Cryptocurrency and the Law
Authors Note: Often times technology advances faster than the law. There are many issues related to cryptocurrency that are established in the legal code. However, others are still being resolved as of the writing of article.
Fintech Innovations & Intellectual Property Protection
The laws have changed dramatically from the early days of the Internet. Back in the 90s, there were many software and business model patents granted. However, a Supreme Court decision in 2010 changed the landscape. Since this was a landmark case, let’s review some of the details and the subsequent impact on patentability of business model patents. In 1997 Bernard L. Bilski and Rand Warsaw filed a patent application with the USPTO. The patent was for a method of hedging risks in commodities trading. Without getting into the details the proposed system linked a buyer and seller and completed the transaction using options transactions in a way that “balanced out” the risks. These types of patent claims have traditionally been referred to as “business method” claims. The patent was basically for a simpler method of linking a buyer and seller with more limited price fluctuation risk. The patent office rejected the patent claims on the grounds that the invention is not implemented on a specific apparatus and merely manipulates abstract idea and solves a purely mathematical problem. Basically, they were saying it was an “idea” and not an invention. The case was appealed all the way to the Supreme Court. In support of the majority opinion, Justice Breyer wrote, "general method of engaging in business transactions is not a patentable 'process.”
Aftermath of Bilski Decision
• Business method patent application approval percentages have plummeted
• For proprietary algorithms there are other IP regimes, e.g. Trade Secret, to protect innovation.
• However, for forward facing business method fintech developments, e.g. anything pertaining to financial data and products, there may not be patent protection available.
What can be protected?
• Trade secrets – If you have a mathematical algorithm or technique to expedite transactions it can be protected if you keep it a trade secret
• Trade secrets are protected in perpetuity (i.e. the formula for Coca Cola)
• Copyright does not provide adequate protection and is easily circumvented
There are many misconceptions about cryptocurrency. Some of them are listed below:
Myth 1 - Bitcoin and other altcoins are universal currencies on the Internet
Myth 2- Cryptocurrency transactions are anonymous
Myth 3- ICOs do not need to comply with SEC regulations
Myth 4 - You don’t need to calculate your profits if you use cryptocurrency to make purchases
Myth 5 - If you pay someone in cryptocurrency they don’t need to declare it as income.
Initial Coin Offerings
The Security and Exchange Commission (SEC) regulations regarding ICOs are evolving. The case of Tomahawk Exploration LLC gives us insight as to how the SEC is defining ICOs as securities.
A Case Study
• Tomahawk Exploration LLC held an ICO and sold “Tomahawkcoins” in an attempt to raise $5 million in capital to pay for an oil drilling venture in California.
• SEC found that the defendants published fraudulent promotional materials overstating the economic potential of their coins
The SEC found that the defendants had violated federal law in the following ways
The company was selling securities without complying with registration requirements. This was in violation of Securities Act of 1933. They were also accused of making materially false and misleading statements in connection with that sale in violation of the Securities and Exchange Act of 1934. So basically, the SEC considered the ICO as a security offering. They noted that, the “free” nature of a token giveaway “does not mean that there was not a sale or offer for sale” because a “gift of a security is a sale . . . when the donor receives some benefit.” The SEC specifically pointed to the online marketing benefits associated with their bounty programFor a good discussion of the details of this case I would suggest you read the article, No Fraudulanet Initial Coin Offering Is Too Small for the SEC (https://www.jdsupra.com/legalnews/no-fraudulent-initial-coin-offering-is-48054/). This article nicely reviews the facts of the case.
Take home Message
• The SEC enforcement actions in this case shows they are taking a close look at token sales and bounty programs
• Violators of standard SEC regulations are likely going to be subject to penalties moving forward
• ICOs will likely be treated like IPOs and need to comply with the rules regarding security offerings
• When it comes to violations of securities laws size doesn’t matter. They can come after you even if you are a small operation!!!
Bitcoin Anonymity & Currency Status
By definition blockchain based “currencies” record all transactions. Some altcoins (i.e. Zcash, Monero, etc…) are harder to trace, but you should assume that ultimately all your transactions can be monitored. An increasing number crimes are now being solved by tracing the transactions that occur on blockchain based currency. This is particularly true of Bitcoins. The US government currently does not consider Bitcoin as a “legal tender” currency. Legal tender is any official medium of payment recognized by law that can be used to extinguish a public or private debt, or meet a financial obligation. The Internal Revenue Service (IRS) is aware that “virtual currency” may be used to pay for goods or services, or held for investment. It is treated as a taxable asset. It is basically viewed as a property.
What if you receive cryptocurrency as a payment for goods and service?
• Payments of virtual currency need to be reported be reported using the fair market value of the virtual currency in U.S. dollars as of the date of payment
• Just like fiat currency, payments of $600 or more in a taxable year to an independent contractor require reporting to the IRS, and to the payee on Form 1099- MISC, Miscellaneous Income. These laws can change and you should check with your tax advisor when it comes to tax filing. This article is not intended to give tax advice.
Money Laundering Laws
• If you are paying anyone in cryptocurrency you need to make sure you are in compliance with money laundering laws
• Each person engaged in a trade or business who, in the course of that trade or business, receives more than $10,000 in cash in one transaction or in two or more related transactions, must file form 8300. (These laws are changing and you should consult your tax advisor as to the current forms required and the amount that needs to be reported)
• Consult your tax advisor!!!!! This article is not intended to give tax advice.
Like all new technologies the regulations and the laws lag behind. However, it is safe to assume that increased regulations will be coming soon. Bitcoin and the underlying blockchain technology will be the catalyst for many inventions and innovations. In addition to spawning new business models and industries, it will likely keep the regulators busy for the foreseeable future.