Motivations for a Bitcoin ETF

As Bitcoin matures into a viable asset class investors demand easier ways to join the burgeoning market. Apart from retail interest, institutions have billions of dollars on the sidelines patiently waiting to enter the market.

The S-1 filing describes shares of the ETF to be “Easily Accessible and Cost Efficient.”  The Winklevoss Bitcoin Trust will allow investors to avoid the process of purchasing bitcoins on exchanges and having to handle security and storage. Shares would trade just like stocks, allowing mainstream investors to enter the market through an existing broker easily.

SEC Ruling: Winklevoss’ ETF Denied

Recently, the SEC denied The Winklevoss’ Bats BZX Exchange, Inc. (BZX) second ETF proposal. The Commission was careful to emphasize that the decision denying a Bitcoin ETF does not rest on evaluating whether or not bitcoin has inherent value.

Manipulation Still a Primary Concern

The SEC has yet to approve a digital currency-based ETF. In the latest decision, the SEC noted that more than 75% of the volume of bitcoin trading occurs outside the U.S., with only 5% of trading taking place on U.S. exchanges. Many overseas exchanges are unregulated, making markets susceptible to illegal market manipulation strategies such as wash trading.

SEC Commissioner Dissents

According to Commissioner Hester Peirce, the disapproval order focuses on the characteristics of the spot market for bitcoin, rather than on the ability of BZX to surveil trading of and to deter manipulation in their listed shares. Peirce noted if the disapproval order’s rigorous standard were applied consistently, many commodity-based ETFs would not pass.

Approval of this order would demonstrate the SEC’s commitment to acting within the scope of their limited role in regulating the securities markets. The disapproval denies investors from accessing Bitcoin through a predictable, transparent, and simplified product.

 100% Chance of a Bitcoin ETF

 The Winklevoss twins aren’t alone in the Bitcoin ETF space. On July 24th, the SEC delayed its decision on a separate Bitcoin ETF application from investment firm Direxion. Bitwise also filed its own application that would track an index of ten cryptocurrencies.

Jan van Eck, CEO of VanEck Associates is 100% certain the SEC will pass a Bitcoin ETF in the long run. The VanEck, Cboe, and SolidX partnership currently awaits SEC ruling on their proposed Bitcoin ETF. VanEck is hopeful of gaining approval addressing the SEC’s concerns here. Mark your calendars — the ruling is expected to occur between August 10th and 16th.

Conclusion

The disapproval order unintentionally undermines investor protection, precluding investors from benefiting from the increased institutional discipline that comes with approval. Bitcoin markets are steadily maturing, and mainstream finance is knocking at the door. Mass adoption is so close yet so far.

SegWit, short for Segregated Witness, is a system that makes your Bitcoin transactions faster.

Why do we need SegWit?

Think of a single lane highway with 5,000 vehicles driving along smoothly. As traffic builds to 50,000 and more, that single lane becomes clogged forcing you to wait hours on end in congested traffic and maybe miss your appointment. That’s Bitcoin. It’s called the scalability problem, and it’s an issue that the smartest blockchain developers have been trying to find solutions to for years.

SegWit is the Bitcoin team’s solution.

The scalability problem

One of Bitcoin’s most aggravating issues is its lack of speed. Ten transactions take about a second on average to process. Compare that to payment companies like Visa that are able to process around 5,000 to 8,000 transactions per second.

Pay more and you can get yours to the front of the queue, but that makes Bitcoin an expensive and undemocratic system. Besides which, Bitcoin wants to make its platform as efficient and as whizzingly fast as the internet to retain its users and grow its appeal.

The SegWit solution

Bitcoin transactions are made up of blocks with each block able to absorb no more than 1MB of data.

The blocks come in two parts: a header and a body. The header stores a cryptographic hash of the previous block, along with a time signature and other data. The body stores the transactions, including sender data and receiver public keys, which shows you this is a legitimate transaction. Each part takes up room and increases the mass of the block. The signature part alone that is needed to validate the information takes up around 60 percent of its bulk.

In October 2016, Pieter Wuille, co-founder of Blockstream and a Bitcoin Core developer decided to hack of the signature part and put it in a separate block.

Model: Structure of Segregated Witness

This block, called the “witness” block is separate to Bitcoin’s original block. We now have more room in our core block to slip in more information.  The block becomes lighter, so Peter’s idea also helps Bitcoin transactions move more efficiently.

