommodation of quick technological advancement. By their very nature, cryptocurrencies can never exist in the tangible world as they are written, computed, published, and traded exclusively within a digital space by a global cloud computing network from the moment a given cryptocurrency’s blockchain is launched. By utilizing an exclusively electronic medium, the only means of interacting, let alone offering, cryptocurrency will inherently risk running afoul of “directly or indirectly [making] use of means or instruments of transportation or communication in interstate commerce to offer to sell or to actually sell securities, or to carry or cause such securities to be carried through interstate commerce for the purpose of sale or for delivery after sale”105 given that “the internet, which necessarily includes email, is an ‘instrumentality of interstate commerce.”83

Even in instances where cryptocurrency marketing materials are all physical, tangible copies, there will always be need for a miner which, as a computational program, only exists in the digital space. While it is possible to have a closed network generate cryptocurrency for use exclusively on that network, one would still need to employ some form of an intra- or internet to convert it or trade it, conduct of which would feasibly fall within the SEC’s scope of ‘interstate commerce’. That is especially so because the SEC continues to expand the definition. This adds the additional risk that any violation of local, state, federal, or international laws that operate outside the SEC regulations may also be compounded into more serious federal charges, even where SEC regulations would otherwise not cover the conduct.

Individual holders of cryptocurrencies are also open to a unique array of liabilities that go beyond the Act because of the connections cryptocurrencies inherently create amongst holders of a singular cryptocurrency. Mixed cryptocurrencies with the anonymity aspect and conduct begins to run afoul of other pieces of legislation such as RICO, BSA, and SCA, regardless of whether or not it is converted to fiat. This can lead otherwise innocent holders to become the latest addition to various agency watchlists, such as the FBI’s and INTERPOL’s.106

i. CROSS-OVER OF CRIMINAL LIABILITIES AND CRYPTOCURRENCY OWNERSHIP

Risk of cross-over liability for cryptocurrencies is best explained in application of the RICO Act. It was drafted to curtail organized crime. RICO was different from prior law as it allowed the government to pursue the organization rather than the individual members, considering all components and parties involved in a venture or enterprise rather than what one individual was responsible for. With the creation and rise of cryptocurrencies the statute has becoming overinclusive with its definitions—especially with the definitional expansions under the 2022 Jobs Act that mostly impact 18 U.S.C. §§ 1956 and 1957 as well as 26 U.S.C. § 6050I. Reading cryptocurrencies as securities may deem holders to be within the same ‘enterprise’ as others (few if any of whom know each other personally) for purposes applicability of the Act.

The primary difference between § 1956 and § 1957 is that the former is more focused on the pursuit of the organization, while the latter is more focused on the individual. The two share definitions for the principal terms of: “knowing that property involved in a financial transaction represents the proceeds of some form of unlawful activity” (for brevity’s sake this ‘term’ will be called KUT (Knowing Unlawful Transaction)); “conducts”; “transactions”; “financial transactions”; “financial institutions”; “money instruments”; “specified unlawful activity” (SUA); “state”; and “proceeds”.

KUT requires that for any one party (collective or individual) to be pulled into § 1956 the person(s) involved must have knowledge of the fact that the property they are handling in some way was derived from or represents the proceeds of an activity that is regarded as unlawful. The definition of knowledge is flexible and is not defined at any length within the title. Taken by its dictionary definition the terms can apply to “theoretical or practical understanding.”107  So, in theory, a cryptocurrency holder should have some understanding, or at least awareness, of the fact a person selling cryptocurrency might be doing so to get legitimate funds after converting illicit ones into cryptocurrency.

“Conducts” and “transactions” are both fairly sensical definitions; §§ 1956 and 1957 define conduct as the acts of initiating, participating, concluding or by having played a part in those stages of a transaction, which covers purchasing, sales, loans, gifts, transfers, delivery or other. “Money instruments” refer to coin or currency, of traditional formats108 or “investment securities or negotiable instruments in bearer form or otherwise in such form that title thereof passes upon delivery.”109

Where the sections start getting worrisome wiggle room is under the definitions of “financial institution” and “financial transaction”. The definition of a financial institution is found under 31 U.S.C. § 5312 (r) which effectively provides any person who is engaged with a business transmission of funds, including transmissions via informal money transfer systems or networks of people that facilitate the transfer of money outside the conventional financial institution systems globally or domestically are still qualified as a financial institution.

Cryptocurrency’s ability to exclude a centralized ledger means that any party holding a cryptocurrency ledger is effectively a financial institution for purposes of RICO. Considering § 1956 is structured to focus on the group rather than the individual means that anyone who is involved with the ‘network’ created by the trades of illicit groups are open to liability. Due to blockchain’s structure, there is no means by which a holder can verifiably distinguish a Mr. Rogers from an Al Capone.110 Add in the fact that § 1957 focuses on the individual, the anonymity and ‘blind trust’ of blockchain begins to create a picture that likely will not sit well in a court room.

This double-blind nature of blockchain has left the government struggling to decode who is doing what. Often relying on monitoring amounts transferred rather than accounts, agencies such as the FBI and INTERPOL are left with a high-tech rendition of an age-old problem; how do you decode an encoded ledger? By monitoring monetary amounts, agencies are as likely to see criminal activity of black-market traders as they are lucky breaks, business to business transactions, or various home purchases. Nor is it a particularly new way of looking at financial records. Even within the traditional systems, criminals know to withdraw amounts just under the monitored sum in order to avoid detection (the amount is public knowledge after all).111 What cryptocurrency facilitates is an increased ability to quickly move high volumes of assets in low sum amounts across numerous accounts through countless transactions, a process which can be fully automated with the right programing.112

The implications of the breadth of §§ 1956 and 1957 are best understood in the following hypothetical situation where an otherwise law-abiding individual could unknowingly be looped into statutory violations simply by virtue of using cryptocurrencies to operate their otherwise legitimate business.

