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Writer's pictureAnna Aseeva

#5: Regulation of Cryptoassets. A Toolbox for a Regulatory Compliant and Sustainable Tech: Winter Recipes. Recipe #5

Disclaimer: This is an updated version of Section 7 of my article Liable and Sustainable by Design: A Toolbox for a Regulatory Compliant and Sustainable Tech

You can read article in full (in open-access) here:



Now that I have your attention (food is good, old but gold, right?), let us delve into some tenets of the regulation of crypto

In June 2021, El Salvador adopted Bitcoin as legal tender, becoming the first country to make it the official national currency. In April 2022, the Central African Republic followed El Salvador. A few jurisdictions use Bitcoin in some payment capacity as a kind of exchange token, including Switzerland and the US; some US states (e.g., Colorado) and Swiss cantons (for instance, Zug) even accept tax payments in Bitcoin.

(A necessary introduction that you will see in every recipe :)

The pandemic has exacerbated the effects of the digital transformation: the extractive economy is steadily giving way to the new economic space—the digital economy. This transformation shakes the very foundations of the existence and purpose of law, i.e., the regulation of social relations. However, today, the consequences of developing tech in an unsustainable manner are becoming obvious. Unsustainable tech development contributes to trust erosion, misinformation, and polarization, leading to such legal/ethical issues as irresponsible practices of all sorts, unsafe and insecure digital market, inequality, lack of transparency, breach of privacy, etc.

 

These developments occur partly because the algorithms that shape our economies, society, and even public discourse were developed with few legal restrictions or commonly held ethical standards. Consequently, ensuring that technologies align with our shared values and existing legal frameworks is crucial.

 

This series of blog posts explores existing and prospective legal and regulatory frameworks that make tech not only legal by design but also, and especially, liable and sustainable by design. The key questions include whether new laws are necessary or if existing legal, regulatory, and ethical concepts can be adapted (or both!).

 

It is argued here rather in favour of the adaptation of pre-existing legal concepts, ethical standards, and policy tools to regulate the digital economy effectively, while paying attention to possible gaps and possibilities to fill those gaps. The objective is to synthesize these concepts, analyse their applicability to Web 3.0 and Web 4.0 regulation, and provide a toolkit (see below) for a regulatory compliant and sustainable tech. The blog series focuses on organizations involved in tech and innovation, particularly Web 3-4 actors, using systems analysis to examine regulatory constructions both functionally and institutionally.)

Figure 1: Toolbox. Source: Anna Aseeva (2023), 'Liable and Sustainable by Design: A Toolbox for a Regulatory Compliant and Sustainable Tech', in Sustainability, Vol.16, https://doi.org/10.3390/su16010228


In the 5th and last Episode of the series, I analyse the most relevant concepts, recent practice and case law, and avenues in the regulation of cryptoassets.


Recipe #5: Regulation of cryptoassets


1. In this episode


When one speaks about AI and other algorithms, NFTs, blockchain, and the regulation thereof, naturally, one cannot avoid considering the regulation of cryptomoney and of a broader category of cryptoassets. Such regulation plays a major, even critical, role in virtually any Web 3-4 project.


As we saw in the previous episode (the one on IP for Web 3-4), many NFTs can be purchased only with cryptocurrency, most of them with ETH, which makes the former a kind of a good and the latter a payment method for that good. Cryptocurrencies are built using the same kind of programming as NFTs, but that is where the similarity ends. Like fiat (physical) money, cryptocurrencies are fungible because they store value and act as a medium to buy or sell goods and services. That is the topic of the present post (which is the last in this blog post series): monetary and financial aspects of the regulation of cryptoassets.


In policy terms, the monetary system and the regulation thereof refer to national currency and exchange-rate policies, and the financial system and its regulation encompass the creation and access to (trade in) credit that could be either national or international, or, more precisely, transnational (S. Strange, 1998). In this blog post, I address some relevant legal and policy highlights of the first, monetary, dimension, specifically, its first part—national currency—while also looking at the second strand—the national and international financial system. I will also consider the connected tenets of tax law. I equally delve into some peculiarities of cryptocurrency regulation around the world.


