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A Beginner's Guide to Cryptocurrencies: Explaining the A Beginner's Guide to Cryptocurrencies: Explaining the
Technologies Behind Cryptocurrencies, How the United States Technologies Behind Cryptocurrencies, How the United States
Taxes and Regulates Them, and Offering Changes to the Existing Taxes and Regulates Them, and Offering Changes to the Existing
Taxation and Regulation Schemes Taxation and Regulation Schemes
J. Merritt Francis
University of Richmond School of Law
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Recommended Citation Recommended Citation
J. Merritt Francis,
A Beginner’s Guide to Cryptocurrencies: Explaining the Technologies Behind
Cryptocurrencies, How the United States Taxes and Regulates Them, and Offering Changes to the Existing
Taxation and Regulation Schemes
, 30 RICH. J.L. & TECH. 45 (2023).
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Richmond Journal of Law & Technology Volume XXX, Issue 1
45
A BEGINNER’S GUIDE TO CRYPTOCURRENCIES: EXPLAINING
THE TECHNOLOGIES BEHIND CRYPTOCURRENCIES, HOW THE
UNITED STATES TAXES AND REGULATES THEM, AND
OFFERING CHANGES TO THE EXISTING TAXATION AND
REGULATION SCHEMES
J. Merritt Francis
*
Cite as: J. Merritt Francis, A Beginner’s Guide to Cryptocurrencies:
Explaining the Technologies Behind Cryptocurrencies, How the United
States Taxes and Regulates Them, and Offering Changes to the Existing
Taxation and Regulation Schemes, 30 RICH. J.L. & TECH. 45 (2023).
*
LL.M. in Taxation Candidate, 2024, New York University School of Law; J.D., 2023,
University of Richmond School of Law; B.S., 2018, University of South Carolina. I
would like to thank Professor Christopher A. Cotropia, whose guidance and assistance
yielded the analyses’ depth and clarity throughout the challenging topics addressed. I
would also like to thank Payton A. Miles, Paige R. Skinner, Joseph R. Patrell, and the rest
of the Richmond Journal of Law & Technology for their steadfast efforts in bringing this
article to publication.
Richmond Journal of Law & Technology Volume XXX, Issue 1
46
ABSTRACT
The United States federal government has attempted to use its existing
regulatory and taxation schemes to regulate and tax cryptocurrencies, while
many individuals are still unsure as to what cryptocurrency really is. The
Securities and Exchange Commission and the Commodities Future Trading
Commission have both asserted their jurisdiction over cryptocurrency,
resulting in unclear guidance for developers in the cryptocurrency space and
a failure to adequately protect investors. Further, the Internal Revenue
Service taxes cryptocurrency like a security rather than a currency, which
disincentivizes adopting cryptocurrency as a form of payment.
Nevertheless, although cryptocurrencies are taxed like securities, there are
tax breaks for securities and commodities activities that are not currently
available for cryptocurrency activities. Under the United States’ current
approach, investors will remain vulnerable to fraud, and businesses and
individuals using cryptocurrencies for goods and services will be subject to
an extra level of taxation.
This paper’s initial purpose is to provide readers with sufficient background
knowledge on the architecture underlying a blockchain network. The paper
then endorses creating a joint self-regulatory organization and providing the
organization with original jurisdiction over all cryptocurrency activities to
provide uniform registration and reporting requirements. Further, the paper
offers suggestions on how the United States can change its approach to
taxing cryptocurrencies, so they are treated more like currencies when used
for goods or services, and treated more like securities when the taxpayer is
an active trader or participant node on the blockchain network.
Richmond Journal of Law & Technology Volume XXX, Issue 1
47
I. INTRODUCTION
[1] Whether you saw a crypto.com commercial with Matt Damon or
heard about the FTX bankruptcy, you have likely heard about
cryptocurrency. Even though most people have heard about cryptocurrency,
there seems to be a general lack of understanding about what cryptocurrency
really is. This lack of understanding cryptocurrency is common in all stages
of life, from middle schoolers to senior citizens, and is common amongst all
walks of life, from teachers to attorneys and congresspeople. Some
members of Congress do not understand the first thing about
cryptocurrency, while others actively trade cryptocurrency.
1
[2] The technology underlying cryptocurrency, blockchain technology,
is complicated on its own. People are reluctant to allocate their time and
energy to learn about digital currencies when they have paper dollars in their
pockets and bank accounts that work just fine. Beyond the complex
technology underlying crypto, some people fail to understand its
macroeconomics and potential efficacy on a global scale.
2
Nonetheless,
with so much institutional money in the cryptocurrency market and the
potential applications of cryptocurrency, it is not going anywhere anytime
soon.
1
See generally Stacy Elliot, Members of Congress Who Have Traded Crypto Since 2020,
DECRYPT (June 11, 2022), https://decrypt.co/102614/members-of-congress-traded-
bitcoin-ethereum-coinbase-even-dogecoin-since-2020 [https://perma.cc/VCG8-MSYN]
(discussing a partisan split for cryptocurrency).
2
See How Can Cryptocurrency Reshape the Global Economy?, INT’L FIN. (Mar. 21,
2022), https://internationalfinance.com/how-cryptocurrency-reshape-global-economy/
[https://perma.cc/2XV3-YMRX].
Richmond Journal of Law & Technology Volume XXX, Issue 1
48
[3] The cryptocurrency market cap went from $0 in 2011 to about $3
trillion in November 2021.
3
The crypto market cap then lost over $2 trillion
in the last year due to scandals and hacks, among other things, and the
crypto market cap currently sits at about $1.26 trillion at the time of this
writing.
4
United States federal agencies and officials have responded slowly
in regulating the new technology since the market’s inception, taking a
“regulation through litigation,” ad hoc approach.
5
Some investors have
made more money than they could have imagined from crypto, while others
have taken unfathomable losses. Either way, the United States government
has been there to prosecute wrongdoers and tax the fortunes earned along
the way.
6
The United States’ ad hoc approach has been effective in
prosecuting fraudsters, but it has failed in providing clear guidance to
developers in the space and protecting investors before their injuries occur.
Most people purchasing cryptocurrencies have hopes of earning profit, but
it is unclear whether they are purchasing a commodity, a security, or
something entirely different. With the recent FTX bankruptcy, investors and
policymakers are calling for clear regulation in the crypto industry more
loudly than ever before.
7
3
Overall cryptocurrency market capitalization per week from July 2010 to September
2023, STATISTA, https://www.statista.com/statistics/730876/cryptocurrency-maket-value/
[https://perma.cc/9NA7-NZJF].
4
Id.
5
See SEC Crypto Enforcement Actions on Track to Outpace 2022, PYMNTS (May 5,
2023), https://www.pymnts.com/cryptocurrency/2023/sec-crypto-enforcement-actions-
could-outpace-2022/ [https://perma.cc/5GJB-EUTB].
6
See id.
7
Erin Griffith, Why the Crypto Collapse Matters, N.Y. TIMES (Nov. 17, 2022),
https://www.nytimes.com/2022/11/17/briefing/crypto-collapse-ftx.html
[https://perma.cc/ET4E-3ZM2]; see also Erin E. Broderick et al., FTX Files for Chapter
11 Bankruptcy, EVERSHEDS SUTHERLAND (Nov. 30, 2022), https://us.eversheds-
sutherland.com/mobile/NewsCommentary/Legal-Alerts/254934/FTX-files-for-Chapter-
11-bankruptcy [https://perma.cc/BLC5-UU77].
Richmond Journal of Law & Technology Volume XXX, Issue 1
49
[4] This paper attempts to serve three purposes: (1) to explain
cryptocurrency and its underlying technologies to the common person; (2)
to illustrate the United States’ current regulatory and taxation schemes; and
(3) to offer a regulatory and taxation framework that provides a consumer-
safe environment and promotes the new technology’s growth in the United
States. Section II explains cryptocurrency, blockchain technology, and
cryptocurrency exchanges and wallets. Section III examines the United
States federal government’s approach to regulating cryptocurrency. Section
IV details the United States federal government’s approach to taxing
cryptocurrencies. Section V offers regulatory and taxation schemes the
United States could adopt for cryptocurrencies. Section VI concludes the
paper and gives highlights of the main issues discussed.
II. CRYPTO & BLOCKCHAIN EXPLAINED
[5] Cryptocurrency refers to a digital asset that uses distributed ledger
technology, also known as blockchain technology, to enable and process
transactions.
8
The term “cryptocurrency” is used because this digital
currency uses cryptographic protocols to secure transactions.
9
This section
explains why cryptocurrency was invented in the first place, details the
technologies and architectures underlying cryptocurrencies, and provides
stories and examples of success and loss in the cryptocurrency market.
Although there were cryptocurrencies created as early as the 1990s,
10
8
See Digital Assets, Distributed Ledger Technology and the Future of Capital Markets,
WORLD ECON. F. (May 6, 2021), https://www3.weforum.org/docs/WEF_Digital_Assets_
Distributed_Ledger_Technology_2021.pdf [https://perma.cc/D3BZ-B45R] [hereinafter
Digital Assets].
9
See id.
10
See Nathan Reiff, What Was the First Cryptocurrency?, INVESTOPEDIA,
https://www.investopedia.com/tech/were-there-cryptocurrencies-bitcoin/
[https://perma.cc/FV6Y-JZLM] (last updated July 23, 2022).
Richmond Journal of Law & Technology Volume XXX, Issue 1
50
Bitcoin’s origin story illustrates why this industry came to fruition and helps
explain how cryptocurrencies function.
A. Bitcoin Origin Story
[6] In 2008, Satoshi Nakamoto published a paper titled, “Bitcoin: A
Peer-to-Peer Electronic Cash System.”
11
Satoshi begins the paper by noting
how internet commerce relies “almost exclusively on financial institutions
serving as trusted third parties to process electronic payments[,]” and points
out several flaws with this trust-based, third party model.
12
First,
transactions processed by a trusted third-party are reversible. For example,
if a bank’s customer disputes a charge posted to their bank account, the bank
might cancel the transaction. When a disagreement over a transaction arises
between two parties, the trusted third parties (credit card companies, banks,
Paypal, etc.) are forced to mediate the dispute.
13
It costs money to mediate
these disputes, thereby increasing transaction costs and leading to the
second problem: very small transactions (e.g., paying ten cents to read an
article or watch a short video) are impractical because the transaction costs
involved are too high.
14
Lastly, credit card companies can cancel
transactions even though some services are nonreversible (e.g., renting and
watching a movie online), and no third-party should be able to reverse these
transactions. “With the possibility of reversal, the need for trust spreads[,]”
11
Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, BITCOIN, 1 (Oct.
31, 2008), https://bitcoin.org/bitcoin.pdf [https://perma.cc/6DYN-7CHM].
12
Id.
13
Raphael Meyer, The Bitcoin whitepaper, explained and commented – section 1,
introduction, MEDIUM (Mar. 22, 2020), https://meyer-raph.medium.com/the-bitcoin-
whitepaper-explained-and-commented-section-1-introduction-55f23e96a110
[https://perma.cc/V6NG-K5FD].
14
Nakamoto, supra note 11.
Richmond Journal of Law & Technology Volume XXX, Issue 1
51
and merchants are forced to hassle customers for personal information when
they only need payment for the goods and services.
15
[7] To resolve these issues, Satoshi proposed an electronic payment
system where any two parties can transact directly with each other without
the need for a trusted third party.
16
In theory, without the need for a trusted
third party to validate and process transactions, transaction costs would be
low, no third parties could reverse transactions, and merchants could only
require payment rather than personal information from their customers.
17
Put differently, Bitcoin was designed to be a cash-like payment system that
permits electronic transactions but also includes the advantages of physical
currencies.
18
There are three main concepts to understand how Bitcoin and
other cryptocurrencies work: blockchain technology, nodes on a peer-to-
peer network, and consensus algorithms.
B. Blockchain Technology Explained
[8] Blockchain technology refers to a distributed, decentralized
database that keeps records of transactions.
19
Blockchains are distributed
because transactions are viewable by the public; you can go online and view
all transactions on the Bitcoin blockchain.
20
Blockchains are decentralized
because there is no central authority, such as a bank, to validate and verify
15
Id.
16
Id.
17
Meyer, supra note 13.
18
See Nakamoto, supra note 11.
19
See Digital Assets, supra note 8.
20
See, e.g., Blockchain Explorer – Bitcoin Tracker & More, BLOCKCHAIN.COM, https://
www.blockchain.com/explorer [https://perma.cc/7R73-AFXF] (last visited Oct. 1, 2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
52
transactions.
21
Transactions are validated and processed by a peer-to-peer
network of computers called nodes.
22
It may be helpful to think of
blockchains like a bank ledger, but instead of an individual working at a
bank processing and recording transactions, computers around the world do
all the work. Blockchains are more than a way to process and validate
transactions; blockchains are also a registry and inventory for all assets on
the blockchain.
23
[9] The second element essential to understanding cryptocurrency and
blockchain technology is the concept of nodes working together on a peer-
to-peer network. In this context, nodes are computers located around the
world owned by businesses and individuals that are running the respective
blockchain’s software.
24
The nodes operating on the peer-to-peer network
give blockchains their decentralized feature because there is no single
computer storing and recording transactions—unlike a bank.
25
The nodes
all work together to confirm the history of all transactions on the blockchain
and prevent the “double-spending” problem.
26
The double-spending
problem is when an individual attempts to make a transaction and they lack
sufficient funds, similar to an individual using a check to purchase goods
when they do not have the money in their account to cover the check’s
promised amount.
27
The nodes effectively communicate together to say,
21
See Digital Assets, supra note 8.
22
Id. at 17.
23
See Deen Newman, Blockchain Node Providers and How They Work, INFOQ (Mar. 3,
2021), https://www.infoq.com/articles/blockchain-as-a-service-get-block/
[https://perma.cc/LE9H-MLPH].
24
Id.
25
See id.
26
Nakamoto, supra note 11, at 8.
27
Meyer, supra note 13.
Richmond Journal of Law & Technology Volume XXX, Issue 1
53
“yes, this wallet contains five Bitcoins, and this user has four Bitcoins to
send.”
[10] To send a transaction on the Bitcoin blockchain, an individual must
log into their wallet with a password, input the Bitcoin amount and
recipient, then input another password to confirm the transaction.
28
When
the Bitcoin network processes the transaction, the transaction data is
bundled together with the data of 2,000 other transactions, on average.
29
When a Bitcoin block reaches its data storage capacity (approximately
2,000 transactions), the block of data is added onto the chain, thereby
creating the blockchain.
30
The nodes receive an updated list of all
transactions on the blockchain, which preserves the history of all
transactions on the blockchain.
31
The following picture demonstrates how
transactions are processed, validated, and recorded by nodes on a
blockchain’s peer-to-peer network:
28
Adekola Olawale, Bitcoin Security: Insights into how to secure BTC tokens in storage,
MEDIUM (Mar. 16, 2023), https://medium.com/@Adekola_Olawale/bitcoin-security-
f92ed0ccaa64 [https://perma.cc/HMF6-6X6Q].
29
See Bitcoin Average Transactions Per Block (I:BATPB), YCHARTS,
https://ycharts.com/indicators/bitcoin_average_transactions_per_block
[https://perma.cc/X237-6MQG] (last visited Oct. 1, 2023).
30
See generally Xenia Soares, How Blocks Are Added to a Blockchain, Explained Simply,
COINDESK, https://www.coindesk.com/learn/how-blocks-are-added-to-a-blockchain-
explained-simply/ [https://perma.cc/HCG7-A2XM] (last updated May 11, 2023, 12:52
PM) (explaining how blocks of information are linked on a virtual chain).
31
See id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
54
32
[11] For a node to approve a transaction, the node must satisfy the
blockchain’s respective consensus algorithm.
33
C. How Nodes Approve Transactions: Consensus Algorithms
[12] A consensus algorithm is a core part of any blockchain network.
34
It
is the procedure through which all of the participant nodes on a blockchain
network reach a common agreement about the present state of the
32
Hong-Ning Dai et al., Blockchain for Internet of Things: A Survey, RESEARCHGATE
(June 2019), https://www.researchgate.net/publication/333600905_Blockchain_for_
Internet_of_Things_A_Survey [https://perma.cc/3XMH-RWVQ].
33
Chizurum Ibeawuchi, What is a consensus algorithm?, EDUCATIVE, https://www.
educative.io/answers/what-is-a-consensus-algorithm [https://perma.cc/XN6C-5FUE] (last
visited Oct. 6, 2023).
34
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
55
distributed ledger.
35
Consensus algorithms force the nodes to work together
to achieve reliability in a blockchain, thereby eliminating the double-
spending problem.
36
When a node satisfies a blockchain’s consensus
algorithm, the blockchain transaction is processed and added to the
blockchain’s history, and the node is rewarded with cryptocurrency.
37
There
are two types of consensus algorithms this paper will cover: Proof of Work
and Proof of Stake.
1. Proof of Work Consensus Algorithms
[13] On blockchains using Proof of Work (PoW) consensus algorithms,
the participant nodes on the peer-to-peer network, referred to as crypto
miners, download the blockchain’s entire transaction history.
38
When a
transaction is sent on the blockchain, the nodes run the full blockchain
transaction history through a complex mathematical function called a
“hash” puzzle.
39
When a node solves a hash puzzle, the transaction is added
to the blockchain, and the node is rewarded by being selected to mine a
block, which is the privilege of adding a valid block onto the blockchain.
40
35
See id.
36
See id.
37
See Consensus Algorithms: Securing Blockchain Transactions, MEDIUM (Sept. 21,
2018), https://medium.com/coinbundle/consensus-algorithms-dfa4f355259d
[https://perma.cc/ZUQ6-G9QE].
38
See Ibeawuchi, supra note 33; see E. Napoletano, Proof of Work Explained, FORBES,
https://www.forbes.com/advisor/investing/cryptocurrency/proof-of-work
[https://perma.cc/5DQN-C63J] (last updated Aug. 25, 2023, 1:26 PM); What is a Bitcoin
Node? A beginner’s guide on blockchain nodes, COINTELEGRAPH, https://cointelegraph.
com/learn/what-is-a-bitcoin-node-a-beginners-guide-on-blockchain-nodes
[https://perma.cc/P7ZR-FVBE] (last visited Nov. 28, 2023).
39
See Ibeawuchi, supra note 33; see Napoletano, supra note 38.
40
Napoletano, supra note 38.
Richmond Journal of Law & Technology Volume XXX, Issue 1
56
The node earns cryptocurrency as mining rewards for helping run the
blockchain network, which is why PoW blockchain nodes are called “crypto
miners”.
41
[14] The Bitcoin blockchain is an example of a blockchain employing a
PoW consensus algorithm with hash puzzles. When an individual sends
Bitcoin to someone, nodes around the world race to solve the hash puzzle,
the answer to which is called a hash.
42
For example, the hash
for Bitcoin block #660000 is 00000000000000000008eddcaf078f12c69a4
39dde30dbb5aac3d9d94e9c18f6.
43
When the crypto miner’s node solved
the hash for Bitcoin block #660000, the Bitcoin transactions were added to
the ledger and the node received 6.25 Bitcoin,
44
which was worth
approximately $117,370 at the time.
45
The crypto miner of Bitcoin block
#660000 could sell or hold the Bitcoin it earned after running their node on
the Bitcoin network, thereby helping the network operate.
46
The most
successful cryptocurrency miners on a PoW blockchain solve hash puzzles
more quickly than other miners, which requires an immense amount of
computing power.
47
41
See id.
42
See id.
43
Bitcoin Block 660,000, BLOCKCHAIN.COM, https://www.blockchain.com/explorer/
blocks/btc/660000 [https://perma.cc/ZA4A-2ZWM] (last visited Nov. 8, 2023).
44
Id.
45
Id.
46
See Napoletano, supra note 38.
47
See Leigh Cuen, The debate about cryptocurrency and energy consumption,
TECHCRUNCH (Mar. 21, 2021, 11:30 AM), https://techcrunch.com/2021/03/21/the-
debate-about-cryptocurrency-and-energy-consumption/ [https://perma.cc/GU7P-NN54].
Richmond Journal of Law & Technology Volume XXX, Issue 1
57
[15] One of blockchain’s most redeeming qualities is that it is immutable;
once a transaction processes on a blockchain, it’s practically irreversible,
just as Satoshi intended.
48
The nodes work together to maintain an updated
record of all the transactions on the blockchain, thereby maintaining
consensus and integrity in the network’s transaction history.
49
PoW
consensus algorithms make it almost impossible to alter any aspect of the
blockchain because it requires an impracticable amount of computing
power to rewrite the blockchain’s history.
50
To illustrate: consider a bad
actor who seeks to infiltrate the Bitcoin blockchain and rewrite the
blockchain’s transaction history to give themself all the Bitcoin. The hacker
would need a computer powerful enough to overpower at least half the
nodes on the Bitcoin network.
51
If the hacker could overpower at least half
the nodes on the Bitcoin network, then the hacker could rewrite the Bitcoin
transaction history to make themself own all the Bitcoin, a majority of nodes
on the network (all in control of the hacker) would come into consensus
with each other, and the minority of other nodes (not in control of the
hacker) would follow suit. Overpowering half the nodes on the Bitcoin
network, however, would require approximately 317 million to 1.9 billion
48
Mayank Sahu, What Makes a Blockchain Network Immutable? Immutability Explained,
UPGRAD, https://www.upgrad.com/blog/what-makes-a-blockchain-network-immutable/
[https://perma.cc/BP74-4ZX6] (last updated Nov. 22, 2022); Nakamoto, supra note 11.
49
Ayushi Abrol, What Are Blockchain Nodes? Detailed Guide, BLOCKCHAIN COUNCIL
(Sept. 27, 2023), https://www.blockchain-council.org/blockchain/blockchain-nodes/
[https://perma.cc/2VEV-UKZJ].