1. HYPOTHETICAL SCENARIO: CLIENT EXPOSURE TO CRIMINAL LIABILITIES THROUGH CRYPTOCURRENCIES AND RICO

Daniel owns two cannabis companies; one in Colorado and one in California.  Both sell marijuana for smoking and related byproducts to consumers and authorized resellers. Daniel knows marijuana, as well as its extract, is still a schedule 1 controlled non-narcotic under the federal Controlled Substances Act (“CSA”). As a result, he meticulously complies with advertising regulations and related laws to keep his business marketed to those in states where marijuana is legalized. Due to marijuana’s CSA status, Daniel has found it difficult to find a bank and credit company that will take on his businesses’ financial needs. It has been explained to him that this is because institutions can be exposed to federal liability due to use of the ‘federal airwaves’113 upon which the internal and external transactions take place. Banks, in particular, have made it clear that doing business with Daniel could put them at risk of losing their FDIC insurance coverage as they cannot knowingly engage with the proceeds from activities labeled illicit by the federal government.

To keep his businesses running and for sake of safety of his employees, Daniel has begun accepting cryptocurrencies rather than cash as payment to avoid the risk of robbery.114 What cash he does receive he converts to cryptocurrency at a cryptocurrency ATM located at a nearby gas station. He has been doing this for three years and over the last year his businesses generated around $3,000,000.00 USD. During this time, Daniel has been treating his cryptocurrency wallets as his business banking accounts (having one for each business to act as a ‘register’ which transfers funds at the end of the day to a centralized ‘Business Wallet’ for expenses). He uses the Business Wallet to regularly pay suppliers, rent, bills, payroll, and other expenses and converts it to USD only when needed, preferring to pay in cryptocurrency whenever he can. As a result, Daniel regularly sends $10,000.00 USD from his California and Colorado wallets to his main Business wallet.

Daniel has no idea where customer cryptocurrency comes from and is thus unaware that by accepting Cryptocurrency, he is also accepting a cryptocurrency distantly, but commonly, used by a Cartel to launder funds. He is unaware that under the broadened definitions of §§ 1956 and 1957, RICO now also applies to him.

By using the internet115 to move funds between states Daniel is participating in financial transaction of proceeds from (Federally) unlawful activity (selling of marijuana) involved in interstate commerce. Even though Daniel keeps the California and Colorado wallets separate, because of cryptocurrencies’ digital nature, merely having access to Colorado while in California could constitute crossing state lines. Thus, Daniel still cannot completely avoid federal jurisdiction absent refrain from accessing each wallet unless he is in the respective state in which it also ‘resides’.

Daniel’s problems do not stop there, § 1956(c)(7)(B)(i) specifically states “specified unlawful activity” includes “the manufacture, sale, or distribution of controlled substances (as such term is defined for the purposes of the Controlled Substances Act)” which lists marijuana (alt. marihuana or cannabis) and marijuana extract under DEA numbers 7360 and 7350 respectively as schedule I, non-narcotic. As Daniel deals in marijuana and its byproducts, he falls under § 1957(b)(1) which includes separate punishment and fines where “pre-medical product[s]” are involved.116 If he markets or knowingly sells his marijuana to parties who intend to make secondary products that could constitute medical products (such as CBD which is often marketed as and used in medical products117), he will be liable under these sections as well.

18 U.S.C. § 670’s civil penalty expansion of § 1957 alone subjects Daniel to penalties of three times the economic loss attributed to the violation or $1,000,000.00 and criminal penalties of imprisonment for up to 15-30 years if there is $5,000.00 dollar or more of medical products involved, or an unspecified fine.118 Even if the charges do not involve pre-medical products, Daniel is still at risk of 10-20 years or fines ranging from $250,000.00 to $500,000.00 (or twice the value of involved funds, whichever is greater) per violation.119 All this is before we assess what Daniel’s been reporting for his earnings, and what the IRS has recorded.

It also does not consider how Daniel accounts for: the gain/loss value of when he earns cryptocurrency and when he uses it; how he handles employment related taxes when paying employees in cryptocurrencies; how he deals with sales tax when allowing customers to pay in cryptocurrencies; nor clarify when his business profits become realized and when are they taxed.

Another unknown is to what extent Daniel or any of the parties in the chain of cryptocurrency get to say they did not know the cryptocurrency was acquired via federally illicit means? Could his business with suppliers, who may be exclusively in one state, become part of his ‘enterprise’? It is anyone’s guess, in the meantime there are taxes the government will want to collect.

V. CONCLUSION

The most fundamental problem—and greatest allure—of cryptocurrencies is that they are only taxable so long as they are known. Whether through a formal registry derived from the cryptocurrency exchange or through the conversion point between cryptocurrency and fiat, the proliferation of cryptocurrencies as a fiat alternative means they are here to stay. With the courts offering very little guidance on how to handle cryptocurrencies within the fiat ecosystems, and efforts of the Treasury and OCC best summarized as ‘seeing what sticks’ in terms of regulation approaches, firms will be left guessing as to which path is correct until passage of authoritative legislation.

