Price Manipulation Suspicions and Hacks Drive Market Volatility

Recent events have increased suspicion of cryptocurrency valuations and the reliability of cryptocurrency exchanges. The U.S. Commodity and Futures Trading Commission (CFTC) recently subpoenaed the trading data of four major cryptocurrency exchanges as part of an investigation into potential price manipulation in bitcoin futures products listed on the Chicago Mercantile Exchange (CME). CME uses pricing data from Bitstamp, GDAX (Coinbase), itBit and Kraken – all of which were subjects of subpoenas. According to Cointelegraph, news of the subpoenas appeared to trigger a sharp drop in the price of all of the top 100 cryptocurrencies.

This week also saw the release of new research into bitcoin price manipulation. On June 13, University of Texas professor John Griffin and graduate student Amin Shams published a detailed assessment of Bitfinex’s use of its Tether currency and its effect on bitcoin’s price. Through an analysis of transaction records, timing and price fluctuations, Griffin and Shams concluded that “entities associated with the Bitfinex exchange use Tether to purchase Bitcoin when prices are falling” and that “such price supporting activities are successful, as Bitcoin prices rise following the periods of intervention.”

Continued cyber hacks are also contributing to price volatility. Last weekend, South Korean exchange Coinrail reported that its cryptocurrency reserves had been hacked, resulting in a loss of around $40 million. Japan also recently initiated its first cryptojacking criminal case, charging three individuals for constructing websites that would harness unwitting visitors’ computing power to mine Monero. In Australia, a recent investigation revealed that a Singapore firm may have utilized a “back door” in its smart contract code to withdraw $6.6 million of cryptocurrency from a business partner’s account.

Tax Implications of Initial Coin Offering Events May Be Enormous

As controversy continues over the Security and Exchange Commission’s (SEC’s) treatment of cryptocurrency tokens used in so-called initial coin offerings (ICOs), parties to ICOs would be well-served to also consider how funds raised in ICOs will be treated by the Internal Revenue Service (IRS). The potential tax consequences of an ICO should not be underestimated and can be very surprising. The tax treatment of an ICO token sale depends on how the token is characterized, such as equity, debt, prepaid goods or services, currency, or other property. The general rule is that all income is taxable unless it qualifies for an exception, such as a contribution to capital or a gift. As companies argue that tokens issued in an ICO should not be considered securities, they should consider that this argument may make the issuer of the ICO tokens subject to current taxation under the tax rules for sales of property or prepayments for goods or services (although such a prepayment might permit income deferral for one year). With approximately $5.5 billion raised in ICOs last year and approximately $9 billion raised this year, the tax consequences could be enormous.

To add to the confusion, a token’s characterization for tax purposes at times may differ from its characterization under the rules of a separate regulating body, such as the SEC or CFTC. And in the international context, the regulation, legislation and guidance often differ greatly from one country to another.

The ICO space is ripe for guidance by the IRS, but any guidance may be a long time coming. President Trump signed a new tax bill into law at the end of 2017, and Treasury’s Priority Guidance Plan, released May 9, 2018, was full of projects implementing the new tax laws but makes no mention of any project related to blockchain technology or cryptocurrency. Taxpayers therefore must continue to examine and apply existing tax authorities – which represent imperfect analogies – to determine the likely tax treatment of tokens.

Enterprise-backed Blockchain Rollouts Continue to Gain Steam

Companies of all sizes continue to roll out blockchain enterprise solutions. In the financial services sector, recent reports indicate that Fidelity Investments is seeking to deploy its own digital asset exchange and cryptocurrency custody service. A recently published patent application reveals that Mastercard is researching a solution that could move its payment verification and processing functions to a public blockchain. Santander Bank and Ripple are collaborating with another major payment card brand on a blockchain solution, intended to be released this year, that would enable cross-border transactions at higher speeds and with greater levels of transparency. Outside the developed world, South African startup Wala is working on a blockchain solution that enables the company to facilitate approximately 6,300 transactions a day, the vast majority of which are under $1. With a new round of funding from a token sale and partnerships with banks and trading firms, Wala has plans for future blockchain applications aimed at individuals in the developing world.

Blockchain technologies also continue to gain traction in use cases involving an array of global trade applications across various industries. Last week, DHL announced a partnership with TradeIX, a blockchain trade finance platform, that will enable DHL to “embe[d] multiple funding and risk mitigation options into their product offerings.” With pressure to comply with the requirements of the Drug Supply Chain Security Act, which imposes heightened tracking requirements on certain prescription drugs, many pharmaceutical companies see promise in blockchain solutions that can provide a neutral ground for sharing data. Drug distributor AmerisourceBergen has been exploring a number of pilot projects with manufacturers to better track the provenance of prescription drugs as they move through the supply chain. At the Consensus 2018 Building Blocks Hackathon, winning team LocalTrail unveiled a solution to track produce and other perishable foods quite literally from farm to table. The London Bullion Market is inviting proposals for a similar solution that could help mitigate threats to the integrity of the global precious metals market, including preventing metals used to fund armed conflict from entering the market.

With the increased interest in blockchain’s use in global trade, the United Nations Centre for Trade Facilitation and Electronic Business (UN/CEFACT) has opined on the “smart contract, electronic notary and decentralized process coordination” features of blockchain as a means to move away from paper-based processes and remove the need for trust in systems needed to manage supply chains. While UN/CEFACT noted a number of issues with blockchain technology in the global supply chain, it conceded that the technology held “clear value and use cases.”

Foreign Regulatory and Market Environment Continues to Evolve Rapidly

In foreign jurisdictions, regulators and market actors continue to take a wide range of actions in the blockchain space. Thailand’s securities regulator recently approved a new set of regulations governing ICOs that are set to take effect in late June. According to the Bangkok Post, the Thailand regulator is evaluating 50 ICOs under its new set of rules and has granted approval to five of these. Lithuania’s Ministry of Finance also recently issued new guidance that addresses ICOs and the application of certain tax and anti-money laundering laws to cryptocurrencies. In Indonesia, the Ministry of Trade reportedly has ruled that cryptocurrencies are commodities that can be traded on futures exchanges, thus allowing the launch of bitcoin futures products.

Binance, the world’s largest bitcoin exchange by trade volume, has made recent headlines in multiple jurisdictions. The company historically offered only crypto-to-crypto exchanges but has reportedly been granted a bank account in Malta, through which it intends to begin offering crypto-to-fiat exchanges. Binance also recently signed a memorandum of understanding with an industry organization in Jersey to develop a cryptocurrency exchange in that country. Meanwhile, Chinese financial services firm JD Finance recently announced plans to issue blockchain-based securities, and Japanese mobile content provider I-Freek Mobile Inc. has indicated its intention to enter the cryptocurrency exchange market.

In other foreign jurisdictions, concerns are being raised about the risks of cryptocurrencies and money laundering. Canada recently proposed new anti-money laundering regulations that would tighten rules related to cryptocurrencies, and the UK Financial Conduct Authority has issued a warning to banks on “cryptoassets and financial crime.” Most notably, according to The New York Times and Reuters, the Financial Action Task Force intends to begin discussions soon to draft new guidance governing cryptocurrency exchanges.