Crypto Investments: Legal Or Not?

Investing in cryptocurrencies for other people is a complex and risky endeavour. While it is not outright illegal, there are many legal and financial considerations to take into account.

In the US, for example, it is illegal to invest other people's money without being a registered financial advisor and broker-dealer. Similar regulations exist in other countries, such as the Netherlands, where a licence is required and can cost €5,000.

Even when abiding by these regulations, there are further complications. For example, in the US, the IRS considers cryptocurrencies to be property, meaning that any gains made from investing are subject to capital gains tax laws. This can create a complex tax situation, especially when managing the money of multiple people.

Additionally, cryptocurrencies are highly volatile and insecure. There is no central authority to provide support in the case of lost or stolen funds, and it is often impossible to recover them. As such, investing in cryptocurrencies on behalf of others can put one at serious risk of losing large sums of money and damaging relationships.

Therefore, while it may be legal to invest in cryptocurrencies for other people in some places, it is a highly complex and risky endeavour that should be approached with extreme caution.

Crypto and taxes

In the US, the IRS treats cryptocurrency as property rather than currency. This means that investors are subject to capital gains tax laws when reporting profits and expenses in their tax returns. If you are an employee and receive cryptocurrency as your salary, it is taxed as income. The amount is based on the value of the cryptocurrency in US dollars at the time it was paid.

US taxpayers are required to report crypto sales, conversions, payments, and income to the IRS and state tax authorities where applicable. Each of these transactions has different tax implications. Transactions that result in a tax are called "taxable events", and those that don't are called "non-taxable events". For example, simply buying and owning crypto is not a taxable event. The tax is incurred later when you sell, trade, or spend the crypto, and its gains are "realized".

If you sell your crypto for US dollars, you will owe taxes if you sell your assets for more than you paid for them. If you sell at a loss, you may be able to deduct that loss from your taxes. Converting one cryptocurrency to another is also a taxable event because you have to sell one crypto before buying another. Getting paid in crypto or mining crypto are also taxable events.

Calculating your crypto income can be complex. Your cost basis is generally determined by how much you paid for the cryptocurrency. However, if you received crypto from mining or staking, your cost basis is determined by the fair market value when you received it. For gifted crypto, your cost basis depends on both the basis of the person who transferred it to you and the fair market value when you received it.

To calculate your capital gains or losses, subtract your cost basis from your sale price. If your proceeds exceed your cost basis, you have a capital gain; if not, you have a capital loss. Capital gains taxes are applied at both the federal and state levels and can be long-term or short-term. If you held the crypto for more than a year before selling, you will generally pay a lower rate than if you sold right away. Long-term gains are taxed at reduced capital gains rates of 0%, 15%, or 20% at the federal level, depending on your income. Short-term gains are taxed at your ordinary income rate, which is usually a higher, less favorable rate.

It is important to consult a tax professional who has some familiarity with cryptocurrency when it comes time to file your taxes.

Crypto's decentralised status

Cryptos' Decentralised Status

The decentralised status of cryptocurrencies is a defining feature, setting them apart from traditional currencies and payment systems. By definition, cryptocurrencies are decentralised, meaning they have no physical presence and are not backed by a central authority, such as a government or monetary institution. This lack of central authority means that cryptocurrencies are theoretically immune to government interference or manipulation.

The absence of a central authority has pros and cons. On the one hand, it frees investors from being beholden to institutions, but on the other, it can result in legal complications. For example, the value of digital currencies is entirely dependent on the value ascribed to them by other owners and investors. Without a central authority, investors may be left vulnerable if complications with transactions or ownership arise.

Additionally, cryptocurrencies are not issued by any public or private entities, which has made it difficult to establish their legal status. The regulatory status of cryptocurrencies remains unsettled, and they are not considered a "reportable account" under US federal law. However, the IRS has defined cryptocurrencies as property, making them subject to capital gains tax laws.

The decentralised nature of cryptocurrencies also has implications for security and fraud. Cryptocurrency exchanges are less susceptible to security breaches than centralised exchanges because they don't hold customer funds. However, when a cryptocurrency exchange is hacked, there is often no standard practice for recovering the missing funds, and investors may have limited legal recourse.

Decentralisation exists on a spectrum, and some cryptocurrencies are more decentralised than others. The decentralisation of a blockchain platform can be measured by factors such as the size of its hash rate and the number of entities it is divided among.

Overall, the decentralised status of cryptocurrencies is a key aspect of their appeal, offering freedom from institutional control, but it also creates legal and security complexities that investors should be aware of.

