Decentralized Digital Identity | Decentralized Law
BanklessDAO Legal Newsletter
Dear Crypto-Legal Observers,
In many ways, the blockchain is all about privacy. You can immediately transfer economic value across the globe, without identifying yourself to an intermediary. There is no need to provide an underlying reason for the transfer: privacy goes together with self-sovereignty.
But the blockchain is also transparent, as transactions are publicly stored on a distributed ledger, which makes it possible for every person to verify exchanges of value between users. Except when particular protocols that facilitate private transactions are used, it is simple to track these transfers.
This apparent conflict reveals the tension between blockchain technology and privacy. From a technical point of view, a mere wallet address can be considered pseudonymous data, that, combined with other elements, may help to reveal the identity of a person. Taken together, it would appear that blockchain activities may fall within the scope of data protection laws in many Western legal systems.
How should the law solve this tension? Do we need more or less privacy within the blockchain industry?
The question does not involve only transactional privacy.
In crypto, people tend to remain anonymous, or more accurately for most transactions and people, pseudonymous. Pseudonymity is preferred not because, as many crypto opponents wrongly argue, of some desire to hide something or to escape liability for some act or omission. The truth is that people love creating new identities. Being recognized as a “Legal Eagle,” a “Lion,” or a “Taxpanda” is priceless, because it eliminates barriers and helps people located on different continents feel united, as part of a single team.
The success of NFT profile picture projects demonstrates the innovative use cases and artistic appeal of technology that enables pseudonymous participation in the cryptospace. Nonetheless, there are inherent limitations with pseudonymity that need to be addressed.
For a pseudonymous DAO contributor looking to enhance their reputation, CVs and resumes are of little use. To receive recognition in the cryptoverse, contributors must deliver results under their pseudonymous identity. Claiming to be an experienced marketing professional or battle-hardened lawyer means nothing without a verifiable track record.
Another problem, which could adversely affect DeFi protocols, is connected to legal compliance: what would happen if protocols became legally required to implement Know-Your-Customer (KYC) and Anti-Money Laundering procedures?
The solutions to these problems can be found in technological innovation. We don’t have definitive answers yet, and things are moving quickly in this area, but we are very pleased to discuss the most recent developments on this topic in Decentralized Law’s interview with Ian Place. Ian is the co-founder of Burrata, a company providing tools to help developers build decentralized identity solutions to fulfill KYC requirements. Ian is building decentralized identity verification systems to solve these “trust but verify” problems, and he provides some excellent insights into the future of digital identities.
Also in this issue of Decentralized Law, we unpack NFTs and intellectual property rights, analyze Web3 investment clubs, explore the state of crypto regulations throughout Latin America, discuss “John Doe” summonses and what to do about them, and summarize news and articles from across the cryptoverse.
Although this newsletter may help to familiarize readers with the legal implications arising out of blockchain technology, the contents of Decentralized Law are not legal advice. This newsletter is intended only as general information. Writers’ opinions are their own; therefore, nothing in this newsletter constitutes or should be considered legal advice. Contact a legal expert in your jurisdiction for legal advice.
Ian Place Spills the Tea on Digital Identities
Please tell us something about your background and how you started to engage with crypto-legal issues.
I have been working in risk management, fraud prevention, and compliance for about 10 years now. I’ve worked in a variety of industries within these areas but where my career really kicked off was DraftKings. For those not based in the US, DraftKings is the leader in daily fantasy sports and sports betting. I was one of the original 50 or so employees and while at DraftKings I became more interested in crypto in mid-to-late 2017. I had only been a speculator on the sidelines up until that point but I was beginning to have more conviction for the core technology and use cases. At the same time I was ironically contacted about a compliance role over at Circle. I met with the team, received the offer, and started just a few weeks later.
Initially at Circle I helped establish many of the compliance functions for the Poloniex exchange after the acquisition in late 2017, Circle Pay, and Circle Invest (now Voyager). About 6 months into my time at Circle the company launched USDC. At that point my focus shifted predominantly to risk and compliance operations for USDC. While building out the compliance program for USDC I began working with various blockchain analytics providers. During that time I was introduced to the folks over at Chainalysis and after a few discussions I made the move from Circle to Chainalysis in early 2019.
