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In this issue:

New Cryptocurrency Financial Products and Platforms Announced

An FBI Raid, the $11 Billion Bitcoin Case, and Other Enforcement and Regulatory Actions in the U.S. and Abroad

Hackers Strike With 51 Percent Attack and Crypto-Mining Malware

Tax Analysis: Token Taxonomy Act Would Allow Tax-Free Exchanges of Virtual Currencies

Tax Analysis: Impact of Increases to Crypto Trading and Organized Exchanges

New Cryptocurrency Financial Products and Platforms Announced 

By: Simone O. Otenaike

Last week, SEFToken Inc. launched a new tokenized instrument. The new token, known as a “covered warrant,” will be issued through the Securitize platform on the Ethereum blockchain. According to reports, the “warrant tokens” will be convertible into equity in Mercari, a licensed exchange based in Australia. Warrant token holders will hold the right to buy or sell the underlying security at a fixed price, up until a predetermined date. In the U.K., the country’s oldest Bitcoin exchange, Coinfloor Group, launched CoinFLEX (Coin Futures and Lending Exchange) ‒ the world’s first physically delivered bitcoin futures exchange. CoinFLEX will offer contracts that trade against Tether (a crypto token that is pegged to the dollar) and features the world’s first stablecoin-to-stablecoin futures contract, a contract to trade Tether against USD Coin.

According to reports, investors funded approximately $2.2 billion in U.S.-based crypto projects and $4.6 billion in global crypto projects over the course of 2018, a roughly 400 percent increase from last year. Last week, Bakkt, the Intercontinental Exchange’s cryptocurrency project, raised $182.5 million during its first institutional funding round. After achieving regulatory approval, Bakkt plans to launch a one-day physically delivered Bitcoin futures contract along with physical warehousing. Also this week, the Nasdaq-powered DX Exchange announced plans for its new trading platform. The exchange intends to offer investors the opportunity to trade tokenized stocks in select global companies and support various crypto-to-crypto and crypto-to-fiat pairs.

On the international front, Thailand’s Ministry of Finance, under the recommendation of the SEC Board, granted digital asset business licenses to three digital asset exchanges and one cryptocurrency broker-dealer. The SEC’s press release revealed that two other applicants failed to meet the SEC’s acceptable standards regarding the systems for custody of client assets, Know Your Customer controls and cybersecurity systems.

tZERO, an e-commerce giant’s cryptocurrency subsidiary, filed a patent for a “crypto integration platform” early last week. According to the patent filing, the system will trade securities, tokens, digital shares, cash equivalents and digital assets from broker-dealers and then translate the orders into digital assets on the platform. Among other things, the platform reportedly will aggregate market data from various cryptocurrency exchanges and generate the best price in the crypto market for the digital asset or liability involved in the transaction. tZero’s parent company also announced Thursday it plans to pay part of its business taxes in Ohio via the state’s new cryptocurrency taxpayer platform, OhioCrypto.com. The e-commerce giant will become the first company to pay part of its Ohio state taxes in Bitcoin.

To read more about the topics covered in this week’s post, see the following:

An FBI Raid, the $11 Billion Bitcoin Case, and Other Enforcement and Regulatory Actions in the U.S. and Abroad

By: Robert A. Musiala Jr.

According to reports, late last month the FBI raided the offices of a Michigan-based nonprofit technology center in what appears to be an action related to unlicensed operation of a cryptocurrency exchange business. Late last week, U.S.-based cryptocurrency exchange Kraken reported that the number of inquiries it received from U.S. law enforcement agencies tripled from 2017-2018, with a total of 475 inquiries from global law enforcement agencies received in 2018. Also last week, a U.S. district court judge denied a motion to dismiss and set a Sept. 30 trial date for a civil lawsuit against Australian businessman and self-proclaimed Bitcoin creator Craig Wright, who is being sued by the estate of his deceased former business partner. The plaintiffs in the lawsuit claim Wright fraudulently took possession of over $11 billion of bitcoin that belonged to the deceased. Also, a second private class action lawsuit was recently filed related to the theft of $170 million in cryptocurrency assets from an Italian-based exchange.

In India, police recently arrested a suspect accused of involvement in a $71.6 million fraud scheme related to the sale of cryptocurrency tokens. In the United Arab Emirates, according to reports, the UAE financial regulators intend to introduce new regulations governing initial coin offerings sometime in the first half of 2019. Additionally, this week the European Banking Authority issued a report on “crypto-assets” that advised the European Commission to perform a cost-benefit analysis to assess “whether EU-level action is appropriate and feasible” to address the effects and implications of crypto-assets on the financial sector. On the same day, the European Securities and Markets Authority (ESMA) published a report on initial coin offerings and crypto-assets for the EU Commission, EU Council and EU Parliament. Issues highlighted in the ESMA report include anti-money laundering risks and investor risks related to certain crypto-assets that fall outside of current regulatory frameworks.

