Why We Should Embrace Crypto Reporting Regulations

The cryptocurrency tax provision in the U.S. infrastructure bill has dramatic implications for any institution that has incorporated digital assets into its investment portfolio or payment schedules. This includes millions of businesses, platforms, individuals and investment funds.

For the first time, the bill defined both a digital asset and a broker of those digital assets. This is a crucial first step in a process of regulation that moves from definition to reporting to detailed rules and compliance obligations. “We now have a definition of digital assets in the Internal Revenue Code. This is a big deal,” said Rob Massey, who serves as the global and U.S. tax blockchain and digital assets leader for Deloitte. “It is a codified definition, and intentionally written broadly, and then refers to upcoming Treasury regulations that will give further clarity in time. But for the first time, it codifies digital assets as ‘any digital representation of value, which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary of the Treasury,’ which, again, gives the Treasury room to clarify later.”

Definitions of what is a digital asset and who counts as a broker of those assets are necessary for the new reporting standards that cover the crypto markets. For some, this might be a painful departure from the permissionless, anonymous and amorphous ethos in which crypto has been operating since the creation of Bitcoin 13 years ago.

But many industry insiders see it as a positive development, as regulation allows innovation, reduces risk and facilitates market entry. “This industry is not static and is moving extremely fast,” said Erin Fennimore, global head of information reporting solutions at TaxBit. “Having that regulatory clarity, of the obligations for firms that enter this industry, gives them security, and this includes the big brand names that are coming into this industry.”

Put succinctly, the new reporting regulations are the first step in mainstreaming the regulatory treatment of the crypto markets. But that doesn’t mean that these new rules will stifle activity, nor put a damper on innovation. In fact, it may well turn out to have the opposite effect.

“The whole point of the infrastructure bill and the impending regulations from Treasury are to bring crypto into the traditional financial world of broker reporting,” said Fennimore. “But this is where the opportunity comes for innovation – such as a smart contract that attaches to a digital asset and travels with it for automated reporting purposes. There will be all different kinds of ideas arising out of this that do not exist yet.”

The ideal regulatory environment is one that is clear, but also flexible. And in this first step of creating the regulatory structures around crypto, the U.S. authorities have been careful to balance these two aspects. According to Massey at Deloitte, the clarity contained in the infrastructure bill will “invite new commercial activities. This is really good because it allows other people to enter the crypto markets who are worried about the risks of doing something wrong and falling afoul of the regulators. When we see clarity, you may not love how the clarity was made, but at least we have clarity and that allows innovation to move forward. It allows businesses to facilitate transactions involving digital assets.”

For Fennimore, the nuance is going to be the amount of flexibility that is available to the regulations as the industry mutates and evolves. “The flip side of having really clear regulations is that they cannot keep up with and accommodate future innovation,” she said. “It is a dance of interpretation that we're playing. We need regulations that are dynamic enough that they can flex with the industry. And that is, I think, extremely challenging.”

As Winston Churchill once said, this is not the end, nor the beginning of the end, but it looks like the end of the beginning. This is the first step in the long-awaited regulatory embrace of the U.S. crypto markets. It is yet to be seen how flexible – or restrictive – the rules might be. But the direction of travel is now clear, and this should be welcomed.

Erin Fennimore and Robert Massey were speaking at a CoinDesk Webinar “Crypto Regulations: What the Infrastructure Bill Means for Your Business,” moderated by Quincy Enoch, co-chair of Financial Services Practice Group at Invariant.