At Chainalysis I started off in customer success working with many of our largest clients and then shifted over to help spin up the solution architecture function. It was truly the greatest career experience I’ve ever had as I was able to work closely with crypto native businesses (CEXs, VASPs, DeFi protocols, fintech, etc…), domestic/international regulators, government agencies, and large financial institutions. While in this role I saw an extremely urgent need for some form of on-chain digital identities. These identities would be necessary to help meet inevitable regulatory compliance requirements across the world, provide greater consumer protection, and grow the crypto market from 2 trillion USD to somewhere closer to the multi-hundred trillion fiat financial markets.
How would you define “Digital Identity?”
I would define a digital identity as information and characteristics that can help establish a unique entity. This definition is not limited to financial applications as digital identities are utilized for social applications as well. For example, an Xbox or Playstation gamer profile is a digital identity with unique pieces of information and characteristics (i.e. trophies for in-game accomplishments, badges, gaming skins, etc…).
Why is Digital Identity important for the growth of the crypto-space?
Digital identities will be essential for the growth of Web3 by solving five key areas:
Navigating regulatory headwinds: KYC compliance requirements are inevitable for the space and the first step in addressing these requirements is establishing and validating identities. If we as an industry can proactively establish compliant controls we help reduce the risk of severe top-down regulatory requirements that would stifle growth and innovation.
Lack of consumer protection: Rug pulls and scams have become commonplace in our space. If we can begin to establish digital identities on-chain we can have greater consumer protection for users and more accountability of the criminals.
Missing off-chain attributes: Web2 and Web3 systems are siloed. Because of this we lack crucial data points in Web3 that would enable new types of applications and help enrich the user experience across applications.
Inefficient markets: The lack of metrics necessary to properly establish counterparty risk in Web3 creates the need for overcollateralization of assets. If we establish digital identities and attributes on-chain we will be able to significantly reduce the collateralization we see today.
Institutions want to get involved: Financial institutions are foaming at the mouth on the sidelines watching the crazy yields and growth in Web3. However, until they are able to identify who their counterparty in a transaction is they will not engage in Web3. If we can make an environment that makes both the native Web3 community and institutions comfortable we will drastically grow the market capitalization of cryptoassets.
Do you see any issues concerning the protection of privacy? If so, how are these concerns addressed?
I strongly believe in digital identities that also preserve user privacy. The level of information necessary to establish and maintain regulatory compliance can be utilized without needing the user to provide information beyond what is required. With that said, when utilizing Burrata, dApps and DAOs can verify the necessary information to maintain regulatory compliance while neither the dApp, DAO, or Burrata store that information in a centralized database.
Are KYC and AML procedures feasible for decentralized applications?
To be explicitly clear, none of this is legal advice so please do your own research and discuss with your own counsel. But yes, I would say it is absolutely feasible for DAOs and dApps to implement KYC and AML programs. When we look at the amount of coordination we see in most DAO and dApp Discord servers there is certainly a possibility for vetted compliance experts to provide their assistance in one way or another. Additionally, there is no one-size-fits-all approach to compliance so each DAO and dApp will vary in how they employ KYC and AML programs.
With regards to KYC and AML technologies, almost every solution has created features and functions to make compliance as efficient as possible to suit the needs for smaller core teams of DAOs and dApps. I would encourage DAO and dApps core team members to think about some of the following questions when implementing a KYC and AML program:
What types of products, services, or community memberships does our dApp or DAO offer?
Who are our expected dApp participants and organization members?
Do we have age requirements for protocol participants and organization members?
Depending on the governance model of the dApp or DAO, do we need to get KYC and AML policies established through community governance?
What jurisdictions do we allow protocol participants or organizational members from?
Do those jurisdictions have existing or unique regulatory requirements that need to be met?
What does normal behavior for our protocol participants or organizational members look like?
Do we have gaps in the existing KYC and AML controls, policies, and procedures?
If so, which gaps pose the most immediate danger and risk to enabling illicit activities?
If you start to answer some of these questions you will begin establishing the foundation for your KYC and AML program. Again, this is simply a starting point but there are many other areas that need to be addressed with your legal counsel. I’m always happy to talk about compliance and Web3 so please feel free to follow or DM me on Twitter!
