A few weeks back, a flurry of actions by international regulators targeted Binance, leading to the firm pulling support for tokenized stocks, ending derivatives offerings in Germany, Italy, and the Netherlands, and announcing they're seeking a new CEO with "a compliance background". Now, bipartisan policymakers and state law enforcement alike in the United States are putting the heat on cryptocurrency markets. Compromise language in the draft infrastructure bill by Senator Portman (R-PA) and the White House clarifies tax reporting responsibilities for crypto market actors. Meanwhile, the bipartisan group of state regulators targeting cyrptocurrency lending platform BlockFi continues to grow, now reaching five states.

Blockchain Association Complains of Crypto Tax Compliance in the Infrastructure Bill

Part of the "pay for" in the $550 billion bipartisan infrastructure proposal that the Senate expects to vote on next week is language "strengthening tax enforcement when it comes to crypto currencies", according to a White House factsheet. It's reported to raise $28 billion in revenue due to increased compliance with existing tax laws on cryptocurrency trades.

While bill text hasn't been publicly released, cryptocurrency lobbying consortium the Blockchain Association published excerpts of what they claim is a draft of the bipartisan infrastructure bill in a letter to Congress:

As presently drafted, the Bill would expand the definition of “broker” under section 6045(c)(1) of the Internal Revenue Code of 1986 to include “(D) any person who (for consideration) is responsible for and regularly provides any service effectuating transfers of digital assets.”

The Blockchain Association notes that cryptocurrency actors defined as "brokers" in the tax code would need to provide reporting including "the name and address of each customer, with such details regarding gross proceeds".

How severe of a crackdown this will be on crypto markets will likely hinge on the definition of digital asset, and if it clarifies that decentralized exchanges are included, as these platforms typically conduct no "Know Your Customer" requirements at all – something that would need to change should lawmakers clarify they must furnish tax reports.

Politico reports this is an issue of debate:

Behind the scenes, lawmakers have debated language that would expand the definition of broker to include decentralized exchanges, without traditional middle men, and peer-to-peer transactions, though some say the language of the proposal is broad enough to sweep in others like cryptocurrency miners.

Blockchain Association's Executive Director Kristin Smith told Politico the current tax would "potentially driv[e] a lot of these actors and businesses and individuals involved in crypto overseas". But this argument begs the question: where, precisely, would crypto markets go? After all, in recent weeks, international regulatory scrutiny facing crytpo markets has intensified:

While cryptocurrency lobbyists are raising the alarm, the language appears to be a bipartisan compromise between Republican Senator Rob Portman of Pennsylvania and the White House, according to reporting from Bloomberg:

The proposal -- which updates rules requiring brokers to report cryptocurrency transactions and for businesses investing in crypto to disclose trades of more than $10,000 -- was the result of a compromise between the White House and Senator Rob Portman, a lead Republican negotiator. The provision includes portions of a Portman measure, according to a person familiar with the matter. The White House has also proposed similar ideas in recent months.

On Saturday, Politico's Zach Warmbrodt tweeted a statement from Senator Portman's offices saying the crypto tax language does not force "software developers and miners" to "comply with IRS reporting" but rather:

"clarifies that any person or entity acting as a broker by facilitating trades for clients and receiving cash must comply with a standard information reporting obligation."

Until the bipartisan infrastructure bill text has been released, it's hard to know where this will land. But it's clear that both the Treasury Department itself and a bureau within it, the Financial Crimes Enforcement Network (FinCEN), has been looking for some time now on ways to ensure enforcement with U.S. tax laws, including with its past proposal on "unhosted" crypto wallets.

BlockFi scrutiny heats up as Kentucky and Vermont join in crackdown

Last week, I wrote about orders Alabama and New Jersey sent to crypto lending firm BlockFi, alleging they may be selling unregistered securities. Now, financial regulators from Texas, Vermont, and Kentucky have joined this growing group of states.

Texas State Securities Board  joins BlockFi scrutiny

On July 22, the Texas State Securities Board (TSSB) filed a Notice of Hearing against BlockFi over its Cryptocurrency Interest Accounts.

The Notice of Hearing states that BlockFi is violating Texas' Securities Act and that “BlockFi Interest Accounts” (BIA) are investment contracts (emphasis mine):

19. Section 4.A of the Securities Act defines the term securities to include traditional products  such  as  stocks  and  bonds.  The  statute  also  broadly  defines  the  term  securities to include investment contracts, notes, and evidences of indebtedness – broad  categories  of  products  that  capture  the  endless  number  of  unique  and  innovative investment schemes continuously introduced into the market.

20. The mere fact an investment is tied to a cryptocurrency, blockchain technology, or some  type  of  digital  asset does  not  remove  it  from  securities regulation  if  it  constitutes an investment contract, note, evidence of indebtedness, or other type of security.  

