The U.S. Infrastructure Bill And Cryptocurrency Regulation – Technology

M. Ridgway Barker co-authored this article with Joseph
Bambara, CIPP/US.

The regulation of cryptocurrency has been a point of interest
lately for U.S. lawmakers. The $1 trillion infrastructure bill H. R. 3684, which includes provisions for
crypto regulation, passed the Senate. The developing U.S.
cryptocurrency regulation will address: stopping cryptocurrency
crime and tax evasion, stablecoin regulation, and investment
vehicles, e.g., cryptocurrency ETFs. One such newly proposed
cryptocurrency regulation is included as a provision of the $1
trillion bipartisan infrastructure bill moving through Congress.
The provision: SEC. 80603. INFORMATION REPORTING FOR BROKERS AND
DIGITAL ASSETS would expand the definition of a brokerage to
include companies that facilitate digital asset trades like
cryptocurrency exchanges. The change would mean increased tax
reporting responsibility to facilitate the IRS’s ability to
track crypto tax evasion. The provision SEC. 80603 is a “Pay
For” provision in TITLE VI called Other Provisions. Other
Provisions tries to detail how the bill will pay for itself.
Congress believes it will raise $28 billion in new revenue through expanded
reporting requirements for any cryptocurrency firm deemed a
“broker” and changing how the IRS taxes “digital
assets.” These provisions have been described as tightening
the laws around taxing digital asset sales. Unfortunately, it is
not a well-thought-out way to help pay for the larger bill. While
we do agree that digital asset exchanges and brokers should have
reporting requirements, and those that earn should pay their
capital gains taxes. The bill incorrectly expands the definition of
a broker to “any person who (for consideration) regularly
provides any service responsible for effectuating transfers of
digital assets, including any decentralized exchange or
peer-to-peer marketplace.” That would virtually include every
player in the industry, from miners and validators to software
developers and node operators. This provision reveals a fundamental
misunderstanding of how distributed ledger technology
(“DLT”) works and how best to regulate it. Let’s
consider three types of DLT players: miners, validators, and
decentralized exchanges.

Miners verify transactions via a consensus method know as
proof-of-work (“POW”). It, as most know, requires a large
amount of computing power provided by the miners to verify a
transaction. In exchange, the miners are compensated with
cryptocurrency. In 2021, the reward per block was 6.25 bitcoins for
bitcoin miners, and one bitcoin is worth around $45,000 at
publication. But miners have nothing to do with the actual
onboarding of buyers and sellers or the transactions executed
between them. They do not store the identities of participant
buyers and sellers.

Validators use a different consensus method to confirm
transactions. It is known as proof of stake (“POS”). Here
parties anonymously stake platform tokens, i.e., assets, to support
transaction validation and maintain the network platform by running
less expensively than a POW platform. The number of tokens the
party’s stake determines the number of transactions they get to
validate. They are compensated for each transaction they validate.
Here again, they do not know nor store the identities of
participant buyers and sellers. Please see our article on staking
HERE.

As for exchanges, traditional centralized cryptocurrency brokers
and exchanges such as Coinbase should comply with new reporting laws
approved by Congress. But increasingly, these exchanges, e.g., Uniswap, have
become decentralized exchanges. A decentralized exchange (DEX) is
an exchange that operates based on a distributed ledger. It
doesn’t store user funds and personal data on its servers and
acts only as a platform for matching bids to buy or sell user
assets. Trading on such platforms takes place directly between
participants (peer-to-peer) without any financial intermediaries.
As such, there is no central authority to identify and report
individual transactions on the network. On the contrary, a
combination of algorithms, mathematics, cryptography, and software
performs all the functions of a financial intermediary but in a
transparent, decentralized, and auditable manner.

So how do we proceed? There are several ways that we can begin
to properly address digital assets, DLT, and the new Internet of
Value. Lawmakers in the House must find a way to amend the bill
SEC. 80603 before passing the omnibus infrastructure bill H. R. 3684. Sen. Pat Toomey (R-Pa.) explained which players are brokers and why an
amendment is a sensible way of proceeding: “We are not
proposing anything sweeping or anything radical.[A] broker means
only those persons who conduct transactions on exchanges where
consumers buy, sell, and trade digital assets.”. The House
needs to develop more precise language that sets up more reasonable
regulation and taxation. We need an educational campaign for all
state and federal lawmakers to understand this new DLT/blockchain
and its many new applications. To properly develop policy around
digital assets and DLT/blockchain, we especially need vigorous
discussion engaging all stakeholders and covering the many
interconnected elements in regulating the second era of the digital
age. This is a pivotal moment in the development of DLT/blockchain
technologies that hold so much potential for effecting positive
change to supply chains, health care, education, and virtually
every aspect of banking and financial services. We can’t allow
poorly conceived laws and regulations to have a chilling effect on
the whole industry and ultimately derail the development of
America’s innovation economy.

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