2018 February 17 - Volume.2 Issue.7

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2018 February 17 - Volume.2 Issue.7

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CFTC, SEC Draw Guns Against Questionable Cryptocurrency Activities

After being for the better part of 2017 observant on cryptocurrency activities, the U.S. Commodity Futures Trading Commission (CFTC) is starting to take a proactive approach in 2018 in order to protect US investors. The agency has been warning cryptocurrency investors about fraud and manipulation and advises them to do independent research. And the SEC hasn't stayed quiet either this week gunning down a few targets of their own.


The CFTC advised customers on Thursday to avoid pump-and-dump schemes of low liquidity coins or tokens. The agency strongly recommended to thoroughly research the coins and the entities behind them instead of relying on social media tips, sudden price spikes or paid advertisements. In its report, the CTFC reminded customers that pump-and-dump schemes of penny stocks have been around for long before cryptocurrencies.

In fact, just a day after the CFTC issued this warning, the Securities and Exchange Commission (SEC) temporarily suspended trading of three penny stocks citing the risk of manipulation or fraud after announcing questionable cryptocurrency-related investments. The SEC warned to be wary of companies that have suddenly switched their business focus to cryptocurrency-related activities.

The CFTC said that executing pump-and-dump schemes is now even easier with virtual currencies because they can be organized anonymously on private group chats or social media. As with most scams, it is the organizers that pull their money out first making the most returns leaving their followers scrambling to sell before realizing losses.

CFTC Ups Actions in 2018

Date Action
19/01/2018 Started developing a “heightened review” process for virtual currencies such as bitcoin futures
24/01/2018 Sues three virtual currency operators for fraud
05/02/2018 Issued a warning about cryptocurrency retirement accounts claiming to be approved by the IRS
06/02/2018 The chairman says that 'Do no harm' is the right approach for DLT
14/02/2018 Approved the creation of two subcommittees (cryptocurrencies and DLT)
15/02/2018 Issued a Pump-and-Dump warning

Source: CFTC


While the CFTC admitted that their regulatory oversight over largely unregulated cash markets is limited, they reassured investors that they are committed to anti-fraud and preventing manipulation. They could seek enforcement actions against pump-and-dump organizers. To counter the anonymous nature, the CFTC added that any “original information that leads to a successful enforcement action that leads to monetary sanctions of $1 million or more could be eligible for a monetary award of between 10 percent and 30 percent”.

IRS Still Mum on Preferred Cost Basis Method For Tax Calculations

The IRS hasn’t released guidance since 2014 and it’s leaving cryptocurrency attorneys and investors blindfolded. The IRS, which treats virtual currencies as property for tax purposes, means every exchange of cryptocurrencies is treated as a taxable event even when fiat is not directly involved. Following the price boom in 2017, the IRS has yet to clarify which accounting method to use when calculating capital gains and has yet to establish how to determine the cost basis of hard forks and air drops.


The first time Internal Revenue Service (IRS) acknowledged cryptocurrencies was in 2014 with Notice 2014-21. The notice referred to cryptocurrencies as ‘virtual currencies’ and said that they will be treated as property for federal tax purposes. Different U.S. regulators have come out and labeled cryptocurrencies in various classifications - a currency, asset or commodity (Diar, 12 February). Cryptocurrencies are generally held by investors as capital assets because they are expected to generate value over long term. Therefore, cryptocurrencies are taxed very similarly as stocks transactions where capital gains rules apply.

The problem of labeling cryptocurrencies as property is that every single exchange of cryptocurrencies becomes a taxable event. Technically, even small purchases paid in cryptocurrencies are treated as a sale and therefore considered a taxable event by the IRS. Trading one cryptocurrency for another is also considered a taxable event and it’s treated as if the cryptocurrency is sold for fiat and another cryptocurrency is bought for the same amount of fiat. Previously, there was a loophole that allowed a tax-free like-kind exchange of cryptocurrencies. Starting from the tax year of 2018, the real estate is the only type of property that qualifies as a tax-free like-kind exchange. Simply moving cryptocurrencies on the blockchain to yourself; for example from an exchange to a personal wallet; is not a taxable event.