The Lowdown on NFTs and Intellectual Property
NFTs have been portrayed as an ideal mechanism to enable artists to receive automatic royalties from their work. Smart contracts can pay the artist each time the NFT is resold, enabling artists to generate more income from their work as compared to a normal sale. But a lack of understanding of exactly what rights an NFT buyer is receiving, and the options available to an artist to address plagiarized NFTs, means the NFT marketplace has many traps for both buyers and sellers. One might think that new legislation is needed on NFTs and intellectual property rights. But the truth is that existing law is sufficient to address NFTs, notwithstanding that the laws vary from one jurisdiction to another. This article answers some of the most common questions about NFTs as they relate to intellectual property rights.
Which intellectual property rights do I own when I buy an NFT?
Many NFTs buyers think that when they purchase an NFT on a platform like OpenSea or Rarible, they are the only ones who can post the picture and that they can preclude other users from posting the picture linked to the NFT. However, buyers need to be clear on exactly what rights they acquire when they buy an NFT and how copyright laws work. The author of a picture, song, or digital file owns its copyright from the moment the work is incorporated into a tangible medium, and no registration is required. Owning the copyright allows the author to preclude other users from reproducing their work, creating derivatives, distributing it, performing it, and displaying it.
If the author sells the picture, song, or digital file, the buyer does not automatically acquire the right to copy or distribute it or to upload pictures of its content to the internet. Those rights are generally retained by the author, who is the copyright holder. The author also retains the right to grant licenses to others to exercise some of the rights that make up the copyright. NFT buyers receive only a kind of certificate proving their ownership of a digital asset, and that ownership does not include the right to forbid others from displaying the picture. Only the author, or someone granted a license by the author, has the right to compel others to remove the picture.
I bought an NFT. Can I display the picture on my social media profile?
Like so much about NFTs, the answer is that it depends. Generally, buying an NFT means ownership, and not the right to reproduce or display a piece of art. Only the author or someone licensed by the author has the right to reproduce or display the picture. Therefore, unless the buyer has specifically acquired the copyright to the art with the NFT or a license to display it, then displaying the picture would infringe the author's rights.
Some NFT marketplaces include in their Terms of Service that the marketplace is acquiring the right to use, copy, modify and display any content related to an NFT. See, for example, Clause 7 from the OpenSea Terms of Service, which provides that the NFT seller is granting OpenSea a license to use, copy, modify, and display any content, including any digital file, art, or other material linked to or associated with the NFT displayed on OpenSea. FTX has a similar clause in its Terms and Conditions.
NFT buyers, on the other hand, have to analyze the rights that they obtain with each purchase, including whether they have the right to display an NFT on social media. Generally, buying an NFT does not come with any intellectual property rights. If the platform on which the NFT is purchased does not expressly state that the buyer has such rights, then the buyer should never assume that any rights come with the NFT. For example, OpenSea has a “description” box for each NFT that lists the intellectual property rights with the purchase. If it says there that the buyer acquires the right to reproduce the image, then it can be displayed on the buyer's social media.
What recourse do I have if I see my art minted as an NFT and listed on a marketplace?
As noted above, the author owns the copyright to a piece of art, which gives the author the power to preclude others from reproducing it. Minting an NFT of someone else's art, without the author's permission, infringes on the rights of the author to reproduce and distribute the art. Minting a file like a picture or a song without a license or authorization would give the author the right to bring a lawsuit to enforce those rights.
The author can try to contact the marketplace and notify them of the infringement. For example, OpenSea's website provides a mechanism to report copyright infringement. In practice, due to the large numbers of NFTs and transactions, marketplaces cannot cope with all the copyright infringements and may do nothing to help the author. OpenSea recently announced that they will limit the number of NFTs that a user can mint for free, having realized that 80% of the NFTs minted on their platform are either fake or stolen.
In the end, the problem is that because there is so much dumb money in the crypto market, silly behaviors arise. For example, imagine that your best friend tells you that he wants to sell you a Picasso painting. Most people in this situation would try to find out if that painting is really by Picasso because its provenance is what really gives value to it. This diligence that people would have with physical assets seems to disappear when it comes to NFTs. People are buying these tokens only with the expectation of making a profit in the future, without investigating if the underlying asset is created by the person who is selling it.