For more information, please refer to the following links:

Hackers Strike With 51 Percent Attack and Crypto-Mining Malware

By: Joanna F. Wasick

Barely into the new year, Ethereum Classic (ETC), an offshoot of Ethereum (ETH) and the 18th-largest cryptocurrency by market cap, was subject to a “51% attack” – a type of hack possible on cryptocurrencies using a proof-of-work (POW) protocol. In essence, a single entity or group gains a majority of the network hash rate, enabling it to rewrite blockchain data and therefore “double-spend” ‒ sell cryptocurrency for fiat, and then amend the ledger to get the coins back, while keeping the fiat. Reports indicate that nearly $1 million worth of ETC was stolen in the recent attack. A Chinese security firm, SlowMist, published technical details on the attack and claimed it may be able to identify more information on the attacker if certain cryptocurrency exchanges assisted by providing information. This news comes on the heels of The Ethereum Foundation’s announcement that it will slash energy consumption in 2019 by replacing POW with a proof-of-stake protocol, which cuts energy consumed per Ethereum transaction. In addition to ecological benefits, the protocol switch may thwart these kinds of thefts, although it is unclear whether other types of attacks will be made possible.

But POW-targeted attacks are hardly the only kind of theft in crypto news. A new study reports a staggering 4,000 percent rise this year in cryptocurrency mining malware ‒ malware used by criminals to hack into an innocent user’s computer, smartphone or other device in order to harness processing power to use for mining cryptocurrencies. The study estimates that illicit crypto-mining was responsible for nearly $57 million in revenue. The most popular cryptocurrency was Monero, 4.3 percent of which was mined through the use of illicit malware. Bitcoin was the second-most-targeted currency, but its popularity has declined over the past three years due to an increase in hash rate and difficulty in mining.

Conventional bitcoin wallet attacks continue as well. According to reports last week, a hack targeted at the Electrum bitcoin wallet provider stole approximately $750,000 worth of bitcoin from Electrum wallet users.

For more information, please check out the following links:

Tax Analysis: Token Taxonomy Act Would Allow Tax-Free Exchanges of Virtual Currencies

By: Roger M. Brown and Heather K.P. Fincher

The Token Taxonomy Act, introduced by Rep. Warren Davidson, R-Ohio, on Dec. 20, 2018, would treat so-called “trading pair” exchanges of virtual currency, where one cryptocurrency is exchanged for another cryptocurrency, as tax-free exchanges.[1]

Prior to 2018, many holders of virtual currency took the position that exchanges of one token for another qualified as a tax-free exchange of like-kind property under pre-tax reform rules (pre-2018 Section 1031 of the U.S. Tax Code). In certain ways, the rules could be flexible by focusing on like-kind asset classes, rather than on similar value.

This approach was applied to certain financial assets, such as an exchange of gold bullion for Canadian Gold Maple Leaf coins, and an exchange of one bundle of patents for another.

The 2017 Tax Cuts and Jobs Act changed the like-kind exchange rules. They now only apply to exchanges of real property. The Token Taxonomy Act would permit the tax-free exchange of virtual currency (in addition to real property), and apply to post-Jan. 1, 2017, exchanges.

All cryptocurrency assets are not created equal. Some may even fall into another bucket all together and be outside of what the bill treats as a crypto asset from a U.S. tax perspective. This is because labels mean little in tax law, and some tokens, particularly securitized tokens, may be treated as actual ownership in the underlying reference assets. In such an instance, the token could even be outside of the protection offered by the new bill.

[1] The proposed legislation would also exclude up to $600 of gain when virtual currency is sold or exchanged for cash or cash equivalents.

Tax Analysis: Impact of Increases to Crypto Trading and Organized Exchanges

By: Roger M. Brown and Nicholas C. Mowbray

On Dec. 11, 2018, the Commodity Futures Trading Commission released a request for public comments signaling their belief that there will be an increase in the trading of crypto assets and crypto-based derivatives on organized exchanges. This belief is evidenced by the launch of the Coin Futures and Lending Exchange, and the anticipated launch of Bakkt and the Eris Exchange’s crypto market.

The increases in trading and the number of organized exchanges give rise to unique U.S. tax issues that may not have applied to a crypto asset before, including:

  • Whether gain or loss will be triggered annually, regardless of whether the crypto asset is sold.
  • Whether a non-U.S. fund can trade a crypto asset without being subject to U.S. taxation.
  • Whether certain rules apply that can defer the recognition of a tax loss despite the sale of an asset.

This is because the tax consequences of trading in an asset can change as it becomes actively traded, and in some instances, whether trading is on an organized exchange.

Thus, holders of crypto assets should review their holdings and consider whether an asset’s trading has become sufficiently active to be subject to tax treatment that differs from its prior treatment. Further, the differences in active trading and whether such trading is on an organized exchange can cause differences in tax treatment among tokens.