50
Joey Prebys, Can bitcoin be hacked?, OLLIV (June 22, 2021), https://www.olliv.com/
en-US/intro-to-crypto/safety-security/can-bitcoin-be-hacked [https://perma.cc/4H5V-
MHW6].
51
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
58
qubits of computing power,
52
while IBM’s record-breaking quantum
computer has only 127 qubits of computing power.
53
Thus, the hacker’s
computer would have to be (at least) approximately 2.5 million times more
powerful than the current world’s best computer. Bitcoin’s immutability is
one of the reasons it has a market cap of over half a trillion dollars: investors
trust the math behind the cash-like payment system where computers keep
perfect record of transactions rather than trusting third parties.
54
[16] Although blockchains employing PoW consensus algorithms are
extremely effective at preserving and securing blockchains, PoW
blockchains require nodes around the world to exert immense amounts of
computing power, which comes at a cost to the environment.
55
Ethereum,
another highly touted and popular cryptocurrency blockchain, initially
employed a PoW consensus algorithm.
56
The nodes operating on
Ethereum’s blockchain consumed around 73.2 terawatt hour (TWh)
annually, which is the energy equivalent of a medium-sized country like
Austria.
57
Tesla, at one point, accepted Bitcoin to purchase its vehicles, but
52
Matthew Sparkes, Quantum computers are a million times too small to hack bitcoin,
NEW SCIENTIST (Jan. 25, 2022), https://www.newscientist.com/article/2305646-quantum-
computers-are-a-million-times-too-small-to-hack-bitcoin/ [https://perma.cc/ADR5-
T44F].
53
Id.
54
See Bitcoin Market Cap (I:BMC), YCHARTS, https://ycharts.com/indicators/bitcoin_
market_cap [https://perma.cc/297Y-UV3M] (last visited Oct. 29, 2023).
55
See Amy Castor, Why Ethereum is switching to proof of stake and how it will work,
MIT TECH. REV. (Mar. 4, 2022), https://www.technologyreview.com/2022/03/04/
1046636/ethereum-blockchain-proof-of-stake/ [https://perma.cc/NM68-5E7C].
56
Id.
57
Alice Feng, Is Cryptomining Harming the Environment?, PSCI (Feb. 27, 2021),
https://psci.princeton.edu/tips/2021/2/27/is-cryptomining-harming-the-environment
[https://perma.cc/ZY8W-57GS].
Richmond Journal of Law & Technology Volume XXX, Issue 1
59
suspended vehicle purchases using Bitcoin due to climate change
concerns.
58
Elon Musk elaborated on the decision in a tweet, saying,
“[c]ryptocurrency is a good idea on many levels and we believe it has a
promising future, but this cannot come at great cost to the environment.”
59
In response to the PoW blockchains’ negative externalities, the Proof of
Stake (PoS) consensus algorithm was created as an environmentally
friendly alternative.
60
2. Proof of Stake Consensus Algorithms
[17] As discussed above, PoW consensus algorithms require nodes
around the world to race each other to solve a complex mathematical
function (the hash puzzle)—the winner of the race being rewarded with
mining a block.
61
Consequently, PoW consensus algorithms allocate block
mining proportionally to the relative computing power a node has (i.e., the
nodes that can prove their work the most).
62
PoS consensus algorithms, on
the other hand, use game theory and randomization to choose which node
58
Lora Kolodny, Elon Musk says Tesla will stop accepting bitcoin for car purchases,
citing environmental concerns, CNBC, https://www.cnbc.com/2021/05/12/elon-musk-
says-tesla-will-stop-accepting-bitcoin-for-car-purchases.html [https://perma.cc/QZ8J-
DXNK] (last updated May 12, 2021, 8:26 PM).
59
Id.
60
Jake Frankenfield, What Does Proof-of-Stake (PoS) Mean in Crypto?, INVESTOPEDIA,
https://www.investopedia.com/terms/p/proof-stake-pos.asp [https://perma.cc/QTY9-
8MZ6] (last updated May 31, 2023).
61
Napoletano, supra note 38.
62
Sivleen Kaur et al., A Research Survey on Applications of Consensus Protocols in
Blockchain, 2021 HINDAWI: SEC. & COMMC’N NETWORKS 1, 5 (Jan. 22, 2021),
https://doi.org/10.1155/2021/6693731 [https://perma.cc/PQG3-NXQN].
Richmond Journal of Law & Technology Volume XXX, Issue 1
60
gets to validate the new block.
63
Blockchains employing a PoS consensus
algorithm include Cardano (ADA), Tezos (XTZ), Binance Coin (BNB),
Avalanche (AVAX), and Algorand (ALGO).
64
PoS blockchains consume
substantially less energy than PoW blockchains because selecting nodes to
validate transactions is a significantly less energy-intensive process than
nodes around the world racing to solve a hash puzzle.
65
The Cardano
blockchain, for example, is 47,000 times more energy-efficient than
Bitcoin.
66
[18] Under a PoS consensus algorithm, crypto holders can “stake” their
coins with nodes operating on the blockchain, and those nodes have a
chance to validate new blocks on the blockchain.
67
When the node validates
a new block on the blockchain, the node and the individuals staking their
crypto with the node earn “staking rewards.”
68
PoS blockchains have their
own distinct ways of operating and titling things, but there are three
common activities and functions necessary to understand PoS blockchains:
staking, the nodes on a PoS network, and staking rewards. This paper will
63
See Proof-of-stake vs. proof-of-work: Pros, cons, and differences explained,
COINTELEGRAPH, https://cointelegraph.com/learn/proof-of-stake-vs-proof-of-work:-
differences-explained [https://perma.cc/S49Z-RMFB] (last visited Oct. 6, 2023)
[hereinafter Proof-of-stake vs. proof-of-work].
64
See CryptoPolitan, How to Benefit from the Meteoric Rise of Proof of Stake Coins,
CRYPTORANK (Sept. 14, 2023), https://cryptorank.io/news/feed/14455-proof-of-stake-
coins [https://perma.cc/JZ96-AUJX].
65
See Proof-of-stake vs. proof-of-work, supra note 63.
66
Jordan Major, Cardano is 47,000x more energy-efficient than Bitcoin, data shows,
FINBOLD (Feb. 22, 2022), https://finbold.com/cardano-is-47000x-more-energy-efficient-
than-bitcoin-data-shows/ [https://perma.cc/GP7A-FKNE].
67
Napoletano, supra note 38.
68
Lyle Daly, What is Staking in Crypto?, THE MOTLEY FOOL, https://www.fool.com/
terms/s/staking/ [https://perma.cc/79V8-U2K2] (last updated Apr. 21, 2023, 9:55 AM).
Richmond Journal of Law & Technology Volume XXX, Issue 1
61
use the Cardano blockchain and its native cryptocurrency, ADA, as an
example.
[19] Consider an individual possessing 1,000 ADA in their wallet. The
individual could let the ADA sit in their wallet, or they could stake their
ADA with a node on the Cardano network to earn staking rewards (nodes
on the Cardano network are referred to as “stake pool operators”).
69
Staking
ADA is a passive investment that yields staking rewards, which are similar
to the interest payments on savings accounts in the traditional world of
finance.
70
As of this writing, staking ADA yields an estimated 3.3% annual
return on the principal ADA invested.
71
Cardano offers self-custodian
staking, which allows users to stake their ADA with a stake pool operator
without the crypto even leaving their wallet.
72
To stake their 1,000 ADA
with self-custodian staking, the individual would log into their wallet, select
the stake pool operator they want to stake their ADA with, and hit “stake.”
Cardano’s PoS consensus algorithm, titled Ouroboros, yields staking
rewards every five days.
73
Individuals are permitted to either “claim” their
69
See Stake Pool Operation, CARDANO, https://cardano.org/stake-pool-operation/
[https://perma.cc/L3ZD-L868] (last visited Oct. 6, 2023).
70
Staking rewards – what are they?, BITPANDA, https://www.bitpanda.com/academy/en/
lessons/staking-rewards-what-are-they/ [https://perma.cc/NDF6-C6K7] (last visited Oct.
6, 2023).
71
Cardano ADA Staking Validators & Calculator, STAKING REWARDS, https://www.
stakingrewards.com/asset/cardano?category=pos&sort=staked_tokens&timeframe=30d&
order=desc&verifiedFirst=true [https://perma.cc/9BBK-K57Q] (last visited Oct. 6, 2023)
[hereinafter Stake ADA].
72
Albert Kim, Cardano 101: Self-custodial Staking and Why it is Important, EMURGO
(Feb. 9, 2023), https://emurgo.io/cardano-101-self-custodial-staking/
[https://perma.cc/8LNW-3Z7Y].
73
See Tommy Kammerer, (Re)introduction to Cardano, CARDANO DEV. PORTAL,
https://developers.cardano.org/docs/operate-a-stake-pool/introduction-to-cardano/
[https://perma.cc/WVZ2-4ZZA] (last updated May 15, 2023) [hereinafter Kammerer,
(Re)introduction to Cardano].
Richmond Journal of Law & Technology Volume XXX, Issue 1
62
staking rewards from the stake pool operators or leave them unclaimed, and
unclaimed staking rewards are added to the principal ADA amount staked.
74
So here, the individual could stake their 1,000 ADA with a stake pool
operator on January 1 and log into their wallet on December 31 to see 1,033
ADA.
[20] The nodes on the Cardano network are called stake pool operators
because they pool other peoples’ staked ADA together to help run the
blockchain.
75
Operating a stake pool on the Cardano network does not
require the expensive hardware required to mine Bitcoin, but stake pool
operators must administer, maintain, and secure their own server.
76
While
Ouroboros utilizes game theory and randomization to choose which nodes
validate new blocks,
77
on average, stake pool operators are selected to
validate new blocks in proportion to the node’s current holdings (i.e., the
amount the node proves it has at stake).
78
For example, if a Cardano stake
pool operator holds 1% of all ADA, the stake pool operator will be selected
to validate, on average, 1% of all new blocks on the Cardano blockchain.
79
The stake pool operator gets their cut of the staking rewards, which is
74
See Stake ADA, supra note 71.
75
Kammerer, (Re)introduction to Cardano, supra note 73.
76
See Tommy Kammerer, Operate a Stake Pool, CARDANO DEV. PORTAL,
https://developers.cardano.org/docs/operate-a-stake-pool/ [https://perma.cc/2JC8-2W6P]
(last updated May 15, 2023) [hereinafter Kammerer, Operate a Stake Pool].
77
Aggelos Kiayias et al., Ouroboros: A Provably Secure Proof-of-Stake Blockchain
Protocol, CRYPTOLOGY EPRINT ARCHIVE at 3 (July 20, 2019), https://eprint.iacr.org/
2016/889.pdf [https://perma.cc/3X9N-ZGPY] (describing the use of coin-flipping as
protocol for randomization); see Stake ADA, supra note 71 (stating that Ouroboros uses a
game-theoretic approach).
78
Id. at 1–2.
79
See id. at 1.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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around 4.3% annual return on the ADA staked,
80
and the rest of the rewards
go to the individuals who staked their ADA with the node (around 3.3%
annual return).
81
[21] In short, PoS blockchains consume substantially less energy than
PoW blockchains because the PoS block validation process consumes less
energy.
82
The individuals operating nodes on a PoW blockchain are called
“crypto miners,” and they compete amongst each other to solve hash
puzzles and earn crypto mining rewards.
83
Nodes on a PoS blockchain are
called “stake pool operators” and are selected to validate new blocks in a
randomized order.
84
On average, however, PoS consensus algorithms select
nodes to validate new blocks in proportion to the amount of cryptocurrency
the nodes have staked.
85
[22] The PoW consensus algorithm was created first, and the United
States federal government has had more time to issue guidance and rulings
on activities in PoW blockchains. As discussed in Sections III, IV and V,
PoS blockchains and the activities surrounding staking are becoming a point
of emphasis for the United States federal government.
80
Stake ADA, supra note 71.
81
Id.
82
Johannes Sedlmeir et al., The Energy Consumption of Blockchain Technology: Beyond
Myth, 62 BUS. & INFO. SYS. ENG’G 599, 604 (2020), https://link.springer.com/article/
10.1007/s12599-020-00656-x [https://perma.cc/65UH-R5XW].
83
Miner Meaning, LEDGER (Aug. 15, 2023), https://www.ledger.com/academy/glossary/
miner [https://perma.cc/W43A-NWZ5].
84
Kiayias et al., supra note 77 at 1; Kammerer, (Re)introduction to Cardano, supra note
73.
85
Kiayias et al., supra note 77 at 1–2.
Richmond Journal of Law & Technology Volume XXX, Issue 1
64
[23] This paper’s purpose is, in part, to explain cryptocurrency to the
common person. With a better understanding of the technologies underlying
cryptocurrency, it is equally helpful to explain how people purchase and
hold cryptocurrencies.
D. How Investors Purchase and Hold Cryptocurrency
[24] As a practical matter, regardless of what type of cryptocurrencies
investors purchase, there are established methods of purchasing and holding
cryptocurrencies. First, people mostly purchase cryptocurrencies on
centralized exchanges such as Binance, Coinbase, and KuCoin.
86
Many
crypto investors leave their crypto holdings on centralized exchanges, but
this will change in the future as more people are increasingly using crypto
wallets.
87
1. Storing Cryptocurrency on a Centralized Exchange
[25] Leaving crypto on a centralized exchange allows investors to sell
and purchase crypto assets quickly, and investors can exchange crypto
assets for cash or another crypto asset, all on the exchange.
88
Further,
investors can watch the value of their entire crypto portfolio, which may
86
See Nathan Reiff, What Are Centralized Cryptocurrency Exchanges?, INVESTOPEDIA,
https://www.investopedia.com/tech/what-are-centralized-cryptocurrency-exchanges/
[https://perma.cc/9CK3-8N5R] (last updated July 31, 2023) [hereinafter Reiff,
Centralized Cryptocurrency Exchanges]; Dock David Treece, Binance vs. Coinbase:
Which Crypto Exchange Is Right For You?, FORBES (Sep. 1, 2023, 4:49 PM),
https://www.forbes.com/advisor/investing/cryptocurrency/binance-vs-coinbase/
[https://perma.cc/WM9L-6XHN] (last updated Sep. 1, 2023, 4:49 PM).
87
See Crypto Wallet Market Size, Share, and Growth Report, GRAND VIEW RSCH.,
https://www.grandviewresearch.com/industry-analysis/crypto-wallet-market-report
[https://perma.cc/Z33Z-BD6F] (last visited Oct. 1, 2023).
88
See Reiff, Centralized Cryptocurrency Exchanges, supra note 86.
Richmond Journal of Law & Technology Volume XXX, Issue 1
65
consist of dozens of different cryptos, all on the exchange.
89
However, when
someone purchases cryptocurrency and leaves it on a centralized exchange,
they do not own the cryptocurrency itself—rather, what they own is a
redeemable ticket for the right to their cryptocurrency.
90
[26] There is a popular phrase amongst cryptocurrency enthusiasts: “not
your keys, not your coins.”
91
Each crypto token has a cryptographic key
associated with it, and possessing the keys represents actual ownership of
the cryptocurrency.
92
As such, the person or exchange possessing the crypto
keys is the sole custodian of the cryptocurrency, which means they can sell
it, trade it, or send it as they please. When cryptocurrency is left on a
centralized exchange, the exchange possesses the keys to your crypto, and
you are entrusting a third party with custody of your funds.
93
Contrarily,
crypto was created, in part, to establish a payment system where no third
party has control over your funds.
94
A minority of crypto is stored off
exchanges in crypto wallets, where the wallet owner possesses the crypto
keys.
95
89
See generally id. (comparing the centralized exchange to the stock market where
instead of stocks, the portfolio compromises of various cryptos).
90
See Why and How to Withdraw Your Bitcoin from Exchanges, BITCOIN MAG. (July 26,
2022), https://bitcoinmagazine.com/guides/why-and-how-to-withdraw-your-bitcoin-
from-exchanges [https://perma.cc/TE6B-ASLB].
91
Id.
92
See id.
93
Id.
94
Nakamoto, supra note 11.
95
See Why and How to Withdraw Your Bitcoin from Exchanges, supra note 90.
Richmond Journal of Law & Technology Volume XXX, Issue 1
66
2. Storing Cryptocurrency on a Wallet
[27] There are dozens of different brands of crypto wallets available, and
crypto wallets vary in which cryptocurrencies they are compatible with.
Sending crypto from an exchange to a wallet is a fairly simple process: users
input the amount of crypto they are sending and the recipient’s crypto wallet
address, and hit send.
96
Blockchains vary in how quickly they process
transactions, but the crypto could be in the recipient’s wallet within
seconds.
97
Crypto wallets can be bifurcated into two general categories:
software wallets and hardware wallets.
a. Software Wallets
[28] A software wallet is an entirely digital crypto wallet.
98
Software
wallets are applications you can use on your computer or, in some instances,
mobile phone.
99
MetaMask is a popular software wallet compatible with all
Ethereum network cryptos.
100
MetaMask is free, takes only minutes to set
up, and is a downloadable application on your internet browser and mobile
96
See Crypto transfers, ROBINHOOD, https://robinhood.com/us/en/support/articles/
cryptocurrency-wallets/ [https://perma.cc/XS37-CRKV] (last visited Oct. 1, 2023).
97
Harshini, Top 10 Cryptocurrencies with Their High Transaction Speeds in 2023,
ANALYTICS INSIGHT (Mar. 20, 2023), https://www.analyticsinsight.net/top-10-
cryptocurrencies-with-their-high-transaction-speeds-in-2023/ [https://perma.cc/HAJ7-
6RJG].
98
See What is Software Wallet, BITDEGREE, https://www.bitdegree.org/crypto/learn/
crypto-terms/what-is-software-wallet [https://perma.cc/96X6-J54Y] (last visited Oct. 1,
2023).
99
Id.
100
Metamask: The Leading Non-Custodial Wallet, BITDEGREE, https://www.bitdegree.
org/crypto/learn/what-is-metamask [https://perma.cc/4M59-4UJZ] (last visited Oct. 1,
2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
67
phone.
101
In November of 2021, the MetaMask creator issued a press release
claiming MetaMask surpassed 21 million monthly active users.
102
Users
creating a new MetaMask wallet receive a “seed phrase,”
103
which is a series
of 12 to 24 randomly generated words that provides the data needed to
recover a lost or broken crypto wallet.
104
Users will choose a password,
which must be input every time the user logs into the wallet or tries to send
funds from the wallet.
105
[29] A notable benefit of software wallets is that they provide users with
the keys to their crypto; you can only access the crypto if you know a wallet
owner’s login information.
106
Further, software wallets are very accessible,
and it is easy to send or receive crypto on them (if you know the login
information).
107
For this reason, software wallets are often called “hot”
101
See id.
102
MetaMask Surpasses 21 Million MAUs as Consensys Raises $200 Million to Make
Web3 Universally Easy to Use, Access, and Build On, CONSENSYS (Nov. 17, 2021),
https://consensys.net/blog/press-release/metamask-surpasses-21-million-maus-as-
consensys-raises-200-million-%20to-make-web3-universally-easy-to-use-access-and-
build-on/ [https://perma.cc/57E9-WJ8V].
103
User Guide: Secret Recovery Phrase, password, and private keys, METAMASK (Mar.
2023), https://support.metamask.io/hc/en-us/articles/4404722782107-User-Guide-Secret-
Recovery-Phrase-password-%20and-private-keys [https://perma.cc/GL2E-V6H5].
104
Id.
105
See id.
106
See id.
107
See Frequently Asked Questions, METAMASK, https://metamask.io/faqs/
[https://perma.cc/AF96-4U6F].
Richmond Journal of Law & Technology Volume XXX, Issue 1
68
wallets.
108
The biggest disadvantage of software wallets is that the wallets
are connected to the internet, which exposes them to viruses or hackers.
109
Hardware wallets, often called “cold” wallets, are the most secure option
available for holding and storing crypto.
110
b. Hardware Wallets
[30] Hardware wallets are physical devices used to store your crypto’s
keys offline.
111
Ledger and Trezor are among the highest respected
hardware wallet manufacturers.
112
The Ledger Nano X is similar in size and
appearance to a thumb drive, and the offline storage can be accessed with a
Bluetooth or USB connection on a computer or mobile phone.
113
The Trezor
Model T is regarded as one of the most secure hardware wallets and is
compatible with over 1,000 different cryptocurrencies, including Bitcoin.
114
The greatest advantage hardware wallets have over software wallets is the
additional security from storing your crypto offline. Hardware wallets are
typically left entirely disconnected from a computer, which is why people
108
CFI Team, Cryptocurrency Wallet, CORP. FIN. INS. (Feb. 1, 2023),
https://corporatefinanceinstitute.com/resources/cryptocurrency/cryptocurrency-wallet/
[https://perma.cc/BV6J-4DCR].
109
Patrick McGimpsey, Hardware Wallets Explained, FORBES ADVISOR AUSTL.,
https://www.forbes.com/advisor/au/investing/cryptocurrency/hardware-wallets-
explained/ [https://perma.cc/3D6U-EBR9] (last updated Mar. 14, 2023, 12:12 PM).
110
CFI Team, supra note 108.
111
McGimpsey, supra note 109.
112
Id.
113
See Ledger Nano X, LEDGER, https://shop.ledger.com/products/ledger-nano-x
[https://perma.cc/Y8VL-GBJN] (last visited Oct. 6, 2023).
114
Evan Jones, Trezor Model T Review: Still Worth the Hype in 2023?,
CRYPTOVANTAGE (Oct. 6, 2023), https://www.cryptovantage.com/best-crypto-
wallets/trezor-model-t/ [https://perma.cc/BPN8-P9Q3].
Richmond Journal of Law & Technology Volume XXX, Issue 1
69
refer to them as “cold” wallets.
115
However, software wallets are free, while
the Ledger Nano X and Trezor Model T currently cost $149.00 and $219.00,
respectively.