Bottom line: when buying or minting an NFT, it is very important for the participants to understand the terms and conditions imposed by each marketplace. Buyers need to understand exactly what rights come with the purchased NFT to avoid possible future copyright infringement suits, and authors and artists who wish to create and mint art as NFTs need to understand what rights they are giving up when they sell an NFT. Intellectual property is a bundle of rights, and understanding these rights is good for both buyers, sellers, and authors.
Friends With Benefits: Web3 Investment Clubs
An investment club is a group of people who pool their money to invest together. The club members jointly decide what to invest in — stocks, bonds, art, real estate, franchises, lemonade stands, or whatever — and everyone is involved in making investment decisions and sharing the profits or losses. Investment clubs are nothing new. But creating a decentralized Web3-native investment club, in which groups of people pool their crypto and use a governance token to make investment decisions, is a relatively new concept that has not, until now, been easy to do. One obstacle is setting up a wallet to hold the club's funds and crypto-based investment portfolio that has the appropriate governance and controls. Another is integrating the club with the legal infrastructure needed to open bank accounts, make off-chain investments, get a tax identity number, and do tax filings. Developing the smart contracts to automate management of the club's assets, deposits, and distributions can also be challenging.
Syndicate has built a suite of tools for Web3 investment clubs to operate as Ethereum-based DAOs with a club-owned wallet and smart contracts to manage deposits, capitalization tables, the investment portfolio, reporting, and distributions. Syndicate provides step-by-step instructions for creating a wallet, connecting it to Syndicate, adding members, issuing ERC-20 tokens for voting and governance purposes, and creating an admin dashboard to keep track of the members' stakes, portfolio performance, and other information. Syndicate also provides tools for legal documents (such as an operating agreement and a subscription agreement) that are created, signed, and stored electronically as well as guidance and forms for creating a legal entity. The clubs are fully composable with other Syndicate and Web3 infrastructure and tools.
The Syndicate platform is intended to create SEC-compliant investment clubs. The SEC generally does not regulate investment clubs as long as they have no more than 99 members, all members actively participate in making investment decisions, there are no performance fees, no public solicitations or public offering, and no transferability. The club must also follow all tax laws. If the club allows members that are not "accredited investors," or does not have a separate legal entity, then the club can only invest in NFTs and tokens. Members also have to be fully disclosed to comply with U.S. anti-money laundering and anti-terrorism rules.
Participating in a Syndicate investment club is not without risk. If the club has only a DAO and no legal entity, then the club members could be exposed to legal or financial liability incurred by the DAO. The club may make bad investments, the smart contracts may not function as intended, or the club's wallet could be hacked, all of which would lead to financial losses for the members. But if you have smart friends, pooling your resources to create a Syndicate investment club may be the best way to bring out your inner venture capitalist without having to be actually employed by a VC firm.
In Brief: A Country-By-Country Breakdown of Crypto Adoption and General Regulation in Latin America
According to Crypto.com, cryptoasset holders worldwide increased from 106 million (in January 2021) to 295 million (in December 2021), a growth rate of 178%. This growth is viewed with enthusiasm by those who are part of the ecosystem and with caution by the different public and private institutions worldwide.
However, the adoption of cryptoassets is not uniform worldwide, as can be seen in the Chainalysis chart below.
What About Latin America?
From every point of view, Latin America has always been a melting pot of developing cultures and therefore a constant challenge to analyze. The emergence and adoption of cryptoassets has been no exception.
According to Chainalysis “Latin America has the sixth largest cryptocurrency economy of the eight regions with $352.8 billion in cryptocurrency value received between July 2020 and June 2021.” Latin America ranks sixth in cryptocurrency adoption globally in number of users and accounts for 9% of all transaction activity. And there are three Latin American countries in the top 20 index: Venezuela, Argentina, and Brazil.
What Is the Reason for Adoption?
Latin America has been involved in recurring financial and economic crises for decades. Venezuela and Argentina are two clear examples of this situation. Venezuela has been experiencing hyperinflation for more than five years and last year had an inflation rate of almost 700%. In Argentina, inflation has been above 50% since 2020.