21. Based  on  the  information  and  allegations  set  forth  herein,  the  BIAs  constitute  investment contracts, notes, or evidences of indebtedness regulated as securities as that term is defined by Section 4.A of the Securities Act.

The notice also states that Texas first notified BlockFi that they "may have offered securities in Texas that may not comply with the Securities Act" or about April 20, 2021. Despite this, BlockFi "continued to offer the BIAs to Texans in violation
of Sections 7 and 12 of the Securities Act."

Next up will be a hearing on October 13, 2021, where the Enforcement Division of the  Texas State Securities Board "will present testimony and other admissible evidence" against BlockFi. Should a judge approve, they'll enter a cease-and-desist order against the firm.

The Texas State Securities Board isn't new to cryptocurrency. In 2018, they conducted a four-week investigation into crypto, examining 32 cryptocurrency investments. They issued a report entitled "Widespread Fraud Found in Cryptocurrency Offerings". Among their findings:

  • None promoters were registered to sell securities in Texas, a violation
    of the Texas Securities Act;
  • At least five promoters all but ignored investing risks by
    guaranteeing returns, some as high as 40% per month; and
  • Only 11 promoters provided potential investors with a physical

In addition, the TSSB's website has an entire section dedicated to crypto, an "Investors Guide to Cryptocurrency", where they warn that "Extensive hype, combined with investors’ lack of understanding, has made investments related to digital currencies particularly susceptible to fraud."

Vermont issues Show Cause against BlockFi

On July 26, the Vermont Department of Financial Regulation (DFR) posted a Show Cause order against BlockFi, alleging that the BlockFi Interest Accounts
"appear to  be  securities".

In the order, Vermont's DFR revealed that they'd first reached out to BlockFi back in January. Vermont noted that BlockFi might be in violation of both state law and federal securities law (emphasis mine):

On  or  about  January  7,  2021,  the  Department  notified  BlockFi  Lending  that the [BlockFi Interest Accounts or] BIAs appear  to  be  securities  and  requested that  BlockFi  Lending explain how Respondents’ offering of BIAs complies with or is exempt from the registration and reporting requirements of the Securities Act, as well as the Securities Act of 1933, and the Securities Exchange Act of 1934. Respondents provided an unsatisfactory response to the Department’s request.

In the order, DFR cites both Vermont state law, and the federal Howey test for detemining if something is a security (emphasis mine):

Pursuant to 9 V.S.A § 5102(28), the term “security” includes notes, investment contracts, evidence of indebtedness, and related types of participation in profit-sharing agreements.  Section 5102(28)(D) specifies that the Securities Act’s definition of security includes “an investment in a common enterprise with the expectation of profits to be derived primarily from the efforts of a person other than the investor and a ‘common enterprise’ means an enterprise  in  which  the  fortunes  of  the  investor  are  interwoven  with those  of  either  the person  offering  the  investment,  a  third  party,  or  other  investors.”  Id. (adopting  the definition set forth in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), commonly referred to as the “Howey test”).

DFR orders BlockFi to show cause to their Commissioner, within thirty (30) days, why the Commissioner shouldn't send them a cease-and-desist, prohibiting offering their BlockFi Interest Accounts in  Vermont (which would come with a $15,000 per violation fine).

Kentucky Issues Emergency Cease-and-Desist against BlockFi

Lastly, on July 29, Kentucky's Department of Financial Institutions issued an emergency cease-and-desist order against BlockFi.

From the order:

11. …DFI has become aware that [BlockFi] is offering securities in the form of investment contracts in exchange for the deposit of assets with the Company. These investment contracts allow passive investors to earn interest on the assets deposited with the Company, and qualify as securities under the Act.
12. As these BIAs amount to an “investment of money in a common enterprise with profits to come solely from the efforts of others,” they qualify as investment contracts and thus securities under the Act. See S.E.C. v. W.J. Howey Co., 328 U.S. 293, 301 (1946).
12. A review of DFI’s records revealed that neither BlockFi nor the securities offered on its website are registered with the Department as required under the Act. Additionally, neither BlockFi nor these securities appear to be entitled to any exemption from registration under the Act.

The order concludes that BlockFi “shall CEASE AND DESIST from soliciting or selling any security in Kentucky unless that security is registered with the Department pursuant to KRS 292.340".

BlockFi is by no means the only cryptocurrency firm offering crypto lending products. For example, Coinbase allows its users to sign up to earn interest on their cryptocurrency – as do other firms like Compound and Aave.  This raises questions about whether Coinbase et al are also offering unregistered securities in New Jersey, Alabama, Texas, Vermont, and Kentucky.

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