Biden’s Executive Order Sets the Tone for Digital Assets
Last week, the Biden administration released a long-awaited executive order containing a government-wide outline for digital assets, focusing on cryptocurrency. The soaring size of the crypto market, the increasing participation of American investors and the growing number of countries planning to digitize their sovereign currencies indicate the guidance is a welcome and timely development.
The Need for Coordination
Right now, how federal government treats cryptocurrency depends on whom you ask. Since 2014, the IRS has viewed cryptocurrency as property instead of currency for federal income tax purposes. However, this does not mean tax reporting for cryptocurrencies is clear or easy; taxpayers have filed lawsuits regarding crypto gains reporting, and tax basis variations across different dates mean record-keeping could be onerous. At the same time, the IRS has targeted cryptocurrency exchanges in pursuit of noncompliant investors, recovering millions in underpaid taxes.
The U.S. Securities and Exchange Commission (SEC), the agency tasked with maintaining fair and orderly security markets and protecting investors, believes cryptocurrencies are securities and are therefore subject to its oversight. The SEC has brought to courts several cases regarding entities that failed to follow SEC registration and disclosure rules. It has also fined multiple operators, including a $50 million penalty in February 2022 against BlockFi, which offered investors interest for lending cryptocurrencies.
In addition, the Commodity Futures Trading Commission (CFTC) views cryptocurrencies as commodities. It has taken actions against unregistered crypto-trading platforms for failing to comply with the Commodity Exchange Act.
Finally, the Financial Crimes Enforcement Network (FinCEN), with its primary mission to safeguard the financial system from illicit use and combat money laundering, has a different view from the IRS, the SEC or the CFTC. In a published guidance, the agency indicated that cryptocurrency is a form of currency under FinCEN regulations. Specifically, it states that cryptocurrency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of a real currency. For instance, it does not have legal tender status — typically held by coin and paper money — in any jurisdiction.
Although the cryptocurrency universe continues to evolve and the potential for new offerings is limitless, these different perspectives across federal agencies highlight potential inconsistencies and room for a united approach — which will not only benefit the industry, but also the regulators.
The Executive Order
The administration’s executive order includes six major areas: consumer and investor protection, financial stability, illicit finance, U.S. leadership in the global financial system and economic competitiveness, financial inclusion and responsible innovation. This blog post discusses a few key areas.
Consumer and Investor Protection
The executive order directs the Department of the Treasury and other agency partners, including the SEC, to develop policy recommendations regarding the changes imposed by digital assets on financial markets.
An increasing number of Americans have participated in the cryptocurrency market, including a sizable portion of young investors who are comfortable with technology. The pandemic has enabled the surging popularity of online trading platforms, such as Robinhood; however, a series of trading interruptions, a potential lack of disclosure, and the suicide of a young investor have alarmed the SEC regarding the sufficiency of investor protection in this innovative market.
A variety of platforms and exchanges provide easy access to cryptocurrency trading, and the financial risks associated with crypto-trading could be significant. However, despite the uncertainty of returns and price fluctuations, investor protection lags behind that of regulated security markets. For instance, the federal securities laws only allow accredited investors to participate in certain security offerings, such as offerings in private equity, hedge funds and equity crowdfunding. Accredited investors are generally individuals who either have earned income of over $200,000 ($300,000 with a spouse) in the two preceding years, have a net worth that exceeds $1 million (excluding one’s primary residence) or have certain financial professional licenses. In other words, these investors have certain levels of knowledge or an ability to withstand potential losses. By contrast, cryptocurrency investments pose unique investment risks, and yet there are no safeguards that protect individuals from pursuing these “trendy” investments. The executive order’s emphasis on investor protection is a welcome development.
The executive order also directs the Department of the Treasury to focus on financial inclusion, which involves ensuring access to secure and affordable financial services for everyone.
As the digital economy has evolved, practitioners have cautioned that digital exclusion may lead to financial exclusion. Lower income households and small businesses are more vulnerable to digital exclusion and suffer more from the loss of financial and business opportunities than higher income households and larger corporations. A lack of knowledge and resources may lead these groups to be slow adopters and unable to benefit from technological innovations.
The pandemic potentially exacerbates this concern. A substantial shift of consumer payment habits took place during the pandemic, which led to the reduced use of cash and increased use of digital payment forms. Even after the health concerns recede, consumers may not completely return to their old payment habits. The executive order asks the Department of the Treasury to provide a report that addresses the changing capacity of money and payment systems, which play essential roles in conducting transactions and ultimately affect economic growth.
Central Bank Digital Currencies
The development of a dollar-based central bank digital currency (CBDC), the digital form of the U.S. dollar, is not officially listed as one of the six priority areas. However, over 100 countries have been exploring the concept of a CBDC; the executive order elevates the sense of its significance and asks agencies to evaluate the technological infrastructure and design a strategic plan related to a CBDC.
In January 2022, the Federal Reserve issued a study about the benefits and risks of a CBDC. The study does not provide any policy recommendation; instead, it aims to foster discussions with stakeholders and invites public comments. The Federal Reserve does indicate that it will not issue a CBDC unless it has support from Congress and the executive branch. In addition, the Federal Reserve states that even if a CBDC is issued, it will complement instead of replace paper currency. In other words, the CBDC and paper money will coexist.
The executive order offers a roadmap for federal agencies to collectively address the issues related to regulating digital assets. To industry operators, it sends a positive message that the administration recognizes digital assets as a vehicle to safeguard U.S. technological and economic competitiveness. It also identifies cryptocurrency as an investment, albeit a risky one, and directs regulators to provide policy recommendations for sufficient oversight. Furthermore, despite the underlying security and privacy concerns, the executive order acknowledges cryptocurrency as a potentially viable form of payment. The policy focus is on ensuring equal and secure access for all, instead of banning these transactions.
However, some uncertainties remain. The executive order generally commands a series of studies and research to continue exploring issues associated with digital assets. Although directionally encouraging, the meaningful policy recommendations will be revealed over the course of the year, when agencies finalize their studies and provide specific policy proposals. Observers also indicate November’s midterm elections may influence the timing of implementing any suggested policies.
Prior to any policy change, agencies may continue to use existing approaches such as bringing cases to courts or imposing fines and penalties. They may also leverage the newly granted transparency requirement for their enforcement efforts. For instance, the Infrastructure Investment and Jobs Act passed in November 2021 includes a provision that formally classifies cryptocurrency exchanges as brokers, meaning that the exchanges need to report digital asset transactions on Form 1099-B to the IRS and taxpayers.
The executive order sets the tone for future regulatory developments regarding digital assets. Although it surely will generate more regulations for the industry, it will also bring more consistency, certainty and transparency. It remains to be seen what policy recommendations will be generated, but it is certain that digital assets are here to stay, and properly managing this asset class will be the correct policy path.
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