Investment Firms Trading Crypto: Legal Or Not?

The legality of investment companies trading cryptocurrency varies by jurisdiction. In the United States, cryptocurrencies are considered a form of money, but the Internal Revenue Service (IRS) treats them as financial assets or property for tax purposes. In the UK, the government has allowed the use of cryptocurrency since its introduction, while in China, cryptocurrency exchanges, transactions, and mining are banned within its borders. In India, there are no clear laws prohibiting or regulating the trading of cryptocurrencies, but the government has proposed a 30% tax on gains from cryptocurrencies.

Cryptocurrency and taxes

The world of cryptocurrency is a complex and ever-evolving space, and the same can be said for the world of taxes. When these two worlds collide, it's essential to understand the implications and your obligations. Here's a guide to help you navigate the intersection of cryptocurrency and taxes.

In the United States, the Internal Revenue Service (IRS) considers cryptocurrencies to be property, similar to stocks, bonds, and other capital assets. This means that any profits or income derived from cryptocurrency transactions are generally subject to capital gains tax laws. The tax implications can vary depending on the specific circumstances of your crypto activities.

Buying and Holding Cryptocurrency

Simply buying and owning cryptocurrency is typically not a taxable event in and of itself. Taxes usually come into play when you sell or dispose of your crypto holdings. However, it's important to keep records of your transactions, including the amount you paid and the market value at the time of purchase, to accurately determine your tax obligations when you eventually sell.

Selling Cryptocurrency

When you sell your cryptocurrency for a profit, you will likely owe capital gains taxes on that profit. The tax rate will depend on whether your gains are considered short-term or long-term. Short-term gains, from assets held for less than a year, are generally taxed at a higher rate than long-term gains, which apply to assets held for more than a year.

Using Cryptocurrency for Purchases

Using cryptocurrency to buy goods or services is also considered a taxable event. This is because you are effectively selling a portion of your crypto holdings to make the purchase. You will need to pay taxes on the difference between the price you paid for the crypto and its value at the time of the transaction, plus any applicable sales taxes.

Receiving Cryptocurrency as Payment

If you receive cryptocurrency as payment for goods or services, you must report it as business income. The amount you receive will be taxed according to your income tax bracket.

Mining Cryptocurrency

Mining cryptocurrency can result in tax obligations as well. The value of the crypto at the time it was mined is generally considered taxable income. If your mining activities are part of a business enterprise, you may be able to deduct expenses related to mining operations, such as hardware and electricity costs.

Staking and Rewards

Staking cryptocurrency, which involves locking your crypto as collateral to become a transaction validator, also has tax implications. Any rewards received through staking are taxed as income, based on their fair market value at the time they are received.

Donating or Gifting Cryptocurrency

Donating cryptocurrency to a qualified tax-exempt charity or non-profit organisation may allow you to claim a charitable deduction. On the other hand, if you receive crypto as a gift, you generally won't incur a tax until you sell or engage in another taxable activity.

Tax Reporting and Compliance

It's important to stay organised and maintain proper records of your cryptocurrency transactions. Unlike traditional investments, you may not receive a Form 1099 from the currency exchange. Therefore, it's your responsibility to keep track of receipts, confirmations, and cost basis information for each transaction. Working with a tax professional who understands cryptocurrency is highly recommended to ensure accurate reporting and compliance with tax regulations.

Cryptocurrency and foreign bank accounts

Cryptocurrency investors need to be aware of the legal implications of their actions, particularly when it comes to foreign bank accounts and reporting requirements. Cryptocurrency trading often involves holding cryptocurrency in a foreign account, and investors must understand the relevant tax and banking rules.

In the United States, 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, regardless of where they purchased their digital coins. As of August 2023, a foreign cryptocurrency account is not considered a "reportable account" under federal law, meaning that 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.

The Report of Foreign Bank and Financial Accounts (FBAR), or FinCEN Form 114, is typically required for US taxpayers with substantial overseas accounts. As of 2021, a foreign account holding only virtual currency is generally not considered reportable for FBAR purposes, unless it holds other reportable assets in addition to virtual currency. However, if a taxpayer exchanges their foreign virtual currency for another currency within that account, it may be considered a hybrid account that requires reporting.

The Foreign Account Tax Compliance Act (FATCA) is another important consideration for US taxpayers. Form 8938, known as FATCA, must be filed by taxpayers with substantial assets in foreign accounts. As of August 2023, there is no definitive ruling from the IRS on whether cryptocurrency wallet owners must report their holdings using Form 8938. Given the severe penalties for failing to comply with reporting requirements, it is recommended that owners of cryptocurrency wallets consult with tax professionals familiar with cryptocurrency when filing their taxes.

To summarise, the legal landscape surrounding cryptocurrency and foreign bank accounts is complex and evolving. While a foreign cryptocurrency account may not currently be considered a "reportable account", this could change in the future. It is important for investors to stay informed about the latest regulations and to consult with tax professionals to ensure compliance with reporting requirements and tax laws.

Cryptocurrency registration and licensing

The registration and licensing requirements for cryptocurrency businesses vary across different jurisdictions. Here is an overview of the key considerations for registering and licensing a cryptocurrency business:

Understanding the Regulatory Landscape

Before initiating the licensing process, it is crucial to thoroughly understand the regulatory environment and requirements specific to the chosen jurisdiction. This includes examining regulatory documents such as the EU Markets in Crypto-assets Regulation (MiCA), which may establish common standards across European countries.

Selecting the Right Jurisdiction

The choice of jurisdiction plays a pivotal role in the licensing process. Factors such as regulatory clarity, tax incentives, and the overall business environment for cryptocurrencies should be considered. Countries like Estonia, Malta, Liechtenstein, Lithuania, Poland, and the Czech Republic are often favoured due to their progressive regulatory frameworks and favourable conditions for crypto-businesses.