For now, the best practical solution is to communicate to clients as much knowledge and awareness about the real risks of cross legislative liability as possible and to keep meticulous records across all client-used exchanges to ensure that when an audit does strike, the client is ready. Ultimately the best law for cryptocurrencies will be one written expressly for cryptocurrencies. While some are in the works they still share some of the fundamental flaws of today’s patched together framework. Moreover, even with the passing of legislation it will only be applicable within the boundaries of the enacting jurisdiction. With the impending launch of stablecoins, it is unclear if the U.S. government will even want to deal in-depth with original cryptocurrencies—which may be forced to go the way of the Bearer Bonds120 as stablecoins replace them in the cryptocurrency landscape. Either way, it is unlikely there can ever be a complete shutdown of the cryptocurrency market—if only because no one nation or collection thereof can ever freeze a person’s cryptocurrency, which has freed many of the real fear and inconvenience of frozen assets. In the meantime, it leaves several questions still unanswered: For companies who deal only in cryptocurrencies, what point of disposition will be taxed? For employees paid in cryptocurrencies, when does taxation trigger? How is sales tax applied? How do you calculate employee tax withholdings? Where and how do miners report passive income that was never fiat to begin with?121 How do you reliably identify and track who has what and for how long without violating other laws (such as those of Fin-Privacy) that were put in place to guard against excessive financial monitoring in the first place?122

  1. In 1965, Intel Founder Gordon Moore stated that the rate of transistors per silicon chip would double every year. In 1975, he revised this theory to double every 18 months. While transistors no longer increase at the same rate, today it is commonly understood that improvements in the technology sector, for both hardware and software, develop in cycles of roughly 18-24 months, if not less. (Editors of Encyclopedia Britannica, Moore’s Law, Britannica.com, https://www.britannica.com/technology/Moores-law (last visited Aug. 30, 2022)).
  2. Here “practitioners” can include Lawyers, Scholars (Academic and legal), Certified Public Accounts and others who are regularly faced with navigating regulatory structures on behalf of themselves and clients.
  3. The complexity of the law in the United States is due to the fundamental legal process and structure of the country. Where in States can more freely and quickly enact legislation before the federal government but both tend to significantly lag behind cutting edge innovation. Thus, when it comes to the most current applications of almost any technology, especially where cryptocurrencies are involved, there is a distinct lack of comprehensive frameworks as local/state laws can vary too greatly from one state to another, and absent national legislation the state law is the controlling rule. Thus, it can be difficult to derive a general ‘national guideline’ that’s applicable across the board.
  4. Kevin Harris, 3 Bills Introduced in US to Make CFTC Primary Regulator of Crypto Spot Markets (2022) bitcoin.com, https://news.bitcoin.com/3-bills-introduced-in-us-to-make-cftc-primary-regulator-of-crypto-spot-markets/ (last visited Aug. 29, 2022) and Ritu Lavania, New US Senate Bill to Make CFTC the Official Crypto Regulator Cryptotimes.io (2022), https://www.cryptotimes.io/new-us-senate-bill-to-make-cftc-the-official-crypto-regulator/ (last visited Aug. 29, 2022).
  5. Treating cryptocurrencies as a commodity. (H.R. 7614 Digital Commodities Exchange Act of 2022 (2022) congress.gov, https://www.congress.gov/117/bills/hr7614/BILLS-117hr7614ih.pdf (last visited Aug. 29, 2022)).
  6. Defines cryptocurrencies as a “digital asset” and states they should be taxed as a security. (S. 4356 Lummis-Gillibrand Responsible Financial Innovation Act (2022) congress.gov, https://www.congress.gov/117/bills/s4356/BILLS-117s4356is.pdf (last visited Aug. 29, 2022)).
  7. Collectively these bills offer little clarity as to if cryptocurrencies are a security, commodity, or other digital asset for purposes of taxation and estate planning as each proposes a different approach and definitions.
  8. Quote is attributed to Marc Kenigsberg, founder of Bitcoinchaser.com, the date, time and location of the quote’s origin is unknown. (Andre Stoorvogel, The Blockchain—Future of Fad? (2019) Rambus.com, https://www.rambus.com/blogs/the-blockchain-future-or-fad/ (last visited Apr. 24, 2022)).
  9. As all current proposed bills fundamentally attempt to approach cryptocurrencies as either a security or a commodity, which is already a central issue to this comment, and have yet to move beyond proposal, they will not be discussed in depth at this time.
  10. William Kenton, General Ledger Investopedia.com (2022), https://www.investopedia.com/terms/g/generalledger (last visited Apr. 24, 2022).
  11. For example, when the party sells such as groceries, a new car, place a down payment on a house and so on.
  12. Shobhit Seth, What is a Cryptocurrency Public Ledger? Investopedia.com (2021), https://www.investopedia.com/tech/what-cryptocurrency-public-ledger (last visited Apr. 24, 2022).
  13. Currently many would argue that this honor system applies currently to income reporting by individuals. However, changes to federal laws over the years has resulted in establishing a federal requirement that an income source (employer, exchange, etc.) must report income paid to and received by the individual during the course of their relationship to the IRS. State requirements vary. It is against these submitted reports that the IRS will compare reported income provided by the recipient against that of the source. Where there is an error or discrepancy an audit is typically triggered. Under the American Innovation and Jobs Act there will be a new requirement of U.S. based exchanges to comply with such reporting, while some exchanges prior to the act did report to the IRS it was not a requirement. Even after the act’s effective date it will still not be a requirement for non-U.S. based exchanges due to a lack of jurisdiction. Preserving the ‘good-as-my-word’ reporting of foreign exchanges when it comes to cryptocurrency gains and losses and making it an inherent part of the cryptocurrency ecosystem.
  14. Laura M., What is a Cryptocurrency Wallet and How Does it Work? (2021), https://www.bitdegree.org/crypto/tutorials/cryptocurrency-wallet (last visited Apr. 24, 2022).
  15. Jake Frakenfield, Private Key, Investopedia.com (2021), https://www.investopedia.com/terms/p/private-key (last visited Apr. 24, 2022).
  16. Jake Frakenfield, Public Key, Investopedia.com (2021), https://www.investopedia.com/terms/p/public-key (last visited Apr. 24, 2022).
  17. Shobhit Seth, What is a Cryptocurrency Public Ledger? Investopedia.com (2021).
  18. Within the banking community this would be phrased as ‘Title’ and would identify the party with signing authority for that account.
  19. Jake Frakenfield, Peer-to-Peer (Virtual Currency), Investopedia.com (2021), https://www.investopedia.com/terms/p/ptop (last visited Apr. 24, 2022).
  20. 18 U.S.C.S. § 2701.
  21. Matter of Coleman, 2019 NY Slip Op 29067, 63 Misc. 3d 609, 96 N.Y.S.3d 515 (Sur. Ct.).
  22. James Chen, Bearer Bonds, Investopedia.com (2021), https://www.investopedia.com/terms/b/bearer_bond.asp (last visited Aug. 31, 2022).
  23. Michael Brown, The Top 5 Biggest Lost Bitcoin Fortunes (That We Know About) cryptovantage.com (2022), https://www.cryptovantage.com/news/the-top-5-biggest-lost-bitcoin-fortunes-that-we-know-about/ (last visited Apr. 24, 2022).
  24. Jake Frankenfield, Private Key, 2022.
  25. James Chen, Know Your Client (KYC) Investopedia.com (2022), https://www.investopedia.com/terms/k/knowyourclient.asp (last visited Apr. 27, 2022).
  26. It should be noted that the only way to ensure that U.S. requirements of any legislation are enforceable would require that the exchange be subject to the laws of the United States. Even if the current bills succeed and place control of cryptocurrencies under the CFTC, they ignore the international implications and practicalities of Cryptocurrencies. The CFTC has no power over an exchange, miner, or other party involved that is based in a foreign country. Nor can it bring about any truly expedient legal action if it seeks such. This issue exists currently when it comes to bringing any legal action against an international party under U.S. internet laws. The only way for there to be reliable enforcement is for the United States to limit or ban exchanges that are not somehow ‘certified’ (e.g. under the jurisdiction of the United States) or otherwise based within the United States.

