E XCLUSI V E R EP ORT

Cryptocurrency Regulations
How To Invest Legally and Be Positioned for the
Coming Regulatory Crackdown

BY CHARLIE SHREM & R ANDALL OSER

 Cryptocurrency Regulations
How To Invest Legally and Be Positioned for
the Coming Regulatory Crackdown
CHARLIE SHREM • R ANDALL OSER

“Hey, I want to invest in cryptocurrency,

what do you think?”

Lately it seems I’ve barely had time to

finish answering this question before yet
another friend, family member or casual
acquaintance asks it again. Typically it’s
immediately followed by, “my buddy just
made a killing in bitcoin,” etc.

And while some global banking chieftains

may outwardly dismiss “Crypto,” they
aren’t being very honest. Or realistic.

You’ve probably heard the snarky

comments from JPMorgan Chase CEO
Jamie Dimon, saying “if you’re stupid
enough to buy Bitcoin, you’ll pay the price
for it one day.”

Well my own personal translation of

Dimon’s comments might go something

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like, “Goldman is probably making a sh%!-ton of money in this stuff, and we damn well
better figure out how to do the same!”

Indeed, not long after Dimon’s comments it was widely reported that Goldman is in
fact weighing a new trading operation dedicated to Bitcoin and other digital currencies.
Surprise surprise.

Looking at the charts of Bitcoin, Ethereum, et al., I’m starkly reminded of 1999, when
shares of Nasdaq flag-bearers such as Qualcomm and Amazon seemed to click up 5-10%
daily like clockwork, and all sorts of people began eschewing their morning shower and
business attire in order to day trade in their pajamas, lured by that age-old siren song called
“Easy Money.”

Nearly 20 years ago, knowing I was a trader at a

prominent hedge fund, all manner of folks would
ask my opinion on various dot.com ticker symbols.
My typical response then matches what I tend
to challenge people with now when asked about
cryptocurrency: “Do you even know what it is?”

Better than 9 times out 10 the answer I get back is,

“Not really.”

Crypto is a cottage industry of well over 1,000

distributed ledger currencies, with a combined market capitalization in excess of $330
billion. That’s right, illion with a B. (A comprehensive, sortable list of cryptocurrencies is
available at coinmarketcap.com).

These currencies come in digital form only (thus cannot be stacked like beloved Benjamins
or rolled like coins) and are created and stored electronically in blockchains, using
encryption to both control the creation of monetary units and verify fund transfers.

While the phrase “top-heavy” doesn’t even begin to describe the crypto market — the largest

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15 digital currencies represent 90% of the “industry” market cap, with leaders Bitcoin,
Ethereum, and Ripple dwarfing the rest — mid-cap coins like Tether and Einsteinium are
seeing a substantial amount of active daily volume. Hundreds of small caps such as Steem
Dollars, Zencash and Feathercoin, have sprung up as well.

But cryptocurrencies don’t trade on NYSE,

Nasdaq, the CME or your favorite electronic
ATS. Instead they trade on newly developed
exchanges like Coinbase, BitFinex, BitMex,
Bithumb and others. These new digital
exchanges function seperately from the big
boys, and still do huge amounts of volume
outside of the reach of the SEC.

But you can bet that traditional exchanges are itching to get in on the action.

Just recently the CFTC approved trading in Bitcoin futures on the CME and CBOE, as well
as binary bitcoin options on the Cantor Exchange. Even the NASDQ has committed to
having a tradeable futures product by 2Q 2018 (I’m old enough to remember when the Nazz
was actually the new kid on the block and a tech upstart…my how times have changed).

And just like IPOs back in the dot-com era, “ICOs” (Initial Coin Offerings) are raging
today, with brand new cryptocurrencies being born on a seemingly daily basis. In the case
of flagbearer Bitcoin, various non-direct ETF instruments such as Bitcoin ETI and XBT
Tracker in Europe, and the Bitcoin Investment Trust here in the U.S. are available as well.

The increased transparency, decentralization and ease of cross-border transactions (since

cryptocurrencies are non-national) have allowed this cottage, “next-gen” distributed ledger
currency industry to spring up almost overnight, attracting bets from around the World like
a Vegas craps table on Fight Night.

