If you granted one wish to virtually anyone doing business in the cryptocurrency world, and especially those involved in making payments and transferring money, they would likely ask for regulatory certainty.
With the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), Office of the Comptroller of the Currency (OCC), Internal Revenue Service (IRS) and a whole alphabet soup of other federal and state agencies claiming at least some control over cryptocurrencies and cryptocurrency transactions, crypto companies often find themselves uncertain over which rules apply.
The sheer number of players in the regulatory field leaves companies wondering where the guardrails actually are, said Stephen Gardner, chief legal officer of Zero Hash, a B2B2C infrastructure provider for companies that want to offer crypto to their end users.
“Without guardrails,” Gardner told PYMNTS, companies just want to know “what consumer laws apply — and when — and who is going to be enforcing them. Oftentimes they overlap, and crypto firms must be adept at responding to each of the different regulatory bodies.”
However, he said there are signs that clarity could be coming, with legislators like Sens. Cynthia Lummis of Wyoming and Kristen Gillibrand of New York pushing legislation to clarify both the rules of the road and who enforces them.
For now, though, one of the three biggest legal challenges the crypto assets industry is facing is “defining clearly which assets are securities, which assets are commodities,” he said.
The problem is, there are no rules laid down by the SEC and the Financial Industry Regulatory Authority (FINRA) that deal specifically with custody of crypto assets.
If almost all crypto firms issue or support cryptocurrencies that are securities, as the SEC claims, “It’s one thing to say, ‘OK, everyone go become a broker dealer,’” Gardner said. “Well, after that, how do we legally and properly custody assets?”
Decentralized finance (DeFi) can be another pitfall in this regard, Gardner said.
“I think people who aren’t really in the industry don’t really understand the difference” between centralized and decentralized finance, Gardner said. “Let’s assume the SEC says these DeFi exchanges should be regulated exchanges. What interaction with that [technology] would require additional licensing? If I can allow a customer to withdraw to a DeFi wallet, am I facilitating that securities exchange business?”
Another big issue — probably the biggest one from a payments perspective — deals with taxes. Specifically, the IRS now treats any sale of cryptocurrency as a realized gain that must be reported, Gardner said.
“People want to see tax rules that recognize that if I’m using crypto to buy a stick of gum at CVS, having a realized tax event at that moment is kind of burdensome, and it harms the industry overall,” he said. “It’s been kind of a hot-button issue for a while.”
The problem, he said, is that a cryptocurrency “can be a payment, it can be an investment, it can be a [non-fungible token (NFT)] — sometimes all three at the same time.”
As a result, he added, “Payments really aren’t able to take off.”
Finally, there’s bankruptcy, which became a bigger concern when Nasdaq-listed crypto exchange Coinbase was forced to add a warning to its 10-Q filing that customer assets it holds could leave customers treated as unsecured creditors in the event of a bankruptcy.
“There are established bankruptcy rules and procedures and precedent,” he said. “I think people want to see how crypto will fit in. Will it be a UCC asset that protects the customer’s assets in case of bankruptcy?”
Get a Specialist
That’s why it’s so important to work with a company that is built specifically for crypto, he said.
While there are basics that any compliance department can handle — the anti-money laundering (AML) requirements of the Bank Secrecy Act, for example — “identifying that red flag and following what it means,” or what alerts from blockchain intelligence firms mean, “takes a little bit of specialized knowledge,” Gardner said.
But even setting aside AML compliance, there are other considerations, like, “Is your balance sheet built to be able to handle the volatility of crypto assets?” he said. “Do you want crypto assets on your balance sheet? Will your regulators allow you to do that?”
Using a regulated business specializing “in the business of crypto and only crypto allows you to avoid some of those governance pitfalls that that companies aren’t really prepared for,” Gardner said.
For all PYMNTS crypto coverage, subscribe to the daily Crypto Newsletter.
We’re always on the lookout for opportunities to partner with innovators and disruptors.