    Under the Schrems I (Case C-362/14, Maximilian Schrems v. Data Protection Officer & Digital Rights Ireland, 2015 E.C.R. 650) and Schrems II (Case C-311/18, Data Protection Officer v. Facebook Ireland Ltd. & Maximilian Schrems, 2020 E.C.R. 176) cases in the European Union jurisdiction of servers was based on their location even if privately owned by a foreign entity and all transmissions are internal, thus it’s feasible that by physically moving mining servers outside the United States an exchange can avoid U.S. jurisdiction.

  27. Euny Hong, How Does Bitcoin Mining Work? Investopedia.com (2022), https://www.investopedia.com/tech/how-does-bitcoin-mining-work/ (last visited Apr. 24, 2022).
  28. Id.
  29. Zack Voell, Bitcoin Miners Usually Create 6 Blocks per Hour. They Just Banged Out 16 Coindesk.com (2020), https://www.coindesk.com/markets/2020/05/01/bitcoin-miners-usually-create-6-blocks-per-hour-they-just-banged-out-16/ (last visited Apr. 23, 2022).
  30. What is a protocol?, Coinbase.com, https://www.coinbase.com/learn/crypto-basics/what-is-a-protocol (last visited Apr. 24, 2022).
  31. Jake Frakenfield, Hard Fork (Blockchain), Investopedia.com (2021), https://www.investopedia.com/terms/h/hard-fork (last visited Apr. 24, 2022).
  32. Jake Frakenfield, Soft Fork, Investopedia.com (2021), https://www.investopedia.com/terms/s/soft-fork (last visited Apr. 24, 2022).
  33. Using a bug in the Ethereum protocol, hackers instigated a fork that split the blockchain and created two separate records for Ethereum’s network, effectively making parallel ‘books’. This allowed coins to be spent more than once and transactions were reversable. Due to the fact Ethereum uses smart contracts within its protocols meant billions of dollars’ worth of contracts were also at stake. (MacKenzie Sigalos, Ethereum had a rough September. Here’s why and how it is being fixed CNBC.com (2021), https://www.cnbc.com/2021/10/02/ethereum-had-a-rough-september-heres-why-and-how-it-gets-fixed.html (last visited Apr. 27, 2022)).
  34. This is a summary of the definitions and approaches as proposed by H.R.7614, S. 4356 and S.4760.
  35. Jake Frakenfield, Initial Coin Offering (ICO), Investopedia.com (2022), https://www.investopedia.com/terms/i/initial-coin-offering-ico (last visited Apr. 24, 2022).
  36. Peter Loshin & Michael Cobb, What is Encryption and How Does it Work? TechTarget.com, https://www.techtarget.com/searchsecurity/definition/encryption (last visited Apr. 24, 2022).
  37. Rahul Nambiampurath, What is Cryptocurrency Market Cap? (2022) thedefiant.io,  https://www.thedefiant.io/what-is-crypto-market-cap (last visited Aug. 31, 2022).
  38. The decision of what to mine is firmly rooted in both (1) the value of the cryptocurrency to be mined and (2) the reward that the miners receive for having mined the currency. As the value of any cryptocurrency is based solely on its popularity, the miners’ involvement serves only to feed into the issues of volatility of cryptocurrency value. If a cryptocurrency suddenly becomes worthless, the miners will cease mining that protocol, regardless of whether the cap has been reached or not and shift to more profitable cryptocurrencies.
  39. James Chen, Fiat Money, Investopedia.com (2022), https://www.investopedia.com/terms/f/fiatmoney (last visited Apr. 24, 2022).
  40. Samira Sadeque, Colorado to become first US state to accept cryptocurrency tax payments, theguardian.com, https://www.theguardian.com/us-news/2022/mar/01/colorado-tax-payments-cryptocurrency (last visited Apr. 24, 2022).
  41. While facially obvious questions in terms of fiat (e.g. once it’s paid you’re good to go), the fact of the matter is that cryptocurrency’s impact on auto deposits such as rent payments and other areas that have separate specific local and state rules is rarely considered when talking about its regulation. For example, if you overpay rent, just as if you overpay at the time with fiat, the landlord must either return the surplus or count it towards future rent depending on the area’s rules. However, if this surplus doesn’t occur until after you’ve paid it but before he converts to fiat whose gain is the surplus value?
  42. Generally, regulates categories of persons who directly or indirectly make use of the internet (a recognized instrumentality and channel/means of interstate commerce) to offer for sale or delivery a security that does not have an effective registration statement.
  43. Such as the Colonial Hack that happened in March, 2021, see https://www.bloomberg.com/news/articles/2021-06-04/hackers-breached-colonial-pipeline-using-compromised-password and https://www.vice.com/en/article/g5qebq/how-cryptocurrency-gave-birth-to-the-ransomware-epidemic.
  44. Always keep in mind that Blockchain is anonymous. To gain access to one’s wallet and the cryptocurrencies within, verify what cryptocurrencies are held by an individual, and whether those held are ‘registered’ properly, the investigating authority would need to seek a deidentification of personal and financial information governed by the SCA, BSA and various state privacy laws such as California’s CCPA. Thus far, governments have resorted to ‘reverse engineering’ all this information; however, any in-depth look at the process of reverse engineering makes it clear that future privacy laws, particularly on a federal level, will serve to further impede the government’s ability to ‘reverse engineer’ as it is dependent on identifying data that comes from the exchanges—which current laws and proposed regulations are seeking to restrict. For example, under the European Union’s base privacy law (The General Data Protection Regulation, “GDPR”) identifying data cannot be released to third parties nor governments without adequate legal tools (e.g. warrants).
  45. Current bills under consideration seek to place the CFTC in charge of cryptocurrencies, however, as no one bill has won out, it is reasonable to believe that in the interim the SEC would be the overseeing agency until such bills become active.
  46. As of September 2, 2022, there are over 20,000 cryptocurrencies (Homepage, coinmarketcap.com (2022), https://coinmarketcap.com (last visited Sept. 2, 2022)). In comparison there are only 180 recognized global fiat currencies (Inyoung Hwang, Fiat Currencies: Defined, Explained, Compared to Cryptocurrencies, sofi.com (2022), https://www.sofi.com/learn/content/fiat-currency/ (last visited Sept. 2, 2022)).
  47. This does not consider the ability of cloud computing in which a server’s ability is based on the online network of multiple computers which can be located around the world.
  48. This is the case with Non-Fungible Tokens (“NFTs”) which are entirely computer generated after the initial components are input by a human source.
  49. Where the cryptocurrency being funded by investors is never mined in the first place.
  50. Jake Frakenfield, Crypto Tokens, Investopedia.com (2021), https://www.investopedia.com/terms/c/crypto-token (last visited Apr. 24, 2022).
  51. Jake Frakenfield, Cryptocurrency, Investopedia.com (2022), https://www.investopedia.com/terms/c/cryptocurrency (last visited Apr. 24, 2022).