2. Monetary, financial, and tax regulation of relevant assets


Over the last few years, many countries have been developing their central bank digital currency (CBDC)—digital tokens issued by their central banks—a ‘crypto-version’ of their national currency. For instance, in August 2023, the US and Russia conducted pilot studies before launching their national CBDCs. That is, unlike private cryptocurrencies such as BTC, a US CBDC, for instance, would be issued and backed by the Federal Reserve, just like US fiat money—USD bills and coins.


Regarding all cryptoassets, and, particularly, private cryptocurrencies (basically, everything that is not official legal tender in a given jurisdiction), the first point is easy and quite obvious. If a tech firm, a collaborative innovation project, or even an individual author produces an entrepreneurial or an LDMA work, they might consider (or even should, if they can) tokenizing their work. If they create NFTs, these NFTs can be purchased, as said in my previous blog post, with cryptocurrency.


Today, many NFTs can be purchased only with ETH, for example, which, unlike the above national CBDCs, is not considered money or currency and is one of the so-called private cryptocurrencies. Thus, the entity must have a digital wallet, and, more precisely, a cryptowallet (even more precisely, today, an ETH wallet for receiving payments for NFTs is advisable). Clearly defining the holder(s) of the key to the cryptowallet is thus a sine qua non step if an entity decides to, partially or totally, receive and/or issue payments in, or else save, invest in, cryptoassets.


Thus, the next set of questions comes naturally: the taxes. With respect to tax law, there will be an obligation for the organization to enter in its accounting books the Value Added Tax (VAT) on cryptoassets with the values expressed in crypto, which will involve drawing up a balance sheet, etc. Here, it will be extremely important to know which cryptoasset has which status (i.e., currency or investment (here, further distinguishing between property and security, especially, in the US)) in the jurisdiction where the entity declares and pays its taxes.

 

This point brings me to the next concern, which stems from the important and ongoing debate around the regulation of private cryptocurrencies, their status, registration, the connected tax declaration, etc. Consider that, while BTC is not defined as a security in most jurisdictions, important cryptos such as ETH and Ripple (XRP), the second and third most valuable private cryptocurrencies, respectively, which today are the most widely used for payments and transactions of many kinds, are under significant regulatory pressure in many jurisdictions, primarily in the US.

 

The US Securities and Exchange Commission (SEC) has clarified that BTC is not a security:

 

- ‘[c]ryptocurrencies are replacements for sovereign currencies…[they] replace the yen, the dollar, the euro with bitcoin. That type of currency is not a security’.

 

However, with respect to XRP, in December 2020, the SEC filed an action against Ripple Labs Inc. (the creator of XRP) and two of its executives, alleging that they raised over 1.3 billion USD through an unregistered, ongoing digital asset securities offering. The recent ruling of 13 July 2023 in the above case concluded that sales of Ripple’s XRP token directly to institutional investors violated the SEC’s rules but offerings to retail investors on exchanges did not. That is, Judge Analisa Torres of the US District Court for the Southern District of New York issued a split decision in which she found that XRP was

 

- ‘not in and of itself a ‘contract, transaction [,] or scheme’ that embodies the Howey requirements of an investment contract’.

 

Judge Torres essentially stated that such a transaction did not involve investment contract securities and thus that the XRP token at issue was not a security. Note that, at the time of writing, the SEC asked a federal judge to ignore these parts of the ruling, saying the judgment did not square with existing securities laws and that it might appeal. This case illustrates three major points.


(i) Firstly, the above ruling is singularly important not only for Ripple Labs Inc. and XRP holders around the world, but also for the larger digital assets industry and holders, as the SEC has long taken the position that nearly all tokens except BTC are, in and of themselves, investment contract securities.

(ii) Secondly, this case, and especially the SEC decision to appeal the judgment, show that today XRP itself (still), ETH, and any crypto except BTC are the focus of pressure from regulators—in the US, first of all, but also around the world.

