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Regulatory Uncertainty Giving Blockchain Companies Pause

07/13/2018  |  By: Andrew E. Hill, JD, Manager, State and Local Tax

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Blockchain technology has been around for almost 10 years. From the launch of Bitcoin – the first blockchain application – in 2009, a lot has changed in the regulatory landscape. Companies operating in this space have begun to rethink and reshape their funding model in response to regulatory pressures. To say there is regulatory uncertainty in this area is an understatement.

What is a Cryptocurrency?

Regulators of all stripes have looked at blockchain technology – and the cryptocurrencies that have proliferated in recent years – and come to their own conclusions about whether and/or how to regulate the industry. Here is a rundown of the current state of play:

  • Securities and Exchange Commission – Cryptocurrencies issued via Initial Coin Offering (ICO) or Initial Token Offering (ITO) are securities.
  • Commodity Futures Trading Commission – Cryptocurrencies are commodities. 
  • Department of Treasury – Cryptocurrencies are currencies and ICOs are subject to FinCEN money transmitter rules and reporting.
  • Internal Revenue Service – Cryptocurrencies are property and their sale is taxable.

In short, four separate regulators think they have dominion over cryptocurrencies in some way.

Rethinking the Structure of the ICO Model

Blockchain companies have often relied on the issuance of tokens or coins to raise money. Essentially, the ICO/ITO model is crowdfunding for blockchain start-ups. Companies took great pains to structure their offerings, with the help of their legal counsel, to ensure that SEC regulations did not apply. This was typically done by designing the token or coin to have utility on the network rather than having features of a regulated security.

However, companies are increasingly thinking about leaning into SEC regulations and structuring the offerings as registered securities. The tokens or coins can be offered in private placements to accredited investors and registered with the SEC. The acceptance of SEC oversight during the ICO process can help alleviate uncertainty down the road.

Income Taxes Matter  

As discussed above, the IRS treats cryptocurrency as property and the sale of tokens or coins is subject to federal income tax. For companies issuing utility tokens, this presents a host of challenges for early-stage blockchain start-ups as a substantial portion of the money raised via ICO is earmarked for taxes.

For companies issuing securities via the blockchain, special attention must be paid to the structure of the offering. There is potential for a worst-of-both-worlds outcome where an offering is subject to SEC regulations while also being subject to income tax according to the IRS.

Under either model, it is essential to have your tax advisor involved from the beginning of the ICO process to help reduce and plan for the potential tax burden. 

If you have additional inquiries regarding blockchain, please contact Andrew Hill at ahill@lbmc.com

Posted in: Tax