The capital gains or losses are calculated by first determining the cost basis, which is the price at which the cryptocurrency was bought. The cost basis also includes the cost of commissions. In 2017, it was possible to deduct investment-related fees such as exchange or transaction fees assuming that deductions were itemized but the deduction was eliminated for individuals in the new tax reform that takes effect from 2018 to 2025. Business can still deduct investment-related fees in the new tax reform.

The IRS does not provide guidance on how to match buys and sells, which means that when there is a taxable event, investors can choose whether they want to use First-In-First-Out (FIFO), Last-In-First-Out (LIFO) or other matching methods.

In the falling rate environment, the lowest possible tax outcome is by using FIFO but in the rising rate environment, LIFO will usually be more favorable. FIFO is the most often used method in other types of property, which makes it the safest option to avoid any potential problems in the future. It is possible that future legislation will mandate FIFO retroactively.

If a cryptocurrency is held for more than a year before a taxable event, it's considered a long-term gain or loss and if it’s less than a year, it is a short-term gain or loss. Short-term capital gains are taxed at the investor's ordinary income tax rate. Long-term capital gains’ rates range from 0% to 20% depending on the income of taxpayers.

The only guidance by the IRS was released in March of 2014 and caused a proper chaos as it was mere weeks before the tax deadline. The American Institute Of Certified Public Accountants (AICPA) wrote a letter to IRS asking to "release additional, much needed, guidance on virtual currency".

It is still unclear how to determine a cost basis or how to deal with hard forks or air drops from a tax perspective. Tyson Cross, a cryptocurrency attorney, said that the “IRS knows many people have made tremendous wealth with cryptocurrencies”. IRS recently formed a new team of international crime investigators and according to Don Fort, chief of the IRS Criminal Investigation Division, the team will also investigate tax evaders who use cryptocurrency.

In November 2016, IRS ordered Coinbase to hand over all the information they had about millions of U.S. customer accounts due to concerns of tax evasion. In a court document, the IRS claimed that in 2015, only 802 individuals filed returns that declared virtual currencies. This claim has been widely disputed in the community as tax firms came forth and said that they themselves filed more virtual currency returns than IRS is claiming.

Jeff Berns, managing partner at Berns Weiss LLP who filed a motion to stop the procedure, said that it was an unprecedented action by the IRS for casting such a wide net for information. Mr Weiss called IRS’s request a “fishing expedition”.

In November 2017, a federal court ruled in favor of the IRS but narrowed the order only to customers whose transactions exceeded $20,000 and communication between Coinbase and the users no longer had to be disclosed.

Reportedly, the IRS is also cooperating with blockchain analysis company Chainalysis to help them identify the transactions and unmask the users who do not report their income from cryptocurrencies.

Tax Example: Purchase of 1 Bitcoin (BTC) January 1, 2017 $998 FIFO and October 1, 2017 $4,395 LIFO

Date of Sale Capital Gains Holding Period Tax Rate Total Tax
October 2, 2018 - $4404 - - - -
FIFO 3406.3 Less than one year 25% 851.575
LIFO 9.3999999999996 Less than one year 25% 2.3499999999999
- - - - -
December 31, 2017 - $13860 - - - -
FIFO 12862.44 Less than one year 25% 3215.61
LIFO 9465.54 Less than one year 25% 2366.385
- - - - -
January 2, 2018 - $14741 - - - -
FIFO 13743.1 More than one year 15% 2061.465
LIFO 10346.2 Less than one year 25% 2586.55

Ripple Bags Major Financial Institutions in More Testing

In a highly anticipated move by the Ripple community, Hikmet Ersek, the CEO of Western Union, announced that the cross-border payments focused company is officially experimenting with xRapid, which uses Ripple’s native cryptocurrency XRP.

Mr Ersek said: "We are looking especially in the processing settlement and working capital optimization, also in the regulation part, on the compliance part on the blockchain capabilities." Western Union joins Moneygram, Cuallix, MercuryFX, IDT and FlashFX who have also been testing Ripple’s xRapid.

