The Breakdown - The Treasury's Broker Definition Could Crush US Crypto

Episode Date: August 28, 2023

On Friday the US Treasury and the IRS dropped a 300-page guidance on crypto tax policy, including an updated of "broker" that some say could threaten the very fundamentals of decentralized finance in the United States. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. What's going on, guys? It is Monday, August 28th. And today we are talking about the new broker definitions from the U.S. Treasury and all of the scuttle butt around them. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it. Give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Hello, friends. Hope you had a great late summer weekend. Today, we are getting into news

that broke just before the beginning of the weekend, but has continued to reverberate throughout. The U.S. Treasury has finally released their definition of a broker as part of broader crypto tax reporting rules. The nearly 300-page rule proposal was published on Friday to codify language in the 2021 Infrastructure Investment and Jobs Act. The rule would require, centralized crypto exchanges, payment processors, and other entities that regularly redeem crypto issued by them to report customer transactions to the IRS in a similar way to stock brokers. Now, the issue is that the definition of broker is so broad that it captures some hosted wallet services, some defy applications, and potentially much more. In addition to the reporting requirements, the rulemaking

introduces a new dedicated tax form, the 1099 DA, which settles confusion around which form crypto brokers should file. Miners and validators are expressly excluded from the reporting requirements, but the rules seek to capture essentially all other web-based services that provide access the trading platforms within their own user interface. Now, of course, this set of rules was controversial from the start. In late 2021, as the infrastructure bill was being negotiated, there was an industry outcry that the rulemaking instructions as drafted would be unworkable. These concerns were shared by many lawmakers, including a small group of pro-crypto-democrats. Still, the loudest complaint came from Republican Patrick McHenry, who said the current language

is completely unacceptable. It needs to be fixed. The major concern in 2021 was that the loose language would be used to put reporting requirements on minors, validators, and self-hosted wallet providers who plainly did not have the personal information and transaction data required to comply. As the bill moved towards a vote, the Treasury attempted to ease nerves. One source told Bloomberg that the Treasury Department wasn't looking to go after businesses that don't have transaction data. However, they noted that much of the lobbying was aimed at limiting the Treasury Department's authority to collect legitimate tax information. This was viewed as an indication that the rules were not intended to place an unworkable reporting burden on minors and validators. The Treasury has stuck to their word on this end and ensured that the rules do not apply to those groups within the crypto ecosystem.

Alexis Goldstein, financial policy director at the Open Markets Institute, and frequent anti-crypto witness at congressional testimonies, argued that Defi Protocols should not be given a carve-out from the new rules. She said at the time, we will continue to be pushing to make sure that major market participants in crypto are not explicitly carved out of the tax reporting requirements. Ultimately, an 11th hour effort to amend the language in the bill was snuffed out by an unrelated procedural quirk, which forced an unamended vote. Cryptobbians recognized that the rules would need to be objected to once published. Since then, there have been multiple legislative efforts to repeal the rules before they were issued,

but none have progressed. Now, the rulemaking is being justified as a measure to close the tax gap. The Joint Committee on Taxation estimated that these provisions would raise up to $28 billion in additional tax payments over the next decade. The Biden administration and the IRS under them view unpaid taxes on digital asset trading as a major contributor to the tax gap, which is the difference between taxes owed and taxes collected. Some estimates put this overall tax gap issue in the ballpark of $500 billion per year. The Treasury directly addressed this issue as the reasoning behind the rulemaking and stated that it was,

quote, an effort to crack down on tax cheats while helping law-abiding taxpayers know how much they owe on the sale or exchange of digital assets. Now, this isn't really the main point, but obviously the crypto industry as a source of tax revenue looks very different to the way it looked in mid-2020 when the infrastructure bill was passed. And what's more, even if somehow this rulemaking brought in the entire $28 billion in additional revenue over the next 10 years, which most think is extremely overzealous, it would still barely make a dent in the $1 trillion price tag for the industry. Infrastructure Act. Maybe because of that, the Treasury gave the impression that funding the Infrastructure Act was a secondary consideration. Now, speaking of Patrick McHenry, he said that he was,

quote, glad to see the carve out for minors and validators, as well as the long implementation date. Other than that, however, he was disappointed in how broad the rulemaking was. He stated that, quote, following the passage of the Infrastructure Investment and Jobs Act, numerous lawmakers of both parties made clear that any proposed rule must be narrow, tailored, and clear. However, it fails on numerous other counts. Any additional rulemaking related to the other sections from the law must adhere to congressional intent. McHenry also directly called out the White House for yet another piece of bad faith policy, adding that, quote, the Biden administration must end its effort to kill the digital asset ecosystem in the U.S. and work with Congress to finally deliver clear rules of the road for this