116
[31] The global crypto wallet market size was valued at $8.42 billion in
2022, and some projections indicate that figure will grow at 24.8% per year
from 2023 to 2030.
117
Increasingly, individuals are opting to hold their
crypto in their own wallets rather than leaving it on a centralized exchange,
and there is one person in particular to thank for that: Sam Bankman-Fried,
founder of the once-popular crypto exchange, FTX.
3. Not Your Keys, Not Your Coins: Sam Bankman-Fried
and FTX
[32] Sam Bankman-Fried is a 31-year-old M.I.T. graduate and convicted
felon.
118
In 2017, he exploited an arbitrage in the Bitcoin markets known as
the “Kimchi Swap,” where he would purchase Bitcoin on one crypto
exchange and sell it on exchanges in other countries posting higher
115
CFI Team, supra note 108.
116
Ledger Nano X, supra note 113; Trezor Model T, TREZOR, https://trezor.io/trezor-
model-t?gclid=Cj0KCQjw8e-
gBhD0ARIsAJiDsaWSlFTATNkIIl2r398HdjdGmimweZWm7xirAv-Ztzg705jJ-
ruL3LMaAge6EALw_wcB [https://perma.cc/EQZ6-5SAH] (last visited Oct. 6, 2023).
117
Crypto Wallet Market Size, Share & Growth Report, supra note 87.
118
David Gura, Sam Bankman-Fried is found guilty of all charges in FTX’s spectacular
collapse, NPR, https://www.npr.org/2023/11/02/1210100678/sam-bankman-fried-trial-
verdict-ftx-crypto [https://perma.cc/K5U8-C4DX] (last updated Nov. 2, 2023, 10:20
PM).
Richmond Journal of Law & Technology Volume XXX, Issue 1
70
prices.
119
Bankman-Fried wanted to scale his operation, so he founded
Alameda Research.
120
Alameda Research was wildly successful, and
Bankman-Fried used his earnings and lured capital from investors to found
his very own crypto exchange, FTX, in 2019.
121
Alameda Research and
FTX operated alongside each other inside FTX’s office headquarters in the
Bahamas.
122
[33] In 2021 alone, FTX facilitated $719 billion in crypto exchanges.
123
By January of 2022, FTX was the third-largest cryptocurrency exchange in
119
MacKenzie Sigalos, From $32 billion to criminal investigations: How Sam Bankman-
Fried’s crypto empire vanished overnight, CNBC,
https://www.cnbc.com/2022/11/15/how-sam-bankman-frieds-ftx-alameda-empire-
vanished-overnight.html [https://perma.cc/7ARD-BAJF] (last updated Nov. 16, 2022,
12:05 AM).
120
Id.
121
Whizy Kim, Sam Bankman-Fried’s arrest is the culmination of an epic flameout,
VOX, https://www.vox.com/the-goods/23458837/sam-bankman-fried-ftx-sbf-downfall-
explained [https://perma.cc/T4N6-9PDQ] (last updated Dec. 22, 2022, 3:11 PM).
122
Tracy Wang, Bankman-Fried’s Cabal of Roommates in the Bahamas Ran His Crypto
Empire – and Dated. Other Employees Have Lots of Questons, COINDESK,
https://www.coindesk.com/business/2022/11/10/bankman-frieds-cabal-of-roommates-in-
the-bahamas-ran-his-crypto-empire-and-dated-other-employees-have-lots-of-questions/
[https://perma.cc/PJ7J-X6XP] (last updated Aug. 16, 2023, 5:57 PM).
123
David Curry, FTX Revenue and Usage Statistics (2023), BUS. OF APPS,
https://www.businessofapps.com/data/ftx-statistics/ [https://perma.cc/TJZ2-C9GP] (last
updated Jan. 9, 2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
71
the world and boasted a $32 billion valuation.
124
FTX struck partnerships
with household names like Visa, MLB, Tom Brady, Stephen Curry, and
Kevin O’Leary.
125
Bankman-Fried had a net worth of approximately $16
billion, and people were comparing him to finance magnates like Warren
Buffet.
126
Bankman-Fried was viewed as a visionary; FTX created its own
crypto called FTT, which reached an all-time-high price of $85.02 per coin
in September 2021, representing a $12.73 billion market cap.
127
People felt
comfortable leaving their funds on FTX because they trusted Bankman-
Fried with the keys to their crypto.
128
FTX, and Bankman-Fried’s public
124
Ryan Browne, Cryptocurrency exchange FTX hits $32 billion valuation despite bear
market fears, CNBC, https://www.cnbc.com/2022/01/31/crypto-exchange-ftx-valued-at-
32-billion-amid-bitcoin-price-plunge.html [https://perma.cc/T574-XY5J] (last updated
Jan. 31, 2022, 7:44 PM); Nathan Reiff, The Collapse of FTX: What Went Wrong With the
Crypto Exchange?, INVESTOPEDIA, https://www.investopedia.com/what-went-wrong-
with-ftx-6828447 [https://perma.cc/ZM89-AK3M] (last updated Feb. 27, 2023)
[hereinafter Reiff, The Collapse of FTX].
125
Luc Olinga, FTX Collapse: Tom Brady, Steph Curry and ‘Mr. Wonderful’ Are in Big
Trouble, THE STREET CRYPTO (Nov. 16, 2022, 4:35 PM), https://www.thestreet.com/
cryptocurrency/ftx-collapse-tom-brady-steph-curry-and-mr-wonderful-are-in-big-trouble
[https://perma.cc/FG2W-5W3N]; Kate Rooney, Visa partners with FTX in a bet that
shoppers still want to spend cryptocurrencies in a bear market, CNBC,
https://www.cnbc.com/2022/10/07/visa-partners-with-ftx-in-a-bet-that-shoppers-still-
want-to-spend-cryptocurrencies-in-a-bear-market.html [https://perma.cc/MML2-W8MM
] (last updated Oct. 7, 2022, 10:34 AM); Justin Byers, MLB Latest To Cut Ties With FTX,
FRONT OFFICE SPORTS (Nov. 18, 2022, 02:02 PM), https://frontofficesports.com/mlb-
latest-to-cut-ties-with-ftx/ [https://perma.cc/EUL2-LJRP].
126
Kim, supra note 121.
127
FTX Token price today, FTT to USD live price, marketcap and chart,
COINMARKETCAP, https://coinmarketcap.com/currencies/ftx-token/
[https://perma.cc/NUB3-UPV5] (last visited Oct. 6, 2023).
128
See Allison Morrow, Customers who trusted crypto giant FTX may be left with
nothing, CNN, https://www.cnn.com/2022/11/14/business/ftx-customer-money-
bankruptcy/index.html [https://perma.cc/M46F-QEL8] (last updated Nov. 15, 2022, 4:35
AM).
Richmond Journal of Law & Technology Volume XXX, Issue 1
72
perception, came crashing down within hours after a few tweets from
Changpeng Zhao (CZ), the CEO of FTX’s rival crypto exchange,
Binance.
129
[34] Bankman-Fried’s original business venture, Alameda Research, was
in a $10 billion hole as a result of speculative venture investments, lavish
real estate investments, and large political donations.
130
In an effort to keep
Alameda Research afloat, Bankman-Fried misappropriated FTX’s
customers’ funds to Alameda Research.
131
Binance held a minority stake in
FTX, but exited the investment in 2021 and received $2.1 billion in
cryptocurrencies in return, including FTT coins worth $529 million.
132
On
November 6, 2022—allegedly after CZ realized Bankman-Fried was
misappropriating customer funds—CZ tweeted his intention to sell
Binance’s $529 million worth of FTT coins.
133
After CZ’s ominous tweet,
many investors began withdrawing their funds from FTX as quickly as
possible, which led to a multi-billion dollar liquidity crisis.
134
FTX lacked
the solvency to fulfill its customers’ withdrawals, so FTX suspended
129
See Sigalos, supra note 119.
130
See Complaint at 2, SEC v. Sam Bankman-Fried, No. 22-cv-10501 (S.D.N.Y. Dec. 13,
2022), https://www.sec.gov/files/litigation/complaints/2023/comp25616.pdf
[https://perma.cc/UR8X-N8F8].
131
Id.
132
Olga Kharif, Binance to Sell $529 Million of Bankman-Fried’s FTT Token,
BLOOMBERG (Nov. 6, 2022, 2:12 PM), https://www.bloomberg.com/news/articles/
202211-06/binance-to-sell-529-million-of-ftt-token-amids-revelations#xj4y7vzkg
[https://perma.cc/47CB-D4BM].
133
Sigalos, supra note 119.
134
Samantha Delouya, Sam Bankman-Fried reportedly said it was a mistake to pick a
fight with Binance CEO Changpeng Zhao: ‘not a good strategic move on my part”, BUS.
INSIDER (Nov. 14, 2022, 8:15 PM), https://www.businessinsider.com/sam-bankman-
fried-ftx-binance-changpeng-zhao-cz-crypto-report-2022-11 [https://perma.cc/UKX8-
8QRF].
Richmond Journal of Law & Technology Volume XXX, Issue 1
73
withdrawals, and customers could not get their funds back out of the
exchange.
135
[35] FTX filed for bankruptcy on November 11, 2022, just five days after
CZ’s tweet.
136
On December 12, 2022, Bankman-Fried was arrested in the
Bahamas after the United States Department of Justice indicted him on eight
counts, including conspiracy to commit wire fraud, wire fraud, conspiracy
to commit commodities fraud, conspiracy to commit securities fraud,
conspiracy to commit money laundering, and conspiracy to defraud the
Federal Election Commission and commit campaign finance violations.
137
Sam Bankman-Fried was ordered to remain on house arrest after posting a
$250 million bond, but was remanded to jail after being accused of witness
tampering.
138
And on November 2, 2023, a jury found Sam Bankman-Fried
guilty of two counts of wire fraud and five counts charging conspiracies to
commit wire fraud, securities fraud, commodities fraud, and money
135
Niket Nishant, FTX suspends addition of new clients, withdrawals, REUTERS (Nov. 10,
2022, 6:35 AM), https://www.reuters.com/technology/ftx-suspends-onboarding-new-
clients-2022-11-10/ [https://perma.cc/Z7TZ-4NSB].
136
Ryan Browne, FTX says it could have over 1 million creditors in new bankruptcy
filing, CNBC, https://www.cnbc.com/2022/11/15/ftx-says-could-have-over-1-million-
creditors-in-new-bankruptcy-filing.html [https://perma.cc/VBL9-TR3P] (last updated
Nov. 15, 2022, 2:14 PM).
137
Press Release, U.S. Att’y Off., S. Dist. N.Y., United States Attorney Announces
Charges Against FTX Founder Samuel Bankman-Fried (Dec. 13, 2022),
https://www.justice.gov/usao-sdny/pr/united-states-attorney-announces-charges-against-
ftx-founder-samuel-bankman-fried [https://perma.cc/FE3Z-V3DU].
138
Luc Cohen & Jody Godoy, FTX’s Bankman-Fried headed for jail over alleged witness
tampering, REUTERS (Aug. 11, 2023, 7:22 PM), https://www.reuters.com/legal/ftxs-
bankman-fried-seeking-avoid-jail-due-back-court-2023-08-11/ [https://perma.cc/JG7G-
YRJ].
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laundering.
139
He is facing up to 115 years in prison and will be sentenced
in March of 2024.
140
[36] Crypto investors who did not transfer their assets to their own
wallets and instead left their funds on the FTX exchange became creditors
to a bankruptcy proceeding rather than customers of a trusted exchange.
141
According to a September 11, 2023 bankruptcy filing, bankruptcy advisors
have recovered approximately $7 billion of FTX assets, which pales in
comparison to the $16 billion in customer claims and $65 billion of non-
customer claims filed with FTX’s bankruptcy advisors.
142
[37] In short, when a crypto investor leaves their crypto on a centralized
exchange, the centralized exchange has actual possession of the crypto
because they retain possession over the crypto keys.
143
To have actual
possession of their crypto’s keys, investors must transfer the crypto from an
exchange to a hardware or software wallet.
144
Bankman-Fried was able to
139
McKenzie Sigalos, Sam Bankman-Fried found guilty on all seven criminal fraud
counts, CNBC (Nov. 2, 2023 at 7:51 PM), https://www.cnbc.com/2023/11/02/sam-
bankman-fried-found-guilty-on-all-seven-criminal-fraud-counts.html
[https://perma.cc/Q59S-KKD4].
140
Id.
141
Id.
142
Notice of Presentation to Stakeholders at 8-9, In re FTX Trading LTD., No. 22-11068
(Bankr. D. Del. Sep. 11, 2023), https://assets.bwbx.io/documents/users/iqjWHBFdfxIU/
rGgfh7D1z_38/v0 [https://perma.cc/7MWC-87GH].
143
Gaurav Roy, What is a Centralized Cryptocurrency Exchange (CEX)?, LEDGER ACAD.
(June 16, 2023), https://www.ledger.com/academy/topics/crypto/what-is-a-centralized-
cryptocurrency-exchange-cex [https://perma.cc/N3LP-RLMU].
144
Jake Frankenfield et al., Cryptocurrency Wallet: What It Is, How It Works, Types,
Security, INVESTOPEDIA, https://www.investopedia.com/terms/b/bitcoin-wallet.asp
[https://perma.cc/9CKN-2S9D] (last updated Aug. 29, 2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
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steal billions of dollars from FTX’s customers because they entrusted FTX
with their crypto’s keys.
145
[38] The FTX bankruptcy and Bankman-Fried’s thefts had a chilling
effect on the crypto industry, as evidenced by the crypto market cap falling
by $183 billion in the days following CZ’s tweet.
146
Investors were left
questioning how Bankman-Fried could steal billions of dollars from
customers without a government agency first uncovering the scam. Crypto
exchanges across the world had to regain their customers’ trust. One
exchange, Coinbase, acted quickly to tell the world how it was different
from FTX.
147
4. Coinbase: A Crypto Exchange Headquartered in the
United States
[39] Coinbase, the largest crypto exchange in the United States, has
approximately 110 million verified users and close to $80 billion in assets
on the platform.
148
In the days following the FTX bankruptcy, Coinbase
went on the offensive by obtaining a full-page advertisement in the Wall
145
Rohan Goswami & MacKenzie Sigalos, How Sam Bankman-Fried swindled $8 billion
in customer money, according to federal prosecutors, CNBC, https://www.cnbc.com/
2022/12/18/how-sam-bankman-fried-ran-8-billion-fraud-government-prosecutors.html
[https://perma.cc/763H-FU8R] (last updated Dec. 19, 2022, 2:06 PM).
146
Lyllah Ledesma, FTX Collapse Leaves Total Crypto Market Cap Under $800B, Close
to 2022 Low, COINDESK (Nov. 17, 2022, 5:05 PM), https://www.coindesk.com/markets/
2022/11/17/ftx-collapse-leaves-total-crypto-market-cap-under-800b-close-to-2022-low/
[https://perma.cc/76L8-DFG5].
147
Steve Mollman, Coinbase CEO Brian Armstrong says it’s ‘baffling’ FTX’s Sam
Bankman-Fried isn’t ‘in custody already’, YAHOO (Dec. 3, 2022), https://www.yahoo.
com/video/coinbase-ceo-brian-armstrong-says-231208022.html [https://perma.cc/A46A-
33BM].
148
Will Robinson, Introducing Base, COINBASE (Feb. 23, 2023), https://www.coinbase.
com/blog/introducing-base [https://perma.cc/T72A-ECN2].
Richmond Journal of Law & Technology Volume XXX, Issue 1
76
Street Journal that read, “Trust us.” in a prominent typeface.
149
Below the
eye-catching plea for trust, Coinbase explained to its audience that:
We are headquartered in the United States; We hold our
customers’ assets 1:1; We don’t trade against our customers,
and we don’t leverage their funds without consent; We
provide the transparent accounting and audits that are
required of a public company[.]
150
[40] In short, Coinbase relied on its United States roots, promised to
never touch or interfere with its customers’ funds without consent, and
noted the regulations and reporting requirements United States public
corporations must follow.
151
So, what are the regulations surrounding a
public company in the United States operating a crypto exchange, and how
is crypto regulated if it is in someone’s wallet? Who in the United States
federal government should have known about FTX’s scheme and protected
investors, if anyone? Section III addresses these questions.
III. HOW THE UNITED STATES REGULATES CRYPTOCURRENCY
[41] United States federal agencies have attempted to apply an already-
existing regulatory framework to a brand-new technology.
152
In some cases,
cryptocurrency is categorized as a commodity, the same asset-type as eggs
and wheat, and subject to the Commodity Futures Trading Commission’s
149
Patrick Coffee, Crypto Brands Reposition Themselves in Wake of FTX and Market
Tumble, WALL ST. J. (Feb. 7, 2023, 6:00 AM), https://www.wsj.com/articles/crypto-
brands-reposition-themselves-in-wake-of-ftx-and-market-tumble-11675731537
[https://perma.cc/DZ7E-PDF5].
150
Max Erdenberger, Coinbase – Trust Us, ERDENBERGER, https://www.erdenberger.me/
project/coinbase-trust-us [https://perma.cc/A7GH-86QF].
151
Id.
152
Id.
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77
(CFTC) jurisdiction.
153
In other cases, cryptocurrency is categorized as a
security and treated like stock in a company, which is regulated by the
Securities and Exchange Commission (SEC).
154
Both the CFTC and SEC
have exerted their jurisdiction over cryptocurrencies in different
circumstances, even though cryptocurrencies have qualities distinct from
both commodities and securities.
155
Thus, the answer to the question of how
the United States regulates cryptocurrency is “it depends.”
A. Congressional Power Under the Constitution: The SEC and
the CFTC
[42] The U.S. Constitution grants Congress with the power “to regulate
commerce with foreign nations, among States . . . .”
156
This Constitutional
provision, known as the Commerce Clause, has been interpreted broadly
and grants Congress the power to regulate a wide range of activities.
157
The
Constitution also grants Congress the power to create its own agencies and
153
Robert Stevens, Securities vs. Commodities: Why It Matters For Crypto, COINDESK,
https://www.coindesk.com/learn/securities-vs-commodities-why-it-matters-for-crypto/
[https://perma.cc/UF2N-TJLF] (last updated May 5, 2023, 11:16 AM).
154
Id.
155
See Timothy G. Massad & Howell E. Jackson, How to Improve Regulation of Crypto
Today–Without Congressional Action–and Make the Industry Pay For It, BROOKINGS
INST., 1–10 (Working Paper No. 79, 2022), https://www.brookings.edu/wp-
content/uploads/2022/10/WP79-Massad-Jackson-updated-2.pdf [https://perma.cc/43E2-
WJXZ]; see also Cheryl L. Isaac et al., CFTC and SEC Perspectives on Cryptocurrency
and Digital Assets – Volume I: A Jurisdictional Overview, K&L GATES, 1–3, 5–7 (May 6,
2022), https://www.klgates.com/CFTC-and-SEC-Perspectives-on-Cryptocurrency-and-
Digital-Assets-Volume-I-A-Jurisdictional-Overview-5-6-2022 [https://perma.cc/779S-
KJW8].
156
U.S. CONST. art. I, § 8, cl. 3.
157
Commerce Clause, CORNELL L. SCH.: LEGAL INFO. INST., https://www.law.cornell.
edu/wex/commerce_clause [https://perma.cc/KZ4N-7TEX] (last updated July 2022).
Richmond Journal of Law & Technology Volume XXX, Issue 1
78
delegate those agencies law-making power over certain issues.
158
Congress
used its Commerce Clause and delegation powers to protect investors and
avoid fraud on markets when it established the SEC and CFTC.
159
[43] After the stock market crash of 1929, Congress passed the Securities
Act of 1933 and the Securities Exchange Act of 1934.
160
Together, the
securities laws require publicly traded companies to register with the SEC;
disclose financial and other important information; and refrain from
engaging in certain types of fraud, deceit, and misrepresentation.
161
The
Securities Act of 1933 regulates companies selling their securities directly
to the public,
162
while the Securities Exchange Act of 1934 regulates
securities transactions on secondary markets.
163
The 1934 Act also
158
U.S. CONST. art. I, § 1.
159
See Mission, SEC, https://www.sec.gov/about/mission [https://perma.cc/MXU6-
X8TZ] (last modified Aug. 29, 2023); see also John H. Stassen, The Commodity
Exchange Act In Perspective a Short and Not-So-Reverent History of Futures Trading
Legislation In the United Legislation In the United States, 39 WASH. & LEE L. REV. 825,
830, 832–835 (1982).
160
The Role of the SEC, INV.GOV, https://www.investor.gov/introduction-
investing/investing-basics/role-sec [https://perma.cc/YV7B-8CYK] (last visited Sept. 24,
2023).
161
See The Laws That Govern the Securities Industry, SEC, https://www.sec.gov/about/
about-securities-laws [https://perma.cc/9D83-P5HM] (last modified Oct. 1, 2013).
162
What Is the Securities Act of 1933?, WINSTON & STRAWN, https://winston.com/en/
legal-glossary/what-is-securities-act-of-1933 [https://perma.cc/6PSU-SW2L] (last visited
Sept. 24, 2023).
163
Will Kenton, What Is the Securities Exchange Act of 1934? Reach and History,
INVESTOPEDIA, https://www.investopedia.com/terms/s/seact1934.asp
[https://perma.cc/3E9T-4YMU] (last updated Feb. 24, 2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
79
established the SEC, which is tasked with enforcing both Acts and aims to
ensure a transparent and fair environment for investors.
164
[44] In 1936, Congress created the Commodity Exchange Commission
(CEC) when it passed the Commodity Exchange Act (CEA).
165
Congress
tasked the CEC with regulating the commodities enumerated in the CEA:
cotton, rice, mill feeds, butter, eggs, Irish potatoes, and grains.
166
Congress
also tasked the CEC with overseeing futures contracts of the enumerated
commodities, and the Commodity Exchange Administration was formed
under the Department of Agriculture.