  52. A Token and a Coin while different are types of cryptocurrencies. Bitcoin, Etherium and other digital currencies that are native to their own block chain are “Coins”. “Tokens” by comparison represent an asset or offer platform specific features that vary depending on the platform, common tokens are Very Very Simple Finance (VVS), Uniswap (UNI) and Cronos (CRO). Neither of these are Non-fungible Tokens (“NFTs”).  (Crypto.com, Crypto Tokens vs Coins – What’s the Difference? (2022), https://crypto.com/university/crypto-tokens-vs-coins-difference (last visited Aug. 29, 2022).
  53. Alyssa Hertig, How Do Ethereum Smart Contracts Work? Coindesk.com (2022), https://www.coindesk.com/learn/how-do-ethereum-smart-contracts-work/ (last visited Apr. 23, 2022).
  54. Remember, a company or formal entity is not needed to create a cryptocurrency, thus anyone capable of writing a protocol can issue a cryptocurrency, NFT, coin, token or other digital asset. Especially given the increase of programs and middlemen who for a fee with write he protocol for that party.
  55. This means that holders of a cryptocurrency issued by Company A will have no rights over company A despite a purchase of the cryptocurrency from company A and cannot control company A’s course of action nor their management, if any, of the associated protocol.
  56. S.E.C. v. W.J. Howey Co., 328 U.S. 293, 299 (1946).
  57. United Hous. Found., Inc. v. Forman, 421 U.S. 837, 852 (1975).
  58. Tcherepnin v. Knight, 389 U.S. 332, 336 (1967).
  59. Such as registration certificates, an issuing company, management, promoters, prospectuses, and so on.
  60. The phrase ‘absolute zero’ here is used in the context of describing the value of a cryptocurrency that has not yet been traded or exchanged for anything thus has the same value to the holder as writing ‘2+2=4’ on a piece of paper. Until a cryptocurrency is exchanged for something it has no calculable value for purposes of the marketplace or consumers.
  61. The cryptocurrency investor marketplace is extremely varied; while a prospectus might go to the more business savvy, platforms such as radio, streaming services, ad spots, and television and so on for cryptocurrency is direct to the layman. A main exemplar would be the ads featured during the 2022 Super bowl (https://www.ft.com/content/feb76586-065e-41a7-9903-de5e62aec2fd).
  62. Meta (previously known as Facebook) has announced that they will allow users to connect their Wallets (such as Coinbase, Trust, Rainbow, and MetaMask) to their social media platforms of Facebook and Instagram to allow posting/sharing of Non-fungible Tokens (NFTs) on their feeds. As NFTs are a digital asset along with cryptocurrencies, there is no reason to think that posting and sharing of cryptocurrencies will remain restricted in the future. This ability to share and post increases the ability of the individual to affect the valuation of a NFT which, like cryptocurrencies, is a value derived mainly from the ‘limited’ edition nature of the NFT, pure social opinion, and perception of that unique value. As some users have millions of followers, this gives individuals the ability to directly affect the value of a digital asset. Should they be considered promoters in terms of security liability? (Renuka Tahelyani, Meta Allows Instagram & Facebook Users to Post NFTs on Feed (2022),  https://www.cryptotimes.io/meta-allows-instagram-facebook-users-to-post-nfts-on-feed/ (last visited Aug. 30 2022)).
  63. Revak v. SEC Realty Corp., 18 F.3d 81, 87 (2d Cir. 1994) as quoted in Balestra v. ATBCOIN LLC, 380 F. Supp. 3d 340 (S.D.N.Y. 2019) which added that the sharing or pooling of funds was required.
  64. Even if only in terms of a donative write off to good will or the funds from a recycle center when they pull out all the coper wiring from their CAT-9 cables.
  65. For cryptocurrency holders they cannot even ‘throw away’ any ‘rotten’ cryptocurrencies and generally must retain them in a Wallet or give it away to someone else who indefinitely holds it. There is no destruction option either due to the open ledger system.
  66. Here, “passive” is used in context of technology and computing which refers to an automated process that requires little to no direct human/user input to operate.
  67. S.E.C. v. Edwards, 540 U.S. 389, 395 (2004).
  68. As some countries’ governments have invested in mining facilities, accordingly holders of cryptocurrencies would be implying they have a right to control or influence on the government of a nation they are otherwise completely detached from.
  69. Recall that miners are ‘paid’ rewards in fractions of cryptocurrencies and that the conversion to fiat in order to use those cryptocurrencies is less and less necessary as their use becomes more ubiquitous. Thus, a miner’s rewards may be income, not only what is converted.
  70. See collective case law addressing issues of safe harbor under the DMCA. Generally, the ‘platform’ as applied to cryptocurrencies would be likely be limited to the exchange, which is run by people, and not the cryptocurrency itself nor the miners.
  71. As developed in this section, the questions are whether those involved in the creation of the protocol constitutes ‘efforts of others’, or if the determination of value (based on public opinion) constitutes the ‘effort of others’? There is no active guidance nor case law that the author is aware of that answers this issue.
  72. Balestra citing United States v. Leonard, 529 F.3d 83, 88 (2d Cir. 2008).
  73. This revisits the issue of who is a promoter? Everyday individuals who post on social media feeds their latest and greatest NFT or other cryptocurrency venture? Or is it still only limited to the exchanges? If it does apply to the average person are metrics such as follower counts and how many times a post is seen, reposted, or shared considered? As with all internet based legislation, the proverbial buck must stop eventually or the bill risks being overly broad and vague, thus void on constitutional grounds in the United States.
  74. This excludes NFTs which currently are at the forefront of application of copyright law and protection.
  75. Data which has been stripped of all identifiable markers that would allow a party to derive the identify of another from that data.
  76. Referring to the process of where the encoding that de-identifies data is used to restore the identifiable markers of the data and thus allow the identity of the individual to be determined.
  77. Traditionally boards of a company will put it up to a stockholder vote when it comes to certain major decisions for a company. While a minimum threshold may be needed to obtain these voting rights, they exist, nonetheless. No such rights exist with cryptocurrencies, thus there are no grounds for an ultra vires action against miners who, in addition to being servers not people, have no fiduciary duty or other relationship with the cryptocurrency holders.
  78. Defining cryptocurrency as a “digital commodity”. (S.4760 Digital Commodities Consumer Protection Act of 2022 (2022) congress.gov, https://www.congress.gov/117/bills/s4760/BILLS-117s4760is.pdf (last visited Aug. 29, 2022)).
  79. Wheat from Farm A’s harvest from season 1 will be the same kind of wheat as produced in season 2. While not the exact same product grain for grain, wheat is still fundamentally wheat. The same stands for raw materials, such as gold and oil, as well as cryptocurrencies. While the exact number of a specific Bitcoin will not be created one Bitcoin coin is the same as another from the same sequence. Interchangeability can also apply to exchanges at agreed upon rate (e.g. one USD for five pounds of wheat; one Bitcoin for one month’s rent, etc.).