Beyond the specific cases mentioned, the region in general lives with unstable exchange rates, uncontrolled inflation, or expensive financial and banking systems. In addition, there are restrictions on access to foreign currency, regulatory restrictions, and capital controls. This produces a perfect combination for monetary instability.
As a result, digital assets have become a store of value to preserve savings from inflation and a cheaper and more agile means of “cash transfers,” remittances, and commercial transactions. In addition, crypto is a payment method adopted by those who provide services abroad.
In that sense, Venezuela is one of the main markets for P2P cryptocurrency transactions. Conversely, Brazil is the largest cryptocurrency market by transaction volume and is more oriented to DeFi and institutional investment because of its more stable currency.
What Is Happening at the Regulatory Level?
Many nation-states and international organizations have started or will start to establish guidelines, recommendations, and regulations to deal with this incipient crypto industry.
One of the most important focal points is to establish normative and regulatory frameworks that contemplate not only tokens and cryptoassets but also cryptocurrencies, as well as tax regulation and money laundering.
In Latin America, different countries in the region have adopted different strategies. At the general regulatory level, the region still does not have uniform or clear regulations for crypto transactions. Below is a brief overview of the state of crypto regulations by country.
Argentina: There is no regulation of cryptoassets. There are two bills referring to cryptoassets. Regulation Bill 6055D of 2020 seeks to generate an integral regulatory framework for the crypto and fintech ecosystem and Regulation Bill 2933D of 2021 seeks to authorize the payment of salaries partially in crypto. Notwithstanding, the tax regulation contemplates cryptocurrencies for the payment of taxes.
Bolivia: In 2014, the Central Bank (Resolution 044/2014) banned all cryptocurrencies not issued or regulated by states or countries. In 2020, the Central Bank banned all cryptoassets (resolution 144/2020).
Brasil: There is no regulation of cryptoassets. There is a bill referring to cryptoassets. Regulatory Bill 2303/2015, with half approval (Deputies Chamber), seeks to generate an integral regulatory and control framework for the crypto ecosystem.
Chile: There is no regulation of cryptoassets. There is a Regulation Bill to establish a legal framework for the acceptance of Bitcoin.
Colombia: There is no regulation of cryptoassets. There is a bill referring to cryptoassets. Regulatory Bill 139/2021C seeks to generate a regulatory and control framework for exchanges. In addition, there are discussions of a regulatory sandbox.
El Salvador: In September 2021, it became the first country in the world to regulate Bitcoin as legal tender. The so-called Bitcoin Law, which was issued by Decree 57 in 2021, established a legal framework for the acceptance of Bitcoin as legal tender and unrestricted full discharge.
México: Since 2018 there is a Law to Regulate the Institution of Financial Technology, called Ley FinTech, that establishes a very complex global regulatory and control framework to Fintech, exchanges, and the general system.
Panamá: There is no regulation of cryptoassets. There are two bills referring to cryptoassets to regulate them as a means of payment and crowdfunding. Regulatory Bill 696/2021 and Regulatory Bill 697/2021.
Paraguay: There is no regulation of cryptoassets. There is a bill referring to cryptoassets. Regulatory Bill S-2110314, with half approval, seeks to generate an integral regulatory and control framework for the production and commercialization of the crypto ecosystem (virtual assets, cryptoassets, and mining).
Peru: There is no regulation of cryptoassets. There is a bill referring to cryptoassets. The regulatory bill 1042-2021 seeks to generate a regulatory and control framework for exchanges.
Uruguay: There is no regulation of cryptoassets. There are two bills referring to cryptoassets. Regulatory Bill 526/2021 seeks to generate an integral regulatory and framework for the cryptoassets ecosystem and Regulatory Bill 547/2021 seeks to establish a regulatory framework for cryptoassets and exchanges under Central Bank jurisdiction.
Venezuela: There is a general and complex regulatory framework for cryptoassets, exchanges, production (included registration of mining), and commercialization. The Decreto sobre Sistema Integral de Criptoactivos and a very complex tax regulation.
The Year of Regulation
Despite the fact that the crypto ecosystem is growing and Latin America participation in the ecosystem is very important, there is a significant backlog in terms of regulation of the crypto sector in this region.
