Crypto Investing: Navigating Legal And Illegal Territories

Investing in cryptocurrencies carries certain legal risks that vary across jurisdictions. While some countries have explicitly allowed the use and trade of cryptocurrencies, others have banned or restricted it.

In the US, for example, the Internal Revenue Service (IRS) treats cryptocurrencies as property rather than currencies, meaning that individual investors are subject to capital gains tax laws when reporting profits and expenses on their annual tax returns. In the UK, the Financial Conduct Authority (FCA) has declared all cryptocurrency ATMs illegal as of March 2022.

Other countries where cryptocurrencies are banned include China, Nepal, Afghanistan, Bangladesh, Morocco, Algeria, Egypt, Bolivia, and Tunisia.

It is important to note that the legal status of cryptocurrencies is still evolving and may change over time. As such, investors should stay informed about the latest regulations and consult with tax professionals to ensure compliance with the law.

Cryptocurrencies and Taxes

The legal status of cryptocurrencies varies from one jurisdiction to another, and the regulatory implications of their use as a means of payment or a commodity are still unclear in many places. While some countries have explicitly permitted their use and trade, others have prohibited or restricted it.

In the US, the Internal Revenue Service (IRS) has defined cryptocurrencies as property rather than currencies. This means that individual investors are subject to capital gains tax laws when reporting cryptocurrency profits and losses on their annual tax returns, regardless of where they purchased their digital coins. The amount owed is based on the cryptocurrency's fair market value in US dollars at the time of the transaction.

It's important to note that the above applies to investors who buy and sell cryptocurrencies. If you are an employee and receive cryptocurrency as salary, it is taxed as income.

Cryptocurrency trading often involves holding cryptocurrency in a foreign account. As of August 2023, US federal law does not consider a foreign cryptocurrency account a "reportable account". This means that cryptocurrency account holders are not required to disclose their foreign accounts to the Financial Crimes Enforcement Network (FinCEN). However, this could change at any time, as FinCEN intends to propose amending the filing requirements to include cryptocurrency holdings.

Additionally, the IRS requires taxpayers with substantial assets in foreign accounts to file Form 8938, the Statement of Specified Foreign Financial Assets. As of August 2023, the IRS has not ruled definitively on whether cryptocurrency wallet owners must report their holdings using this form. Given the severe penalties for failing to file the required forms, owners of cryptocurrency wallets should consult a tax professional familiar with cryptocurrency when filing their taxes.

In the UK, the government has allowed the use of cryptocurrencies since their inception, using existing policies and growing experiences to develop a framework for crypto-asset regulation. The Financial Services and Markets Act was updated in 2023 to guide the regulation of digital assets, granting the government the ability to designate crypto-asset activities and impose reporting and operational requirements, consumer protections, and safeguards. The government regulates various crypto assets, including exchange tokens (cryptocurrencies), asset-referenced tokens, commodity-linked tokens, crypto-backed tokens, fan tokens (sports-related cryptocurrencies), and fiat-backed stable coins.

In the European Union, the European Central Bank classifies Bitcoin as a convertible decentralized virtual currency. While the EU has not passed specific legislation regarding Bitcoin as a currency, it has stated that VAT/GST is not applicable to the conversion between traditional (fiat) currency and Bitcoin. However, VAT/GST and other taxes, such as income tax, still apply to transactions made using Bitcoin for goods and services. The Markets in Crypto-Assets (MiCA) Regulation defines the services and assets that fall under regulatory controls, and EU member countries can regulate cryptocurrency and crypto-assets as they see fit, as long as businesses involved in specific crypto-assets meet the minimal requirements set by MiCA.

Canada maintains a generally bitcoin-friendly stance, and the Canada Revenue Agency defines Bitcoin as a crypto-asset taxed based on the circumstances in which it was used. Any income from a Bitcoin transaction is considered business income or a capital gain and must be reported as such. Canada considers cryptocurrency exchanges to be money service businesses, bringing them under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada's version of AML/CFT laws). As a result, these exchanges must register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), report suspicious transactions, abide by compliance plans, and maintain certain records.

In Australia, the Australian Taxation Office considers Bitcoin a financial asset with value that can be taxed when specific events occur. For example, if you trade, exchange, sell, gift, convert it to fiat currency, or use Bitcoin for purchases, you trigger a capital gains tax. Record-keeping of any transactions made using Bitcoin is also required for tax purposes. However, if you hold your Bitcoins strictly for personal use and make gains on them, you may not owe any taxes.

Fraud and Money Laundering

Cryptocurrencies are a new phenomenon, and the legal standing of these digital currencies is still unclear. This has created a breeding ground for fraud and money laundering.

The decentralised nature of cryptocurrencies means that they are not backed by a central authority. This makes them vulnerable to fraud, as there is no regulatory body to oversee transactions. When a cryptocurrency exchange is hacked, there is often no standard practice for recovering the missing funds.