  80. A buyer who buys wheat can, in the same hour, purchase gold, oil, USD, Yen, and Pound Sterling within the same marketplace. A buyer who wants to do the same purchases plus those in the securities market would have to engage in the commodity marketplace and securities marketplace at the same time and comply with respective rules of each with limited ability to easily cross trade his wheat purchase into a stock.
  81. Cryptocurrencies that are less mined run the risk of not being as widely accepted (as less people will have it) and of having a disproportionate value that is either too high to too low to be practical  because of their lack of volume. Analogously, to make a purchase for $1, you can use your credit card, cash ($100, $50, $20, $10, $5, or $1 bills), a dollar coin, two half dollars, four quarters, ten dimes, twenty nickels, or a hundred pennies—which are the most common ways to pay the $1 charge and which are the least likely? Chances are card and a $1 bill would be the most common, followed by quarters. Least common would likely be dollar and half dollar coins that while they exist are so rare and minimally minted that their actual market value far exceeds the value they represent.
  82. There have been instances where companies or groups will create and issue their own cryptocurrency as a means of creating their own sub-market that exclusively used the cryptocurrency they themselves created. This is more common in areas where the national currency has little to no value or a value that is noted for its instability, such as Venezuela. These restricted cryptocurrencies have been created by lawful institutions such as Goldman Sachs for inter-institutional transfers, as well as by illicit organizations, such as cartels when paying growers who would prefer the cartel cryptocurrency over the local currency due to its stability.
  83. SEC v. Levin, 849 F.3d 995 (11th Cir. 2017).
  84. The CEA’s jurisdiction over cryptocurrencies as a commodity is rooted in cases such as CFTC v. McDonnell, 287 F. Supp. 3d 213, 217 (E.D.N.Y. 2018) though like many cases regarding cryptocurrencies as securities the argument focuses more on establishing plaintiff standing for fraudulent conduct than the cryptocurrencies themselves.
  85. The OCC has also been one of the primarily issuers of guidance on treatment of cryptocurrencies within the fiat marketplace and banking.
  86. S.4760 Digital Commodities Consumer Protection Act of 2022 (2022) congress.gov, https://www.congress.gov/117/bills/s4760/BILLS-117s4760is.pdf (last visited Aug. 29, 2022).
  87. Adam Hayes, Stablecoins, Investopedia.com (2022), https://www.investopedia.com/terms/s/stablecoin (last visited Apr. 24, 2022).
  88. As the mining process is a decentralized ledger system composed of a network of computers, any government who seeks to control a cryptocurrency’s mining process would have to make substantial investment in mining machines in order to obtain mining dominance. Given how expensive mining equipment is there is a high probability that eventually the mining ‘farms’ (e.g. huge warehouses of servers) will be owned primarily by various countries and their governments rather than individuals as mining superiority is difficult to obtain and costly to maintain.
  89. Due to the digital format and network of cryptocurrencies, the ‘location’ of a transaction is based on the physical location of an exchange’s or other platform’s servers. Thus, a U.S. based exchange is one that has its servers located within the United States, whereas an exchange with its headquarters in the United States but servers in the Republic of Ireland would be a foreign exchange as the servers, and thus location of the transactions, take place in Ireland which is both an independent nation as well as member state of the European Union. Thus, any exchange of information from the servers to the headquarters in the United States are protected by Ireland and the European Union’s privacy laws and regulations, not the United States’. The Union’s view on applicable jurisdiction over servers and data within them under the General Data Protection Regulation (“GDPR”) is expressed in the rulings of Schrems I and Schrems II.
  90. Binance is one of the largest, it not the largest cryptocurrency exchange. It hosts over 350 cryptocurrencies, over 43 Fiat currencies and has over 17 million weekly visits. Within 24 hours between September 1st and 2nd of 2022 its volume-metrically moved $15,240,312,994 USD. Comparatively FTX moved $1,656,786,768 with over 3 million visits and Coinbase moved $1,468,289,085 USD with over 1.6 million visits. (https://coinmarketcap.com/rankings/exchanges/, last visited Sept. 2, 2022).
  91. Kucoin supports 616 coin types, over 45 Fiat currencies, a weekly average of 2.29 million visits and volume-metrically moved $787,806,199 USD within a 24-hour period. (https://coinmarketcap.com/rankings/exchanges/, last visited Sept. 2, 2022)
  92. Where local laws and regulations would apply, so in the case specifically of the south pacific there could be little to no regulation compared to Europe where there are robust KYC and other privacy laws and regulations.
  93. Such data includes (not exhaustive) requiring users to provide: name, mailing address, email, and social security numbers.
  94. As stated in 26 U.S.C. § 6050I(c)(1).
  95. The $10,000.00 has been understood to not be a required threshold and thus any ‘suspicious activity’ can result in an IRC 6050 filing.
  96. Robinhood Crypto is a notably smaller exchange, not appearing within the top 300 crypto exchanges (ranked by volume-metrics); it currently offers 7 coin types and provides no 24 hour volume metrics as of March 12, 2022.
  97. Compare that to the U.S. that requires copies of proof of identification (IDs, passports, bills, SSN, immigration number etc.) in addition to sufficient contract information (emails, phone numbers, etc.) alongside a name and physical address.
  98. While the IRS has reporting requirements for foreign/international income and assets it is a reporting scheme built on a centralized system whereby the IRS can ‘double check’ reporting against information obtained from foreign governments. If neither the IRS nor those governments have the information then there is no way for the IRS to verify if a person’s reporting is truthful or not.
  99. There is a difference between an account number and de-identified account number, de-identification means that without access to the algorithm that generates the number there is no way for a holder of de-identified information to summarize who the data belongs to.
  100. Such companies have been hospitals, banks, gas, and oil suppliers as well as smaller private institutions including law firms—and is now what digital ransom policies are becoming a requirement with malpractice insurers.
  101. Andrew Froehlich, Walled Garden, West Gate Networks, techtarget.com, https://www.techtarget.com/searchsecurity/definition/walled-garden (last visited Apr. 24, 2022).
  102. As of May 5, 2022, California Governor Gavin Newsom signed an executive order wherein California will consider “Crypto Assets” will be an alternative term for “Digital Assets” and encompasses any digital asset that may be used as a medium of exchange for which generation or ownership records are done via Blockchain.  (see https://www.gov.ca.gov/wp-content/uploads/2022/05/5.4.22-Blockchain-EO-N-9-22-signed.pdf)

