2020 may have brought the bulk of the world to a standstill, but definitely not the world of crypto. In fact, this has been one of the most critical years for the industry. At least from a legal perspective.
In the past 12 months, we’ve seen the SEC clarify its stance on ICOs and the IRS introduce new crypto-specific questions to US tax forms.
We’ve seen the leadership of one of the biggest crypto exchanges in the world taken down for non-compliance with KYC AML regulations and discovered that one of the most prominent crypto-friendly jurisdictions was a sham.
Meanwhile, we also saw the rise of a number of new unregulated crypto investment opportunities that are now flirting dangerously with the authorities.
Overall, it’s been a very exciting year for crypto law.
In case you haven’t been following every development as closely as I have, read on in today’s article for an overview of this year’s biggest crypto law developments.
Table of Contents
1. The IRS Gets Serious About Crypto Reporting
For several years now, it has been well-established that crypto gains are taxable in the US. The IRS classifies crypto as “property” and thus US citizens and residents are required to pay capital gains tax on any earnings from trading crypto assets.
However, 2020 was the first year that the IRS specifically asked taxpayers to report whether or not they had acquired, used or traded cryptocurrency.
This was found in the form of a new question on taxpayers’ Form 1040 Schedule 1:
“At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
This is a significant development because the IRS is not simply looking for information on taxable income. The IRS goes beyond taxation and is seeking information without regard to taxability.
This information gathering exercise on citizens’ crypto holdings sent chills through the community. Skipping that question and failing to report one’s holdings counts as tax fraud and can come with severe consequences, even if no taxes are owed.
In recent weeks, the IRS has sent out dozens of letters to taxpayers claiming that they had underreported crypto gains on their previous tax forms.
It has been reported that in many cases the IRS’ calculations are exaggerated. Nonetheless, this goes to show how closely the IRS is keeping its eye on crypto.
If you would like to learn more about crypto tax requirements for US citizens, residents and companies read on in The Ultimate Crypto Tax Guide.
2. The SEC’s Approach to ICOs Becomes Clearer
This year we saw two of the most prominent cases against ICOs reach resolution.
Typically the SEC takes action only after a securities offering has been completed, but in an uncharacteristic move by the agency, the SEC took preemptive measures to block Telegram from launching its network and conducting an offering for its GRAM token.
Though Telegram had not done anything illegal yet, regulators claimed that as soon as it released its token it would be in violation of securities laws.
This was a huge blow to the industry because Telegram was a very well-established project. Not one to be compared with the scams and pyramid schemes typically targeted by the SEC.
In addition, the investors in Telegram’s initial token offering were well-funded, accredited investors. Even after the SEC’s initial warning, the investors declined the opportunity to withdraw their funds and opted instead to keep their funds with the company.
Nonetheless, in the space of 7 months, the case was opened and closed. Telegram lost and was forced to shutter its TON network on the eve of launch and return $1.2 billion of the capital it had raised back to investors. An entire project completely canned.
A few months later, this was followed by a summary judgment ruling against Kik, in which the court sided yet again with the SEC.
After nearly two years of battle with the SEC and after the SEC won summary judgment, which meant it could demand the highest penalties possible, we expected Kik to be wiped out. Just like the TON network, the resolution of this case looked to be the end of KIN.
But this time, the SEC shocked everyone yet again. The agency handed Kik a meager $5 million penalty and did not require the project to return funds to investors.
While we may never know why the SEC took such different approaches in the resolutions of these two cases, the regulators’ approach toward token offerings was somewhat consistent. These two cases served as significant and valuable steps toward regulatory certainty for the industry in how to legally conduct ICOs.
To learn more about the key legal takeaways from these cases, read on in How the SEC Wants you to Conduct an ICO.
3. Authorities Take Down BitMex for Failing to Perform KYC AML
This year, we also saw the nightmare of every crypto entrepreneur come to reality.
This happened when the founders of BitMEX were served with both civil and criminal charges for ‘willfully’ violating KYC AML requirements.
While the news of the BitMEX crackdown sent a stir through the crypto space, for those that are familiar with the exchange, it might not have come as a complete surprise.
For years, BitMEX founders had openly flaunted US regulations. BitMEX CEO, Arthur Hayes, famously commented a few years back that it incorporated in Seychelles rather than the US because it only cost a “coconut” to bribe the authorities there. Ouch.
Now, the US authorities’ crackdown on the exchange definitively demonstrates to all projects in the crypto space something that we’ve been trying to emphasize for years: If a crypto project focused on financial services has US customers, it must abide by US regulations — regardless of where the company is incorporated.
