On Monday, November 15, 2021, President Biden signed into law the Infrastructure Investment and Jobs Act (the “Act”). The Act, designed to improve the nation’s public transit, broadband access, and the power grid, also outlines methods to pay for the infrastructure changes, including more targeted reporting requirements.[1] Through these reporting requirements, cryptocurrencies have been thrust into the congressional regulatory spotlight. The crypto community has largely come out against the Act, but what does it mean for community stakeholders?

In a miscellaneous portion of the Act, titled “Title VI — Other Provisions,” is an amendment to the Internal Revenue Code to redefine a broker as “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” This would expand the definition of broker to not just include an exchange (what most people would traditionally define as a broker), but also potentially developers, miners, and middlemen.

This expanded definition of broker has widespread implications for stakeholders operating under U.S. law. The Act goes on to dictate that these brokers must file identifying information with the broker’s clients or users. Thus, brokers, as redefined by the Act, would need to implement information-gathering protocols to comply with U.S. law.

Further, and potentially more existentially for crypto, the Act includes digital assets under the definition of “cash” for certain transactions with a trade or business. Internal Revenue Code 6050I governs reporting for cash transactions in a trade or business. Under the rule, if a person, in the course of their trade or business, receives $10,000 or more in one transaction or in multiple, related transactions, then they must report who made the transaction, what the transaction was for, and who received the transaction. The Act redefines “cash” to include digital assets in this context. Thus, any single transaction or related, multiple transactions of digital assets equaling $10,000 or more must be reported to the Internal Revenue Service. Some lawyers have pointed out that compliance with the law as it relates to digital assets may be impossible.[2] Further, while other sections of the Internal Revenue Code impose fines and misdemeanor charges for violations, section 6050I violations are considered felonies and, in addition to fines, punishable by up to five years in prison.

The Act and its mandatory reporting provisions certainly cause some alarm for digital asset stakeholders because it strikes at the heart of the privacy and decentralization that has become synonymous with digital assets. However, nothing is settled yet. The Act does not take effect until 2024, which provides stakeholders time to either encourage congressional amendment of the Act or introduce new legislation restructuring its effects. The Treasury Department also has some freedom in how it chooses to interpret the legislation. The NEAR Legal Guild team looks forward to providing further updates as legislation develops.

An Update From the FATF: A Look at Regulation to Come?

In October 2021, the Financial Action Task Force (“FATF”) set forth new reporting guidance for public and private sectors on virtual assets (“VAs”) and virtual asset service providers (“VASPs”). The FATF is an independent inter-governmental watchdog that sets international standards aimed at preventing money laundering and terrorist financing. While the FATF is not a regulator itself, its recommendations are recognized as the standard on global anti-money laundering (“AML”) and counter-terrorist financing (“CFT”). The new guidance focuses on six areas:

(1) Clarify the definitions of VA and VASP to make clear that these definitions are expansive and there should not be a case where a relevant financial asset is not covered by the FATF Standards (either as a VA or as another financial asset);

(2) Provide guidance on how the FATF Standards apply to stablecoins and clarify that a range of entities involved in stablecoin arrangements could qualify as VASPs under the FATF Standards;

(3) Provide additional guidance on the risks and the tools available to countries to address money laundering and terrorist financing risks for peer-to-peer transactions;

(4) Provide updated guidance on the licensing and registration of VASPs;

(5) Provide additional guidance for the public and private sectors on the implementation of the ‘travel rule’; and

(6) Include Principles of Information-Sharing and Co-operation Amongst VASP Supervisors.[3]

Prior to the latest guidance, the FATF promulgated what should be considered a VA or VASP. Generally, a VA is a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes, but excludes digital representations of fiat currencies, securities and other financial assets that are already covered elsewhere in the FATF Recommendations.. Additionally, a designation as a VASP is important because the FATF requires VASPs be regulated for anti-money laundering and countering the financing of terrorism (AML/CFT) purposes, that they be licensed or registered, and subject to effective systems for monitoring or supervision.[4] These definitions are important because they differentiate what structures may fall under certain regulations and what might not.

Operators in the cryptocurrency community should keep abreast of FATF recommendations because of the FATF’s position as an intergovernmental watchdog for financial crimes. With the gaining popularity of digital assets and increasing governmental scrutiny, the FATF will likely play a role in developing a coordinated, international effort at regulation. Below, we dive into some key takeaways on the FATF’s latest guidance:

  1. Defining VASPS to Potentially Include De-Fi and NFTs

The FATF’s October 2021 guidance clarifies how regulatory bodies might bring concepts such as DeFi and NFTs under their purview. DeFi, or “decentralized finance,” is an umbrella term for peer-to-peer financial services on public blockchains.[5] With DeFi, you can do most of the things that banks support — earn interest, borrow, lend, trade, and more — but it’s faster and doesn’t require paperwork or a third party to facilitate the transaction.[6] Under the FATF definition, a DeFi application is not considered a VASP. However, “creators, owners and operators or some other persons who maintain control or sufficient influence in the DeFi arrangements… may fall under the FATF definition of a VASP where they are providing or actively facilitating VASP services.”[7] The FATF emphasizes that, even if a DeFi app appears decentralized, persons who “maintain control or sufficient influence” may still be considered a VASP and thus fall under the regulatory requirements that the designation entails.

