The crypto market has grown from an obscure hobby project to a roughly $2 trillion asset class over the past decade. With the rise of decentralized finance (DeFi) and non-fungible tokens (NFTs), the blockchain is revolutionizing everything from personal loans to fine art. Not surprisingly, all of this growth has drawn the attention of regulators.
The IRS hopes to recoup an estimated $28 billion in taxes by identifying crypto transactions that skirt income tax, while the SEC is cracking down on security-like crypto projects. While many crypto enthusiasts see the crackdown as a negative, others hope that the new regulations will provide greater legitimacy to the industry.
Let's look at a handful of new regulations that could reshape the crypto industry over the coming years.
The Wash Sale Rule
The IRS' Wash Sale Rule prohibits loss deductions from wash sales of stocks and securities. So, for example, you cannot purchase a stock, sell it after it falls in value, and immediately repurchase it to realize a loss. However, the Wash Sale Rule doesn't apply to "property," which is the designation given to cryptocurrencies by the IRS in 2014.
Unfortunately, lawmakers recently introduced a bill that would apply the Wash Sale Rule to cryptocurrency transactions. In effect, the rule would prevent investors from selling crypto holdings to realize a tax loss and immediately repurchase it. Instead, crypto investors would have to wait 30 days to repurchase the same security and be able to claim the loss.
If passed, the bill would go into effect in 2022 and could close an estimated $16.8 billion tax loophole over ten years. Then, crypto traders and investors may need to grapple with the definition of "substantially identical" cryptocurrencies. That way, they can continue to take advantage of tax-loss harvesting within the confines of the new rules.
Tax Reporting Requirements
The $1 trillion infrastructure bill introduces new tax reporting requirements on the crypto industry. In particular, the bill will require crypto brokers to adhere to strict tax-related reporting on crypto transfers. The problem is the definition of "broker" is broad enough to encompass miners, developers, and even some users.
While amendments are unlikely, since it could risk sending the entire bill back to the Senate for reconciliation, lawmakers reiterated that the provision isn't designed to impose new reporting requirements on miners, stakers, or others that validate distributed ledger transactions. But, of course, these reassurances could mean little outside of the law.
For its part, insiders believe that the Treasury Department is primarily interested in capturing centralized exchanges and decentralized exchanges (DEXs) that have intermediaries as part of their platforms. The transactions running across these platforms alone could be enough to raise $28 billion in taxes over ten years.
Stablecoins have drawn especially harsh scrutiny from regulators, from the Treasury to the SEC. As a critical source of liquidity for crypto exchanges, the value of the three largest stablecoins has soared to more than $100 billion. The problem is that many stablecoins don't provide a detailed breakdown of their reserves.
In addition, the reserves held by stablecoins could make them a sizable player in traditional capital markets. For example, Tether has about half of its reserves in commercial paper. And in 2019, New York Attorney General Letitia James investigated the firm for taking at least $700 million out of Tether's reserves to shore up its exchange's balance sheet.
In December, the President's working group released a statement recommending that stablecoin issuers maintain a 1:1 reserve ratio and hold high-quality, U.S.-dollar denominated assets at U.S.-regulated entities. In July, the group met again to discuss the market and how regulations might address it to reduce potential systemic risk factors.
Numerous State Regulations
The federal government isn't the only legislative body introducing crypto regulations. Several states have introduced legislation that could impact traders, investors, and businesses operating within their boundaries. Of course, these bills are in various stages of approval and can positively or negatively impact the industry, depending on their nature.
These pieces of legislation include:
- Research Activity - Several states established committees to study crypto assets. For instance, Arizona HB 2544 establishes a blockchain and cryptocurrency study committee.
- Unclaimed Property - Several states modified their unclaimed property laws to include virtual currencies. For instance, Indiana signed SB 188 into law to include virtual currencies.
- Adding Definitions - Several states clarified who controls virtual currencies. For instance, Illinois HB 3968 gave such power to its Department of Financial and Professional Regulation.
- Building Incentives - Kentucky modified with Incentives for Energy-Related Businesses to include cryptocurrency facilities with a minimum capital investment of $1 million.
- Restricting Activity - New York's AB 7389 and SB 6486 would establish a moratorium on the operation of cryptocurrency mining centers subject to an environmental impact review.
- Taxation - Washington's HB 1406 and SB 5426 establish a 1% wealth tax on more than $1 billion intangible financial assets, including virtual currencies.
State-by-state regulations will continue to evolve as the industry matures. Of course, some states will naturally introduce more rules than others. For example, New York houses the world's largest financial institutions, making it necessary to impose greater regulation in rural states with few crypto businesses.
What It Means for Your Portfolio
The new crypto regulations could have an impact on some traders and investors. For example, you may need to rethink your expected returns without the use of tax-loss harvesting or keep an eye out for tax forms from exchanges that you use. That said, most traders won't experience a meaningful change in their existing workflows.
That said, the new regulations could impact the industry as a whole. For example, exchanges could begin sending tax forms to their customers, like conventional stockbrokers, whereas stablecoins could be forced to outline their reserves, providing greater reassurances. The burden of these requirements could put some smaller organizations out of business.
Crypto traders and investors can ensure they're keeping up with the latest requirements with crypto tax software. For instance, ZenLedger makes it easy to aggregate transactions across exchanges—including DeFi and other complex transactions—and compute your total capital gain or loss. You can even pre-fill popular IRS forms to avoid the headache at tax time.
The Bottom Line
New regulations could dramatically reshape the crypto industry over the coming years. While new reporting requirements have already passed, there are several other pieces of legislation in various stages of writing and approval. Investors should keep abreast of these regulations to ensure that they remain in compliance and avoid penalties.