But determining the ultimate winners and losers among 1,300+ digital assets is no amateur
task, just like crowning the dot.com winners and losers back in the day.

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Unlike stocks or bonds, there are no balance sheets or quarterly SEC filings to review, nor
earnings estimates or historical figures. Unlike commodities or foreign exchanges, there
are no economic reports, or regional and global economies to rank and analyze.

Instead, crypto traders and investors must evaluate the particular technology upon which
any digital currency is based, the strength of its security (can it be easily hacked?) the
quality and reputation of its developers and partners, how likely it is to more broadly
adopted, etc., as well as its liquidity – how accessible is a particular cryptocurrency to
market participants worldwide.

Not surprisingly, some countries, like China for instance, have completely banned
exchanges that trade Bitcoin, fearing the ease of capital flight that cryptocurrency presents.
Japan, on the other hand, has chosen to regulate it as a legitimate traded market. Other
countries like India and Sweden are considering creating their own digital currencies.

As for who regulates crypto here in the U.S….well,

that’s a good question. The CFTC, SEC and IRS have
all thrown their sheriff hats in the ring.

On March 25, 2014, the IRS issued Notice 2014-21,

which for the first time established an official IRS
position on the taxation of virtual currencies, such as
Bitcoins.

According to the IRS Notice, “Virtual currency is

treated as property for U.S. federal tax purposes.” The Notice also stated, “General tax
principles that apply to property transactions apply to transactions using virtual currency.”

In other words, the IRS is treating the income or gains from the sale of a cryptocurrency as
a capital asset, subject to either short-term ordinary income tax rates or long-term capital
gains tax rates, if the asset is held greater than twelve months (15% or 20% tax rates based
on income).

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By treating Bitcoins and other crypto assets as property and not currency, the IRS is
imposing extensive record-keeping rules (and significant taxes) on its use.

Meanwhile, back in 2015 the CFTC confirmed that it views cryptocurrencies as commodities
subject to CFTC purview when it charged a San Francisco-based startup, Coinflip, with
failing to register its cryptocurrency, Derivabit, with the Commission.

More recently, the SEC weighed in several weeks ago when it issued an investigative report
warning market participants that offer and sell digital assets are subject to federal securities
laws.1

And while SEC Chairman Jay Clayton has proclaimed that the formation of new capital is his
top priority, you can bet that the SEC rank and file are salivating about bringing some high
profile cases to glossy up their resumes with when they go job hunting in the private sector.

1. This was no surprise, as the SEC had previously made clear that they had employed the
standard Howey test to conclude that the DAO token was indeed a ‘security’ and, thus
subject to federal securities law.

What is The Howey Test?

The Howey test is a ‘substance over form’ test created by the Supreme Court
for determining whether certain transactions qualify as “investment contracts.”
If so, then under the Securities Act of 1933 and the Securities Exchange Act of
1934, those transactions are considered securities and therefore subject to certain
disclosure and registration requirements. Under the test a transaction is deemed
an investment contract if:

1. It is an investment of money
2. There is an expectation of profits from the investment
3. The investment of money is in a common enterprise
4. Any profit comes from the efforts of a promoter or third party

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Nevertheless, these “new breeds” of offerings justifiably merit some type of ‘touch’ from the SEC.

Marijuana may have been decriminalized in New

York, but if you walk up to a cop and fire off a 3
foot bong and blow the cloud of smoke into that
cop’s face while yelling “Black lives matter motherf
*$%#,” it’s likely you’ll be spending the night in the
pen, decriminalized or not.

In the end, you’d do well to keep reminding yourself

that most of the regulatory landscape is less about safeguarding the little guy from abuse, and
more but about preserving the status quo.

It’s certainly not unreasonable to expect that some sort of registration requirements may
soon be implemented by federal regulators to provide market participants with some basic
disclosures and protections about new issues as they come to market. Even if they’re only
“short form” fixes…they’re coming.

