Crypto policy trends and predictions for 2020

From our Crypto Theses for 2020 - download the full report here.

1 As China/Congress goes, so goes the crypto price. It’s wild (though maybe not entirely surprising to me) that the “China narrative” still seems to drive so much sentiment within the global crypto markets. Expect more chatter around “bitcoin bans” in China and the U.S. in the years to come, particularly as China rolls out its state-issued digital currency, and the U.S. Congress lumps crypto projects together with its most despised initiative, Libra. States aren’t going to cede one of their primary sources of power to these leaderless networks, and they don’t necessarily have to “ban” them to severely hinder their progress.

In China, the major miners and exchanges continue to operate at the pleasure and under the watchful eye of the CCP, and there remains serious “stroke of the pen” risk that the party could ban non-state sanctioned currencies outright. In the U.S., it’s unlikely that Congress would get its act together any time soon to pass legislation that cripples the industry, but then again they don’t need to. The mere Congressional threat of enhanced oversight, led seven major payments partners in the LIbra initiative to exit at the 11th hour.

2 Crypto’s Single Point of Failure: Banking. The path to crippling crypto’s growth in the U.S. without banning it is manifold. Crypto banking is facilitated - more or less - by three small banks: Silvergate, Metropolitan, and Signature, and major regulatory actions against any of those banks would border on an existential threat to the industry. Silvergate, which recently went public on the NYSE, may be the primary bank to watch as they make regular filings with the SEC, serve 750+ crypto firms, and currently custody over $1.3 billion in crypto customer deposits, roughly 60% of their total deposits. The only other bank that reports on that metric specifically is Metropolitan, who handles less than 20% Silvergate’s deposits. Silvergate truly is a crypto-first bank, and the stakes are enormous for them and their customers.

3 Tax Reporting Nightmares Continue It keeps me up at night thinking about the havoc that the IRS could wreak on so many people in the industry personally...not through willful non-compliance with the tax code, but because it’s likely the major exchanges are reporting data to the IRS that makes it all but impossible for the agency to reconcile a taxpayers’ cost basis and portfolio details with those of the multiple services the taxpayer may have used.

If you were early in the industry, you knew better than to keep all your assets on one exchange or wallet. But if the IRS sees an outflow from Coinbase and doesn’t realize that transaction was a like-kind transfer to Poloniex, and the auditors assume instead it was actually a sale vs. a transfer, it’s going to be a nightmarish process to comb through all the old records. Many people are going to get audited and penalized unfairly because of how early they were and because of the immaturity of the tax reporting infrastructure.

Beyond that, the IRS’s most recent guidance on forks and airdrops is insane, and it will severely hurt users depending on how and whether the major custodial wallets and exchanges share that information in the first place. It must be nice to live in Germany, where there are no capital gains taxes for crypto held longer than one year, or France, where crypto-crypto transactions are not taxed at all. While poor tax law could prove to be a weapon for countries that wish to strangle crypto, I’d expect favorable environments to continue to attract more capital in the years ahead.

4 IRS Auditing Nightmare Begins If reporting is a nuisance, then audits and fraud nightmares are just about to begin. It will likely start with those who failed to comply with the IRS’s strictest warning letters this past summer regarding potential penalties for non-compliance, and I am 90% confident we’ll see at least one high-profile tax evasion case of a high-profile early adopter in 2020. The IRS will go with the lowest hanging fruit (true fraud), then work their way to more advanced cases as they begin to rack up legal wins and important precedents.

The first batch of targets will date back to the subpoena of Coinbase and the 13,000 customer records they turned over in 2018. But you can rest assured that records of anyone and everyone who has traded on Coinbase, Poloniex, Kraken, Gemini, and Bittrex in the U.S. since then are now in the hands of the IRS. The next shoes to drop in 2021+ will be in cases where customers failed to report crypto-crypto trades, inappropriately flagged them as “like kind”, or failed to account for forks and airdrops. Short of a safe harbor provision for crypto investors who transacted before a certain date (or an act of Congress), these cases will linger for many, many years. And it gets worse!

The truly scary new development lies in what we know the IRS is already pursuing, and the fact that the IRS has three years after a return’s due date to assess a deficiency, but six years if income is understated by more than 25%. That means you can expect enforcement against beneficiaries of the 2013 Coinbase bubble by October of this year, and enforcements against 2017 Poloniex/Bittrex token flippers and shitcoin traders as late as 2023.

Like I said, just getting started.

5 The war on privacy. Oh, wait you thought that last section was bad? No no no. It gets worse still, if you think about this in the context ofprivacy, and “un-confiscatable” wealth. The IRS for one has added this loaded question to its tax questionnaire for 2019: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The only folks who can answer “no” here are those with zero crypto exposure or holders with zero transactions. That’s one step closer to putting crypto - the “Swiss bank account in your pocket” - in FBAR territory, Report of Foreign Bank and Financial Accounts. That is, the tax authorities will at some point in the future demand that even holders disclose their wallet addresses if they contain more than $10k in aggregate value held in a financial account “located outside of the U.S.” Outside the U.S. doesn’t really apply to crypto, though. It’s fuzzy, and I’m certain that by 2025 (if not sooner), barring successful legal victories that invoke the 4th and 5th amendments, the FBAR reporting requirements will expand to include crypto. A dangerous and Orwellian path indeed that would put bitcoin and crypto-currencies functionally equivalent to state-issued digital currencies.