167
In 1974, Congress amended the
CEA when it passed the Commodity Futures Trading Commission Act of
1974, and the CEA turned into its own independent agency, the CFTC.
168
Congress granted the CFTC with “powers greater than those of its
predecessor agency” by giving it exclusive jurisdiction over futures trading
in all commodities—beyond those specifically enumerated in the 1936
Act.
169
164
Id.
165
US Futures Trading and Regulation Before the Creation of the CFTC, CFTC,
https://www.cftc.gov/About/HistoryoftheCFTC/history_precftc.html
[https://perma.cc/8Z9V-CCCQ] (last visited Sept. 24, 2023) [hereinafter US Futures
Trading and Regulation].
166
Id.
167
Id.
168
See Dan M. Berkovitz, Gen. Couns., CFTC, Position Limits and the Hedge
Exemption, Brief Legislative History (July 28, 2009), https://www.cftc.gov/PressRoom/
SpeechesTestimony/berkovitzstatement072809 [https://perma.cc/D4D8-GFNF].
169
CFTC History in the 1970s, CFTC, https://www.cftc.gov/About/HistoryoftheCFTC/
history_1970s.html [https://perma.cc/24EB-LYL6] (last visited Sept. 24, 2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
80
[45] The CFTC decided that cryptocurrencies are commodities in
some contexts and are thus subject to CFTC regulatory oversight.
170
On
the other hand, the SEC decided that cryptocurrencies are securities in
some contexts and thus are subject to SEC regulatory oversight.
171
Solutions to regulating cryptocurrencies will continue to develop in the
future, but the United States federal government has employed a
bifurcated approach to resolving this novel issue thus far.
B. Regulating Cryptocurrencies as Commodities
[46] The Commodity Exchange Act defines a commodity as “wheat,
cotton, rice, corn, oats . . . butter, eggs, . . . and all other goods and articles,
. . . and all services, rights, and interests . . . in which contracts for future
delivery are presently or in the future dealt in.”
172
At first glance, it appears
cryptocurrencies would not fall within this definition of “commodity”—
especially considering the CEA’s original purpose was to regulate
agricultural commodities.
173
However, the CFTC employed this definition
and argued that Bitcoin was a commodity in In the Matter of Coinflip, Inc.
174
170
An Introduction to Virtual Currency, CFTC, https://www.cftc.gov/sites/default/files/
2019-12/oceo_aivc0218.pdf [https://perma.cc/VKN5-TZ5X] (last visited Sept. 24, 2023).
171
See Press Release, SEC, SEC Charges Ripple and Two Executives with Conducting
$1.3 Billion Unregistered Securities Offering (Dec. 22, 2020), www.sec.gov/news/press-
release/2020-338 [https://perma.cc/CRE2-WMBR] [hereinafter SEC Press Release].
172
Commodity Exchange Act, 7 U.S.C. § 1a(9) (2010).
173
US Futures Trading and Regulation, supra note 165.
174
See Coinflip, Inc., C.T.F.C. Docket No. 15-29 at 2 (Commodity Trading Futures
Comm’n Sept. 16, 2015) (initiation).
Richmond Journal of Law & Technology Volume XXX, Issue 1
81
1. In the Matter of Coinflip
[47] Coinflip, owned and operated by Francisco Riordan, was a
Delaware corporation operating in San Francisco, California.
175
Coinflip
operated a website, derivabit.com, which connected buyers and sellers of
standardized Bitcoin options and futures contracts.
176
Coinflip users were
first required to register an account and deposit Bitcoin.
177
After that,
Coinflip users could post bids and offers for Bitcoin options contracts or
accept other users’ Bitcoin put and call options.
178
At the conclusion of an
option contract, premiums and payments of settlement were paid using
Bitcoin at a spot rate determined by a third-party Bitcoin exchange.
179
Under the CEA, platforms offering futures contracts on commodities must
be registered with the CFTC as an exchange.
180
The CFTC alleged that
Coinflip:
violated Sections 4c(b) and 5h(a)(l) of the Act and
Commission Regulations 32.2 and 37.3(a)(l) by conducting
activity related to commodity options contrary to
Commission Regulations and by operating a facility for the
trading or processing of swaps without being registered as a
swap execution facility or designated contract market.
181
175
Id.
176
Id.
177
Id. at 3.
178
Id. at 2–3.
179
Coinflip, Inc., supra note 174.
180
Id. at 4.
181
Id. at 2.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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[48] Thus, in determining whether Coinflip violated the CEA and CFTC
Regulations, the sole issue was whether Bitcoin classified as a
commodity.
182
[49] In the CFTC’s Order in Coinflip, the CFTC stated that “Virtual
Currencies Such as Bitcoin are Commodities[,]” and provided that:
Section 1a(9) of the Act defines "commodity" to include,
among other things, "all services, rights, and interests in
which contracts for future delivery are presently or in the
future dealt in." 7 U.S.C. § 1a(9). The definition of a
"commodity" is broad . . . Bitcoin and other virtual
currencies are encompassed in the definition and properly
defined as commodities.
183
[50] In short, the CFTC relied on case law, which held that the definition
of commodity is “broad,” and concluded that Bitcoin and other virtual
currencies are properly defined as commodities.
184
That is the extent of the
CFTC’s legal analysis in its Order in Coinflip.
[51] Coinflip submitted an offer to the CFTC waiving its right to a trial
and agreed to cease its operations as an unregistered swap execution
facility.
185
This was the first time the CFTC characterized a cryptocurrency
as a commodity.
186
However, it was a proper case for the CFTC to exert its
182
Id. at 3.
183
Id.
184
Coinflip, Inc., supra note 174.
185
Id. at 1.
186
Matt Clinch, Bitcoin now classed as a commodity in the US, CNBC,
https://www.cnbc.com/2015/09/18/bitcoin-now-classed-as-a-commodity-in-the-us.html
[https://perma.cc/DP65-V57L] (last updated Sep. 18, 2015, 3:48 PM).
Richmond Journal of Law & Technology Volume XXX, Issue 1
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jurisdiction over cryptocurrencies because Coinflip was offering futures
contracts on Bitcoin, thus falling within the CFTC’s jurisdiction over
futures contracts dealing in “goods.”
187
It was unclear whether the CFTC
would exert its jurisdiction over cryptocurrencies outside the context of
futures contracts until the CFTC charged Patrick McDonnell in 2018 for his
role with his fraudulent company, Coin Drop Markets.
188
2. CFTC v. Patrick K. McDonnell and Cabbage Tech,
Corp. d/b/a Coin Drop Markets
[52] Coin Drop Markets advertised itself as a team of Wall Street crypto
trading advisors and offered membership subscriptions where members
would receive expert trading advice and investment services.
189
In reality,
McDonnell was operating Coin Drop Markets alone in his Staten Island
basement, he never provided any expert crypto trading advice to his
customers, and he lied about his investing experience.
190
Some members
only purchased memberships from McDonnell to receive investing
advice.
191
Other investors were lured by McDonnell’s promises of 200 to
300% daily returns and thus transferred their crypto to Coin Drop
Markets.
192
After receiving $290,429.29 from members,
193
McDonnell
deleted Coin Drop Markets’ social media accounts and websites and ceased
187
Fast Answers: Commodity Futures Trading Commission, SEC, https://www.sec.gov/
fast-answers/answers-cftc [https://perma.cc/F6UY-TVDT] (last updated May 26, 2010).
188
CFTC v. McDonnell, No. 18-CV-361, 2018 U.S. Dist. LEXIS 146576, at *27–28
(E.D.N.Y. Aug. 23, 2018).
189
Id. at *7.
190
Id. at *8.
191
Id. at *29.
192
Id. at *31.
193
McDonnell, 2018 U.S. Dist. LEXIS 146576, at *43.
Richmond Journal of Law & Technology Volume XXX, Issue 1
84
communications with investors (also known as a “rug pull” in the
cryptocurrency market).
194
The CFTC alleged that Coin Drop Market
operated “a deceptive and fraudulent virtual currency scheme . . . for
purported virtual currency trading advice” and “for virtual currency
purchases and trading . . . and simply misappropriated [investor] funds.”
195
[53] The CFTC filed charges against McDonnell in the United States
District Court of the Eastern District of New York, seeking a preliminary
injunction.
196
McDonnell (who represented himself) filed a motion to
dismiss and argued the CFTC lacked jurisdiction over the Coin Drop
Market scheme because crypto was not a commodity.
197
The court had to
decide two questions presented in order to determine whether the CFTC had
jurisdiction over McDonnell: (1) whether virtual currency may be regulated
by the CFTC as a commodity; and (2) whether the amendments to the CEA
under the Dodd-Frank Act permit the CFTC to exercise its jurisdiction over
fraud that does not directly involve the sale of futures or derivatives
contracts.
198
In granting the CFTC’s preliminary injunction, the court held
that “[b]oth questions are answered in the affirmative.”
199
The court began
194
Id. at *8; Rosie Perper, What Is a Rug Pull? How to Protect Yourself From Getting
‘Rugged’, COINDESK, https://www.coindesk.com/learn/what-is-a-rug-pull-how-to-
protect-yourself-from-getting-rugged/ [https://perma.cc/X549-PX36] (last updated May
11, 2023, 12:50 PM).
195
McDonnell, 2018 U.S. Dist. LEXIS 146576, at *10.
196
Press Release, CFTC, Federal Court in New York Enters Preliminary Injunction Order
against Patrick K. McDonnell and His Company CabbageTech, Corp. d/b/a Coin Drop
Markets in Connection with Fraudulent Virtual Currency Scheme (Mar. 6, 2018),
https://www.cftc.gov/PressRoom/PressReleases/7702-18 [https://perma.cc/2TNT-
LKKM].
197
See CFTC v. McDonnell, 287 F. Supp. 3d 213 (E.D.N.Y. Mar. 6, 2018).
198
Id. at 217.
199
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
85
its opinion by saying: “Until Congress clarifies the matter, the CFTC has
concurrent authority, along with other state and federal administrative
agencies . . . over dealings in virtual currency.”
200
[54] In answering the first question presented, the McDonnell court relied
on the CEA’s broad definition of “commodity,”
201
holding that “[a]
‘commodity’ encompasses virtual currency both in economic function and
in the language of the statute.”
202
According to the court, cryptocurrencies
are “goods” exchanged in a market for a uniform quality and value, falling
within both the common definition of “commodity” and the CEA’s
definition of “commodities” as broadly encompassing “all . . . goods”
203
[55] Addressing the second question presented, the court held that the
CFTC’s “broad [statutory] authority . . . extends to fraud or manipulation in
the virtual currency derivatives market and its underlying spot market[,]”
204
and that the CFTC “may exercise its enforcement power over fraud related
to virtual currencies transacted in interstate commerce.”
205
In the end, the
court held McDonnell liable for violating CEA § 6(c)(1) and CFTC
Regulation 180.1 for engaging in fraudulent activity in connection with
commodities.
206
The CFTC obtained a judgment against McDonnell
200
Id.
201
Id.
202
McDonnell, 287 F. Supp. 3d at 217 (showing that the CEA defines “commodity” as
agricultural products and “all other goods and articles . . . and all services, rights, and
interests . . . in which contracts for future delivery are presently or in the future dealt
in.”).
203
Id. at 228.
204
Id. at 217.
205
Id.
206
Id. at 234.
Richmond Journal of Law & Technology Volume XXX, Issue 1
86
totaling over $1.1 million, of which $290,429.29 was awarded as restitution
as well as a civil monetary penalty of $871,287.87 (which was three times
the amount McDonnell stole from customers under the statute’s treble
damages provision).
207
Further, McDonnell was permanently banned from
trading in cryptocurrencies.
208
[56] The McDonnell case was the first time a federal district court held
that cryptocurrency fell under the definition of a commodity.
209
As a result,
some crypto exchanges (including FTX) filed with the CFTC as required
under the Commodities Exchange Act.
210
However, the SEC defined and
regulated cryptocurrencies differently.
211
Before the CFTC asserted its
jurisdiction over cryptocurrencies as commodities, the SEC exerted its
jurisdiction over investment contracts dealing in cryptocurrencies.
212
C. Regulating Cryptocurrencies as Securities
[57] As previously mentioned, the SEC is charged with enforcing the
Securities Act of 1933 and the Securities Exchange Act of 1934, which
207
See CFTC v. McDonnell, No. 18-CV-361, 2018 U.S. Dist. LEXIS 146576 (E.D.N.Y.
Aug. 23, 2018).
208
Id.
209
Id.
210
Press Release, Dennis M. Kelleher, CEO of Better Markets, FTX Was Registered
With and Licensed by the CFTC, Which Failed to Properly Regulate or Supervise It and
Its Innumerable Former CFTC Officials (Nov. 14, 2022), https://bettermarkets.org/
newsroom/ftx-was-registered-with-and-licensed-by-the-cftc-which-failed-to-properly-
regulate-or-supervise-it-and-its-innumerable-former-cftc-officials/
[https://perma.cc/RA27-QBGG].
211
Fast Answers: CFTC, supra note 187.
212
Isaac et al., supra note 155.
Richmond Journal of Law & Technology Volume XXX, Issue 1
87
together comprise the nation’s securities laws.
213
The Securities Act of 1933
defines a “security” as “any note, stock, treasury stock, security future,
security-based swap, bond . . . [or] investment contract” (emphasis
added).
214
To determine whether an investment contract exists, courts apply
a four-prong inquiry called the Howey test.
215
[58] In its 1946 decision in SEC v. W.J. Howey Co., the U.S. Supreme
Court held that an investment contract exists when there is: (1) an
investment of money, (2) in a common enterprise, (3) with the expectation
of profit, and (4) the profit is derived from the efforts of others.
216
If these
four factors are present in an agreement, the agreement constitutes an
investment contract and is subject to the SEC’s rules and regulations.
217
To
consider how courts interpret the Howey test, the 2014 case SEC v. Trendon
T. Shavers and Bitcoin Savings and Trust is illustrative.
218
1. SEC v. Trendon T. Shavers and Bitcoin Savings and
Trust
[59] Trendon T. Shavers solicited investments in his company, Bitcoin
Savings and Trust, promising returns of up to 1% per day or 7% weekly and
touting his own skills at trading in Bitcoin.
219
Investors provided Shavers
213
Kenton, supra note 163.
214
15 U.S.C. § 77b(a)(1); SEC v. Shavers, No. 4:13-CV-416, 2014 U.S. Dist. LEXIS
130781 (E.D. Tex. Sept. 18, 2014).
215
SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
216
Id. at 298.
217
Id.
218
SEC v. Shavers, No. 4:13-CV-416, 2014 U.S. Dist. LEXIS 194382, at *1 (E.D. Tex.
Aug. 26, 2014).
219
Id. at *1–2.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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with a username, an email address, their investments in Bitcoin, and a
Bitcoin wallet address to receive investment withdraws.
220
With his newly
obtained Bitcoin, Shavers built his own Bitcoin mining operation and left a
small reserve fund for investors withdrawing their funds.
221
Soon
afterwards, Shavers reduced his promised rate of return from 7% to 3.9%
and eventually shut down his operation when too many investors withdrew
their funds at once.
222
The SEC determined that Bitcoin Savings and Trust
was a Ponzi scheme.
223
Of the approximately 732,100 Bitcoins investors
provided, around 180,819 Bitcoins went towards Shavers’ personal
expenses.
224
[60] In response to these allegations, Shavers argued federal securities
laws did not apply to cryptocurrencies and, accordingly, that the court
lacked jurisdiction.
225
The court examined Shavers’ conduct under the
Howey test and held that the investments in his company constituted
investment contracts because: (1) Bitcoin is a currency or form of money;
(2) there was a common enterprise because the investors were dependent on
Shavers’ expertise in Bitcoin markets; (3) investors expected to profit
because Shavers promised a substantial return on their investments; and (4)
the expected profits were to be derived from Shavers’ efforts.
226
Thus, the
court held an investment contract existed as a matter of law between Bitcoin
Savings and Trust and its investors, and Bitcoin Savings and Trust fell
220
Id.
221
Id. at *3.
222
Id. at *5
223
Shavers, 2014 U.S. Dist. LEXIS 194382, at *2.
224
Id. at *9–10.
225
Id. at *1.
226
Id., at *3.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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within the SEC’s jurisdiction.
227
The court held that Shavers violated the
Securities Exchange Act of 1934 because:
Section 10(b) of the Exchange Act . . . and Rule 10b-5 . . .
make it unlawful for any person, in connection with the
purchase or sale of a security, directly or indirectly, to (a)
“employ any device, scheme, or artifice to defraud”; (b)
“make an untrue statement of a material fact” or a material
omission; or (c) “engage in any act, practice, or course of
business which operates . . . as a fraud or deceit upon any
person.
[61] Further, the court held that Shavers knowingly and intentionally
operated a Ponzi scheme and made misrepresentations to investors.
228
[62] The set of facts surrounding Bitcoin Savings and Trust’s fraudulent
operations provided the SEC with a perfect opportunity to exert its
jurisdiction over cryptocurrency activities. Shavers accepted Bitcoin as
investments in his fraudulent company, forming an investment contract.
Shavers was not operating an unregistered exchange dealing in “goods”
(unlike the defendant in Coinflip),
229
nor was he offering subscription
services for cryptocurrency trading advice (unlike the defendant in Coin
Drop Markets).
230
According to the SEC, the investment contracts in
Bitcoin Savings and Trust were formed between the investors and the
227
Id. at *22.
228
Shavers, 2014 U.S. Dist. LEXIS 194382, at *14–15.
229
Id. at *3; CFTC v. McDonnell, 287 F. Supp. 3d 213, 224, 228 (E.D.N.Y. Mar. 6,
2018).
230
Shavers, 2014 U.S. Dist. LEXIS 194382, at *1; see also McDonnell, 287 F. Supp. 3d
at 232.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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company itself, but the investments were paid for in Bitcoin.
231
As such,
rather than address the question of whether Bitcoin itself was a security, the
court in SEC v. Shavers held more narrowly that the SEC could regulate
investment contracts dealing in Bitcoin.
232
In fact, the SEC has since
provided guidance that Bitcoin and Ether (the native token on the Ethereum
blockchain) do not constitute securities under the Howey test, which is still
being debated today.
233
2. Initial Coin Offerings and the Howey Test
[63] In June 2018, the Director of the SEC’s Division of Corporation
Finance, William Hinman, spoke at a summit about cryptocurrency
regulation.
234
Hinman told the crowd that Bitcoin and Ether fail the Howey
test because they both “[lack] a central third party whose efforts are a key
determining factor in the enterprise. The network[s] on which Bitcoin [and
Ether] function [are] operational and appear[] to have been decentralized
for some time, perhaps from inception.”
235
In an interview with CNBC in
July 2022, current SEC chair Gary Gensler reaffirmed the SEC’s position
that Bitcoin is a commodity, yet he declined to extend that classification to
Ether.
236
Commentators (and possibly Gensler himself) believe Ether may
231
Shavers, 2014 U.S. Dist. LEXIS 194382, at *2–3.
232
Id. at *22.
233
William Hinman, Dir. of Div. of Corp. Fin., Sec. Exch. Comm’n, Remarks at the
Yahoo Finance All Markets Summit: Crypto: Digital Asset Transactions: When Howey
Met Gary (Plastic), 3–4 (June 14, 2018), https://www.sec.gov/news/speech/speech-
hinman-061418 [https://perma.cc/6H5U-HVJK].
234
See id.
235
Id.
236
André Beganski, SEC Chair Gensler Again Says Bitcoin Is Not a Security. What About
Ethereum?, DECRYPT (June 27, 2022), https://decrypt.co/103926/sec-chair-gensler-
bitcoin-not-security-what-about-ethereum [https://perma.cc/M8TJ-QWCA].
Richmond Journal of Law & Technology Volume XXX, Issue 1
91
be considered a security because it was first offered to customers in an
Initial Coin Offering (ICO).
237
An ICO is when companies offer their newly
created cryptocurrencies to the public for the first time.
238
An ICO in the
crypto industry is analogous to an initial public offering in the traditional
finance industry.
239
[64] As previously noted, the SEC initially took the position that Bitcoin
and Ether failed the Howey test because both cryptos operate on blockchains
that are sufficiently decentralized and thus lack a common enterprise (i.e.,
Howey’s second prong).
240
However, when Ethereum first launched in
2014, the Ethereum Foundation sold over 60 million tokens in an ICO at
roughly $0.31 per coin.
241
The Ethereum Foundation planned on using the
funds it raised from the ICO to continue developing the Ethereum
blockchain, and the assets were not usable or transferable until the “genesis
block” was released to the public.
242
Investors purchasing the tokens during
the ICO expected a return on their purchases due to the Ethereum
Foundation’s continued development of the Ethereum blockchain.
243
Consequently, when a common enterprise like the Ethereum Foundation
237
See id.
238
Jake Frankenfield, Initial Coin Offering (ICO): Coin Launch Defined, with Examples,
INVESTOPEDIA, https://www.investopedia.com/terms/i/initial-coin-offering-ico.asp
[https://perma.cc/G77Q-FPV4] (last updated Aug. 18, 2022).
239
See id.
240
See Hinman, supra note 233.
241
Ethereum (ETH) ICO, COINCODEX, https://coincodex.com/ico/ethereum/
[https://perma.cc/65C7-8KHD] (last visited Oct. 6, 2023).
242
Vitalik Buterin, Launching the Ether Sale, ETHEREUM FOUND. BLOG (July 22, 2014),
https://blog.ethereum.org/2014/07/22/launching-the-ether-sale [https://perma.cc/8XBM-
GZ9J].
243
See id.; see also Ethereum (ETH) ICO supra note 241.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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sells its cryptocurrencies in an ICO, the cryptocurrencies may represent an
investment contract between the purchaser and the issuer.