In the last few years, the number of bills to regulate the crypto ecosystem has multiplied, and this will be reflected in upcoming regulations in different ways. At present, even though regulatory laws are lacking, many countries have included an obligation for taxpayers to report and pay taxes on cryptocurrency holdings.
From the reading of the draft regulations and bills, it is evident there is no uniform regulation. It is also clear that regulators lack knowledge of the sector. This lack of knowledge and uniformity could be a red flag for the crypto projects, exchanges, assets holders, stakeholders, and the ecosystem in general.
2022 is the year of regulation, and there will be a turning point in regulatory standards in Latin America. But, from a reading of the regulatory bills, there appears to be a lack of deep knowledge about the crypto ecosystem, which could lead to laws that harm the sector.
The states are focused on regulating the crypto ecosystem without understanding what it is at all. And this is not good. It should be mandatory that the different stakeholders of the crypto ecosystem be involved in the discussions on sector regulation in order not to harm the crypto growth and adoption in Latin America.
The IRS is Coming for You: “John Doe” Summonses and IRS Letters to Taxpayers
This year, the U.S. Court of Appeals for the First Circuit is expected to hear James Harper’s appeal of a U.S. district court ruling in favor of the Internal Revenue Service (IRS) in relation to its procurement of his records from the cryptocurrency exchange Coinbase in 2016. Harper was one of more than 10,000 U.S. taxpayers who received a letter from the IRS in 2019 notifying them that it had information about their cryptocurrency holdings. Since then, many taxpayers have received similar letters as the IRS continues to pursue information about U.S. taxpayers and their crypto transactions. Harper filed a lawsuit against the IRS in federal district court alleging that the government violated his Fourth and Fifth Amendment rights by obtaining his financial records from third parties. The district court dismissed Harper’s lawsuit on the grounds that Harper was barred from suing the Commissioner under the Anti Injunction Act, a U.S. law that generally prevents a taxpayer from filing a lawsuit “for the purpose of restraining the assessment or collection of tax.”
In 2016, the IRS formally requested that Coinbase provide information about its customers who engaged in crypto transactions between 2013 and 2015 in the form of a special summons that is not required to identify a specific taxpayer. This nameless summons is known as a “John Doe” summons. Specifically, the IRS requested complete user profiles, KYC due diligence, transaction logs, records of processed payments, correspondence between Coinbase and its users, and account or invoice statements. Coinbase tried to fight the summons, but was eventually ordered to comply with a limited version of the original request. In March 2018, Coinbase notified approximately 14,000 users that their account information would be made available to the IRS.
Based on information obtained from the John Doe summonses, the IRS began its campaign by sending taxpayers one of three “educational” letters (referred to as Letters 6174, 6174-A, and 6173) about their tax reporting obligations. The outcome of Harper’s case may affect the IRS’s ability to gather information via John Doe summonses in the future. But, as it seems likely the IRS will continue sending these letters for now, it’s worth knowing what they say and what to do if you get one.
Letter 6174 provides that the taxpayer is receiving the letter because the IRS has information that the taxpayer has or had cryptocurrency but may not have known about the tax reporting requirements. Similarly, Letter 6174-A indicates that the IRS has information about the taxpayer’s history of holding cryptocurrency, except that the taxpayer is being notified because they may have incorrectly reported those amounts. Both letters include a list of common income tax return schedules for reporting crypto-related transactions, and neither require the taxpayer to respond. However, Letter 6174-A also provides that the taxpayer may receive additional correspondence about potential future enforcement actions, which could indicate that the IRS has gathered specific information about the taxpayer's obligations.
Letter 6173 provides that the IRS has the taxpayer’s information but has not received an income tax return or applicable form or schedule to report cryptocurrency transactions. Notably, Letter 6173 also says that the taxpayer must respond by a specific date and either file any delinquent returns, amend any incorrect returns, or provide a statement of facts explaining why the taxpayer believes they are in compliance. The response must be signed under penalty of perjury.
Each of the three IRS letters refers to the period between 2013 and 2017. This period may be extended in future letters, as it doesn’t appear that the IRS intends to stop issuing summonses to the exchanges. One IRS official confirmed at a conference hosted by the American Bar Association Section of Taxation in December 2021 that the John Doe summonses have proven successful — recent summonses resulted in approximately 85,000 responses — and that an increase in their use going forward “would not be surprising.” In 2021, federal courts authorized the IRS to issue John Doe summonses to Circle and Kraken requesting information about their U.S. users who conducted cryptocurrency transactions worth at least 20,000 USD between 2016 and 2020.