industry. Now, on the flip side, Elizabeth Warren, leader, of course, of the anti-crypto army, didn't think the Treasury went far enough. She said in a statement, a strong rule is essential to preventing wealthy tax sheets from hiding income and digital assets, and one should be implemented by the end of the year. Kristen Smith, the CEO of the Blockchain Association, noted that by overreaching, the Treasury has presented both an unworkable set of rules and failed to execute on policy which could lower the burden of calculating taxes for everyday crypto users. If done correctly, she said, these rules could help provide everyday crypto users with the necessary information to accurately comply with tax laws. However, it's important to remember that the crypto

ecosystem is very different from that of traditional assets, so the rules must be tailored accordingly and not capture ecosystem participants that don't have a pathway to compliance. Another concern was the cost of implementation and the sheer difficulty of compliance, even for well-established centralized exchanges. Coinbase vice president of tax Lauren Zlatkin said in a statement, the sheer magnitude of this data requirement would be hundreds of times more than the annual reported transactions of any major brokerage, and goes well beyond the scope of pursuing wealthy tax cheats. The practicality of the IRS's requirement to report, let alone enforce this incredible minutia of taxpayer data, is questionable at best. Miles Fuller, head of government

solutions at Cryptotax Software company Tax Bit, was a little more credulous about the feasibility compliance for large firms, stating that, quote, there's obviously an immediate investment cost to brokers that will have to implement this and digest and figure out how to do it, but the longer term outlook in my view is good for the industry because it'll help bring more mainstream adoption. Still, by far the most common discussion point on Twitter was that these rules were overly broad and capture far too much of defy infrastructure in their definition of a broker. Crypto-commentator Spreek writes, so to recap the new proposed tax rules, Metamask is a broker and has to K-YC and report all users unless it removes swaps.

Uniswop is a broker and is required to update its UI to a new KYC version. Anything with a multi-sig is a broker and required to add KYC. Now, for completeness, the proposed definition of a broker includes a person who in the ordinary course of a trade or business operate a non-custodial trading platform or website, the stands ready to affect sales of digital assets for others, by allowing persons to exchange digital assets directly with other persons for cash stored value cards or different digital assets, including by providing access to automatically executing contracts, protocols, or other software that automatically affect such sales. End quote. Meaning, in other words, that if these regulations

are enforced in their current form, they would apply equally to both centralized and decentralized exchanges. The Treasury claimed this was an attempt to ensure the rules were equally applied to all trading venues. They stated in the published notes that, quote, this decision was made because the reasons for requiring information reporting on dispositions of digital assets do not depend on the manner by which a business operating a platform affects customer transactions. Miller Whitehouse Levine, chief executive officer of the Defy Education Fund, said in a statement, today's proposal from the IRS is confusing, self-refuting, and misguided. It attempts to apply regulatory frameworks predicated on the existence of intermediaries where they don't exist.

unsquareable circle that the proposal itself acknowledges. While acknowledging that self-hosted wallet users effectuate their own transfers, the proposal still somehow attempts to find third parties responsible for effectuating transfers on behalf of a wallet user. Now, another big theme of comments from the crypto lobby over the past few years has been that lawmakers need additional education on how crypto and particularly defy work to be able to enact functional policy. Often when a clumsy worded piece of legislation or guidance was issued, the industry gave the benefit of the doubt and assumed that sensible policymakers wouldn't want to snuff out a potentially lucrative industry while it was still in its infancy. Indeed, many thought that

the first draft of these rules in the original infrastructure bill was exactly that, just a mistake. Sad for them to discover that it was not. And to the extent that there was any benefit of the doubt left, for some, that clearly stops now. Gabriel Shapiro, the General Counsel at Delphi Digital, tweeted, the worst thing you could think is that the new treasury broker rules are based on tech ignorance. All the little details show otherwise, including hypotheticals that exactly match how defy web apps work, how metamask swaps work, etc. They know how it works and don't care. They even went out of their way to say that a website that communicates with a user's wallet and receives revenue from ads on the site can be a broker with tax reporting obligations,

sweeping in ether scan. So what is to be done? Well, some discussed ways to deal with these rules if they were to be implemented. Many suggested that services could be pushed to the protocol layer or otherwise decentralized away from any recognizable developer group to ensure there was no target for compliance. Consensus lawyer Bill Hughes, for example, wrote, Offer your exchange and or Dex interface services for free, and you aren't a broker because it isn't part of a trade or business. Still, the more common reaction was that DeFi protocols would simply need to geoblock U.S. customers and accept that defy just wasn't compatible with the current policy agenda in the land