244
In contrast,
Bitcoin lacks the centralized common enterprise Ethereum has: There is no
Bitcoin foundation continuing to develop the blockchain, and the first
Bitcoin was mined by a node on the peer-to-peer, decentralized network
rather than sold directly to customers.
245
Accordingly, because Bitcoin lacks
a common enterprise, it fails the Howey definition of “investment contract.”
[65] Other cryptocurrencies (e.g., XRP and ATB Coin) have also
launched through ICOs.
246
In Balestra v. ATBCOIN LLC, investors in ATB
Coin’s ICO sued the company in the United States District Court of the
Southern District of New York for selling unregistered securities.
247
ATB
Coin filed a motion to dismiss the suit arguing the court lacked jurisdiction
on account of its cryptocurrency failing to constitute a security, and the
motion was denied.
248
The plaintiffs in the case settled with ATB Coin for
244
See generally Hinman, supra note 233 (discussing the Howey test and the broad nature
of investment contracts).
245
See Hinman, supra note 233; David Floyd, How Bitcoin Works, INVESTOPEDIA,
https://www.investopedia.com/news/how-bitcoin-works/ [https://perma.cc/85DZ-CQ9C]
(last updated Aug. 20, 2023); see e.g., Alice Ivey, Primary vs. secondary markets: Key
differences, COINTELEGRAPH (Mar. 15, 2023), https://cointelegraph.com/news/primary-
vs-secondary-markets-key-differences [https://perma.cc/Q644-HVQA]; Benedict George,
The Genesis Block: The First Bitcoin Block, NASDAQ (Jan. 3, 2023, 11:03 AM),
https://nasdaq.com/articles/the-genesis-block:-the-first-bitcoin-block
[https://perma.cc/T9XC-2WMC].
246
See SEC Press Release, supra note 171; Press Release, Cointelegraph, ATB Coin
Cryptocurrency ICO Now Underway Across Globe, (June 15, 2017),
https://cointelegraph.com/press-releases/atb-coin-cryptocurrency-ico-now-underway-
across-globe [https://perma.cc/7S59-665X].
247
Balestra v. ATBCOIN, LLC, 380 F. Supp. 3d 340, 346–47 (S.D.N.Y Mar. 31, 2019).
248
Id. at 346.
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$250,000,
249
but the fact the court denied ATB Coin’s motion to dismiss
indicated it was plausible cryptocurrencies sold through ICOs constitute
securities.
250
On its part, the SEC asserted that cryptocurrencies, including
those offered through an ICO, constitute securities after it charged Ripple
Labs Inc. for selling its cryptocurrency, XRP.
251
3. SEC v. Ripple Labs, Inc.
[66] In its filing against Ripple Labs, the SEC alleged that Ripple Labs
engaged in three types of unregistered XRP offers and sales: (1)
“Institutional Sales” to sophisticated buyers (such as hedge funds) under
written contracts amounting to $728 million; (2) “Programmatic Sales,”
which were $757 million in public sales to public buyers on digital asset
exchanges; and (3) “Other Distributions,” which reference $609 million
worth of XRP distributions to employees as compensation and to third
parties to develop new applications for XRP.
252
Further, the SEC alleged
Ripple Labs’ former CEO, Christian Larsen, and current CEO, Bradley
Garlinghouse, engaged in the unregistered sale of securities in their
individual capacities on digital asset exchanges.
253
And lastly, the SEC also
alleged that Larsen and Garlinghouse aided and abetted Ripple’s Section 5
violations.
254
249
Samuel Haig, Lead Plaintiff Settles Class Action Targeting $20 Min ICO for
$250,000, COINTELEGRAPH (Apr. 12, 2020), https://cointelegraph.com/news/lead-
plaintiff-settles-class-action-targeting-20-mln-ico-for-250-000 [https://perma.cc/MZW3-
TETX].
250
Balestra v. ATBCOIN, LLC, 380 F. Supp. 3d 340, 351 (S.D.N.Y Mar. 31, 2019).
251
SEC Press Release, supra note 171.
252
SEC v. Ripple Labs, Inc., No. 1:20-CV-10832, 2023 U.S. Dist. LEXIS 120486
(S.D.N.Y. July 13, 2023).
253
Id.
254
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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[67] Ripple Labs responded to the allegations by making a nuanced
argument, asserting that XRP failed to constitute a security under the Howey
test because it lacked the “essential ingredients.”
255
According to Ripple
Labs, every investment contract case prior to 1933 involved an actual
contract, imposed post-sale obligations on the promoter, and gave the
investor a right to receive profits (the “essential ingredients”).
256
Ripple
Labs argued these characteristics do not apply to XRP and no Supreme
Court or Second Circuit Court of Appeals case since Howey has held that
an investment contract exists without these three essential characteristics.
257
Ripple Labs—and Larsen and Garlinghouse—also raised a fair notice
defense under the Due Process Clause of the Fourteenth and Fifth
Amendments to the U.S. Constitution, which requires the language of
criminal statutes be sufficiently clear to objectively give fair notice of what
is prohibited.
258
Nevertheless, the main issue was whether Ripple Labs’
XRP transactions constituted investment contracts under the Howey test.
[68] On July 13, 2023, the U.S. District Court for the Southern District
of New York issued its much anticipated order in response to the cross-
motions for summary judgment, granting and denying both motions in
part.
259
The court rejected Ripple Labs’ “essential ingredients” analysis, and
instead applied the three-prong version of the Howey test to each type of
transaction at issue.
260
255
Def.’s Reply Supp. Mot. Summ. J. at 13.
256
Ripple Labs, 2023 U.S. Dist. LEXIS 120486, at *20.
257
Def.’s Reply Supp. Mot. Summ. J. 6–7.
258
Ripple Labs, 2023 U.S. Dist. LEXIS 120486, at *43.
259
Id.
260
Id. at *11–*19.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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[69] Under the three-prong version of the Howey test, an investment
contract is “a contract, transaction[,] or scheme whereby a person [(1)]
invests his money [(2)] in a common enterprise and (3) is led to expect
profits solely from the efforts of the promoter or a third party.”
261
The first
prong merely requires a payment by someone to “provide capital” or “put
up their money.”
262
The second prong requires the invested capital to be
pooled together, such that the investors and enterprise share risk, and that
the “fortunes of each investor are tied to the fortunes of other investors, as
well as to the success of the overall enterprise.”
263
Under the third prong,
the court analyzes communications made to investors to determine whether
they would reasonably expect to profit from the enterprise’s efforts.
264
[70] After considering the “economic reality and totality of
circumstances surrounding the offers and sales of the underlying asset[,]”
265
the court concluded the Institutional Sales constituted investment contracts,
while the Programmatic Sales and Other Transactions did not.
266
[71] The court first concluded that Ripple Labs’ offers and sales of XRP
to Institutional Buyers constituted investment contracts.
267
As to the first
prong, the court held that the institutional buyers’ payments in fiat and other
currencies in exchange for XRP constituted an investment, regardless of
261
Id. at *18.
262
Id.
263
Ripple Labs, 2023 U.S. Dist. LEXIS 120486, at *26–*27.
264
Id. at *19.
265
Id. at *22.
266
Id. at *35, *39, *41.
267
Id. at *35.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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whether the Institutional Buyers had an intent to make an investment.
268
Under the second prong of the Howey test, a common enterprise existed due
to Ripple Labs’ conduct after the sales: Ripple Labs pooled its investors’
assets together by failing to segregate and separately manage investor funds,
and Ripple Labs’ success was tied to the Institutional Buyers’ profits.
269
And third, the court held that the Institutional Buyers had a reasonable
expectation of profits to be derived from Ripple’s efforts based off Ripple’s
communications, which involved a marketing campaign for Institutional
Buyers and quarterly market reports touting XRP’s potential value.
270
By
satisfying all three prongs of the Howey test, “Ripple’s Institutional Sales
of XRP constituted the unregistered offer and sale of investment contracts
in violation of Section 5 of the Securities Act.”
271
[72] The court next examined Ripple’s “Programmatic Sales” of XRP
and held that these sales failed to constitute investment contracts under the
third prong of the Howey test.
272
The Programmatic Sales were blind bid/ask
transactions on digital asset exchanges. In conducting its Programmatic
Sales, “Ripple did not make any promises or offers because Ripple did not
know who was buying the XRP, and the purchasers did not know who was
selling it.”
273
According to the court, even if these investors expected to
profit off their investments, such buyers “could not have known if their
payments of money went to Ripple, or any other seller of XRP.”
274
In this
268
Ripple Labs, 2023 U.S. Dist. LEXIS 120486, at *26.
269
Id. at *27–*28.
270
Id. at *30–*31.
271
Id. at *35.
272
Id.
273
Ripple Labs, 2023 U.S. Dist. LEXIS 120486, at *37.
274
Id. at *35–*36.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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blind, bid/ask transaction context, “the economic reality is that a
Programmatic Buyer stood in the same shoes as a secondary market
purchaser who did not know to whom or what it was paying its money.”
275
Thus, the buyers could not reasonably expect for Ripple to use any capital
it received to improve the XRP network—thereby increasing the XRP price.
And even if some Programmatic Buyers reasonably expected to derive
profit from Ripple’s efforts, “[t]he inquiry is an objective one focusing on
the promises and offers made to investors; it is not a search for the precise
motivation of each individual participant.”
276
In short, the Programmatic
Sales failed to constitute investment contracts under the third prong of the
Howey test.
[73] The $609 million worth of “Other Transactions,” which was Ripple
Labs’ book value for the XRP it paid to employees and third parties, also
failed to constitute investment contracts.
277
These payments failed under the
first prong of the Howey test, which requires a payment of money.
278
The
SEC argued these payments constituted an indirect public offering because
the parties receiving XRP in these Other Transactions were free to transfer
their XRP to another holder.
279
Nevertheless, the court rejected this
argument because “the payment of money for these XRP sales never traced
back to Ripple, and the Court cannot make such a finding.”
280
As a result,
275
Id. at *36.
276
Id. at *37.
277
Id. at *39–*40.
278
Ripple Labs, 2023 U.S. Dist. LEXIS 120486, at *40.
279
Id. at *41.
280
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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“Ripple’s Other Distributions did not constitute the offer and sale of
investment contracts.”
281
[74] Lastly, the court applied the Howey test to the XRP sales made by
Ripple Labs CEOs, Larsen and Garlinghouse, in their individual
capacities.
282
From 2013 to 2020, Larsen sold $450 million worth of XRP
he retained after founding the XRP blockchain. Garlinghouse sold $150
million worth of XRP from 2017 to 2020, some of which was earned as
compensation.
283
The court concluded that these sales failed under the third
Howey prong, like the Programmatic Sales.
284
These sales were conducted
on various digital asset exchanges in blind bid/ask transactions—Larsen and
Garlinghouse did not know to whom they sold the XRP, and the buyers did
not know the identity of the seller.
285
“Thus, as a matter of law, the record
cannot establish the third Howey prong as to these transactions.”
286
[75] In sum, the court concluded Ripple’s sales to Institutional Buyers
constituted investment contracts, while neither the Other Transactions nor
any of the defendants’ sales on digital asset exchanges constituted
investment contracts.
287
[76] The court rejected the defendants’ fair notice defense as to the
Institutional Sales and denied both parties’ motions for summary judgment
281
Id.
282
Id. at *41–*42.
283
Ripple Labs, 2023 U.S. Dist. LEXIS 120486, at *10.
284
Id.
285
Id. at *42.
286
Id.
287
Id. at *35, *39, *41.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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as to the aiding and abetting charges against Larsen and Garlinghouse.
288
On October 19, 2023, the SEC stipulated and agreed to dismiss the aiding
and abetting claims against Garlinghouse and Larsen, which Ripple’s Chief
Legal Officer described as a “surrender by the SEC.”
289
The SEC will likely
appeal, but the Ripple Labs decision was viewed as a huge win in the crypto
industry.
[77] The Ripple Labs decision seemed to give a clear answer that
cryptocurrencies sold through ICOs constitute investment contracts,
whereas cryptocurrencies sold through digital asset exchanges do not. This
clarity was short-lived, however. The SEC filed for an interlocutory appeal,
and in denying the SEC’s motion, the Ripple Labs court asserted that the
SEC misconstrued her holding to mean “offers and sales on crypto asset
trading platforms cannot create a reasonable expectation of profits based on
the efforts of others[.]”
290
Judge Torres made clear that her rulings applied
only in the Ripple case because they were based on "the totality of the
circumstances . . . , including an examination of the facts, circumstances,
and economic realities of the transactions[.]”
291
[78] Thus, the Ripple Labs decision can be properly read as requiring
judges to examine the facts, circumstances, and economic realities of the
transactions to determine whether a cryptocurrency is a security, a
commodity, or neither.
292
This judge-made line drawing fails to provide
288
Ripple Labs, 2023 U.S. Dist. LEXIS 120486, at *44, *46.
289
Katherine Ross, No trial: SEC moves to dismiss charges against Ripple’s
Garlinghouse, Larsen, BLOCKWORKS (Oct. 19, 2023 at 5:32 PM), https://blockworks.co/
news/sec-drops-dismisses-garlinghouse-case [https://perma.cc/Y3VT-H96V].
290
SEC v. Ripple Labs, Inc., No. 1:20-CV-10832, 2023 U.S. Dist. LEXIS 178300 at
*12–*13 (S.D.N.Y. Oct. 3, 2023).
291
Id. at *13.
292
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
100
clear guidance to those in the cryptocurrency industry, especially when
judges in the same district as the Ripple Labs court have declined to follow
the decision.
293
All the while, the SEC and CFTC have continued to assert
their jurisdiction over cryptocurrency exchanges, including against
Coinbase and Binance.
294
Congressional action is needed.
4. Current Congressional Efforts
[79] The 118
th
Congress have introduced a number of bills on
cryptocurrency, but there are two main pieces of legislation this paper will
cover: the Financial Innovation and Technology for the 21st Century Act,
295
and the Lummis-Gillibrand Responsible Financial Innovation Act.
296
a. The Financial Innovation and Technology for
the 21st Century Act
[80] The Financial Innovation and Technology for the 21st Century Act
(the “FIT Act”) was introduced on July 20, 2023 by Representatives Glenn
293
Toby Galloway & Jamie Lacy, Federal Court in Terraform Labs Rejects Ripple
Decision, JDSUPRA (Aug. 1, 2023), https://www.jdsupra.com/legalnews/federal-court-in-
terraform-labs-rejects-9576629/ [https://perma.cc/U6XS-YRY6].
294
Press Release, SEC, SEC Charges Coinbase for Operating as an Unregistered
Securities Exchange, Broker, and Clearing Agency (June 6, 2023), https://www.sec.gov/
news/press-release/2023-102 [https://perma.cc/A2K6-66D8]; Press Release, SEC, SEC
Files 13 Charges Against Binance Entities and Founder Changpeng Zhao (June 5, 2023),
https://www.sec.gov/news/press-release/2023-101 [https://perma.cc/JR34-JBEF].
295
See Financial Innovation and Technology of the 21st Century Act, H.R. 4763, 118th
Cong. (2023).
296
See Lummis-Gillibrand Responsible Financial Innovation Act, S. 2281, 118th Cong.
(2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
101
Thompson, French Hill, and Dusty Johnson.
297
The bill provides a
definition for “digital commodity”
298
and establishes certain qualitative and
quantitative thresholds for a blockchain network to determine whether a
digital asset will be regulated by the SEC or the CFTC.
299
The FIT Act
focuses on two key principles, functionality and decentralization, “[t]o
clarify how the Supreme Court’s Howey Test applies to digital assets.”
300
[81] The FIT Act provides the CFTC with primary jurisdiction over
digital assets and digital asset markets.
301
When a blockchain network is
both “functional” and certified as “decentralized,”
302
as those terms are
defined in the Act, the asset on the blockchain network constitutes a “digital
commodity.”
303
Digital commodity issuers and intermediaries must register
with the CFTC.
304
The SEC has jurisdiction over “Restricted Digital
Assets,” which are digital assets on blockchain networks lacking
functionality or certification of decentralization or are digital assets in the
297
Press Release, French Hill, Representative, Reps. Hill, Thompson, Johnson Introduce
Financial Innovation and Technology for the 21st Century Act (July 20, 2023),
https://hill.house.gov/news/documentsingle.aspx?DocumentID=9157
[https://perma.cc/E958-QNY2].
298
See H.R. 4763. at § 101.
299
Id.
300
Press Release, H. Fin. Servs. Comm., McHenry Delivers Opening Remarks at Historic
Markup of Comprehensive Digital Asset Market Structure Legislation (July 26, 2023),
https://financialservices.house.gov/news/documentsingle.aspx?DocumentID=408928#:~:t
ext=%E2%80%9CTo%20clarify%20how%20the%20Supreme,not%20developed%20in
%20a%20vacuum [https://perma.cc/VX6B-3DZ4].
301
See H.R. 4763.
302
Id. at § 101.
303
Id.
304
Id. at § 404.
Richmond Journal of Law & Technology Volume XXX, Issue 1
102
hands of its issuer.
305
Thus, the determining factors in applying the FIT
Act’s regulatory scheme to digital assets are functionality and
decentralization. As explained below, functionality examines whether the
blockchain operates, while decentralization focuses on digital asset
ownership and control over the blockchain, among other things.
306
[82] A “functional network” is a blockchain network that allows
participants to either (i) use its network to transmit and store value on the
blockchain, (ii) participate in services or applications on the network, or (iii)
participate in the decentralized governance of the blockchain system.
307
Thus, for commodity treatment, a blockchain network must have some
functionality in terms of currency, operate services or applications, or
provide voting rights.
308
After constituting a functional network, the digital
asset must also be on a “decentralized network,”
309
as defined below.
[83] Under the FIT Act, a “decentralized network”
310
is a blockchain
network where:
(i) during the 12-months prior to issuance, no person had
the unilateral authority to control or materially alter the
functionality or operation of the blockchain system;
(ii) no digital asset issuer or affiliated person (relates to
ownership) beneficially owned, in the aggregate,
305
Id. at §§ 101, 301.
306
See H.R. 4763, at § 101.
307
Id.
308
Id.
309
Id.
310
Id. at § 101.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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20% or more of the total amount of units of such
digital asset or had the ability to do so;
(iii) during the 3-month period prior to issuance, the digital
asset issuer or any related person has not altered the
blockchain’s source code, unless to address
vulnerabilities or adopted through consensus (consensus
is when token holders approve a software update through
a decentralized governance system);
(iv) during the 3-month period prior to issuance, neither any
digital asset issuer nor any affiliated person has marketed
to the public the digital assets as an investment (focusing
on communications made to the public by the enterprise
or any affiliated persons); and
(v) during the previous 12-month period, all issuances of
units of such digital asset through the programmatic
functioning of the blockchain system were end user
distributions (end user distributions are issuances
involving no money for consideration and are incentive-
based; air drops and staking and mining rewards would
presumably be end user distributions).
311
[84] In toto: the “decentralized network” definition: (i) examines whether
someone has unilateral control over the blockchain network’s operability,
(ii) establishes ownership thresholds for issuers and affiliated people, (iii)
disallows the digital asset issuer or its employees changing the network’s
code within three months prior to issuance (with exceptions), (iv) disallows
the issuer or any affiliated person to market the asset as an investment for
three months before issuance, and (v) permits programmatic issuance
through end user distributions, which are presumably air drops and staking
311
See H.R. 4763, at § 101.
Richmond Journal of Law & Technology Volume XXX, Issue 1
104
and mining rewards.
312
Once a blockchain network is decentralized, a
person can file the certification of decentralization.
313
[85] The FIT Act permits digital asset issuers to file a certification of
decentralization with either the CFTC or the SEC.
314
But the Act makes it
unlawful to act as a digital commodity broker or dealer without registering
with the CFTC, and imposes registration requirements similar to existing
securities laws if the asset is a restricted digital asset.
315
In line with the
definition of “decentralized network,” the certification of decentralization
details the blockchain network’s activities, development history, and
ownership.
316
After a certification of decentralization is filed, the SEC has
thirty days to rebut a certification if they determine the blockchain system
is not a decentralized network.
317
The CFTC has twenty business days to do
so (or two days if an intermediary is filing for an asset on a network with
certification of decentralization).
318
If these deadlines are passed and neither
commission raises an objection, then the filing becomes effective with the
CFTC,
319
and the SEC considers the network a decentralized network.
320
312
Id.
313
Id. at §§ 204, 403–04.
314
Id. at §§ 204, 403.
315
Id. at §§ 303, 305, 403–04.
316
See H.R. 4763, at §§ 204, 403.
317
Id. at § 204.
318
Id. at § 403.
319
Id.
320
Id. at § 204.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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[86] The FIT Act grants the SEC and CFTC broad discretion in
determining how frequently—and to what extent—they will require
reporting from digital asset brokers and dealers, and from digital
commodity brokers and dealers.
321
Digital asset brokers and dealers, as well
as digital commodity brokers and dealers, are required to “meet such
minimum capital requirements as the Commission may prescribe to ensure”
the broker or dealer is able to, at all times, fulfill its customers’
obligations.
322
The reporting requirements’ frequency and intensity are left
up to the commissions, but the commissions can require any information
they consider necessary, and the digital asset issuers and intermediaries
must make continued reporting “as the Commission may require.”
323
Further, the FIT Act requires any intermediary dealing in customer’s
restricted digital assets or digital commodities to hold such assets with a
qualified custodian, such as a bank.
324
[87] The FIT Act’s principles in determining whether the SEC and/or the
CFTC should have jurisdiction over a digital asset utilizes similar rationale
to the court’s holding in Ripple Labs. In theory, if a blockchain network is
functional, people purchasing digital assets on the blockchain could
purchase the asset to participate in the blockchain system, rather than with
an expectation to earn a profit. And even if someone reasonably expected
to profit from their purchase, if the blockchain is decentralized, the
speculative investor cannot reasonably expect to derive their profit from the
efforts of an ongoing common enterprise.