Cryptocurrency is expected to play a prominent role in 2022 in the U.S. legal landscape, and that is equally true in the case of U.S. tax law and administration. Aside from the focus on legislation (for example, the increased reporting requirements under the Infrastructure Investment and Jobs Act (Pub. L. 117-58) effective December 31, 2023), the IRS has also made it clear that cryptocurrency will be a target for increased enforcement. To that end, the IRS requested 32 million USD related to crypto tax enforcement measures for fiscal year 2022, which may result in more letters to taxpayers and enforcement actions. Some taxpayers who have diligently kept track of transactions across exchanges and wallets and met their reporting obligations may receive these letters too. If you receive one, don't panic. Best practice is to consult with an attorney who is familiar with both U.S. tax law and the procedural aspects of communicating with the IRS to be sure that issues and potential solutions for your situation are considered.
🌐 News and Selected Articles
Author: Blake Brittain
Nike has filed a lawsuit in a New York federal court against online reseller StockX for trademark infringement due to the alleged sale by the latter of unlicensed NFTs of Nike sneakers.
StockX reportedly started selling these NFTs in January, promising buyers that they would be able to redeem the tokens for real-world versions of the sneakers in the near future.
The shoemaker alleges that StockX has sold nearly 500 NFTs of Nike sneakers at inflated prices and with unclear terms of purchase and ownership, which, adding to the buyers’ reservations on the legitimacy of the online reseller’s model, has damaged its reputation.
The claimant is seeking an undisclosed amount in damages and a halt to the sale of the NFTs.
The U.S. government seized BTC worth 3.6 billion USD from two people — Lichtenstein and Morgan — who were allegedly involved in the 2016 hack of Bitfinex, a virtual currency exchange. The couple laundered over 25,000 BTC through unauthorized transactions, fake identities, complex DeFi tools, and multiple fake wallets on the darknet.
While the accused were earning a living as YouTubers, music rappers, and cyber security consultants, significant progress was made in the investigation when the couple tried to transfer the BTC in August 2021.
While a lower court had set bail at 5 million USD for Lichtenstein and 3 million USD for Morgan, prosecutors asked a judge in Washington for an emergency delay in their release and the request was granted.
It is pertinent to note that regardless of the 2016 incident, central exchanges are still not completely secure. Crypto.com lost 34 million USD in a hack involving 483 users in January 2022. Irrespective of recovery, the customers immediately received a refund as Crypto.com is a well-funded venture capital-backed exchange. Typically, law enforcement and asset recovery is the only solution for smaller exchanges and their customers.
With mass adoption of cryptoassets, undesirable incidents will increase. However, the ratio of desirable to undesirable use of the blockchain is similar to real life use of any emerging technology, meaning the benefits outweigh the costs. Law enforcement authorities are also catching up with the technology, as they are efficiently using the public blockchain to track all transactions.
Author: Times of India
On February 1, 2022, a new regime for taxing cryptocurrencies was announced by the Indian Finance Minister. Cryptocurrencies will be classified as “virtual digital assets,” or VDA, which have been given an expansive definition. Income accruing from transfer of cryptoassets will be taxed at 30%, with the only deduction being the cost of acquisition.
There is, however, some uncertainty as to the applicability of the tax rates. The proposed changes will come into effect on April 1, 2022, but the taxation of income accrued before that is unclear. Crypto investors are nonetheless advised to book profits now to avoid taxes post April 1.
To regulate and capture the transactions, a withholding tax of 1% will be levied on the payment made to the seller. Further, gifting cryptocurrencies will also be taxable at the hands of the recipient.
The Bill fails to provide clarity on three key issues: taxation on activities such as development and creation of VDA, treatment of taxes when a person pays for goods or services with cryptocurrencies, and the treatment of gains or losses from fluctuation of the rupee.
Author: Ian Allison
Evertas, a platform-based cryptoasset insurance company based in Chicago, announced that it has received approval to become a Lloyd’s of London coverholder.