Company Registration

To apply for a licence, it is typically necessary to first register the company as a legal entity in the chosen country or jurisdiction. This involves selecting a company name, registering with the relevant commercial register, and establishing a corporate bank account.

Preparing the Required Documentation

A comprehensive set of documents must be prepared as part of the licence application process. This typically includes a detailed business plan, anti-money laundering (AML) and customer identification (KYC) policies, financial statements, and evidence of the founders' and key personnel's suitability and financial strength.

Applying for the Licence

The licence application should be submitted to the competent regulatory authority in the chosen jurisdiction. It is imperative to carefully review and meet all the regulatory requirements to ensure a smooth application process.

Complying with Regulatory Requirements

Compliance with regulatory standards is a critical aspect of the licensing process. Cryptocurrency businesses must implement robust AML and KYC measures, develop secure operational procedures, and ensure transparency in their business operations.

Obtaining the Licence

Once the application has been approved by the regulatory authority, the company will be granted a licence to operate in the cryptocurrency domain within the specific jurisdiction. It is important to stay abreast of any ongoing regulatory requirements to maintain compliance and avoid legal complications.

Ongoing Reporting and Compliance

Depending on the jurisdiction, cryptocurrency businesses may be subject to ongoing reporting obligations. For example, in the United States, companies dealing with cryptocurrencies may need to report transactions exceeding a certain amount and comply with tax regulations specific to digital assets.

Engaging Professional Services

Given the complexity and evolving nature of the regulatory landscape, it is advisable to consult with legal and financial experts specialising in cryptocurrencies. They can provide valuable guidance on navigating the licensing process, ensuring compliance with regulations, and optimising the company's structure for the specific jurisdiction.

Cryptocurrency fraud and money laundering

The rise of cryptocurrency has brought about an increase in criminal activity, including fraud and money laundering. Cryptocurrencies are often favoured by criminals due to their high degree of anonymity and decentralised nature, which makes it harder to trace transactions and identify those involved. This has led to concerns that cryptocurrency provides criminal organisations with new means of committing fraud and money laundering.

Money laundering using cryptocurrency typically follows a general pattern of placement, layering, and integration, but with some unique features. One key difference is that cryptocurrencies are anonymous at their point of creation, which often means the placement stage of the money laundering process is absent. It is also very easy to create multiple accounts, and it only takes seconds to do so. This allows criminals to create large money laundering schemes with thousands of transfers at a low cost, which can be easily executed using a computer script.

The rapid increase in exchange rates for some cryptocurrencies also makes it easier to justify unexpected wealth. Criminals can further take advantage of special mixing or blending services, as well as mixing or blending protocols, to obscure the source of the cryptocurrency funds and make them even more difficult to trace. These processes involve sending cryptocurrency funds from multiple sources to a single address, mixing them together, and then splitting them into several portions sent to different addresses. This may be repeated several times, making it nearly impossible to connect the funds to their original source.

To combat cryptocurrency fraud and money laundering, crypto firms are advised to implement robust Know Your Customer (KYC) and Anti-Money Laundering (AML) measures. This includes strict customer screening processes to verify identities, addresses, and sources of funds, as well as transaction monitoring and risk assessment. However, some crypto platforms remain non-compliant, posing risks to their businesses and customers.

Regulators have taken an increasingly tough stance on non-compliant crypto platforms, with several platforms being shut down or facing criminal charges for violating AML and KYC regulations. To further address these risks, organisations like the UNODC are conducting projects on cryptocurrency and money laundering, and proper regulation and supervision of cryptocurrency markets are being emphasised.

Cryptocurrency decentralisation

Decentralization in blockchain refers to the transfer of control and decision-making from a centralized entity to a distributed network. It is not a new concept, and it is applied in numerous sectors and industries, from information technology to retail and government.

In the context of cryptocurrency, decentralization is a key feature of blockchain technology. Blockchain is a distributed and secured database or ledger. Transactions are recorded in blocks and verified through automated processes. Once a block is verified, it is closed and encrypted, and a new block is created with information about the previous block and new transactions. This forms a chain, giving blockchain its name.

Decentralization in blockchain has several benefits:

• Trustless environment: In a decentralized blockchain network, members do not need to know or trust each other. Each member has an identical copy of the data in the form of a distributed ledger. If a member's ledger is altered or corrupted, it will be rejected by the majority of the network members.
• Improved data reconciliation: With a decentralized data store, every entity has access to real-time, shared data, reducing the chances of data loss or incorrect data entry.
• Reduced points of weakness: Decentralization minimizes reliance on specific actors, reducing the risk of systemic failures due to resource exhaustion, outages, bottlenecks, or corruption.
• Optimized resource distribution: Decentralization helps ensure that promised services are provided with better performance, consistency, and reduced likelihood of catastrophic failure.

Additionally, decentralized finance (DeFi) is an emerging financial technology that leverages blockchain and cryptocurrency to challenge the traditional centralized banking system. DeFi enables peer-to-peer transactions, removing intermediaries like banks and other financial service providers. This results in lower fees and increased accessibility for financial services.

However, it is important to note that decentralization in blockchain and cryptocurrency also has some downsides, including higher costs due to the need for more systems and people to manage them, challenges in reaching a consensus, and a lack of clarity and discipline in decision-making.

The level of decentralization can vary, and not all cryptocurrencies are fully decentralized. Some exhibit semi-decentralized or hybrid structures, with control shared between multiple authorities or a combination of centralized and decentralized elements.

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