Unfortunately these investor protections come with some unappetizing strings. Most
notably this: increased regulation and registration will make it that much easier for the IRS
to come calling to ask for its share of the profits at tax time.

Based on just Bitcoin’s incredible rise, there are likely legions of bulging 1099’s the IRS
would just love to get its hands on.

This is one is pretty easy to navigate and can best be summed up with the elegant phrase,
“Pay your f&@king taxes.” This isn’t Greece, and most cryptos aren’t even remotely
anonymous, so don’t be the face of public deterrence for failing to file an income tax return
a la Wesley Snipes.

We’ve been advising people since early 2017 that there will be a massive and very public
roundup of tax cheats in late 2018 as the bill comes due for some of the eye popping gains
over the last 18 months.

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Either way, hopefully the finance police tread with a ‘light touch’, lest they drive the market
entirely overseas to more hospitable nation-states like Switzerland, Singapore and Japan.
Hopefully they don’t snuff out that little spark of creativity and positive disruption that still
exists in our country, especially as Silicon Valley enters its menopausal years.

And don’t think for a second that state legislators and regulators are sitting idly by.

New York’s BitLicense Regulation has been on the books for the past two years, and is
viewed as onerous at best by the crypto industry. Ditto for similar regulatory schemes
implemented or proposed in Washington, California, Illinois, Florida and Hawaii.

But not all states are trending this way. Texas, Nevada and New Hampshire have shown
themselves to be more crypto-friendly.

In response to state regulation of virtual currency exchanges, the industry has tacked in two
directions – development of bank-focused private blockchains and the initial coin offerings.

Worth keeping an eye on is the two-year draft legislative initiative dealing with
cryptocurrency just completed by the Congress-like Uniform Law Commission (“ULC”).
A non-profit association of 350 attorneys appointed by each state, the District of
Columbia, Puerto Rico and the U.S. Virgin Islands, the ULC works to provide U.S. states
and jurisdictions with researched and drafted legislation to bring clarity, stability and
uniformity to critical areas of statutory law.

Believe it or not the ULC has been around since 1892. They’re best known for their work
on the Uniform Commercial Code, but just this past summer they came up with a draft bill
titled the Uniform Regulation of Virtual Currency Businesses Act (“URVCBA”) which it
hopes will be considered in several state legislatures soon.

Among its key components, the URVCBA draft bill (1) distinguishes which currency-related
activities are and are not considered money transmission; (2) defines “custody” of crypto
assets; and (3) establishes a 3-tiered license structure that would provide exemptions for
individuals and small entities, special regulations for startups, and fully licensed status for

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larger virtual currency businesses.

Where all these regulatory initiatives wind up is anyone’s guess. But the thought here is
that with the crypto frenzy unlikely to subside anytime soon, regulators will try to find a
way supervise it, collect fees on it, tax it, and levy fines for violators.

In the meantime, the race to distinguish the Crypto “FANGs” from the “FINPs” (Flash-in-
the-Pans) is on. Place your bets (carefully)!

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 Legal Notices: Crypto Insider, LLC, dba Crypto.IQ, is not an investment company,
investment advisor or broker/dealer, and does not provide investment advice. The Legal
E XCLUSI V E R EP ORT
BY CHARLIE SHREM & R ANDALL OSER

Copyright © 2017 Cr ypto.IQ. All rights reser ved.

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 DISCLOSURE APPENDIX

Crypto Insider, LLC, dba Crypto.IQ, is not an investment company, investment advisor or broker/dealer, and does
not provide investment advice. The information contained in this report is not intended to be a source of advice or
investment analysis with respect to the material presented, and the information contained in this report does not
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The information expressed in this report is our opinion and should never be used without first assessing your own
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Now that we’ve made our legal team very happy and gotten the above out of the way (and paid a hefty price for it), let us
put this in the plainest possible terms. Cryptos are extremely volatile.You can lose all of your investment. Do NOT invest
more money than you can afford to lose. There are also a great many risks that are completely outside of our, or anybody
else’s control. Regulatory risk, tax risk, technological risk, act of God risk – you get the point.

© 2018 Crypto Insider, LLC.

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