Lloyd’s is a 366-year-old U.K. insurance market where members operate as syndicates to insure against risks in often niche sectors.
Coverholder status will allow Evertas to write and issue policies on behalf of Lloyd’s syndicate member Arch Insurance.
Evertas policies are designed to protect against the risks of theft and loss of custodial cryptoassets.
The need for insurance coverage across the cryptocurrency industry far outweighs capacity in the market. According to Evertas, currently only 2-3% of global cryptoassets are thought to be insured.
Evertas is the first coverholder at Lloyd’s to specifically cover digital wallet products. The Evertas insurance product is currently available and the stated target market includes traditional funds, crypto funds, family offices, and high net worth individuals.
BlockFi Lending LLC has agreed to pay a 100 million USD fine to settle claims, brought by the SEC and 32 U.S. states, that its crypto lending product violated investor protection laws. BlockFi announced on February 14, 2022 that it will stop offering its interest-bearing accounts to U.S. customers and will register a new product, called BlockFi Yield, with the SEC.
To register the new product, BlockFi will have to provide extensive disclosures to investors about how it works and the associated risks (for example, unlike a bank deposit, there is no FDIC protection if BlockFi goes bankrupt). Once the SEC approves the registration, BlockFi will be able to offer BlockFi Yield to U.S. investors.
This settlement is the first instance of the SEC providing a clear path to compliance for a centralized crypto firm to offer an interest-bearing product to U.S. retail investors, and presumably Coinbase and others will seek to do the same. The settlement is a big win for U.S. retail investors who want to earn a yield on their cryptoassets through a regulated centralized intermediary.
Several major crypto exchanges and advocacy groups are joining forces to fight market manipulation. Solidus Labs, along with Coinbase, Anchorage Digital, Circle, and others, recently announced the formation of the Crypto Market Integrity Coalition.
Its members have pledged to work together to cultivate a fair digital asset marketplace to combat market abuse and manipulation and to promote public and regulatory confidence. With regulators across the globe increasingly concerned about the crypto's impact, the industry needs to show it can clean up its act and regulate itself.
The Coalition appears to be in the early stages of creating a self-regulatory organization (SRO) to police the crypto industry, analogous to how the Financial Industry Regulatory Authority (FINRA) oversees U.S. securities dealers (with the SEC's blessing).
A crypto SRO could, with the backing of U.S. regulators and industry participants, be effective at combating market manipulation by requiring its members to surveil for and take steps to prevent users from misusing their services and by enforcing the rules against members and their employees. FINRA, for example, has anti-manipulation rules and well-established enforcement mechanisms to sanction and even bar participants from the industry.
Members of an SRO would be industry experts familiar with the technology and practices of the crypto market and the various ways it has been and can be manipulated (for example, "pump and dump" schemes or spoofing). Crypto exchanges, dealers, and investors have a shared interest in stable, reliable, fraud-free markets, and the creation of a regulator-backed SRO would be a significant step towards achieving that goal.
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iden3 Uses zkRollups to Help Us Not Get Rugged
A new player in the decentralized identity management ecosystem promises to provide “a more inclusive and egalitarian foundation for better human relationships through open-source cryptography and decentralized technologies.”
The iden3 protocol, based on Ethereum, will use zkRollup technology to provide high capacity while reducing the gas costs associated with Layer 1 solutions. Rollups execute bundles of transactions away from the main Ethereum chain (hence the cost savings) but the transaction data is added to Layer 1 so that the security is retained. Zero-knowledge or zkRollups are so called because they use validity proofs instead of the transaction data in its entirety.
In a further sweetener for gas-weary identities, the iden3 protocol plans to include an ID sponsor module; the idea being that providers could choose to cover the blockchain fees through their own account rather than passing costs on to the individuals using their services.
The protocol will use the iden3 team’s previously developed programming language, known as Circom. Circom has already been implemented in projects such as Polygon Hermez (for token transfers and swaps), Dark Forest (a game), Zkopru (a wallet), and Tornado Cash (for transaction privacy).
There are several use cases for the application of Web3 identity verification. From document signatures and payment identifiers to voting systems and supply chain authorization, the features of the protocol appear to take the best of blockchain technology to date and roll them into powerful new identity control for Web3 citizens.
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