Written by Jonny Fry
Writers linkdin: https://www.linkedin.com/in/jonnyfry/

In Digital Bytes on 1
st December 2021, our guest article from Coinfirm generated an influx of comments and questions as to what the regulation of digital assets in various jurisdiction are. In essence, regulations vary depending on which country you look at, but the common dominator in each jurisdiction is that Anti Money Laundering (AML) requirements are met. This is rather ironic since the current financial regulator has been built for paper-based transactions as opposed to digital transactions. Digital currencies offer the ability to track and trace not just the flow of funds but those engaged in using these funds, and so it is possible to speedily identify the nefarious actors. Initially digital assets, or at least cryptocurrencies, were seen as a way to circumvent financial institutions and transfer capital anonymously, instantaneously, and for very low costs. However, there is no reason why using smart contracts run on blockchain-powered platforms cannot be used very much as a compliance and regulators’ tool in order to ensure that those digital assets being transferred are done so in a fully compliant manner, with all AML requirements being met.

In the USA

There is always the challenge of compliance with both State and Federal laws. The Banking and Secrecy Act (BSA) deals with AML, and all firms trading/dealing in digital assets need to comply with this. The government body which oversees the BSA and aims to tackle and reduce both the financing of domestic and international terrorism and money laundering is the Financial Investigative Unit (FIU).  Further details about this are given by the Financial Crimes Enforcement Network (FinCEN) which has published a helpful interpretive guidance (the Guidance) to “remind” businesses and individuals involved with convertible virtual currencies (CVCs) and digital assets/crypto of the potential applicability of the Bank Secrecy Act (BSA) to their business. Depending on the type of digital assets, compliance requirements with either the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Office of the Comptroller of the Currency (OCC) or FinCen will need to be checked.

Tax: The holder of those digital assets making a profit has to pay a Capital Gains Tax rate between 10-37% for short-term capital gains, and 0-20% for long-term capital gains. In the US, digital asset gains are based on your income and the length of time you have held the digital assets. If you are paid in digital assets as part of your employment, such as for a crypto miner, then income taxation is due.

There seems to have been a gradual thawing in attitude towards the way cryptos are treated. The ProShares Bitcoin ETF has finally managed to be the first ETF in the USA to give exposure to BTC. Instead of holding Bitcoins directly, investors in the ProShares Bitcoin ETF will gain exposure via Bitcoin futures. In its first two days, the ProShares Bitcoin ETF amassed $1billion -  it took State Street’s SPDR Gold ETF 3 days. The Winklevoss brothers first tried to launch a Bitcoin ETF on 8th July 2013 when Bitcoin were priced at $68.08 each (compared to over $48,500 now - each a mere 71,000+% rise!)

In Japan (still the third largest economy in the world)

The Financial Instruments and Exchange Act (FIEA) is Japan’s main regulation on financial securities and, in April 2020, the Japanese established two self-regulatory bodies - the Japanese Virtual Currency Exchange Association (JVCEA) and the Japan STO Association. Furthermore, digital assets are treated as legal property under the Payment Services Act (PSA). Digital assets exchanges in Japan are required to be registered with the Japanese Financial Services Authority (FSA) and this can take up to six months to become regulated. The FSA imposes requirements around cybersecurity and asks regulated firms to carry out Anti Money Laundering checks on potential investors. 

Tax: Digital assets are taxed as “other or miscellaneous income”, no matter whether the profit or assets arise from trading, mining or lending. Therefore, the taxation is subject to a sliding tax rate, up to as much as 55%.

In the UK

In April 2021, Rushi Sunak , the UK’s Chancellor of the Exchequer, announced that the Treasury and Bank of England were establishing a task force to explore a CBDC. The Financial Conduct Authority (FCA) had published a guide for crypto assets back in 2019 stipulating that, from 10th  January 2021, all existing cryptoasset businesses carrying out crypto-asset activity in the UK were required to be registered with the FCA. The key requirement is, however, for firms to be able to prove they have robust and comprehensive KYC and AML procedures in place and comply with the Europe’s 5th Anti Money Laundering Directive (5AMLD). Notably, the FCA has been slow in dealing with the backlog of firms applying to be registered and has now extended the deadline from July 2021 to 31st March 2022 in order to review those firms which had already applied before January 2021. Firms conducting crypto-related activities also need to be mindful of the Joint Money Laundering Steering Group (JMLSG).

Tax: HMRC's views on the taxation of cryptos have been consistent and relatively clear. If you make a profit from trading, you will be liable for Capital Gains Tax and if you are paid crypto instead of a salary, then income tax is due.

In Australia

Some are claiming that Australia has become the third largest country in terms of engagement with cryptocurrencies, with 18% of Australian’s owning some form of crypto. Therefore, it ought to come of no surprise that the Select Committee on Australia as a Technology and Financial Centre would appear to be very supportive of the Australian Parliament taking digital assets very seriously since the committee believes there are considerable commercial opportunities for Australia: Australia has significant potential to keep advancing as a technology and financial centre, if we grasp the opportunity to update our regulatory frameworks, drive innovation and enhance our competitiveness. The committee commends this report and the recommendations in it to government, and industry, to drive this agenda forward.”

The committee has highlighted eight issues in need of addressing:

  • regulation of Digital Exchanges.

  • an appropriate regime for custodial and depository services for digital assets is required.

  • a token mapping exercise to classify the various types of crypto-asset tokens and other digital assets being developed in the market to ensure that the regulatory classifications for these assets are fit-for-purpose.

  • a new Decentralised Autonomous Organisation legal structure is needed to ensure that emerging types of blockchain-based organisations can be established with clarity as to how they can operate.

  • a review of the Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) regulations is required to ensure that these regulations are fit-for-purpose and do not undermine innovation. In particular, issues around the implementation of the Financial Action Task Force 'travel rule' have been raised with the committee as requiring attention.

  • taxation rules for digital assets require further clarification. In particular, the rules around Capital Gains Tax (CGT) for cryptocurrency and digital assets need to be updated to ensure that new types of technology structures are appropriately accounted for, and digital asset transactions only create a CGT event when they genuinely result in a clearly definable capital gain or loss.

  • the opportunities associated with digital asset infrastructure were highlighted in evidence to the committee, as well as the energy intensity of cryptocurrency 'mining' practices. The committee is recommending a tax concession for digital asset miners operating in Australia who source their own renewable energy. 

  • the committee considers that the Treasury should conduct a policy review on the potential for a retail CBDC in Australia.

As one can see, it is no mean feat to work your way through the regulations and requirements in order to legally sell and promote digital assets globally. The above has only reviewed, and very briefly, a mere four countries. The challenge for different jurisdictions will be to have regulations which are able to protect investors, all the while not stifling innovation otherwise we will see businesses being established solely in those jurisdictions which have the ‘lightest regulatory touch’. But make no mistake, the potential commercial opportunities creating highly paid and skilled workers and tax are huge. These digital assets are not physically restricted by national boundaries and boarders so, ideally, we need to see greater global regulatory collaboration to arrest a climate of compliance arbitrage which could undermine confidence in this asset class and potentially the Blockchain technology which runs them.