(iii) Thirdly, and importantly, any cryptowallet owner must hence be mindful of, and must constantly monitor the status of, all the tokens in it, whether they are, or are likely in the near future (especially through keeping up-to-date with relevant regulations, case law, and other important decisions in their country and around the world) to be considered investment contract securities.


This caution is necessary because the method of declaring and paying taxes, as well as the very nature of the tokens in any cryptowallet, will depend on the applicable law and relevant decisions by the authorities.

 

Notably, on 25 July 2023, Singapore’s High Court has ruled that the holder of a cryptoasset has a legally enforceable property right recognisable by the common law courts. This ruling constituted the first time that a common law court made such a decision. While the case concerned corporate fraud and theft from ByBit Fintech, what is important for the analysis here is that Justice Philip Jeyaretnam held that a cryptoasset, more precisely, the stablecoin USDT, is a thing in action, and is thus enforceable in Singapore via court orders and also capable of being subject to a trust. (A thing in action is a personal right of property which can only be claimed or enforced by action, and not by taking physical possession. An example is a debt that gives the creditor a right to money by claiming or enforcing against the debtor.)


3. 50 shades of cryptocurrency... and 100 shades of its regulation

 

Given the above, note that even the legal status of the oldest, biggest, and most expensive (but also, allegedly, the safest) private cryptocurrency, Bitcoin (BTC), varies widely across countries and over time. Consider that in June 2021, El Salvador adopted BTC as legal tender, becoming the first country to make it the official national currency. In April 2022, the Central African Republic followed El Salvador (note, however, that in 2023, the country reversed its decision).

 

A few countries have fully banned BTC use (such as Algeria, Bolivia, Egypt, Iraq, Morocco, Nepal, Pakistan, Vietnam, and the United Arab Emirates), while more than forty have implicitly banned it (e.g., China, Colombia, the Dominican Republic, Indonesia, Kuwait, Lithuania, Macau, Oman, Qatar, Saudi Arabia, and Taiwan). Moreover, Australian banks close down the bank accounts of operators of businesses involving BTC since the country’s National Bank recognized it as too risky (see, e.g., here and here).

 

A few jurisdictions use Bitcoin in some payment capacity as a kind of exchange token, including Switzerland and the US; some US states (e.g., Colorado) and Swiss cantons (for instance, Zug) even accept tax payments in BTC. It should be remembered, however, that at the federal level, the US Internal Revenue Service (IRS) classifies cryptocurrency, including BTC, as property, not currency. Thus, the SEC’s above claims that it considers BTC ‘currency’ rather mean that, contrary to its treatment of all other cryptos, and given the SEC’s scope of competencies (securities), it merely does not treat BTC as security. This classification also means that the US central authority responsible for taxes says that, for tax purposes, BTC and any other cryptocurrency are not currency, but property, and thus, buying and selling cryptocurrency is taxable under US tax law.

 

In the UK, the situation is similar to that in the US, but with more nuances. Like the US, the UK does not classify cryptocurrency as money or currency. Thus, anyone who holds cryptocurrency as a personal investment in the UK will then be taxed on any profits realized on such assets. However, His Majesty’s Revenue and Customs (HMRC) further details in its Cryptoassets Manual how to file cryptocurrency taxes. HMRC distinguishes four categories of cryptoassets:

(i) stablecoins, which are cryptoassets with value pegged to that of fiat money or exchange-traded commodities, such as, for example, Tether (USDT) and USD Coin (USDC), which are pegged to the value of US dollar;

(ii) exchange tokens such as BTC, which can be used as a mode of payment;

(iii) security tokens, which have interests and rights in business, such as, for example, entitlement to shares in future profits; and

(iv) utility tokens, which provide access to goods or services accessible via a platform, usually using distributed ledger technology (DLT).