In essence, Bitcoin added a parallel lane to its highway to divert some of its traffic from Route A (call it that) to Route B. Route A has the blocks with sender and receiver data, while the new parallel lane contains the “witness” segment with the scripts and signatures.

Result? The highway is less congested. Your Bitcoin transactions slip through faster.

Other benefits

  • Node performance – The Bitcoin platform is less congested, so nodes can verify blocks, or transactions, faster.
  • Cheaper transactions – At one time, increased demand raised fees. Now, Bitcoin can reduce its fees.
  • Transaction malleability – Originally, the sender’s signature, or the transaction id (txid), was vulnerable to an intruder hacking and changing it and, thereby, hacking the transaction. By SegWit moving the signature from the transaction data to another “lane”, it protects your transaction data from being hacked. 
  • Linear scaling of signature hashing operations – For certain transactions, adding more data, expands the amount of time that each signature needs to be verified. Segwit resolves this by changing the calculation of the transaction hash for signatures so that each byte of a transaction only needs to be hashed no more than twice.
  • Increased security for multi-signature transactions – SegWit provides two different scripts; one to a single public key that is vulnerable to hacking (and therefore to payments being stolen) and another that directs payments to a script hash. This boosts security for multi-signature transactions.
  • Building on top – SegWit frees Bitcoin for the development of second layer protocols, like its lightning network. SegWit activation also boosted development work on other features such as MAST (which enables more complex bitcoin smart contracts), Schnorr signatures (which would enable another transaction capacity boost) and TumbleBit (an anonymous top-layer network).
  • Protects Lightning Network – SegWit is great for payment channels like the Lightning Network (LN), where a vulnerable signature originally prevented more people from using it to remit Bitcoin. 

Where is SegWit now?

In August 2017, Bitcoin finally integrated SegWit into its system. SegWit is called a “soft fork” which means it is compatible with Bitcoin’s old code, minimalizing the hassle to make SegWit work. A hard fork, in contrast, is a system that is so totally incompatible with the old that a separate blockchain and currency is needed to make it work. 

In SegWit’s case, all the system needed was 95 percent of Bitcoin miners to accept the changes, which happened in less than a year.

In 2017, Bitcoin came out with a controversial hard fork SegWit 2x which increased block sizes from 1 MB to 2 MB. Most of the crypto community resisted SegWit 2x due to its ambitious changes. Consequently, the hard fork was canceled only a week before it was scheduled to occur.

What are the main problems with SegWit?

For one, miners and mining pool operators dislike SegWit. Transactions that go through Lightning Network are in a separate channel (i.e., the parallel “line”), which means these transaction fees will not flow to miners.

Some Bitcoin services – like Bitcoin wallets – have been slow to support the SegWit changes. In February 2018, only 14% of Bitcoin transactions were made using SegWit Bitcoin. The numbers have improved since then, but the network is still in the woods.

Critics complain that SegWit doesn’t go far enough to solve the scalability problem. They maintain that only major changes to the Bitcoin platform and to the way Bitcoin handles transactions can decongest transaction flow.

Finally, SegWit has caused divisions in the bitcoin community leading to several hard forks, such as Bitcoin Cash (BCH).

Cryptocurrency

Bet your bottom dollar, you’ll want to keep a clear account of your cryptocurrency income.

In its recent IR-2018-71, the IRS warned that virtual currency transactions are taxable by law and that people who fail to report their cryptocurrency income, file cryptocurrency late, or file crypto taxes improperly may incur penalties and interest.  

When the IRS speaks, you should notice!

Which accounting model should you use?

You may think that virtual currency is a digital asset and, therefore, should be recorded as such, but since cryptocurrency has no status as legal tender, the IRS requires us to treat it as a property transaction.

Among other things, this means that cryptocurrency investments are bundled under short and long-term capital gains. The amount of tax you pay depends on how long you hold your cryptocurrency.

Thus:

  • Short-term capital gains:  If you hold Bitcoin or another cryptocurrency for less than a year, you’ll be paying regular income tax as with regular property tax. This is anywhere from 10 to 37 percent of your cryptocurrency income depending on your income level.
  • Long-term capital gains: If you hoard your cryptocurrency for longer than a year, you’ll pay long-term capital gains tax, which caps at 20 percent of your cryptocurrency income.