325
Further, end user distributions
321
See H.R. 4763, at §§ 306, 401.
322
Id. at §§ 306, 406.
323
Id.
324
Id. at §§ 304, 306, 406.
325
Id. at § 101.
Richmond Journal of Law & Technology Volume XXX, Issue 1
106
are transactions without money, so these issuances would fail under the first
prong of the Howey test.
326
[88] Although the rationale is similar, applying the FIT Act to the facts
in Ripple Labs would produce a much different result. First, the XRP sold
in the Institutional Sales would constitute restricted digital assets under FIT
because the Ripple Labs founders retained 20 billion out of the 100 billion
(20%) XRP supply,
327
so the network lacked decentralization under the FIT
Act.
328
The XRP sold through Programmatic Sales—the transactions
conducted on crypto exchanges—would constitute restricted digital assets
due to the lack of decentralization, but FIT provides a path to obtaining
commodity treatment: functionality, decentralization, and certification of
decentralization.
329
The XRP paid to employees in the Other Distributions
would constitute restricted digital assets because the employees and third
parties receiving the XRP constitute related persons under the FIT Act.
330
But, under the FIT Act, the XRP would constitute a restricted asset only for
twelve months after receiving the asset, or whenever the XRP Ledger
achieves functionality and certification of decentralization.
331
And lastly,
only some of the XRP Garlinghouse and Larsen sold would constitute
restricted digital assets due to lack of decentralization: after retaining 20%
of the XRP supply, the aggregate ownership between affiliated persons
presumably fell below 20% after the first wave of sales. Under the FIT Act,
Ripple would need to register with the SEC to dispossess any XRP through
326
SEC v. Ripple Labs, Inc., No. 1:20-CV-10832, 2023 U.S. Dist. LEXIS 120486, at *41
(S.D.N.Y. July 13, 2023).
327
Id. at *6–*7.
328
See H.R. 4763, at § 101.
329
Id.
330
Id.
331
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
107
sales or as compensation, or achieve functionality and certification of
decentralization and register with the CFTC.
332
[89] The FIT Act also contemplates situations when a single
intermediary deals in restricted digital assets and digital commodities.
Section 105 of the FIT Act directs the SEC and CFTC to issue joint
rulemakings to prevent duplicative or unduly burdensome reporting
requirements.
333
Further, Section 503 establishes a CFTC-SEC Joint
Advisory Committee on Digital Assets, which would be responsible for
issuing rules and regulations to further the regulatory harmonization
between the two Commissions.
334
[90] The FIT Act is effective in giving objective measures to determine
whether a digital asset is regulated by the CFTC or the SEC, rather than
applying the Howey test to each transaction. It is a comprehensive bill and,
on top of providing a clear regulatory framework, it imposes registration
and reporting requirements on crypto intermediaries, as well as capital
requirements.
335
With the reporting and capital requirements, the FIT Act
grants the CFTC and SEC with discretion in what to impose.
336
Further, the
FIT Act provides several opportunities for the SEC and CFTC to work
332
Id.
333
H.R. 4763, at § 105.
334
See id. at § 503.
335
See e.g., id.
336
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
108
together to ensure the regulatory system is not unduly burdensome. Despite
its positive traits, the bill is not without criticisms.
337
[91] In the Financial Services Committee’s markup meeting for the FIT
Act, Representative Maxine Waters claimed the bill creates more confusion
than provides clarity and offers fewer protections to consumers and
investors than the existing securities laws.
338
Representative Waters
described the bill as “the wish-list of big crypto” and “undeserving of any
of our support.”
339
Nevertheless, on July 26, 2023, the Financial Services
Committee passed the FIT Act out of Committee, which is the first time a
crypto-focused regulatory Act has been voted out of any committee in the
House or Senate.
340
Next, the FIT Act will go to the House Floor for debate.
[92] In the Senate wing of the Capitol Building, Senators Lummis and
Gillibrand have introduced the Responsible Financial Innovation Act
(RFIA).
341
337
Victor Alexander, FIT Crypto Bill Criticized by Democrats, INSIDE BITCOINS (July 28,
2023), https://insidebitcoins.com/news/fit-crypto-bill-criticized [https://perma.cc/X6KM-
N6SB]; Victor Alexander, House Bill May Endanger Crypto Prospects and Strengthen
the SEC, INSIDE BITCOINS (July 23, 2023), https://insidebitcoins.com/news/house-bill-
may-endanger-crypto-prospects-and-strengthen-the-sec [https://perma.cc/C94H-G4CX].
338
Press Release, H. Fin. Servs. Comm., Ranking Member Waters Delivers Opening
Statement at Full Committee Markup (July 26, 2023), https://democrats-
financialservices.house.gov/news/documentsingle.aspx?DocumentID=410718
[https://perma.cc/A6ML-ZNU6].
339
Id.
340
Kristin Smith, The FIT Act Is the Most Comprehensive Crypto Regulation Ever Voted
on by Congress, COINDESK (Aug. 16, 2023, 7:00 AM), https://www.coindesk.com/
consensus-magazine/2023/08/16/the-fit-act-is-the-most-comprehensive-crypto-
regulation-ever-voted-on-by-congress/ [https://perma.cc/YXJ6-YB44].
341
Lummis-Gillibrand Responsible Financial Innovation Act, S. 2281, 118th Cong.
(2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
109
b. The Responsible Financial Innovation Act
[93] Last year, during the 117th Congressional session, Senators Lummis
and Gillibrand introduced the RFIA.
342
The Senators reintroduced the RFIA
this year with several changes to the previous version,
343
but the main
regulatory scheme between the SEC and the CFTC remains the same: The
CFTC will have jurisdiction over “crypto assets” and “crypto asset
exchanges,” while the SEC retains its jurisdiction over securities.
344
[94] The RFIA grants the CFTC with primary jurisdiction over crypto
assets, crypto asset exchanges, and crypto asset transactions.
345
All crypto
asset exchanges must register with the CFTC as such.
346
The RFIA attempts
to make a clear distinction between assets that are commodities or securities
by examining the rights or powers conveyed to customers.
347
Specifically,
if a digital asset provides its holder with a debt or equity interest, liquidation
rights, a right to a dividend payment, or other financial interest in a business
342
Lummis-Gillibrand Responsible Financial Innovation Act, S. 4356, 117th Cong.
(2022).
343
Press Release, Kirsten Gillibrand, Senator, Lummis, Gillibrand Reintroduce
Comprehensive Legislation To Create Regulatory Framework For Crypto Assets (July
12, 2023), https://www.lummis.senate.gov/wp-content/uploads/Whats-New-in-Lummis-
Gillibrand-2023-Final.pdf [https://perma.cc/59AN-FSNB] [hereinafter Press Release,
Gillibrand] (click on “here” after “For a look at what’s new in this version of the bill” at
the bottom of the page).
344
S. 2281, at §§ 403–04.
345
Id. at § 501.
346
Id. at § 404.
347
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
110
entity, the asset would be subject to the SEC’s jurisdiction.
348
The RFIA
considers situations when cryptocurrencies are “ancillary assets,” which is
when cryptocurrency is issued to a purchaser under an investment
contract.
349
When a cryptocurrency is provided to a purchaser under an
investment contract as an ancillary asset, the ancillary asset itself is not
necessarily a security.
350
The CFTC would have jurisdiction over ancillary
assets that fall within its definition of digital asset, but the Bill also imposes
disclosure requirements on issuers of such ancillary assets and gives the
SEC jurisdiction over the disclosure requirements.
351
[95] While it appears to be a relatively straightforward regulatory regime,
the RFIA also “[c]odifies the existing Howey test, as interpreted by the
Federal courts over the last eighty years.”
352
The differing results from
applying the Howey test to cryptocurrencies is one of the main reasons why
clear regulation was so necessary.
[96] The RFIA falls short of providing the ideal regulatory clarity
investors and developers seek because there remains ambiguity in
determining whether an asset is a commodity, a security, or an ancillary
asset. However, in situations involving both an investment contract and an
348
Lummis-Gillibrand Responsible Financial Innovation Act: An Overview of New
Provisions in the Reintroduced Bill, GIBSON DUNN (Aug. 22, 2023),
https://www.gibsondunn.com/lummis-gillibrand-responsible-financial-innovation-act-an-
overview-of-new-provisions-in-the-reintroduced-bill/ [https://perma.cc/G4LZ-JP4L].
349
Press Release, Gillibrand, supra note 343 (click on “here” after “For a section by
section of the bill” at the bottom of the page).
350
S. 228, at § 501.
351
Id.
352
Press Release, Gillibrand, supra note 343 (click on “here” after “For a section by
section of the bill” at the bottom of the page).
Richmond Journal of Law & Technology Volume XXX, Issue 1
111
ancillary asset, the CFTC would have jurisdiction over the asset, while the
SEC would have jurisdiction over the issuer’s reporting requirements.
353
[97] The previous version of the RFIA tasked the CFTC and SEC with
studying, reporting, and developing a proposal for a new self-regulatory
organization (SRO) between the two agencies to oversee cryptocurrency
markets.
354
According to Senator Gillibrand, an SRO between the two
organizations “can play a complementary role, working with regulators to
allow them to be more nimble and efficient, while maintaining strong
supervision.”
355
Although Senator Lummis’s press release fails to address
the lack of a SRO in the new RFIA,
356
this new version creates an Advisory
Committee on Financial Innovation, which will study and report to
regulators any evolutions in the crypto asset market.
357
[98] If the RFIA is passed, it would codify the existing issue with the
United States’ current regulatory scheme: attempting to apply the Howey
test to assets without clear, objective measures to determine whether a
cryptocurrency is a commodity, a security, or something entirely different.
Nonetheless, even if the CFTC has original jurisdiction over all
cryptocurrencies, it is unlikely the CFTC can effectively oversee the
353
S. 2281, at § 501.
354
See Press Release, Kirsten Gillibrand, Senator, Lummis, Gillibrand Introduce
Landmark Legislation to Create Regulatory Framework for Digital Assets (June 7, 2022),
https://www.gillibrand.senate.gov/news/press/release/lummis-gillibrand-introduce-
landmark-legislation-to-create-regulatory-framework-for-digital-assets/
[https://perma.cc/PR3C-TFM6].
355
Id.
356
Id.
357
S. 2281, at § 908.
Richmond Journal of Law & Technology Volume XXX, Issue 1
112
cryptocurrency markets due to its lack of resources.
358
“The CFTC was
underfunded when I was there,” according to former CFTC Chair Timothy
Massad, who claimed the CFTC “didn’t have the resources to do things that
we really needed to do.”
359
FTX was a registered exchange with the CFTC,
for example, and the CFTC failed to proactively protect investors against
FTX’s fraudulent activity.
360
[99] The RFIA is not without merit, though, especially in the consumer
protection realm. Both bills require crypto exchanges to have a Chief
Compliance Officer and to institute risk management functions.
361
The
RFIA goes a step further by requiring crypto intermediaries to maintain
proof of reserves and undergo an annual verification.
362
Under the RFIA,
auditors would go through an exchange’s total balance of customer assets
and ensure the exchanges have an equal (or greater) amount of assets to
cover all potential customer withdrawals.
363
Requiring proof of reserves on
358
Fran Velasquez, Former CFTC Chair: Here’s How SEC and CFTC Can Work
Together to Regulate Crypto, COINDESK,
https://www.coindesk.com/policy/2022/08/22/former-cftc-chair-heres-how-sec-and-cftc-
can-work-together-to-regulate-crypto/ [https://perma.cc/MV54-L83E] (last updated May
11, 2023, 2:39 PM).
359
Id.
360
Dennis M. Kelleher, Crypto, FTX, Sam Bankman-Fried, SEC, CFTC, Banking
Regulators and the Revolving Door, BETTER MARKETS, 6 (Mar. 8, 2023),
https://bettermarkets.org/wp-content/uploads/2022/11/Better_Markets_FTX_
FactSheet.pdf [https://perma.cc/JAK5-K4AN].
361
See S. 2281, at § 404; Financial Innovation and Technology of the 21st Century Act,
H.R. 4763, 118th Cong. (2023), at §§ 404, 406.
362
S. 2281, at § 203.
363
Id. at § 404.
Richmond Journal of Law & Technology Volume XXX, Issue 1
113
an annual basis is a secure and transparent way to ensure customer funds
are safe, and arguably could have prevented the FTX scandal.
364
[100] In sum, some cryptocurrencies fall under the broad definition of
commodities, and the CFTC has exerted its jurisdiction over
cryptocurrencies when there are futures contracts or fraud involved. The
SEC believes most cryptocurrencies (besides Bitcoin) constitute securities.
There are two pieces of legislation introduced in Congress that would grant
the CFTC with main jurisdiction over cryptocurrencies but retain the SEC’s
jurisdiction over digital assets in certain circumstances.
365
The RFIA
utilizes the existing Howey test to determine whether a cryptocurrency
constitutes a security, while the FIT Act provides quantitative and
qualitative measures to determine whether a digital asset constitutes a
digital commodity or a restricted digital asset.
[101] While the next section discusses how cryptocurrencies are taxed,
Section V will offer suggestions on how the U.S. should regulate the
cryptocurrency industry in the future.
IV. HOW THE UNITED STATES TAXES CRYPTOCURRENCY
[102] Although Bitcoin was created in 2009, cryptocurrency investors had
to wait until 2014 before the Internal Revenue Service (IRS) provided any
guidance on how cryptocurrency would be taxed.
366
The IRS released
Notice 2014-21, which provided—most importantly—that cryptocurrencies
are taxed as “property,” and that cryptocurrency earned from mining on a
364
Frederick Munawa, ‘Proof of Reserves’ Emerges as a Favored Way to Prevent
Another FTX, COINDESK (Nov. 17, 2022 at 4:58 PM), https://www.coindesk.com/
tech/2022/11/17/proof-of-reserves-emerges-as-a-favored-way-to-prevent-another-
ftx/#:~:text=If%20in%20place%20at%20FTX,Fried's%20trading%20firm%20Alameda%
20Research) [https://perma.cc/P344-HNXA].
365
See e.g., S. 2281; H.R. 4763.
366
I.R.S. Notice 2014-21, 2014-1 C.B. 938.
Richmond Journal of Law & Technology Volume XXX, Issue 1
114
PoW blockchain is includible in a taxpayer’s gross income.
367
As discussed
below, treating cryptocurrency as property for federal income taxation
purposes results in a double-taxation that other currencies are not subject
to.
368
The IRS has recently increased its focus on preventing tax evasion
through cryptocurrency.
369
However, many substantive questions remain on
how the United States will tax certain cryptocurrency activities.
A. IRS Notice 2014-21
[103] IRS Notice 2014-21 announced to United States taxpayers that
“convertible” virtual currencies (virtual currencies that have an equivalent
value in real currency) are considered “property” for federal income tax
purposes.
370
The IRS listed Bitcoin as an example of a convertible virtual
currency, while Ethereum (ETH) and Ripple (XRP) would also classify as
convertible virtual currencies.
371
Under federal tax law, taxing an asset as
“property” means the asset is given capital treatment, like a security.
372
Cryptocurrency holders in the United States must find their basis in the asset
when they acquire it, which is the cost of acquiring the cryptocurrency.
When cryptocurrency is sold or otherwise dispossessed, taxpayers must
calculate their capital gains or losses.
373
367
Id.
368
See id.
369
Press Release, U.S. Dep’t of the Treasury, IRS Release Proposed Regulations on Sales
and Exchanges of Digital Assets by Brokers (Aug. 25, 2023), https://home.treasury.gov/
news/press-releases/jy1705 [https://perma.cc/7YB8-FCQZ].
370
I.R.S. Notice 2014-21, 2014-1 C.B. 938.
371
Id.
372
26 U.S.C. § 1221.
373
26 U.S.C. § 1001.
Richmond Journal of Law & Technology Volume XXX, Issue 1
115
1. Taxing “Property”
[104] Because cryptocurrencies are treated as property for tax purposes,
crypto is subject to capital gains and losses rules.
374
When someone trades,
sells, or otherwise dispossesses cryptocurrency, they must calculate their
capital gains or losses realized on the exchange by subtracting their basis in
the property from their amount realized.
375
Taxpayers can deduct up to
$3,000 of capital losses against their ordinary income, and losses in excess
of $3,000 can be offset only against any capital gains the taxpayer
recognized.
376
If a taxpayer lacks capital gains to offset the capital losses in
excess of $3,000, the capital losses must be carried over to the next taxable
year.
377
[105] To illustrate how “property” is taxed, consider an individual who
purchased 1,000 ADA on October 25, 2019, when ADA was $.40 each.
378
The individual would have a $400 basis in their ADA, plus any transaction
fees paid to acquire the ADA. If the individual sold their 1,000 ADA on
August 28, 2021, when ADA was $2.85 per coin,
379
the transaction would
result in a $2,450 capital gain (as calculating gain is determined by
subtracting the adjusted basis of $400 from the amount realized of $2,850
to get a $2,450 gain). The taxpayer’s $2,450 gain would be taxed at the
374
Id.
375
Id.
376
26 U.S.C. § 1211.
377
26 U.S.C. § 1212(b).
378
Cardano price, COINMARKETCAP, https://coinmarketcap.com/currencies/cardano/
[https://perma.cc/RV4V-56BC] (last visited Oct. 1, 2023).
379
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
116
preferential, long-term capital gain rate because the individual held the
ADA for over one year.
380
a. Paying for Services with “Property”
[106] If a taxpayer receives cryptocurrency for providing services or
selling goods, then the fair market value of the cryptocurrency received is
includable in the taxpayer’s reportable gross income.
381
This is the same
outcome as when a taxpayer is compensated for goods or services with
United States dollars; however, because cryptocurrency is taxed as
property, taxpayers must also calculate their basis in the cryptocurrency.
382
The taxpayer’s basis in the cryptocurrency is the fair market value of the
cryptocurrency when they receive it.
383
This is the same outcome as when
someone is paid for services with shares in a company.
384
[107] To illustrate: consider a tutor who charges $20 per hour and accepts
ADA as a form of payment. Further, imagine that the tutor has agreed to
give four hours of lessons to our 1,000 ADA investor, beginning on August
28, 2021. The investor prepays for the lessons at the current fair market
value of $2.85 per ADA,
385
which amounts to 28.07 ADA, for the lessons
worth $80 USD. First, the investor dispossessed 28.07 ADA, which
380
26 U.S.C. § 1222.
381
I.R.S. Notice 2014-21, 2014-16 I.R.B. 938–39.
382
Id.
383
Id. at 938.
384
Int'l Freighting Corp. v. Comm'r of Internal Revenue, 135 F.2d 310, 313 (2d Cir.
1943).
385
See generally 26 C.F.R. § 1.61-6 (2023) (applying the general rule of gains derived
from dealings in property to a hypothetical example); Cardano price, supra note 378.
Richmond Journal of Law & Technology Volume XXX, Issue 1
117
constitutes a recognition event under I.R.C. § 1001(a),
386
and had an amount
realized of $80 USD. The investor’s $400 basis in the 1,000 ADA must be
equally apportioned to the 28.07 ADA transferred to the tutor.
387
The
investor’s equally apportioned basis in the 28.07 ADA would be $11.23,
and the investor thus realized a gain of $68.77 on the transaction.
388
The
investor would have to recognize $68.77 in capital gains on their tax returns
and would retain $388.77 of their basis in the 971.93 ADA remaining in
their wallet.
389
[108] The IRS taxes cryptocurrencies like a security rather than a
currency, and the resulting complexities and tax consequences underlying a
simple transaction disincentivize cryptocurrencies’ adoption.
390
Getting
paid in “property” can be equally complicated.
b. Getting Paid with “Property”
[109] This transaction between the investor and the tutor also produces
complex tax consequences to the tutor. The tutor would have to report the
$80 in ADA in their gross income as compensation earned from providing
services,
391
and they would receive an $80 basis in the 28.07 ADA
386
See generally 26 U.S.C. §1001(a).
387
See generally 26 C.F.R. § 1.61-6 (2023).
388
Id.
389
See generally 26 U.S.C. §§ 1001(b)(1)–(2), 1011(a)–(b) (applying the general rule of
gains derived from dealings in property to a hypothetical example).
390
See Katherine Baer et al., Crypto Poses Significant Tax Problems–and They Could Get
Worse, IMF BLOG (July 5, 2023), https://www.imf.org/en/Blogs/Articles/2023/07/05/
crypto-poses-significant-tax-problems-and-they-could-get-worse [https://perma.cc/T6UJ-
VRLX].
391
See generally 26 U.S.C. § 61 (applying the definition of gross income to a
hypothetical example).
Richmond Journal of Law & Technology Volume XXX, Issue 1
118
received.
392
The tutor could hold onto the ADA; however, they might have
to eventually sell some to pay taxes or to pay for goods or services not
accepting ADA. If the tutor sold the 28.07 ADA on an exchange on
December 10, 2021 (when ADA was worth $1.35 per coin—$37.89 in
total),
393
this would be a taxable event.
394
The tutor would have an amount
realized of $37.89 on the sale, thereby yielding a short-term capital loss of
$42.11. The tutor could deduct the $42.11 in capital losses from their
ordinary income because the $42.11 is less than $3,000, the amount of
capital losses permitted to be deducted against ordinary income under
§ 1211(b).
395
If the tutor had many clients paying in cryptocurrency,
however, and had capital losses exceeding the $3,000 threshold, the tutor
would be taxed on the full $80 of ADA under the higher, ordinary income
rates, even after realizing a capital loss.
396
[110] If the tutor recognized a gain when selling the ADA, the tutor would
have to pay capital gains taxes on the capital gains recognized from the sale,
and the $80 in ADA would be taxed as ordinary income earned from
providing services.
397
This simple transaction shows how taxing
cryptocurrency as “property” makes it impractical for cryptocurrency to be
used as an everyday currency. If the investor paid the tutor with $80 USD,
392
See generally id. at § 1011 (applying the general rule of using an adjusted basis for
determining gain or loss to a hypothetical example).