Just a few days afterwards, Saudi Arabian Monetary Authority (SAMA), the central bank of the Kingdom of Saudi Arabia, signed an agreement with Ripple to use its solution to settle payments sent into and out of the country.

SAMA will implement Ripple’s enterprise blockchain solution xCurrent, which does not rely on XRP, to banks in the Kingdom of Saudi Arabia. Previously, Bank of England, the U.K.'s central bank, tested Ripple’s network to facilitate transactions between different DLTs (Diar, 20 November 2017).

JP Morgan Takes Crack at Studying Digital Currencies and Assets

Major investment bank JP Morgan published a report titled "Decrypting Cryptocurrencies: Technology, Applications and Challenges" made available to its clients last week. JP Morgan took the position, much like many central banks (see story below) that no cryptocurrency at this point in time is stable enough to be considered a currency. The firm doesn't believe that any Central Bank, while showing interest, will issue digital currency in the near future (Diar, 20 November 2017). And while JP Morgan seems to have written off the potential use case of cryptocurrencies as a means of payment due to their current volatility, the firm did hone in on the potential of cryptocurrencies being part of a diversified portfolio.

The report does cite the lack of institutional investors – mainly the relatively low volume on the futures exchanges since the contracts launched last year (Diar, 18 December 2017). But of course this could be due to the lack of clearing houses allowing for trading the cryptocurrency. The report highlights the lack of institutional products available, but did look at Grayscale's Bitcoin Investment Trust - and didn't seem thrilled at the investment opportunity due to a premium gap that the Over-the-Counter stock trades at.

Microsoft Identifies Blockchain Opportunity

Microsoft has teamed up with the Decentralized Identity Foundation,a recently founded organization that aims to build a robust interoperable ecosystem that gives access to peoples' identities and information rather than carry the risk of owning that sensitive data (Diar, 20 November 2017). The foundation defines the ecosystem as "decentralized identities anchored by blockchain IDs linked to Zero-Trust datastores that are universally discoverable." And the potential use cases are broad from simple web logins, to Know-Your-Client and Anti-Money Laundering compliance. 38 companies are currently participating in the program, including cryptocurrency startups Civic, uPort and Tieron.

European Central Bank Outlines Views on Bitcoin

The European Central Bank (ECB) released a page on their website defining what Frankfurt believes Bitcoin really is – and that's not a currency. Citing lack of backing by a government institution, lack of merchant acceptance, no protection in case of theft and high volatility, the ECB stated its view that Bitcoin is no more than a speculative asset.

And echoing what ECB President Mr Mario Draghi said recently in a video series, the central bank distanced itself from any possible regulatory oversight saying "it is not the ECB’s responsibility to ban or regulate bitcoin or other cryptocurrencies. But, given the lack of consumer protection, it is important to exercise caution."

Microsoft Weighs in On Block Size Debate
"While some blockchain communities have increased on-chain transaction capacity (e.g. blocksize increases), this approach generally degrades the decentralized state of the network and cannot reach the millions of transactions per second the system would generate at world-scale."
Bank of Thailand Bans Bitcoin (Again...Sort Of)
While the Central Bank of Thailand has no constitutional right to ban cryptocurrencies, it does have oversight over possible capital flight risk - a concern it had in 2013. Last week the Central Bank took it a step further and banned banks from dealing with any sort of cryptocurrency operations.
Citi Bank India Bans Crypto Trading
Towing the usual line that most banks have citing possible economic harm, CitiBank India has banned their clients from cryptocurrency trading activities using not only their credit cards, but also their debit cards too. Note that the Central Bank of India has not banned Bitcoin, but cited concerns.

Mobile Bank Revolut Adding Ripple XRP
UK Fintech startup Revolut, who specialise in easy forex between currencies,  started offering their 1Million user base cryptocurrency exchanges too last November (Diar, 27 November 2017). The 'neobank' announced that they'll be adding Ripple in addition to Bitcoin, Ethereum and Litecoin.

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