The crazy implication of this plan is that the longer you sit on your Bitcoin, the fewer taxes you pay – which is more reason to “hodl” your currency.

7 other IRS implications and rules

  • Payment made using virtual currency has to be reported using the same rules as any other payment made in property. This means the taxpayer who receives virtual currency as payment for goods or services reports how much that digital currency was in USD on the date that cryptocurrency was received. All transactions are converted to and reported in U.S. Dollars.
  • Payment made to an independent contractor, or freelancer, of $600 USD or more has to be reported on Form 1099-MISC using the fair market value of the virtual currency in U.S. Dollars of the date of payment.
  • As with all property tax, it is the payee, not the payor, who deducts tax. For that reason, the payor must ask the independent contractor for a  taxpayer identification number (TIN) and can only pay his worker once that is received.
  • Gain or loss depends on whether the virtual currency is a capital asset, like stocks, bonds, and other investment property. If it is merely a utility token, i.e., a token used by ICOs to operate their system, there’s no tax. Tax only incurs on virtual currency that can be converted to USD, Euros or other money, namely if the coin has economic value. The IRS refers to this kind of cryptocurrency as “convertible virtual currency”.
  • Someone who mines virtual currency needs to report the exchange value of any income received from that mining in USD. He uses that current exchange value on the day his income was received. Income is reported on either an IRS Form W-2 or an IRS Form 1099, depending on whether the miner works for himself or others.
  • Wages paid in cryptocurrency are reported by an employer on a Form W-2.
  • Wages using virtual currency to independent contractors and freelancers are taxable and the regular self-employment tax rules apply. Payers must issue Form 1099.


    Foreign Asset Reporting Requirements

If you have more than 10,000 bitcoins in a non-US/ offshore account, use the following forms to report your stash:

Donating Helps you Save

Make some Bitcoin, Ether, or Dash donations to some non-profit charity, and you may be able to see some deductions on your taxes as well as avoid tax on your gains. This applies only to cryptocurrency that has recognizable value.

Cryptocurrency Amendments since Jan. 1, 2018

  • No More Like-for-Like loophole

Like-for-like allows you to swap one item for a similar one within a certain time period (typically 180 days), so you may be able to avoid taxes. Since the IRS pegs cryptocurrency as property, and since property investors use the like-for-like loophole for assets like real estate, art, or racehorses, you’d think we’d have this loophole for Bitcoin too.  The loophole existed until the current administration did away with it in January 2018. 

  • No more Cryptocurrency Tax Fairness Act

Before the Trump administration, there was a Cryptocurrency Tax Fairness Act (CFTA) that waived tax from cryptocurrency transactions under $600.  So, say, you used Bitcoin to buy a cup of coffee, you didn’t need to add tax to that Bitcoin transaction. The new tax rules added tax to every itty-bitty purchase – that cup of coffee too.

Bonus: 3 cryptocurrency tax resources

  • Coinbase – A free tool for calculating cryptocurrency taxes that, more or less, works as long as you use it for simple hoarding, rather than trading, and as long as you stash your cryptocurrency with Coinbase. (Warning: The moment you send your coins to an external wallet or another site, Coinbase may inaccurately report these transactions as “sales”).
  • BitcoinTax – There’s a free version for transactions done by any cryptocurrency, as long as the transactions are simple and deal with small amounts, For unlimited and more complex transactions, BitcoinTax offers a 19.95 version per tax year.  This option is your closest to a qualified accountant and may be valuable if you trade in cryptocurrency.
  • Bitcoin Tax Attorneys, CPAs, and Accountants – For complex trading and accounts, you’ll likely want a qualified tax attorney, CPA or tax accountant who knows Bitcoin and digital currencies. That’s where the Directory of Bitcoin Tax Professionals helps you.

 

 

The Canadian Securities Administrators (CSA) released a Staff Notice this week (June 11, 2018) providing additional guidance on the securities law implications for offerings of coins and tokens.  The notice was prepared by the CSA in response to common inquiries from cryptocurrency businesses and their advisors. Specifically, the notice addresses the sale of “utility tokens” and identifies scenarios where these sales may also have elements of investment contracts and be subject to securities regulation.  