393
Cardano price, supra note 378.
394
See generally 26 U.S.C. § 1001 (applying the general rule of gains derived from
dealings in property to a hypothetical example).
395
See generally 26 U.S.C. § 1211.
396
See generally 26 U.S.C. § 61 (applying the general rule of gains derived from dealings
in property to a hypothetical example).
397
See generally §§ 61, 1001 (applying the general rule of gains derived from dealings in
property to a hypothetical example).
Richmond Journal of Law & Technology Volume XXX, Issue 1
119
the tutor would have $80 in gross income, and that’s it.
398
The investor and
the tutor would both bypass the additional level of taxation at the capital
gains level, even though the USD value is subject to fluctuation, too.
2. Cryptocurrency Earned from Mining
[111] Notice 2014-21 further provides that, when someone operating a
node on a PoW network successfully “mines” cryptocurrency, the fair
market value of the cryptocurrency at the time of receipt is includible in the
taxpayer’s gross income.
399
For example, the aforementioned miner of
Bitcoin block #660000 received $117,370 in Bitcoin for mining the block,
and the same amount would be includible in their gross income.
400
If a
taxpayer’s cryptocurrency mining activities constitute a trade or business,
the mining operation’s net earnings constitute self-employment income and
are subject to the self-employment tax.
401
Some cryptocurrency miners fail
to meet the trade or business standard and thus treat their mining rewards as
ordinary income.
402
Some cryptocurrency mining activities clearly
constitute a business, such as the operations run by Riot, which is a publicly
traded company.
403
Riot mined 5,554 Bitcoin in 2022, which was worth
398
26 U.S.C § 61.
399
I.R.S. Notice 2014-21, 2014-1 C.B. 938.
400
Id.
401
Id.
402
See Miles Brooks, Crypto Mining Taxes: Beginner’s Guide 2023, COINLEDGER (Mar.
27, 2023), https://coinledger.io/blog/how-to-handle-cryptocurrency-mining-on-your-
taxes#frequently-asked-questions-about-crypto-mining [https://perma.cc/37XL-XJ5F].
403
Riot Platforms, Inc. Common Stock (RIOT), NASDAQ, https://www.nasdaq.com/
market-activity/stocks/riot [https://perma.cc/7KFZ-KF35] (last visited Sept. 24, 2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
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around $259.2 million.
404
In January 2023, Riot broke a record by mining
740 Bitcoin in just a month, which was worth approximately $16.8
million.
405
The Bitcoin’s fair market value at the time it is received is
includible in Riot’s gross income.
406
[112] In sum, IRS Notice 2014-21 provides, in part, that cryptocurrencies
are taxed as “property,” and when cryptocurrency is earned from mining
rewards, the cryptocurrencies’ fair market value at the time of receipt is
includible in the taxpayer’s gross income.
407
As a result of the double
taxation scheme inherent in transacting with “property,” it is impractical for
businesses and individuals to adopt cryptocurrency as a form of payment.
408
Further, cryptocurrencies are volatile assets.
409
Including the fair market
404
Press Release, Riot Blockchain, Inc., Riot Reports Full Year 2022 Financial Results,
Current Operational and Financial Results, Current Operational and Financial Highlights
(Mar. 2, 2023), https://www.riotplatforms.com/investors/news-events/press-
releases/detail/147/riot-reports-full-year-2022-financial-results-current
[https://perma.cc/UH3S-KFF6].
405
Press Release, Riot Blockchain, Inc., Riot Produces New All-Time High of 740
Bitcoin in January 2023 and Provides Infrastructure Update (Feb. 6, 2023),
https://www.riotplatforms.com/investors/news-events/press-releases/detail/146/riot-
announces-january-2023-production-and-operations [https://perma.cc/R6NA-279Y];
Andrew Asmakov, Riot Just Mined The Most Bitcoin It Ever Has in a Month, DECRYPT
(Feb. 6, 2023), https://decrypt.co/120672/riot-just-mined-most-bitcoin-ever-has-month
[https://perma.cc/5VGV-BQFF].
406
I.R.S. Notice 2014-21, 2014-16 I.R.B. 938–39.
407
Id. at 938.
408
Katherine Baer et al., Taxing Cryptocurrencies, 12 (IMF Working Paper, WP/23/144,
2023).
409
Edul Patel, From Lack of Regulations To Speculation: Why Crypto Is More Volatile
Than Stocks, ABP LIVE, https://news.abplive.com/business/crypto/from-lack-of-
regulations-to-speculation-why crypto-is-more-volatile-than-stocks-1582538
[https://perma.cc/KGV5-QHVV] (last updated Feb. 16, 2023, 12:49 PM).
Richmond Journal of Law & Technology Volume XXX, Issue 1
121
value of cryptocurrencies earned from mining and performing services in a
taxpayer’s gross income—and receiving a fair market value basis in
cryptocurrency—potentially leads to disastrous tax consequences.
B. More Recent IRS Activity
[113] The IRS published Notice 2014-21 almost a decade ago, and the IRS
has released subsequent Notices and Rulings pertaining to cryptocurrencies
since then.
410
While the IRS has been forced to address complex substantive
tax issues regarding cryptocurrencies, recent IRS efforts have been targeted
towards the complex administrative issues cryptocurrencies pose.
411
1. IRS Revenue Ruling 2019-24
[114] IRS Revenue Ruling 2019-24 announced that any cryptocurrency
“air dropped” to a taxpayer, because of a “hard fork,” is includible in the
taxpayer’s gross income.
412
A hard fork is when a cryptocurrency on a
blockchain undergoes a protocol change, which results in a permanent
diversion from the existing blockchain history, and a new cryptocurrency is
created on the new blockchain.
413
After the hard fork, new cryptocurrency
transactions are recorded on the new blockchain and transactions involving
the “legacy” cryptocurrency are recorded on the legacy blockchain.
414
Sometimes when a blockchain undergoes a hard fork, the blockchain will
“air drop” the new tokens to the legacy token holders.
415
Pursuant to
410
See I.R.S. Notice 2019-2221; Rev. Rul. 2019-24, 2019-44 I.R.B. 1004.
411
See Rev. Rul. 2019-24, 2019-44 I.R.B. 1004.
412
Id.
413
Id.
414
Id.
415
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
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Revenue Ruling 2019-24, when a blockchain network undergoes a hard fork
and airdrops new tokens to U.S. taxpayers, the new airdropped tokens
constitute gross income under IRC § 61.
416
2. Administrative Efforts to Prevent Tax Evasion
[115] The IRS is focusing its administrative efforts on identifying
taxpayers with cryptocurrency holdings.
417
After IRS Notice 2019-132, the
IRS sent letters to virtual currency owners advising them to pay the taxes
they failed to include in prior taxable years.
418
In 2021, 2022 and 2023, the
IRS required taxpayers to answer a new “yes or no” virtual currency
question when taxpayers filed Forms 1040, 1040-SR, and 1040-NR.
419
Taxpayers who disposed of any virtual currency held as a capital asset
through sale, exchange, or transfer must answer “yes,” compute their capital
gains and losses on Form 8949, and report their gain or loss as income on
Schedule D Capital Gains and Losses.
420
[116] The IRS is put in a difficult position here: it is used to dealing with
financial instruments passing through centralized intermediaries, but
cryptocurrency has no such intermediary besides centralized exchanges,
416
See Rev. Rul. 2019-24, 2019-44 I.R.B. 1004.
417
I.R.S. News Release IR-2019-132 (Jul. 26, 2019).
418
Guinevere Moore, Virtual Currency Reality: The IRS Crack Down on Cryptocurrency,
MOORE TAX LAW GROUP (Sept. 2019), https://www.mooretaxlawgroup.com/wp-
content/uploads/sites/1604214/2020/05/jtpp_21-04_moore.pdf [https://perma.cc/86PJ-
DT5S].
419
I.R.S. News Release IR-2023-12 (Jan. 24, 2023).
420
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
123
some of which are not in the United States.
421
Moreover, cryptocurrency
investors could either leave cryptocurrencies in their wallets or bypass
centralized exchanges by using decentralized exchanges and, consequently,
make no reporting on their returns, which is likely what led to Notice 2019-
132.
422
3. IRS Proposed Regulations for Cryptocurrency
Brokers
[117] Most recently, the IRS issued proposed regulations that extend
reporting requirements to cryptocurrency “brokers”.
423
IRC § 6045 requires
every person doing business as a broker to, when required by the Secretary
of Treasury, file an information return with the name and address of each
customer, details regarding gross proceeds, and the adjusted basis of certain
categories of assets sold.
424
Section 80603(a) of the Infrastructure
Investment and Jobs Act amends the § 6045 definition of “broker” to
include any person who, for consideration, provides services effectuating
transfers of digital assets on behalf of other persons.
425
421
John Buhl, Treasury Takes Big-Picture View with Newest Crypto Proposal, TAX
POLICY CENTER (Sept. 19, 2023), https://www.taxpolicycenter.org/taxvox/treasury-takes-
big-picture-view-newest-crypto-proposal [https://perma.cc/C5U8-S9RE].
422
Joyce Beebe, Did You Report Your Bitcoin Income to the IRS?, BAKER INST. (Apr. 10,
2020), https://www.bakerinstitute.org/research/did-you-report-your-bitcoin-income-irs
[https://perma.cc/TPG2-53QR].
423
Gross Proceeds and Basis Reporting by Brokers and Determination of Amount
Realized and Basis for Digital Asset Transactions, 88 Fed. Reg. 59576 (proposed Aug.
29, 2023), https://www.federalregister.gov/documents/2023/08/29/2023-17565/gross-
proceeds-and-basis-reporting-by-brokers-and-determination-of-amount-realized-and-
basis-for [https://perma.cc/8Z69-A6R9].
424
26 U.S.C. § 6045 (2021).
425
88 Fed. Reg. 59576, supra note 423, at 5.
Richmond Journal of Law & Technology Volume XXX, Issue 1
124
[118] In explaining the rationale for the new reporting rules, the IRS says:
Digital assets have grown in popularity as both a payment
method and an investment or trading asset. Proponents
believe that digital assets may offer potential benefits over
traditional fiat currencies, such as lower transactions costs
and faster transaction speeds. Digital assets may also be
popular, however, because the distributed ledger record of
transactions does not include the identity of the parties
involved in the transactions. This pseudonymity creates a
significant risk to tax administration.
426
[119] The IRS will need to continue its efforts in easing the administrative
burdens cryptocurrencies pose, but there are also unresolved substantive tax
issues.
C. Unanswered Questions on How the United States Taxes
Cryptocurrency
[120] There are three substantive, unresolved tax issues covered here: (1)
whether staking rewards are includible in gross income when they are
received; (2) whether cryptocurrency traders can make a mark-to-market
election; and (3) whether investors in crypto assets are permitted to make
an obsolescence of nondepreciable property deduction.
1. Earning Cryptocurrency as Staking Rewards on PoS
Blockchains
[121] As mentioned above, IRS Notice 2014-21 provides that
cryptocurrency earned as mining rewards are includible in the taxpayer’s
426
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
125
gross income when the cryptocurrency is received.
427
In the years since
Notice 2014-21, the IRS has failed to provide any guidance on whether
staking rewards are includible in gross income when they are received.
[122] A Nashville couple, Joshua and Jessica Jarrett (collectively, “the
Jarretts”), purchased Tezos (XTZ) coins and staked the coins with a node
on Tezos’ PoS network.
428
The Jarretts received 8,876 Tezos (XTZ) in
staking rewards during 2019.
429
The Tezos coins were worth $9,407 when
the Jarretts received them, and the Jarretts reported that amount as income
and paid the corresponding income taxes.
430
On July 31, 2020, the Jarretts
filed an amended tax return requesting a $3,793 refund from the IRS.
431
The
Jarretts argued that, under IRC § 1001(a), the virtual currency they earned
as staking rewards failed to constitute taxable income because property is
only taxed when it is sold or dispossessed, rather than when it is created.
432
The Department of Justice ordered the IRS to issue the $3,793 refund to the
Jarretts, but the Jarretts refused the refund because the IRS did not provide
427
Andrea Ben-Yosef, Cryptocurrency stakers must include rewards in gross income
upon gaining control of them, TAX NEWS UPDATE (Aug. 10, 2023),
https://globaltaxnews.ey.com/news/2023-1388-cryptocurrency-stakers-must-include-
rewards-in-gross-income-upon-gaining-control-of-them [https://perma.cc/U2NH-SHJ6].
428
Jarrett v. United States, No. 3:21-CV-00419, 2022 U.S. Dist. LEXIS 178743, at *5
(M.D. Tenn., Sept. 30, 2022).
429
Shehan Chandrasekera, Crypto Couple's Victory Against The IRS Comes At The Cost
Of Regulatory Clarity, FORBES (Mar. 7, 2022, 9:51 AM), https://www.forbes.com/sites/
shehanchandrasekera/2022/03/07/crypto-couples-victory-against-the-irs-comes-at-the-
cost-of-regulatory-clarity/?sh=2a00a56f48f9 [https://perma.cc/A3BH-432X].
430
Id.
431
Id.
432
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
126
its rationale for issuing the refund.
433
The IRS argued the refund rendered
the Jarretts’ action moot and filed a motion to dismiss, which was granted
on September 30, 2022.
434
Thus, taxpayers earning staking rewards on a
PoS blockchain lack clarity on how, if, or when the IRS will tax their
earnings.
2. Whether Cryptocurrency Traders Can Make a Mark-
To-Market Election
[123] Internal Revenue Code (IRC) § 475(f) provides commodities and
securities traders with the option to make a “mark-to-market” election.
435
If
a trader makes a mark-to-market election, all the securities (and/or
commodities) they hold are deemed as sold for their fair market value at the
end of the year, and the taxpayer recognizes ordinary gain or loss associated
with the deemed sales.
436
If the taxpayer has a gain after the deemed sales,
then the taxpayer recognizes ordinary income on the gain. But if the
taxpayer recognizes a loss on the deemed sales, the taxpayer is permitted to
deduct the losses from their ordinary income.
437
The taxpayer still holds the
assets, and each asset’s basis is adjusted to its current fair market value, just
as if the trader sold the assets to themselves. Recharacterizing a capital loss
as an ordinary loss is significant for two reasons: (1) ordinary income is
taxed at a higher rate than capital income, so deductions against ordinary
income are more valuable than deductions against capital income; and (2)
433
Jarrett v. United States, No. 3:21-CV-00419, 2022 U.S. Dist. LEXIS 178743, at *5
(M.D. Tenn., Sept. 30, 2022).
434
Id. at *1.
435
I.R.C. § 475(f).
436
Id.
437
Michael R. Harmon & William N. Kulsrud, Sec. 475 Mark-to-Market Election, THE
TAX ADVISER (Feb. 1, 2010), https://www.thetaxadviser.com/issues/2010/feb/
sec475mark-to-marketelection.html [https://perma.cc/H5V4-Z9NL].
Richmond Journal of Law & Technology Volume XXX, Issue 1
127
taxpayers can typically deduct only up to $3,000 in capital losses against
their ordinary income, and any excess losses are carried forward to the next
taxable year if the taxpayer lacks sufficient capital gains to absorb the
losses.
438
[124] § 475(a) requires securities dealers to use mark-to-market
accounting for all securities held in inventory at the end of the taxable
year.
439
The mark-to-market election, however, is available to commodities
traders and dealers, as well as securities traders.
440
The SEC and the CFTC
have fought over whether cryptocurrencies are securities or commodities,
but the commissions agree Bitcoin is a commodity and acknowledge most
cryptocurrencies either classify as securities or commodities.
441
Nonetheless, cryptocurrency traders and dealers lack uniform guidance on
whether they are permitted to make this, at times, valuable election.
3. Memorandum Number 202302011
[125] Internal Revenue Code § 165 governs losses for United States
taxpayers.
442
One of the losses, permitted by § 165(g), is called the
“worthless securities” deduction.
443
Under § 165(g), if any security
becomes worthless during a taxable year, the loss resulting therefrom shall
438
Julia Kagan, How to Deduct Stock Losses From Your Tax Bill, INVESTOPEDIA, https://
www.investopedia.com/articles/personal-finance/100515/heres-how-deduct-your-stock-
losses-your-tax-bill.asp [https://perma.cc/X8PY-9CPS] (last updated Mar. 31, 2023).
439
26 U.S. § 475(a).
440
Id.
441
Brady Dale, Bitcoin is the only coin the SEC Chair will call a commodity, AXIOS (Jun.
28, 2022), https://www.axios.com/2022/06/28/bitcoin-is-the-only-coin-the-sec-chair-will-
call-a-commodity [https://perma.cc/H292-V86Y].
442
I.R.C. § 165.
443
Id. at § 165(g).
Richmond Journal of Law & Technology Volume XXX, Issue 1
128
be treated as a loss from a sale or exchange if the investor is unwilling or
unable to sell or otherwise dispose of the security in a taxable transaction.
444
Fraud is rampant in the cryptocurrency industry, with developers luring
investors’ capital by promising to build an expert project, only to abandon
the project after receiving investor’s money.
445
As a result, many
cryptocurrency investors have been left with worthless cryptocurrencies,
and taxpayers requested guidance from the IRS as to whether the worthless
securities deduction applies to cryptocurrencies.
446
[126] In January 2023, the IRS Office of Chief Counsel released
Memorandum 202302011, which concluded that cryptocurrency investors
were not permitted a § 165(g) deduction because cryptocurrencies do not
fall within § 165(g)(2)’s definition of securities.
447
The Memorandum
indicates a deduction may be available, however, under § 165(a) through
Treasury Regulation § 1.165-2(a), which addresses obsolescence of
nondepreciable property.
448
Under Treasury Regulations § 1.165-2(a),
taxpayers can claim a loss when: (1) the loss is incurred in a business or a
transaction entered for profit; (2) the loss arises from the sudden termination
of usefulness in the business or transaction; and (3) the property is
permanently discarded from use, or the transaction is discontinued.
449
444
Id.
445
Amiah Taylor, Watch out for the ‘rug pull’ crypto scam that’s tricking investors out of
millions, FORTUNE (Mar. 2, 2022, 7:36 PM), https://fortune.com/2022/03/02/crypto-
scam-rug-pull-what-is-it/ [https://perma.cc/3HBD-ZFEV].
446
Id.
447
I.R.S. Gen. Couns. Mem. 202302011 (Jan. 13, 2023).
448
Id.
449
26 C.F.R. § 1.165-2
Richmond Journal of Law & Technology Volume XXX, Issue 1
129
[127] Memorandum 202302011 falls short of explicitly permitting the
deduction because, under the facts considered in the Memorandum, the
investor never abandoned the crypto asset.
450
Moreover, the Memorandum
is inconclusive on whether the crypto asset is worthless when each token is
worth less than a penny and the token is traded on at least one exchange.
451
However, Memorandum 202302011 does indicate whether an investor
holding a worthless crypto asset will be permitted to take a capital loss when
the investor abandons the asset.
452
Abandoning the worthless crypto asset
in this context would likely be satisfied by “burning” a crypto asset, which
is the process of sending a crypto asset to an inaccessible wallet on the
blockchain network.
453
V. OFFERING A CRYPTOCURRENCY REGULATION AND TAXATION
SCHEME FOR THE UNITED STATES
[128] When Satoshi Nakamoto wrote the Bitcoin white paper in 2009, the
U.S. federal government had just printed $1 trillion in new money to bail
out the financial sector following the 2007/2008 financial crisis.
454
This
influx of $1 trillion increased the existing money supply and decreased the
450
I.R.S. Gen. Couns. Mem. 202302011, supra note 447.
451
Id.
452
Id.
453
Nathan Reiff, What Does It Mean to Burn Crypto? Practical Applications,
INVESTOPEDIA, https://www.investopedia.com/tech/cryptocurrency-burning-can-it-
manage-inflation/ [https://perma.cc/YN7U-P2AY] (last updated June 2, 2022)
[hereinafter Reiff, What Does It Mean to Burn Crypto?].
454
Frank Emmert, The Regulation of Cryptocurrencies in the United States of America,
RESEARCHGATE (Feb. 2022), https://www.researchgate.net/publication/358906189_
The_Regulation_of_Cryptocurrencies_in_the_United_States_of_America
[https://perma.cc/GZ5Y-398H].
Richmond Journal of Law & Technology Volume XXX, Issue 1
130
value of assets and savings owned by corporations and individuals.
455
In
addition to resolving the issues inherit with third-parties processing
payments, Satoshi sought to create a payment system where no central bank
had power to directly impact a currency’s value.
456
Satoshi embedded a
message on the first block on Bitcoin’s blockchain that said, “Chancellor on
the Brink of Second Bailout for Banks.”
457
[129] What Satoshi created “is a lot like gold,” but “it is digital rather than
a heavy, unwieldy object. In other words, Bitcoin could serve the same
purposes as gold in terms of a currency, but much more efficiently because
it does not have any mass and can be sent easily from place to place.”
458
Some experts believe blockchain technology and cryptocurrencies will
enhance economic efficiency and have a broad lasting impact on global
financial markets in payments, banking, securities settlement, title
recording, cyber security, and more.
459
Blockchain technology’s full
potential will likely be unmet, however, unless our regulatory and taxation
schemes protect consumers and incentivize adopting cryptocurrency as a
form of payment.
455
Id.
456
See Allison Nathan, Interview with Eric Posner, 21 GLOB. MACRO RSCH.: TOP OF
MIND, 3 (2014), https://www.dwt.com/files/paymentlawadvisor/2014/01/GoldmanSachs-
Bit-Coin.pdf [https://perma.cc/3P9K-JLSC].
457
Carla Tardi, Genesis Block: Bitcoin Definition, Mysteries, Secret Message,
INVESTOPEDIA (July 2, 2021), https://www.investopedia.com/terms/g/genesis-
block.asp#:~:text=Bitcoin's%20Genesis%20Block%20Secret%20Message,of%20second
%20bailout%20for%20banks.%22 [https://perma.cc/8TF3-UEHK].