    As of September 2, 2022, a Cryptocurrency bill has passed in California and is awaiting signature by Governor Gavin Newsome defining under 3102(f)(1)“‘Digital financial asset’ means a digital representation of value that is used as a medium of exchange, unit of account, or store of value, and that is not legal tender, whether or not denominated in legal tender.” (see https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=202120220AB2269)

  103. Such as Ethereum.
  104. Defined under current online banking as when an individual transfers funds from their own banking account directly to the account of another. (Oracle Banking Experience Online Help, Peer to Peer Payments (2018), https://docs.oracle.com/cd/E92727_01/webhelp/Content/obdx/retail/p2paymnt/p2pintro.htm (last visited Aug 29, 2022).
  105. Hodges v. Harrison, 372 F. Supp. 3d 1342 (S.D. Fla. 2019).
  106. INTERPOL stands for International Criminal Police Organization and is an international organization that facilitates worldwide police cooperation and crime control.
  107. Merriam-webster.com. 2021. Definition of KNOWLEDGE. [online] Available at: <https://www.merriam-webster.com/dictionary/knowledge> [Accessed 12 May 2021].
  108. Traditional formats being hard or digital Fiat currency of a government of country (such as the USD, Pound, Yen, etc.), checks (traveler’s, personal or bank), and money orders.
  109. 18 U.S.C. § 1956 (c)(5).
  110. Despite KYC practices, all data input on the blockchain is dependent on user inputs for verification, because a Blockchain operates on pure majority rule with data records, anyone with a majority holding of Miners can deem information ‘true’ even if it is in fact incorrect. At most all anyone would need to circumvent KYC policies is a method of offering multi-step authentication to verify their identity—which can likely be accomplished by most school aged students, especially post two years of fully remote learning.
  111. An example of this is how the Bank Secrecy Act requires banks to report withdrawals of money over $10,000; this however being law means it is also publicly accessible and parties can draw anything up $9,999.99 without a bank being legally obligated to report it. While the Bank itself might have more stringent guidelines as to reporting, say at $9,000 they internally flag the account, the fact of the matter is the process is easy enough to work around if the policy is discoverable.

