As blockchains have gained popularity, government use and oversight of blockchains have been a topic of interest for administrators on the local, state, and federal level. Many jurisdictions are also taking a proactive approach to studying the impact of blockchain technology.
There have been attempts by a handful of governments to prohibit the buying, holding, and selling of cryptocurrency. While it is difficult to prove an individual is holding cryptocurrency, aggressive regulators have realized that it is much easier to identify those who are mining bitcoin based off of their excessive energy consumption
As discussed in Blockchain 101, Proof-of-Work mining consumes a lot of energy and has caught the eye of some regulators. Mining regulations vary from the national to municipal level, depending on the unique energy situation dictated by the price and availability of energy.
With reports that the Bitcoin network is using as much energy as a small to medium-sized country, some have criticized the sustainability of Proof-of-Work blockchains. Proponents of Proof-of-Work claim that to achieve any level of security, energy has to be used. The high consumption requirements for mining is a feature rather than a bug. Additionally, they point to the vast amounts of energy used by the banking and finance sectors which could be limited with a greater ability for decentralized banking. Some blockchains have specifically searched for ways to transition to Proof-of-Stake, which consumes significantly less energy. This problem has been brought to legislators. Laws (or the lack of) differ from the municipal to the national level. Regulators are still determining if it is even viable to tackle the energy consumption model.
As most countries have a hand in influencing the economies and monetary policy of their sovereign states, it’s almost expected that the introduction of bitcoin as a viable currency would be originally dismissed, simply because the governmental institutions want to remain in economic control. However, that has NOT led every country to an outright ban. Most countries have, so far, declined to regulate bitcoin. This includes the world’s largest economy, the United States. While there has been a lot of back and forth considering legislators sentiment of bitcoin, there has never really been any non-criminal crackdown on cryptocurrency. In the US cryptocurrency is legal, and it is considered taxable; whether it be for the transfer of cryptocurrency or capital gains, the government views the transfer of cryptocurrency as a taxable event.
Many countries are following the United States’ lead when it comes to a hands-off approach concerning cryptocurrency. Most of the world has taken that exact approach. They are monitoring this developing ecosystem, being careful not to stifle an emerging industry that may bring their country more wealth. The majority of the top economies all, at the very least, tolerate bitcoin. Some countries that recognize deficiencies in the current banking system have embraced the idea of digital currencies with open arms. Most major geographic areas are comprised of countries that have friendly attitudes towards cryptocurrency. North America, the European Union, Eastern, and Central Europe, and most of East Asia.
The biggest issue surrounding governments that permit the use of cryptocurrency is taxation. Even in countries where cryptocurrency is openly mined and exchanged, it’s still unclear as to what transactions are taxable or the rate at which cryptocurrency will be taxed. Even in America, the IRS is expecting crypto holders to keep a record and report all of their transactions, no matter how small. This is how a lot of countries ended up recognizing bitcoin and other cryptocurrencies. The legislative bodies were slow to understand this technology, but the tax collectors were ready.
Several countries do not outlaw the possession or use of cryptocurrency, but they have restricted essential banking services for any digital currency, which kind of puts crypto in limbo. It is tolerated, but the financial systems it is looking to improve or replace simply aren’t eager to provide their services to users of cryptocurrency.
While there were few rules concerning ICOs when they first became popular, the SEC and CFTC saw the evolution of token sales and took a very hesitant approach concerning regulation. The main dispute over the regulation of ICOs is the classification of the tokens, as certain laws have to be followed if the asset that is being transferred is considered a security.
Most tokens fall into one of two categories: security or utility. Utility tokens have an expressed purpose or function. For example, ether is considered a utility because the native currency is used to power the ecosystem. It is not a purely speculative investment, but rather the ability to utilize functions of a decentralized application or network. Essentially, utility tokens represent the ability to use a good or service. Security tokens represent equity and are linked to an asset. Security tokens are seen as speculative investments and are closely monitored by the SEC.
The SEC is slowly beginning to note the difference between utility tokens and security tokens. As a result, many would-be ICOs have been relabeled as Security Token Offerings.
Traditionally, securities are defined by the Howey test. Formed in 1934 under the Security Exchange Act, the Howey test consists of four parts:
Cryptocurrency is currently being taxed in multiple ways. The first is capital gains. When your profits are realized and you cash them in, you’re required to pay taxes on those dividends. The same goes for selling speculative assets, including cryptocurrency. Currently, both utility and security tokens are taxed in the same manner. The second tax that is charged is a sales tax when cryptocurrency is spent. If cryptocurrency is spent on a good or service, both capital gains and sales tax apply. This double taxation has been scrutinized, but the current policy stands. Double taxation and the corresponding records that must be kept are both major deterrents to cryptocurrency adoption.
Blockchains are an emerging technology that has gained a lot of attention. Of course, whenever there is an emerging financial industry, government regulation is sure to follow. In the case of cryptocurrency, many governments have taken a hands-off approach, choosing a wait and see attitude while blockchain technology develops.
This was illustrated when ICOs, a popular way to initially distribute coins, took the cryptocurrency scene by storm. This method of fundraising has brought in billions, garnering the attention of governments worldwide. The United States Securities and Exchange Commission has been monitoring ICOs, making sure basic compliance is being met. There has also been a battle over how these tokens should be classified, which will have great implications concerning taxation.
Other governmental entities have set out to explore the technology to see what it could do for the public sector. A prominent complaint about bureaucratic processes is that there is a lot of red tape preventing a positive action. Blockchain technology may offer methods to help address inefficiencies in government action.
This concludes our second module of Blockchain for Business. In this module, we covered scaling, cryptocurrency markets, decentralized finance and government regulation concerning blockchain technology. Check out our next module to see how businesses are already researching, and even incorporating, blockchain technology.