 

On the topic of utility tokens, CSA Staff Notice 46-308 states:

“We have received submissions from businesses and their professional advisors that a proposed offering of tokens does not involve securities because the tokens will be used in software, on an online platform or application, or to purchase goods and services. However, we have found that most of the offerings of tokens purporting to be utility tokens that we have reviewed to date have involved the distribution of a security, namely an investment contract. The fact that a token has a utility is not, on its own, determinative as to whether an offering involves the distribution of a security.”

 

The notice goes on to highlight a few common scenarios for proposed coin and token offerings that could give rise to various securities law implications.  These scenarios include situations where:

  • A token is intended to be used in the operation of software or an online application that does not yet exist or is still under development, or the token is intended to be used to purchase goods and services that are not yet available
  • Tokens are not immediately delivered to buyers once purchased
  • The stated purpose of the offering is to raise capital, which will be used to increase the coin or token’s value or support the business issuing the coin or token
  • A business offering the coin or token or involved in its sale makes statements suggesting that the coin or token will become more valuable, or take other steps to create an expectation of profit

 

The CSA advises that any business seeking to offer coins or tokens to Canadians consult qualified securities legal counsel.  The CSA also invites applications to the CSA Regulatory Sandbox, which allows fintech companies an opportunity to test and develop innovative business offerings in an environment where they can work collaboratively with regulators and have temporary exemption from some consequences of securities regulation that may otherwise apply.  The sandbox approach to regulation is something that has also been pursued in Bermuda and the UK.

Who are the Canadian Securities Administrators (CSA)?

While most countries have national securities regulators, Canadian securities regulation is solely the jurisdiction of provincial and territorial governments.  The Canadian Constitution divides powers between the federal and provincial government and gives provinces the jurisdiction to regulate property and civil rights.  These provincial and territorial regulators are participants of the Canadian Securities Administrators, which is an organization that aims to promote consensus and harmonized regulations across the different jurisdictions.

 

What are “Staff Notices”?

Staff notices are issued either by a single regulator or by a group of regulators, such as the CSA.   Staff notices do not change securities legislation, reporting requirements or other policies and procedures.  Instead, the notices provide businesses and the public with insight into how regulators are interpreting and applying existing regulations.  The notices often focus on recent issues or areas of concern for the regulator and attempt to provide guidance on these matters to businesses and other market participants.  

The United States Securities and Exchange Commission (SEC) is vehemently opposed to a common crowdfunding practice in the cryptocurrency industry called the initial coin offering (ICO). An ICO is similar to an initial public offering where a company or corporation raises investment capital by offering its stock to the public for the first time. Only in an ICO, a digital currency or token is distributed instead of a stock, and the token can have a variety of uses that blur the line of what defines a traditional security.

Still, the SEC believes that the way ICOs are funded has them falling under security laws, and the companies interested in launching an initial coin offering need to comply with SEC private placement rules and investor protection guidelines. Those that fail to comply, may be subject to cease and desist letters in the future, as has happened with a number of US-based ICOs.

To further warn potential investors of the dangers initial coin offerings, the SEC has published a website on the increasingly popular capital raising method, providing what the SEC calls the “three ‘Rs’ of ICOs: Risks Rewards and Responsibilities.”

The website reads:

“Companies and individuals are increasingly considering initial coin offerings (ICOs) as a way to raise capital or participate in investment opportunities. While these digital assets and the technology behind them may present a new and efficient means for carrying out financial transactions, they also bring increased risk of fraud and manipulation because the markets for these assets are less regulated than traditional capital markets.’

The list of potential risks, rewards, and responsibilities is directed both at investors and potential ICO issuers and cover off on how initial coin offerings could be securities, may need to be registered with the SEC, or may pose “substantial risks.” To avoid those risks, the SEC warns investors to do their own research, ask questions, to understand the product, and to take extreme caution if and when an investment sounds “too good to be true.”

The SEC also takes the opportunity to warn would-be ICO issuers, asking them to “use caution before promoting offers and selling coins.”

A month ago, the SEC launched a fake ICO website called HoweyCoins.com to provide a working example of what a fraudulent ICO may look like. Investors who clicked on any of the fake site’s ‘buy now’ buttons, were redirected to educational materials on what red flags to look out for when considering investing in an ICO.

[Image Credit: WikiMedia Commons]