The good news is that this isn’t just crypto’s fight anymore. Big tech companies are also pushing back against unreasonable requirements that the authorities provision “backdoor access” to systems that could then be similarly exploited by criminals, hackers and repressive regimes. Security holes don’t discriminate between who is a good guy vs. a bad guy, and crypto vulnerabilities in particular could cause literal life and death security threats in the coming years. I’d put the IRS request for information on crypto purchases as one of those security “back doors”, though it only really becomes an issue if and when the government ever puts crypto addresses in their FBAR bucket.

6 SEC Enforcements Who’s afraid of the big bad wolf? Just hire some expensive lawyers! Here’s what I expect to take place in 2020 as the SEC continues to grapple with the glut of 2017 token sales they believe look like unregistered securities offerings.

• The SEC may be drawing a clear line between their pre- and post- DAO report enforcement actions. If you expect leniency for teams that completed token sales prior to July 25, 2017, then Cosmos, Basic Attention Token, and Tezos are in relatively good negotiating position when it comes to top 30 projects with U.S. teams.
  
• If the SEC was willing to settle for a mere $24 million with Block.One over their year long $4 billion EOS crowdsale, then I don’t think we should expect to see a case against Ripple, whose advisory ranks are best in the industry (ex-regulators Mary Jo White (SEC), Ben Lawsky (NYDFS), Gene Sperling (White House) are advisors or directors).
  
• If we expect the SEC to take a “do no harm” approach to public, liquid tokens that have performed well despite the bear market beatings, then Chainlink and Maker should really be in the clear as well.
  
• Most of the other enforcement actions I’d expect are with egregious violations of the securities law or outright fraud. If the SEC is going to give people a hard time, it’s likely going to be with those who completed SAFT mega-rounds in the 6-9 months following the DAO report, but who have yet to come to market. (Telegram, Filecoin, PolkaDot?)
  

7 ETF Proposals It seems as though pretty much every country aside from the U.S. will have a Bitcoin ETF/ETP by the end of 2020. The most important developments of the year on the ETP front have happened in the past month. First with Canadian asset manager 3iQ’s approval from the Ontario Securities Commission to offer an exchange-traded Bitcoin fund on the TSX, a move that could nudge the SEC in the direction of approving a U.S. ETF. Then with WisdomTree’s sponsorship of a European Bitcoin ETP in Switzerland on their SIX exchange.

New York Digital Investment Group (NYDIG) recently received approval by the SEC to offer a closed-end mutual fund that trades cash-settled Bitcoin futures, and Galaxy recently joined the mix of asset managers offering competitive investment vehicles for accredited investors.

Still, the SEC doesn’t look like it’s budging in the election year, at least if you take Blockchain Association ED Kristin Smith at her word. She says Jay Clayton has to go before there is any movement on the bitcoin ETF. I still don’t understand how the SEC can allow Grayscale’s products to trade (with their ~30% premiums), and not go ahead and bless the damn ETF. It’s embarrassing. Bitcoin’s markets are at least as transparent as the commodities markets, with much tighter spreads, and arguably less price manipulation.

8 Stablecoins as Securities? If this section in particular feels very U.S. centric, it’s because a) we live and work in New York, and b) there’s a lot to unpack with respect to how ass-backwards U.S. crypto policy is. Take a recent stablecoin bill that was introduced in Congress, ostensibly aimed at directly impeding Libra’s progress, which aims to classify as a security any stablecoin with “an issuer who plays an active managerial role in adjusting the composition of assets that back the coin and guarantee its stability.” The bill is expected to be reintroduced during the new session of Congress. Coin Center has already highlighted concerns the overly broad language could lead to USD-pegged stablecoins being classified as a security. If you want to cripple the industry, you don’t need to ban it, you just need to make abusive tax and securities laws that are impossible to comply with.

9 Regulatory Competition The world’s largest crypto exchange is currently domiciled in Malta after operating without a real headquarters for stretches of time in 2017 and 2018. Most of the world’s largest crypto businesses are based in Asia, but non technically Asia. Many New York crypto businesses are technically in New Jersey. Many of the wealthiest U.S. crypto investors live in Puerto Rico, but don’t really live in Puerto Rico. It’s all part of the ongoing game of regulatory arbitrage that may only get more prevalent depending on who gets elected in your next regional or national elections. Let’s hope more countries in Europe take France and Switzerland’s relatively friendly stance towards crypto, and let’s hope more U.S. state regulators follow Wyoming’s lead, which has laid the groundwork for a crypto-friendly state regime, and whose model is starting to gain pick up in neighboring states like Colorado.

(Note: Now that I am writing this last section, just minutes away from publishing, I’m kicking myself for excluding Caitlin Long, the real driving force behind the Wyoming legislation, from our top 10 people to watch list. You should follow her.)

10 Common Sense If you couldn’t tell from the above, I’m not an uber-bull on our regulators and government leaders. But I do believe in crypto, and common sense, and maintaining the moral high ground and acting beyond reproach when it comes to building the infrastructure for a more open and efficient financial system. We’ll continue pushing for common sense disclosures norms for projects, standardized data from exchanges, and ethical design of these new protocols. If you’d like to support us, drop us a line at research@messari.io.