458
Nathan, supra note 456, at 4.
459
Chairman’s Testimony on Virtual Currencies: The Roles of the SEC and CFTC:
Hearing Before the S. Comm. on Banking, Hous. and Urb. Aff. 115th Cong. (2018)
(written testimony of Christopher Giancarlo, Chairman of the CFTC).
Richmond Journal of Law & Technology Volume XXX, Issue 1
131
[130] As to regulation, Congress should create a joint SRO between the
SEC and CFTC, provide qualitative and quantitative measures to determine
whether a digital asset is a commodity or a security, and institute consumer
protections such as annual verification of proof of reserves. From a taxation
standpoint, the United States should provide leniency by establishing non-
recognition events and allowing crypto traders and nodes to make
deductions that are available for commodities and securities activities.
A. How the United States Should Regulate Cryptocurrency
[131] To incentivize its adoption from a regulatory standpoint, the United
States should create a joint self-regulatory organization with original
jurisdiction over all cryptocurrencies. Congress should also adopt the FIT
Act’s functionality and decentralization inquiries to provide objective
measures in determining whether a crypto is a commodity or a security.
Further, requiring crypto intermediaries to annually verify proof of reserves,
as the RFIA does, will provide better consumer protection.
1. Advocating for a Joint Self-Regulatory Organization
with Original Jurisdiction over Cryptocurrency
Activities
[132] The SEC and CFTC have attempted to regulate this novel industry
with an already-existing regulatory scheme. Employing the United States’
existing regulatory scheme has worked to retroactively prosecute fraudulent
activity, such as in SEC v. Bitcoin Savings and Trust, but it has failed to
provide effective, proactive oversight for investors, as evidenced by the
FTX scandal. The U.S. federal government has attempted to fit a square peg
(cryptocurrency) into a round hole (the existing regulatory scheme). The
SEC and CFTC have each taken their turns regulating cryptocurrency in
different contexts, and this bifurcated approach has yielded a lack of clarity
for investors and developers.
460
Because cryptocurrencies are unlike assets
460
Id.
Richmond Journal of Law & Technology Volume XXX, Issue 1
132
the world has seen before, Congress should create a new agency to serve as
the first line of regulation for the cryptocurrency industry.
[133] Congress should establish a joint self-regulatory organization to
serve as a one-stop agency for all cryptocurrency activities. Providing the
SRO with original jurisdiction over all cryptocurrency activities would
prevent the initial turf war that ensues between the CFTC and the SEC over
current cryptocurrency matters. Further, the CFTC and SEC could pool their
capital and expertise together to provide clear, uniform guidance to
cryptocurrency developers, while also overseeing markets to protect
cryptocurrency investors. Under the current regulatory regime—and even
after the Ripple Labs case—crypto developers are unsure whether they have
engaged in the unregistered sale of securities or commodities, but the SRO
could provide guidance on all cryptocurrencies and serve as an intermediary
between developers and regulators. If the SRO successfully oversees
cryptocurrency markets, investors will have more confidence in the space,
which would logically bring in more investment. Because this technology
and the products offered are unlike anything the world has seen before,
Congress should create a new regulatory body rather than attempt to use its
current regulatory scheme.
[134] As mentioned in Section IV, the former version of the Lummis-
Gillibrand RFIA tasks the CFTC and SEC with studying, reporting, and
developing a plan for the two agencies to create a joint SRO.
461
The two
Senators are not alone in believing a new SRO is needed to regulate
cryptocurrencies: the former CFTC Chair, Timothy Massad, endorsed this
approach in an interview in August 2022.
462
Massad considered the Digital
Commodity Exchange Act of 2022, which provided the CFTC with
exclusive jurisdiction over cryptocurrencies, and said it was unworkable
because the CFTC is underfunded and would not be able to handle it
461
Id.
462
Velasquez, supra note 358.
Richmond Journal of Law & Technology Volume XXX, Issue 1
133
alone.
463
With a joint SRO, the CFTC and the SEC would have the
collective expertise and resources to oversee the cryptocurrency industry,
and over time, the SRO would provide clear guidance to developers as well
as investor protections.
2. Advocating for a Qualitative and Quantitative Howey
Test
[135] The FIT Act and the RFIA take two different approaches in
clarifying when a digital asset constitutes a security or a commodity. The
RFIA codifies the Howey test, which fails to give the appropriate clarity
developers and investors in the crypto industry seek. The FIT Act, on the
other hand, provides qualitative and quantitative measures for determining
whether a cryptocurrency constitutes a digital commodity or a restricted
digital asset. Further, the FIT Act maintains that digital assets remain
restricted digital assets, subject to the SEC’s regulatory enforcement, until
either the SEC or CFTC certifies a functional blockchain as
decentralized.
464
The FIT Act’s approach provides more clarity than the
RFIA’s, and Congress should adopt legislation with mechanisms like the
FIT Act’s functional and decentralization measures.
3. Advocating for Annually Verifying Proof of Reserves
[136] From a consumer protection standpoint, the RFIA requiring digital
asset intermediaries to undergo annual verification of proof of reserves
provides more extensive consumer protections than the FIT Act. The FIT
Act requires digital commodity exchanges to “establish standards and
procedures that are designed to protect and ensure the safety of consumer
463
Id.
464
See e.g., Financial Innovation and Technology of the 21st Century Act, H.R. 4763,
118th Cong. (2023).
Richmond Journal of Law & Technology Volume XXX, Issue 1
134
money, assets, and property.”
465
While the FIT Act provides explicit
measures for determining whether an asset is regulated as a commodity or
a security, it imposes vague reporting and consumer protection standards.
The opposite is true with the RFIA; requiring digital asset intermediaries to
undergo annual audits ensuring customers’ funds are available is a logical
and worthy policy.
B. A More Lenient Taxation Scheme
[137] Taxing cryptocurrencies as “property” disincentivizes businesses
and individuals to receive payment in cryptocurrency for two main reasons:
(1) it provides two layers of taxation—a tax on the fair market value of the
cryptocurrency at ordinary income rates and a capital tax when the asset is
sold or dispossessed; and (2) it fails to account for cryptocurrencies’
extreme volatility, and a taxpayer may be taxed on ordinary income
exceeding the cryptocurrency’s subsequent fair market value.
466
To
incentivize cryptocurrencies’ adoption, there are four policies the United
States should adopt for greater leniency in taxing cryptocurrencies: (1)
providing a non-recognition event up to a certain amount when using
cryptocurrency to pay for goods or services; (2) taxing staking rewards only
when the asset is sold or dispossessed; (3) allowing nodes to make a mark-
to-market type election at the end of the taxable year; and (4) allowing
investors in crypto assets to make an obsolescence of non-depreciable
property deduction.
1. Providing Non-Recognition Events When Using
Cryptocurrency for Goods or Services
[138] As discussed in Section IV, transacting with cryptocurrencies for
goods or services yields more complex tax consequences than transactions
465
See id. at § 404.
466
Joe Lebkind, Cryptocurrency Taxes, INVESTOPEDIA, https://www.investopedia.com/
tech/taxes-and-crypto/ [https://perma.cc/NSH8-WHAS] (last updated July 23, 2022).
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completed with USD. Complexities aside, transacting in cryptocurrencies
can result in an individual recognizing a taxable gain when using
cryptocurrency to pay for goods or services, such as the 1,000 ADA
investor’s $68.77 gain when paying 28.07 ADA for tutoring services.
Cryptocurrencies are taxed like securities, but cryptocurrencies were
invented to operate as a currency.
467
To limit the extra level of taxation and
to treat cryptocurrencies more like currencies, Congress should establish a
non-recognition event up to a certain amount when cryptocurrencies are
used to pay for goods or services. The RFIA, for example, provides for a
$200 non-recognition event on gains or losses when parties transact with
cryptocurrencies for goods or services.
468
Under the RFIA’s approach, the
1,000 ADA investor’s $68.77 gain would not be included in their gross
income when they paid for tutoring services, which would be a step towards
taxing cryptocurrencies like actual currencies.
[139] Although the RFIA limited the gain or loss exemption to $200, other
countries have provided for even more lenient structures. In Germany,
cryptocurrency investors are not taxed on the first €600 realized from short-
term capital gains on cryptocurrencies.
469
German cryptocurrency investors
initially paid no tax on long-term capital gains realized from selling or
spending cryptocurrencies—until that taxation scheme was reversed by the
German Federal Fiscal Court in March of 2023.
470
Nonetheless, a de
467
Andy Rosen, Cryptocurrency: A Basic Guide for Beginners, NERDWALLET,
https://www.nerdwallet.com/article/investing/cryptocurrency [https://perma.cc/L5AQ-
77Z9] (last updated Aug. 11, 2023).
468
Lummis-Gillibrand Responsible Fin. Innovation Act, S. 4356, 117th Cong. (2022).
469
Cryptocurrency taxation in Germany, BITCOIN.COM, https://www.bitcoin.com/get-
started/cryptocurrency-taxation-in-germany/ [https://perma.cc/P2LY-9NCP] (last visited
Oct. 7, 2023).
470
Jens-Uwe Hinder, German Federal Fiscal Court Decides on the Taxation of
Cryptocurrencies, MORRISON FOERSTER (Mar. 3, 2023), https://www.mofo.com/
resources/insights/230303-german-federal-fiscal-court [https://perma.cc/4KYC-X986].
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minimis non-recognition event when using cryptocurrencies to pay for
goods or services would allow people to use cryptocurrencies more like a
currency than “property.”
2. Staking Rewards Should Be Includible in Gross
Income Only when Sold or Dispossessed
[140] I strongly believe cryptocurrency earned as staking rewards should
be taxed only when the assets are sold or dispossessed. As a statutory matter,
whether staking rewards are taxable income under § 1001(a) is an incredibly
close call. On some PoS blockchains, staking rewards are sent from the node
to the individual staking their coins when the staking rewards are claimed,
which likely constitutes dispossession of property under § 1001(a).
471
On
other PoS blockchains, however, staking rewards auto-populate inside the
individual’s cryptocurrency wallet.
472
When staking rewards auto-populate
in someone’s wallet, there has been no sale, exchange, or dispossession of
the cryptocurrency.
473
In this way, the transaction shows that the staker is
involved in the creation of the property, as the Jarretts argued in United
States v. Jarrett.
474
[141] If the United States federal government treats staking rewards sent
from the node to the staker differently than staking rewards that auto-
populate in someone’s wallet, blockchain developers could eventually
471
See 26 U.S.C. § 1001(a).
472
SafeMoon Dev, SafeMoon: A Deflationary Reflection Token with Automated Liquidity
Acquisition, https://pdf4pro.com/view/safemoon-a-deflationary-reflection-token-with-
automated-624956.html [https://perma.cc/69AU-62XL] (last visited Sept. 24, 2023).
473
Krisztian Sandor, Crypto Staking 101: What is Staking?, COINDESK,
https://www.coindesk.com/learn/crypto-staking-101-what-is-staking/
[https://perma.cc/N3QT-RBE6] (last updated Feb. 21, 2023, 2:34 PM).
474
Jarrett v. United States, No. 3:21-CV-00419, 2022 U.S. Dist. LEXIS 178743, at *5
(M.D. Tenn., Sept. 30, 2022).
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upgrade their networks to allow staking rewards to auto-populate in stakers’
wallets. As such, treating staking rewards differently depending on how the
staker received the cryptocurrency will be only a part-time fix as networks
would eventually evolve to adapt to the taxation scheme.
[142] Under the RFIA, cryptocurrencies earned as staking rewards are
includible gross income only when sold or dispossessed.
475
The RFIA goes
a step further by also providing that mining rewards are includible in gross
income only when the asset is sold or dispossessed, thereby overruling IRS
Notice 2014-21.
476
[143] As discussed in Section II, PoW blockchains consume substantially
more energy than PoS blockchains. From a policy standpoint, Congress
could show bias towards PoS blockchains, as they are healthier for the
environment. Moreover, treating staking rewards differently depending on
how the staker receives the cryptocurrency would only be a part-time fix as
blockchain developers could alter the software for staking rewards to auto-
populate in users’ wallets. If the United States federal government adopts a
scheme where staking rewards earned on a PoS blockchain are not taxable
until the assets are sold or dispossessed, policymakers would incentivize
investors towards blockchains that are healthier for the environment while
adopting a policy that will be workable in the future.
3. Allowing PoS and PoW Nodes to Make a Mark-to-
Market Election on Cryptocurrency Holdings
[144] Under IRS Notice 2014-21, the fair market value of mining rewards
are includible in the recipient taxpayer’s gross income at the time they are
received, and the recipient receives a fair market value basis in the
475
Lummis-Gillibrand Responsible Fin. Innovation Act, S. 4356, 117th Cong. (2022).
476
Id.
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138
cryptocurrencies.
477
It is still unclear whether staking rewards are includible
in gross income at the time they are received, but if staking rewards are
includible in gross income at the time of receipt, then this proposal applies
to network participants on PoS and PoW blockchains.
[145] If the fair market value of cryptocurrency earned as mining and
staking rewards is includible in the taxpayer’s gross income at the time the
cryptocurrency is received, the value of the cryptocurrency holdings may
subsequently decrease after nodes earn the cryptocurrency. Such a situation
would result in the taxpayer reporting more gross income in their tax return
than the underlying assets’ current fair market value. For example: consider
a Bitcoin miner who earned 1 Bitcoin in mining rewards on April 19, 2022,
when Bitcoin’s highest price for the day was $41,665.50.
478
The miner
would have to include $41,665.50 in their gross income, regardless of
whether the miner sold or held the Bitcoin.
479
At the end of the taxable year,
on December 31, 2022, Bitcoin’s highest price for the day was
$16,625.05.
480
Thus, although the miner included $41,665.50 in their gross
income, the Bitcoin they earned and continued to hold was worth only
$16,625.05 at the end of the 2022 calendar taxable year.
481
[146] To prevent such an excessively harsh tax consequence, Congress
could do two things: (1) pass legislation that provides that mining and
staking rewards are includible in gross income only when the assets are sold
477
I.R.S. Notice 2014-21, 2014-1 C.B. 938.
478
See The closing price for Bitcoin (BTC) on April 19, 2022, STATMUSE,
https://www.statmuse.com/money/ask/bitcoin-price-april-19th-2022
[https://perma.cc/CP7K-YD58] (last visited Oct. 7, 2023).
479
I.R.S. Notice 2014-21, 2014-1 C.B. 938.
480
See Bitcoin historical data, COINMARKETCAP, https://coinmarketcap.com/currencies/
bitcoin/historical-data/ [https://perma.cc/Z7ZJ-65F2] (last visited Nov. 8, 2023).
481
Id.
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or dispossessed, such as the RFIA; or (2) pass legislation providing a mark-
to-market type election where nodes could elect to have a deemed sale on
the cryptocurrency rewards they earned the past year. Under the mark-to-
market election, nodes would recognize a gain or loss on the deemed sale,
and any losses realized could be deducted from the taxpayer’s ordinary
income. The taxpayer’s basis in cryptocurrencies earned from mining and
staking rewards would be adjusted to the current fair market value, and in
effect, the amount includible in the taxpayer’s gross income would be equal
to their cryptocurrency holdings’ value at the end of the taxable year rather
than the value at the time the crypto is received. In this way, nodes would
not have to pay high ordinary income taxes on unrealized capital sales, and
nodes’ gross income would more accurately reflect their current holdings
and accessions to wealth.
4. Allowing Cryptocurrency Traders a Mark-to-Market
Election
[147] Cryptocurrency traders, those who consider cryptocurrency trading
to constitute their trade or business, should also be permitted to make a
mark-to-market election at the end of a taxable year under IRC § 475. If the
United States federal government is going to tax cryptocurrencies as
property, this valuable election should also be available to cryptocurrency
traders as it is for securities and commodities traders. The current version
of the Lummis-Gillibrand RFIA provides this election to cryptocurrency
dealers.
482
5. Allowing Investors in Crypto Assets to Take an
Obsolescence of Nondepreciable Property Loss
[148] Although Memorandum 202302011 is inconclusive as to whether
cryptocurrency investors are permitted to make a deduction under Treasury
482
Lummis-Gillibrand Responsible Financial Innovation Act, S. 2281, 118th Cong.
(2023), at § 806.
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Regulations § 1.165-2(a),
483
the IRS should adopt this policy.
Cryptocurrency investors can prove they have abandoned a crypto asset
through “burning” the asset, which is sending the asset to a wallet no one
can access.
484
Burning an asset is the closest thing to abandoning property
in the cryptocurrency context; a person who burns a crypto asset
relinquishes all dominion or control over the asset.
485
As to worthlessness,
the IRS should rely on an asset’s subjective worthlessness—as it does with
partnership interests. The IRS points out in Memorandum 202302011 that
a cryptocurrency may not be worthless if it is still traded on one exchange
because it still has the potential to grow in value.
486
On decentralized
exchanges, however, any crypto asset can be posted for sale by any user.
487
As such, if a taxpayer abandons a crypto asset by burning it, the IRS should
rely on the asset’s subjective value when determining if the taxpayer is
permitted a deduction under § 1.165-2(a).
VI. CONCLUSION
[149] Cryptocurrency refers to a digital asset that uses blockchain
technology to cryptographically record and process transactions.
488
Cryptocurrency can be purchased on centralized exchanges, but it is wiser
483
See I.R.S. Gen. Couns. Mem. 202302011, supra note 447.
484
Reiff, What Does It Mean to Burn Crypto?, supra note 453.
485
See id.
486
I.R.S. Gen. Couns. Mem. 202302011, supra note 447.
487
See What are decentralized exchanges, and how do DEXs work?, COINTELEGRAPH,
https://cointelegraph.com/learn/what-are-decentralized-exchanges-and-how-do-dexs-
work [https://perma.cc/8GHF-8TMW] (last visited Oct. 7, 2023).
488
Jake Frankenfield, Cryptocurrency Explained With Pros and Cons for Investment,
INVESTOPEDIA, https://www.investopedia.com/terms/c/cryptocurrency.asp
[https://perma.cc/R5GK-PQ6B] (last updated Aug. 29, 2023).
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to keep your cryptocurrency in a wallet to ensure you are the sole custodian
of your cryptocurrency.
[150] The United States has taken a regulation-through-litigation
approach to regulating cryptocurrency, which has resulted in unclear
guidance to cryptocurrency developers and investors. Cryptocurrencies are
considered commodities under the Commodity Exchange Act, and the
CFTC has regulatory oversight when a virtual currency is used in a
derivatives contract, or if there is fraud or manipulation involving a virtual
currency traded in interstate commerce.
489
The SEC, on the other hand, has
regulatory oversight when a cryptocurrency passes the Howey test and is
therefore deemed an investment contract and thus a security.
490
SEC v.
Ripple Labs, Inc. illustrates how difficult it is to apply the Howey test to
cryptocurrency, and it failed to provide a clear direction for determining
how the federal government will regulate cryptocurrencies when they are
sold in an ICO or when they are sold on secondary exchanges.
491
Nonetheless, when an investment contract involves cryptocurrency, the
SEC has jurisdiction over the matter.
492
[151] Two pieces of legislation, the FIT Act and the RFIA, attempt to
provide regulatory clarity and provide the CFTC with primary jurisdiction
over cryptocurrencies. The FIT Act provides an objective inquiry in
determining whether an asset is regulated by the SEC or the CFTC, which
489
Bitcoin Basics, CFTC (2019), https://www.cftc.gov/sites/default/files/2019-
12/oceo_bitcoinbasics0218.pdf [https://perma.cc/YH9S-XCH2].
490
Nathan Reiff, Howey Test Definition: What It Means and Implications for
Cryptocurrency, INVESTOPEDIA, https://www.investopedia.com/terms/h/howey-test.asp
[https://perma.cc/T8H8-W2WA] (last updated July 31, 2023) [hereinafter Reiff, Howey
Test Definition].
491
See SEC v. Ripple Labs, Inc., No. 1:20-CV-10832, 2023 U.S. Dist. LEXIS 120486
(S.D.N.Y. July 13, 2023).
492
Reiff, Howey Test Definition, supra note 490.
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is commendable. The RFIA, on the other hand, has excellent proposals for
taxation and consumer protections.
[152] The IRS treats cryptocurrencies as “property” for federal tax
purposes, and transactions involving cryptocurrency are therefore subject to
capital gains and losses.
493
The value of any cryptocurrency earned from
mining is includible in a taxpayer’s gross income when the cryptocurrency
is received, and the miner gets that amount as basis in their
cryptocurrencies.
494
It is still unknown whether cryptocurrency earned from
staking rewards is includible in a taxpayer’s gross income when they receive
it or whether it is includible only when the taxpayer sells or dispossesses
the staking rewards.
[153] I believe Congress should create a joint self-regulatory agency with
the SEC and the CFTC and give the new agency original jurisdiction over
all cryptocurrency activities. A new agency comprised of experts from the
CFTC and the SEC would provide a one-stop agency that could issue
uniform rules, regulations, and guidance to investors and developers in the
cryptocurrency realm. This paper endorses the FIT Act’s approach in
providing a qualitative and quantitate inquiry into whether a digital asset is
regulated by the SEC or the CFTC, and endorses the proof of reserve and
taxation proposals set forth in the RFIA. I believe Congress should provide
non-recognition events when cryptocurrencies are used to pay for goods or
services so cryptocurrencies are treated more like traditional currencies.
Further, I believe Congress should adopt a taxation scheme whereby staking
rewards are includable in gross income only when the asset is sold or
dispossessed. And lastly, Congress should permit cryptocurrency nodes and
traders to take the same deductions and make the same elections currently
available for securities and commodities activities.
493
I.R.S. Notice 2014-21, 2014-1 C.B. 938.
494
Id.