  112. For example: Criminal Calvin sells drug paraphernalia and takes payments only in cryptocurrency. Calvin has programed his wallet so that whenever ten of any cryptocurrencies is held, his program automatically takes five units of cryptocurrency and divide it across 100 transactions so that each transaction is only 0.05 of a singular cryptocurrency unit because he knows such a small fraction will never be worth the monitoring threshold in equivalent USD value. As Calvin uses offshore exchanges he only needs an email to create accounts, thus he can control all 100 wallets to which that the 0.05 cryptocurrency is transferred.

    For all these wallets he has the same system set up and through the foreign exchanges he never transfers the cryptocurrency to an account nor wallet he does not control. As there is no cross porting of historical data, every time Calvin receives any of the transfers between exchanges there is no attached history to the account. Thus, when crypto goes from Exchange 1 to Exchange 2 Calvin can then trade it for fiat currency via a third exchange which he can digitally deposit to a bank account from which he makes a one-time cash withdrawal once the fiat account has the value of the 5 Bitcoin within it. This allows him to convert the sum in cryptocurrency to fiat through digital laundering, alternatively he could never convert to fiat and instead pay for all his needs with the cryptocurrency he earns that remains untraceable to the government because his wallet never has more than ten units of cryptocurrency in it despite that he holds hundreds, if not thousands, of units that are all traded across a network of wallets that he alone controls.

  113. Jurisdiction here is rooted in the Federal Communication Commission (FCC) 47 U.S.C. § 151.
  114. Legalized shops face increasing risk of robberies because of a lack of a banking system as their shops hold high volumes of cash. (See https://www.npr.org/2022/04/20/1093841615/pot-shop-robberies-are-fueling-calls-for-a-u-s-banking-bill).
  115. 47 U.S.C. § 151.
  116. 18 U.S.C. § 670(e)(1); “’pre-medical product’ means a medical product that has not yet been made available for retail purchase by a consumer”.
  117. 18 U.S.C. § 670(e)(2); “‘medical product’ means a drug, biological product device, medical food, or infant formula”’ ‘biological product’ is “a virus, therapeutic serum, toxin, antitoxin, vaccine, blood, blood component or derivative, allergenic product, protein, or analogous product, or arsphenamine or derivative of arsphenamine (or any other trivalent organic arsenic compound), applicable to the prevention, treatment, or cure of a disease or condition of human beings.” Emphasis added, quoted from 42 U.S.C. § 262(i)(1).
  118. 18 U.S.C. § 1957 (b)(1) cites 18 U.S.C. § 670(c)-(d) for penalties regarding pre-medical products which are separate from the penalties of §§ 1956, 1957 themselves.
  119. 18 U.S.C. §§ 1956(a)(2)(b), 1956(a)(3), and 1957(b)(1); § 1957 carries a max penalty of $250k for the individual; however, Daniel is a business and thus an ‘organization’ could fall under § 1956 penalties.
  120. The use of bearer bonds effectively terminated with the passing of the Tax Equity and Fiscal Responsibility Act of 1982 as “[b]earer bonds are virtually extinct in the U.S. and some other countries as the lack of registration made them ideal for us in money laundering, tax evasion, and any number of other under-handed transactions. They are also vulnerable to theft” and are no longer issued by the U.S. Treasury. (James Chen, Bearer Bonds, Investopedia.com (2021), https://www.investopedia.com/terms/b/bearer_bond.asp (last visited Aug. 31, 2022)).
  121. Recall this is akin to asking how to tax someone with a valid currency printer on the money they are printing.
  122. As of the final editing of this article in August of 2022 the proposed legislative bills and guidance that followed the summer 2022 Crypto market crash have yet to offer adequate answers.