Regarding NFTs, the FATF recognizes that they do not necessarily fall within the definition of VAs, but may depending on how they are treated. NFTs, or “non-fungible tokens,” are a special kind of digital asset in which each token is unique — as opposed to “fungible” assets like Bitcoin and dollar bills, which are all worth exactly the same amount.[8] Because every NFT is unique, they can be used to authenticate ownership of digital assets like artworks, recordings, and virtual real estate or pets.[9] The FATF guidance recognizes this distinction from VAs like Bitcoin and Ethereum and understands that NFTs and Vas should be treated differently as long as they serve different purposes. However, if an NFT is used “for payment or investment purposes,” similar to VAs, then it would be classified as a VA. This view illustrates the FATF’s position that it is more important to look at the function than the terminology of digital assets.

2. VASPs are Subject to the Travel Rule

The FATF clarifies that VASPs are subject to the travel rule, as the Legal Guild analyzed in their blog post “Crypto Due Diligence”, and must conduct themselves in accordance with such, as well as any national data protection and privacy rules. The guidance defines the travel rule as a reporting requirement where service providers are obligated to obtain, hold, and transmit required transferor and transferee information, for VA transfers above a certain dollar amount.[10] However, and importantly, the travel rule does not appear to apply to “un-hosted” or non-custodial wallets, where the private keys that control the funds are held by the user rather than an exchange or another centralized entity. This distinction is important because it prevents a reading of the Guidance that might otherwise put impossible reporting obligations on the VASP. However, the Guidance emphasizes that a risk-based approach may be appropriate, where VASPs develop formal risk-based restrictions such as transaction or volume limits between their users and unhosted wallets. Notably, the Guidance does not go as far as imposing reporting requirements on high dollar value transactions involving unhosted wallets, unlike FinCEN’s Proposed Rule in the U.S.[11]

3. How FATF Guidance Includes Stablecoins

Stablecoins are under increased scrutiny because of their (1) design features, including how centralized or decentralized they are and who can access them; and (2) potential for mass adoption as a relatively stable form of VA, making them more suitable for transactions. The Guidance suggests that VASPs “should identify and assess ML/TF risks relating to stablecoins before launch and in an ongoing and forward-looking manner, and take appropriate measures to manage and mitigate the risks before launch. These risks should continue to be mitigated, even after their launch, and take into account the evolving risk if the stablecoin(s) become mass-adopted.”[12]

While the FATF focuses on ML/TF risks, VASPs should also be wary of other regulators that might assert their authority to oversee this growing space. While DLT enjoys a multitude of applications, this also means it may be regulated in several different forms depending on the purpose of the business venture. For example, a non-exhaustive list of agencies that might oversee stablecoin ventures include those that regulate commodities, securities, consumer protection, insurance companies, etc. For this reason, VASPs should take the FATF’s statements seriously and engage in AML policies “in an ongoing and forward-looking manner….”

Conclusion

No matter where a VASP is based, regulatory agencies are working toward creating a legal framework to control bad actors and protect consumers. It is important for VASPs, whether they are in the conceptual stage or already established entities, to consider AML policies and work proactively to establish a policy that protects the entity from potential liability. The regulatory standards that will be applied to VASPs likely will be based on a fact-intensive look at the business purpose of the VASP because VAs have broad-ranging utility and potential applications that don’t fit a single regulatory model.

[1] https://news.yahoo.com/biden-sign-infrastructure-bill-monday-203000757.html

[2] https://www.coindesk.com/business/2021/11/06/house-sends-infrastructure-bill-with-crypto-tax-provision-to-us-president/ (citing https://www.proofofstakealliance.org/wp-content/uploads/2021/09/Research-Report-on-Tax-Code-6050I-and-Digital-Assets.pdf).

[3] https://www.fatf-gafi.org/media/fatf/documents/recommendations/Updated-Guidance-VA-VASP.pdf

[4] https://www.fatf-gafi.org/media/fatf/documents/recommendations/Updated-Guidance-VA-VASP.pdf

[5] https://www.coinbase.com/learn/crypto-basics/what-is-defi

[6] https://www.coinbase.com/learn/crypto-basics/what-is-defi

[7] https://www.fatf-gafi.org/media/fatf/documents/recommendations/Updated-Guidance-VA-VASP.pdf (emphasis added)

[8] https://www.coinbase.com/learn/crypto-basics/plp-what-is-nft?utm_creative=&cb_device=c&cb_placement=&cb_country=us&cb_city=open&cb_language=en_us&msclkid=bfb5eceb07a119ce2a8a8d7b7baafbc6&utm_source=bing&utm_medium=cpc&utm_campaign=rt_p_us_w_m_acq_bin_sea_non_Education-NFTs&utm_term=what%20are%20nfts&utm_content=nft-what-are

[9] https://www.coinbase.com/learn/crypto-basics/plp-what-is-nft?utm_creative=&cb_device=c&cb_placement=&cb_country=us&cb_city=open&cb_language=en_us&msclkid=bfb5eceb07a119ce2a8a8d7b7baafbc6&utm_source=bing&utm_medium=cpc&utm_campaign=rt_p_us_w_m_acq_bin_sea_non_Education-NFTs&utm_term=what%20are%20nfts&utm_content=nft-what-are

[10] https://www.fatf-gafi.org/media/fatf/documents/recommendations/Updated-Guidance-VA-VASP.pdf

[11] https://home.treasury.gov/news/press-releases/sm1216

[12] https://www.fatf-gafi.org/media/fatf/documents/recommendations/Updated-Guidance-VA-VASP.pdf

This document was created by
David McDonald 
Team