 

In the EU, Germany is seen as one of the most cryptofriendly member states in terms of taxation. Under the German Tax Acts, BTC and all other cryptos are considered private money, whereas the German Federal Central Tax Office (BZSt) does not classify cryptocurrency as property, foreign currency, or legal tender. Actually, as Germany treats cryptocurrency as a kind of ‘private money’, its laws favour long-term, buy-and-hold investors: short-term capital gains from cryptocurrency or cryptoassets held less than a year are subject to income tax, while those held longer than one year are not subject to such tax, even if the asset increases in value; individually-held crypto is VAT-exempt, and assets held for over a year do not incur a tax liability on earnings. Moreover, for natural persons, profits from cryptocurrency and cryptoassets of less than 600 EUR a year are exempt from taxation.

 

At the supranational level in Europe, in 2015, the CJEU decided that BTC transactions would be exempt from VAT. On the regulatory front, in 2013, the European Banking Authority (EBA) warned EU consumers about the high volatility of BTC prices and the possibility of general fraud, as well as the possibility that their BTC exchanges could be easily hacked. They thus warned of a need to regulate BTC and crypto more generally.

 

In June 2023, the EU adopted the Markets in Crypto-Asset (MiCA) and the (revised) Transfer of Funds Regulation (TFR) regulations, which aim to regulate the cryptomarket in the EU, and, naturally (because the two instruments are EU regulations), to harmonize the regulatory framework for the cryptoasset market across the Union.

 

MiCA covers cryptoassets that are not currently regulated by the existing EU financial services legislation (primarily, MiFID II), supports innovation and fair competition, and presents the requirements and limitations for those issuing and trading cryptoassets by laying down supranational rules on transparency, disclosure, authorization, and supervision of covered cryptotransactions.

 

The revised TFR binds cryptoasset service providers to accompany any transfer of cryptoassets with information on the originators and beneficiaries, thus applying the equivalent of KYC and due diligence obligations to the cryptoassets market within Union borders and complementing MiCA. The two regulations together also protect EU citizens and bind the operators on the single market at the point where the EU consumer protection rules end, thus filling the gaps that the ESMA warned about ten years earlier, as outlined above.

 

Importantly, MiCA is not supposed to apply to NFTs; to distinguish between cryptoassets covered by MiCA and financial instruments covered by MiFID II, by 30 December 2024, ESMA will have to issue guidelines on the criteria and conditions for the qualification of cryptoassets as financial instruments. MiCA also introduces the concept of cryptoasset service providers under EU law. That is, if cryptocurrency or cryptoassets more generally are the subject of a project, or if a tech enterprise provides services related to cryptoassets (custody, purchase/sale of cryptoassets, exchange, reception or transmission of orders, management of portfolio, etc.), such entity qualifies as a service provider covered by MiCA.

 

The general application date of MiCA and the TFR is 30 December 2024. The cryptoindustry and any tech player that in any way deals with crypto on the EU market now have less than a year to prepare for full compliance with the new legislation. In general, both regulations aim at guaranteeing a lower risk of being scammed or losing one’s cryptos (for further analysis see, e.g., here). The regulations also aim at triggering the development of strategic crypto-related projects in the EU, which European tech enterprises and enthusiasts should consider as a serious and positive message and material support for their efforts. Moreover, the introduction of an EU passport for cryptoasset service providers, which will allow them, once authorized, to provide cryptoasset services in all EU jurisdictions, is likely to enhance the possibility to scale-up cryptoprojects at the European level.

 

4. Summing up

 

In sum, in the EU, as far as cryptoassets (including both digital currency and NFTs) are concerned, an in-depth legal and regulatory analysis and constant monitoring are crucial for the covered tech organizations. By the general application date (30 December 2024) of MiCA and the revised TFR, applicants will have limited time in which to implement their requirements, so it is better to prepare all the necessary information, files, and proceedings in advance.

 

More generally, the bottom line of the finance- and monetary-related regulations that apply to the digital economy and that are relevant to any Web 3-4 enterprise is that knowing and clearly understanding 

(i) what is one’s product, content, or service in both monetary and financial terms,

(ii) what exactly is in one’s cryptowallet, and

(iii) in which jurisdiction one is the taxpayer will define how the entity declares and pays the taxes on its cryptoassets and in which cryptocurrency one would prefer to receive and/or issue one’s payments.

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