The Distributed Ledger: Blockchain, Digital Assets and Smart Contracts – August 2021 | JD

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This issue discusses a variety of legal, regulatory and enforcement developments in the digital asset space in the U.S. and Europe, including expanded reporting requirements for broadly defined cryptocurrency “brokers,” a state law that allows decentralized autonomous organizations to incorporate as limited liability companies and enforcement settlements directed at particular segments of the growing digital asset market.

US Litigation Updates

International Updates

Cryptocurrency Provision in Infrastructure Bill Would Impose Obligations on Numerous Industry Participants

On August 10, 2021, the U.S. Senate passed a $1 trillion infrastructure bill aimed at increasing infrastructure funding over the next eight years. To connect it to increased tax revenue to help pay for these expenditures, the Senate included a provision imposing reporting requirements on cryptocurrency “brokers,” with estimates that such reporting would allow the Internal Revenue Service (IRS) to collect an additional $28 billion in tax revenue over ten years. However, the broad definition of “broker” sparked significant backlash throughout the cryptocurrency community, resulting in an unusual few days of proposals and counterproposals. While the short-term result was that the original definition remained in place, the debate marked the most serious consideration of a cryptocurrency issue by either chamber of Congress to date.

Broad Definition of “Brokers”

The cryptocurrency reporting provision in the infrastructure bill is aimed at closing the reporting gap in the current cryptocurrency landscape. Currently, unclear reporting requirements coupled with the difficult in tracing individual cryptocurrency transactions has left a large disparity between the amount of taxes paid on crypto transactions and what is actually owed. The proposed provision of the infrastructure bill sought to address this issue by requiring digital currency “brokers” to report information to the IRS in a 1099 form, including purchase and sales prices and customer information.

While few stakeholders disagreed with the ultimate purpose of the provision, the bill defines a broker as “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Those in the cryptocurrency community and senators who are more familiar with cryptocurrency transactions quickly criticized the definition as broad and unworkable. As worded, the definition would arguably include a number of industry participants — such as software developers, miners, validators and others involved in a digital currency transaction — who are unable to identify their users. These participants would ostensibly be left with a choice of not complying with the requirement or exiting the market. Critics warned that this could result in pushing these participants out of the U.S. market and into more favorable regulatory environments overseas.

Proposed Amendments

In response to a large and concerted outcry from the cryptocurrency community, Sens. Ron Wyden (D-Ore.), Pat Toomey, R-Pa.) and Cynthia Lummis (R-Wyo.) proposed an amendment that would have excluded from the reporting requirements those cryptocurrency operators who validate transactions, those who develop digital assets or software protocols for use by others, and hardware and software wallet developers. While the fintech community thought this amendment would resolve the issue, the following day, Sens. Rob Portman (R-Ohio), Mark Warner (D-Va.) and Kyrsten Sinema (D-Ariz.) proposed a competing amendment purportedly supported by the Treasury Department and the Biden administration that solely exempted those miners or validators engaged in “proof-of-work” consensus mechanisms (which mechanisms are currently used in the Bitcoin and Ethereum blockchains). Validators or miners participating in other consensus mechanisms, such as “proof-of-stake” (to which Ethereum plans to migrate and which is used by other blockchains), would still be subject to the reporting requirements, as would software developers. The Portman-Warner-Sinema amendment drew even sharper criticism than the original text of the bill since it not only failed to fix the problem of setting attainable reporting requirements, but also exacerbated it by effectively choosing technology winners and losers, imposing reporting requirements on certain technology solutions but not others. After considerable back-channel negotiations, a bipartisan amendment, supported by the Treasury Department, was introduced that would have exempted cryptocurrency participants who validate transactions as well as hardware and software wallet developers. However, the unique procedural posture of the infrastructure bill required unanimous consent. The amendment fell one vote short of such unanimous consent when Sen. Richard Shelby of Alabama objected to the proposal, offering to reserve his objection only if senators included in the legislation his unrelated amendment to increase military spending by about $50 billion. Sen. Bernie Sanders of Vermont voted against the Shelby proposal, and the Senate therefore passed the infrastructure bill with the initial broad definition of “broker.”

What’s Next?

Members of the House of Representatives have already discussed the need for an amendment to narrow the definition of “broker.” Despite these public calls for an amendment, experts say the House is unlikely to amend the bill and risk collapse of the entire infrastructure law by sending it back to the Senate for another vote.

Some lawmakers believe that the Treasury Department will narrow the definition of “broker” through regulations and guidance. The operative provision of the bill explicitly grants the Treasury the regulatory authority to define the scope of the provision. Senators have also attempted to clarify what was actually intended by the legislation, stating that the reporting obligations should only apply to entities that are regularly effectuating transactions of digital assets for consideration. This could strengthen the IRS’s ability to effectively narrow the bill’s applicability.

Key Takeaways

The ultimate takeaways from the events of the last few weeks will not be known until final guidelines and regulations are in place. However, the intense lobbying effort by the cryptocurrency community was a watershed moment highlighting the industry’s growing political influence and its ability, at least for this reporting issue, to unite around a common cause. And, while the compromise amendment failed, debates within the Senate around concepts such as “proof-of-work” and “proof-of-stake” demonstrated a growing sophistication within Congress around cryptocurrency issues and showed that some senators were prepared to advocate on the industry’s behalf. As Sen. Luumis noted: “This amendment has started the debate on many difficult questions related to financial technology that the Senate must address over the next few years.” Finally, the inclusion of this reporting provision in the bill illustrates both the government’s recognition of cryptocurrency as a component of the financial landscape and officials’ focus on ensuring that transactions are properly taxed going forward.

Wyoming Passes New Legislation Recognizing DAOs as LLCs

On April 21, 2021, Wyoming Governor Mark Gordon signed Bill 38, allowing the state to legally recognize decentralized autonomous organizations (DAOs) as limited liability companies. The bill was sponsored by Wyoming’s Select Committee on Blockchain, Financial Technology and Digital Innovation Technology and took effect on July 1, 2021. Under the law, a DAO must maintain its presence in Wyoming through a registered agent and include proper designation in its articles of organization (self-identifying as a “DAO,” “DAO LLC,” or “LAO” (Limited Liability Autonomous Organization)). Importantly, the legislation ensures that members of a DAO will not be held personally liable for the debts and liabilities of the company, addressing a concern that a DAO could be construed as a partnership.

DAO Background

Generally, DAOs are decentralized entities that make governance decisions, and implement certain actions through the use of blockchain-based “smart contracts” (i.e., pieces of computer code that execute specified functions when given…

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The Distributed Ledger: Blockchain, Digital Assets and Smart Contracts – August 2021 | JD