The Cryptocurrency Craze and its Regulatory Response

Cryptocurrencies, like BitCoin and Ethereum, are a hot investing trend.  A cryptocurrency is a digital asset designed to work as a medium of exchange that uses cryptography, or the computerized encoding and decoding of information, to secure its transactions.  Unlike traditional fiat currencies, which are printed by a central bank and regulated by governmental entities, cryptocurrencies are produced at a publicly known rate defined by their respective creators and are largely unregulated.

Since 2009, when Bitcoin was first created, the trading volume of these currencies has exploded.  At the time of writing (according to Coin Market Cap) there were 1515 cryptocurrencies with a market capitalization of $336 Billion.  While cryptocurrencies were largely designed to be immune from government interference, the tide has started to turn.  As investors have increasingly bought cryptocurrencies, government organizations have started to take notice.  In the United States, these entities include the Internal Revenue Service (IRS), the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC).

The IRS has stated that cryptocurrency is treated as property for federal tax purposes.  Therefore, general tax principles applicable to property transactions apply to transactions using virtual currency.  Given the huge volatility of the cryptocurrency market, this can lead to varying tax results.  Investors should therefore consult with tax professionals regarding specific reporting requirements.  The SEC has recently made clear that it is devoting a significant portion of its resources to regulating cryptocurrencies.  Specifically, it has stated that “federal securities laws apply regardless of whether the offered security—a purposefully broad and flexible term—is labeled a “coin” or “utility token” rather than a stock, bond or investment contract.”  SEC Chairman Jay Clayton has even gone as far as to state that Initial Coin Offerings (ICOs) – the cryptocurrency equivalent of an IPO – “involve the offer and sale of securities and therefore directly implicate the securities registration requirements and other investor protection provisions of…federal securities laws.”  Similarly, the CFTC declared virtual currencies to be a “commodity” subject to oversight under its authority under the Commodity Exchange Act.

Given the unpredictability of cryptocurrencies and the ever-changing regulatory framework surrounding them, investors should demonstrate caution before investing.  Just like any other investment - if it sounds too good to be true, it probably is.