Crypto registration and licensing

Registration

In the United States, cryptocurrency exchanges and organisations must register as Money Services Businesses (MSBs) or Money Transmitter Businesses. This requirement reflects the country's decision to create a legal basis for cryptocurrency use rather than banning it. The registration process involves extending registration with the US Department of the Treasury every two years, providing a list of agents, reporting suspicious transactions, and complying with anti-money laundering (AML) and counter-terrorism financing (CFT) policies.

Licensing

Licensing requirements for cryptocurrency exchanges vary across jurisdictions. Some countries, like Japan and Estonia, have implemented specialised crypto-licenses, while others, like the US and Hong Kong, have traditional licenses that indirectly govern cryptocurrency operations. In the US, exchanges must obtain a Money Transmitter License for fiat-to-crypto transactions and an MSB License for crypto-to-crypto transactions, complying with state-level legislation.

Compliance and Reporting

Compliance with anti-money laundering (AML) standards is a critical aspect of the cryptocurrency space. Companies must perform comprehensive risk analyses, implement written policies and procedures, appoint compliance officers, train staff, and constantly monitor operations. Additionally, reporting suspicious transactions to law enforcement authorities is mandatory.

Taxation

The US Internal Revenue Service (IRS) considers cryptocurrencies as property, and profits from cryptocurrency operations are taxed as capital gains. Cryptocurrency investors must carefully navigate tax regulations to ensure compliance and avoid legal repercussions.

Regulatory Considerations

The evolving nature of the cryptocurrency market and the lack of centralised authority present unique challenges for investors and regulators. While the former must stay updated with the latest laws to avoid legal pitfalls, the latter are tasked with understanding and regulating this new technology. The regulatory agencies, tax authorities, and central banks are working to clarify the legal implications of cryptocurrencies and the associated technologies.

Crypto fraud and money laundering

Money laundering is a common theme among many crypto-related crimes. Criminals exploit the anonymity of blockchain technology to launder profits from both off-chain and on-chain crimes. Cryptocurrency is used to launder funds from diverse types of crimes, from real-world criminal activities to cybercrimes, digital fraud, and thefts of cryptocurrencies from online exchanges.

The process of money laundering using cryptocurrencies typically involves creating numerous anonymous accounts or "addresses" to receive and transfer money, often through nested services and mixers/blending services, to obscure the sources of illicit funds and integrate them into the legitimate banking system. This makes it very difficult to trace laundered funds back to their original source.

To combat crypto-related money laundering, most mainstream exchanges and Virtual Assets Service Providers (VASPs) are subject to the Financial Action Task Force (FATF) guidance, which includes Know Your Customer (KYC) regulations to verify customer identities. However, criminals have found advanced techniques to circumvent these measures, such as using Over-the-Counter (OTC) brokers and gambling platforms to anonymously trade large amounts of cryptocurrency.

In addition to money laundering, there is a widespread belief that cryptocurrencies facilitate fraud and other financial crimes. The decentralised nature of cryptocurrencies means that there is no central authority to turn to in cases of fraud or theft. When a cryptocurrency exchange is hacked and customers' holdings are stolen, there is often no standard practice for recovering the missing funds, leaving investors at risk.

To protect yourself from fraud and money laundering when investing in cryptocurrencies, it is important to stay informed about the latest investment laws and regulations. Consult with a tax professional familiar with cryptocurrency when filing your taxes, and be wary of anonymous trading platforms and investment schemes that may be fronts for illegal activities.

Crypto safety

While crypto is considered legal across Europe, it is unregulated and subject to shifting regulations. This makes it a risky investment compared to stocks and government bonds. Crypto investors must also be aware of the legal implications of buying and selling cryptocurrencies.

• Fundamental safety: Research the cryptocurrency project itself, including its use case, the team behind it, and the coin's tokenomics design.
• Sentimental safety: Stay up to date with the crypto community and big actors on social channels to understand how people's attitudes and emotions towards a cryptocurrency can impact its price action.
• Technical safety: Choose a platform or exchange that suits your needs and take advantage of technical trading tools to protect your money and manage risks.
• Research: Understand the ins and outs of cryptocurrency before investing.
• Diversify your portfolio: Don't invest more in crypto than you can afford to lose, and consider spreading your investment across different cryptos.
• Use secure platforms: Choose a legitimate and secure crypto exchange that follows Know Your Customer (KYC) and Anti-Money Laundering (AML) guidelines.
• Secure your wallet: Use a hardware "cold" wallet to store your crypto offline and keep it safe from online hacks.
• Avoid scams: Be wary of phishing and fake software or websites, and never enter your seed words or private key into any website.
• Strong authentication and passwords: Use two-factor authentication and strong, unique passwords for your wallet.
• Avoid public Wi-Fi: Avoid using public Wi-Fi when accessing your crypto exchange or wallet, or use a virtual private network service if necessary.

Frequently asked questions