Incorporation in Seychelles may make it easier for a project to get started, but as long as a project caters to and allows US users on its platform, it’s within the purview of US regulation.
For crypto projects that are not based in the US that would like to minimize their US regulatory compliance burdens, the only way to do this is by completely excluding US customers.
As we’ve now seen with BitMEX, it is not enough to put up some banners saying that US customers are not welcome and a one-time geoblock on new customers. Genuine steps via acceptable KYC AML must be taken to block all US users.
If the decision is made to exclude US customers, projects must take proper steps. To learn more, read on for the 5 steps you must take to effectively exclude US customers.
4. Malta Outed For Not Being the Crypto Hub it Claimed to Be
Prime Minister Joseph Muscat became a star in the crypto space when he announced in 2018 that he was going to make Malta the most crypto-friendly jurisdiction in the world. Or as he called it ‘Blockchain Island.’
To do this, he promised extremely easy business and exchange licensing, as well as negligible KYC and AML requirements.
Excited by these moves, hundreds of crypto projects flocked to the country to apply for licenses under the new legislation and Malta was heralded as one of the best crypto-friendly jurisdictions out there. Even we got caught up in the hype and published this article in 2018.
But at the start of 2020, this all came to an end when Prime Minister Muscat was accused of corruption and pushed to resign.
As spectators wondered what this meant for the future of Blockchain Island, information leaked to show that in the preceding years, not a single company had been awarded a license under the country’s supposedly blockchain-friendly legislation.
This included Binance, which had been the most vocal advocate of incorporation in Malta during that time.
It had sounded to good to be true, and it was.
The key takeaway was that projects shouldn’t be fooled by promises of avoiding securities laws and KYC AML regulations. Those kinds of promises are made by shady jurisdictions that want to make a quick buck selling business licenses. And, as we’ve seen from the BitMEX case, incorporating in one of these jurisdictions does not actually do anything to protect you from these laws.
The best jurisdictions are the ones that are working to make business feasible for crypto projects. These are the ones that are working hard to create regulatory clarity and help crypto businesses establish banking and insurance relationships, something that can be nearly impossible for crypto projects in most parts of the world. Some great examples of serious jurisdictions that are taking action on both fronts are Bermuda and Zug, Switzerland.
As always, before choosing where to incorporate your crypto project, be sure to do your own research and if possible get boots on the ground before making your decision.
To learn more about what happened with Malta and what to watch out for when picking a crypto jurisdiction, read on in The Maltese Deception: The Crypto Hub that Never Came to be.
5. The Rise of DeFi
Now that ICOs are under heavy SEC scrutiny, it’s harder to make the wild fortunes that one could back in 2017. But, in their wake, a number of new investment opportunities have arisen that promise investors double and even triple-digit returns through staking or locking up crypto.
Most of these new opportunities are coming from a new sector called, Decentralized Finance or DeFi. And 2020 has undoubtedly been the year for DeFi.
In June, the DeFi space made headlines for breaking through $1 billion in ‘locked’ assets. That just fueled the fire, and the amount of locked assets has exploded since to over $14.5 billion now at the time of writing.
It’s an exciting space, and while there are a number of excellent, legitimate DeFi projects out there, every day I come across a frightening number of DeFi platforms that are just waiting to be targeted by regulators.
These projects are obviously securities or funds—some even outright call themselves “banks”—but they are not licensed or registered with any regulatory authority nor do they perform any KYC AML.
Though the DeFi space has not caught the eye of regulators just yet, there is very little doubt in my mind that that day will come soon.
While many projects claim that they can’t be regulated because they are “decentralized” or a “protocol”, this doesn’t work with regulators. As we saw with ICOs, regulators look past the jargon to see what activity is actually taking place and see how it applies to existing regulation. Despite the buzzwords, nearly all DeFi projects are engaging in very traditional financial activities, and it won’t take long for regulators to make the same associations.
So, before you start a DeFi project or ‘lock’ your funds in with any of these projects, it pays to be aware of the regulatory risks. Read on in Are DeFi Platforms Subject to Regulation? 3 Questions to Ask Before You Invest.
What Does this Mean for Crypto Law Insiders?
The legal and regulatory advances in 2020 show that authorities across the board are getting more serious about regulating crypto. They’re keeping a close eye on the sector and are willing to take strong action against any violators of the law.
Meanwhile, the industry continues to evolve ahead of regulators, as can be seen with the rise of DeFi. The whole thing is starting to look like a game of whack-a-mole. As soon as regulators got on top of ICO, there came DeFi. Once regulators get on top of DeFi, there will likely be something else.
Though many in the industry may be caught off-guard when DeFi and other decentralized projects eventually come under regulatory scrutiny, Insiders will be prepared.