The anonymous nature of cryptocurrencies also makes them an attractive prospect for money laundering. Criminal networks exploit the anonymity of digital currencies to disguise illegal funds, using online casinos as a cover. In 2024, Singapore banned the use of cryptocurrencies in casinos due to money-laundering fears. Other countries, including Australia and Brazil, have also tightened their regulations on cryptocurrencies in online betting to prevent money laundering.

Cryptocurrency's Decentralized Status

Decentralization is a spectrum, and some blockchain platforms are more decentralized than others. Decentralization is a key feature of cryptocurrencies, and it refers to the absence of a central authority or intermediary, such as a government or bank, that upholds or maintains the currency. Cryptocurrencies typically use decentralized control, and each cryptocurrency works through distributed ledger technology, usually a blockchain.

A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation. This means that cryptocurrencies exist outside the control of governments and central authorities. However, the lack of a central authority can also be a legal and financial risk to cryptocurrency owners. For example, in the case of a dispute or transaction complication, there is no central authority to facilitate a resolution.

The level of decentralization varies depending on the type of blockchain. For proof-of-work blockchains, such as Bitcoin, the level of decentralization can be measured by the size of their cumulative hash rate and the number of entities it is divided among. In contrast, the decentralization of proof-of-stake blockchains can be measured by the percentage of a coin's circulating supply that is staked to the network and how many entities that stake is divided among.

Other factors that should be considered when determining the decentralization of a blockchain platform include governance and development control, network accessibility, and figurehead influence. Additionally, the initial distribution of tokens in private sales can impact the level of decentralization, as early investors may gain an unfair advantage.

While cryptocurrencies are designed to be decentralized, ownership is becoming more concentrated, with companies purchasing and holding them for price appreciation and investment fund managers buying them to hold in their funds. This trend goes against the original intent of cryptocurrencies, which was to create a global monetary network run by and for the people, with no restrictions.

Cryptocurrency Registration and Licensing

The legal status of cryptocurrencies varies from one jurisdiction to another and is still evolving in many places. In most countries, using cryptocurrency is not in itself illegal, but its status as a means of payment or a commodity varies, leading to different regulatory implications.

In the United States, cryptocurrency is regarded as decentralized, operating similarly to fiat currency. This means that exchanges and other organizations dealing with cryptocurrencies are obliged to:

• Register as Money Services Businesses (financial services)
• Obtain licenses for such activity (e.g. bitlicense)
• Report suspicious transactions to law enforcement authorities

In the US, cryptocurrency licenses are issued by the national regulation bureau, FinCEN. The licenses allow for the conduct of activities related to foreign exchange services, background checks, traveler's checks, remittances, money transfers, and sales with prepaid access.

The registration and licensing requirements for cryptocurrency exchanges differ depending on the jurisdiction. For example, in Japan, a popular jurisdiction for obtaining a cryptocurrency license, there is a requirement for a substantial authorized capital of about $90,000 and a director who is a resident of the country. On the other hand, in Hong Kong, there are currently no requirements for authorized capital, but the licensing process involves submitting various documents such as constitutional documents, identity documents, office lease contracts, and a business plan.

The European Union recognizes Bitcoin and other cryptocurrencies as crypto-assets, and it is not illegal to use them within the EU. The Markets in Crypto-Assets (MiCA) Regulation defines the services and assets that fall under regulatory control. EU member countries have the flexibility to make crypto legal or illegal, as long as businesses involved in specific crypto-assets meet the minimum requirements set by MiCA.

Canada considers cryptocurrency exchanges to be money service businesses, bringing them under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act. As a result, these exchanges must register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) and comply with various reporting and compliance requirements.

Cryptocurrency and Foreign Bank Account Regulations

In the United States, the Internal Revenue Service (IRS) has defined cryptocurrencies as property, meaning that investors are subject to capital gains tax laws when reporting profits and expenses on their annual tax returns, regardless of where they purchased the digital coins. This means that profits from cryptocurrency trading are taxable as capital gains.

When it comes to foreign bank account regulations, as of August 2023, federal law does not consider a foreign cryptocurrency account a "reportable account". This means that cryptocurrency account holders are not required to disclose their foreign accounts to the Financial Crimes Enforcement Network (FinCEN), an agency within the US Treasury Department. However, this could change at any time, as FinCEN intends to propose amending the filing requirements to include cryptocurrency holdings.

US citizens with foreign assets, including cryptocurrency, may also be subject to the Foreign Account Tax Compliance Act (FATCA). Under FATCA, individuals with foreign assets exceeding $50,000 at any point during the tax year must report this to the IRS. For married couples filing jointly, this threshold is $100,000.

It is important to note that the regulations regarding cryptocurrency and foreign bank accounts are subject to change, and it is always advisable to consult a tax professional familiar with cryptocurrency when filing taxes.

Frequently asked questions