of the free. And beginning gay off, the CEO of Wintermute said, If this passes no other way but to block U.S. people out of your DeFi protocol, biggest retail market locked out from the rest of the world. CCP make notes. Senior Dogo said, idea. The entire crypto space should geo-block the U.S. to their UIs, but link to that Coinbase website to help you find your congressperson to talk about

bad crypto policy choices with. Now, obviously, another big theme of this is the political ramifications. Alliance Dow's Jacob Franik writes, the Dem's strategy for banning crypto is clear. They won't attempt an outright ban. That draws too much attention. Instead, they'll slowly suffocate it through enforcements, SEC and Treasury, and a DEDAW style flood of bills that are intended to confuse and pick apart crypto at the margins. Ryan Selkis, the CEO at Masari, said, there's no future for crypto in the U.S. if Biden is reelected, I'm sorry. Move abroad, draft Newsom, and hope for the best, or vote GOP, where at least we know the top three candidates are less terrible on this issue.

Crypto has always been political. Andrew at Apiabicus writes, the lengthy, coordinated, and multifaceted approach to attacking crypto over the past 18 months is all about one word, control. It should be obvious by now that the U.S. government is going to allow Bitcoin and Eth to exist, but they want to control it and your use of it. Fidelity, BlackRock, Coinbase, CME, and others are all means of control. Operation Chokepoint 2.0 was a successful campaign directly and indirectly. Crypto-friendly banks were assassinated and held up as examples for other banks as a

this could happen to you example. Decentralization here in the U.S. is very near to being outlawed based on today's developments. SEC, DOJ, IRS, Treasury, OCC. If you aren't convinced by now of this reality, the memo from Treasury and the IRS should end all doubt. Now, so far, the proposal is just for discussion. purposes, with the Treasury to solicit public input and feedback on the proposed regulations. Public comment on the rule will be open until October 30th, after which a public hearing will be

held on November 7th. What's more, the enactment period for the rule is unusually long. The first required reporting date is not until 2026 to cover the previous year's transactions. Now, summing up the mood closing out Friday, Jake Chavinsky wrote, There are good weeks and bad weeks in crypto policy. This week, DOJ and Treasury reminded us of a sad but unsurprising truth. Our effort to manifest the right to privacy through code will be met with fierce resistance. It was a bad week, but that's okay. In the end, we win. So that's the lay of the land, just a couple reflections before we close out here. First of all, Defy was always going to be an incredibly challenging regulatory issue in the United States. We can hem and haw and

scream all we want about the stupidity of the KYC regime, the inefficacy of the Bank Secrecy Act, etc, etc. But at the end of the day, those things absolutely dominate and rule thinking in Washington, basically among both parties. There isn't really any meaningful or serious challenge to that regime. So then, anything that seems or has a whiff of challenging that regime is very likely to be politically challenging. That was always going to be the case. The problem, of course, is that we're not dealing with an environment in which thoughtful good faith conversations, negotiations, discussions, are being or even really can be held. Instead, what we're dealing with is a political environment in which crypto is on the outs due to a variety of self-imposed wounds from last year and before,

due to the extreme, extreme counterreaction of Dems against the industry after their favorite person within it fell from grace, and due to the fact that there were always people within each of these agencies and institutions who just had it out for this industry from the get-go, even holding aside all of those things that transpired. From what I heard, back in 2021 when the infrastructure bill was first being negotiated, Treasury was an absolute bastion of those people. Now, of course, Treasury got quiet over the subsequent couple years, and other agencies and regulators became chief villains. I'm looking at you, Gary Gensler. But that doesn't mean that those people who hated crypto from the get-go ever really went away. I think one of the things that we've learned

this year with Operation Chokepoint 2.0 is that you don't need a press. residential mandate for unelected officials to run roughshod over an industry. All you need is for some portion of people in leadership positions in these various agencies to not be contested by people who are either neutral or on the other side of the issue to get really bad aggressive policy. I believe more than anything that's where we've been since the collapse of FTCS. Sure, some people went from neutral to against, but I think the bigger thing is that the people who were neutral and pro just didn't want to stick their neck out. And frankly, it's kind of understandable why. Now, of course, as we've documented extensively on this show,

that feels to be changing in general. But the Treasury won this battle two years ago. It just hadn't put it into practice subsequent to that. For those feeling glum or gloomy, there is still a ton of politicking to be done here, and this particular issue is far from solved. So keep your heads up, keep letting that anger fuel you, and we will live to fight another day. Until tomorrow, be safe and take care of each other. Peace.