Cryptocurrency

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Abstract

PayPal will soon begin offering support for cryptocurrencies, as the Silicon Valley payments company looks to capitalise on a resurgence of interest among consumers and traders in the virtual currencies likes of bitcoin and Ethereum. 

The New York State Department of Financial Services said on 20 of October 2020 it had granted PayPal a conditional “Bit license”, permitting it to trade and hold cryptocurrencies.

The articles explore the requirements and the process to issue a cryptocurrency licence.

1. What is a Virtual Currency? 

2. Tax consequences in USA

3.  the process to obtain a licence

4.Procedure for the application in NY  

5. After approval is granted

1. What is Virtual Currency 

Cryptocurrencies and blockchain are a monstrous topic.

There are several hundreds of cryptocurrencies and the applications of blockchain technology are also numerous, fundamental is made an immediate distinction between Virtual currency and Cryptocurrency.

Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. 

In some environments, it operates like “real” currency, but it does not have legal tender status in any jurisdiction. 

Cryptocurrency, instead, is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain.

Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. 

Bitcoin is one example of a convertible virtual currency. 

Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.

2. Tax Consequences in USA

The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.

For Federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. 

In fact, virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.

However, who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.

Trading with cryptocurrency for a taxpayer generally mean realize ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer.

Regarding the process call mining, when a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income and must be register as such.

Generally, self-employment income includes all gross income derived by an individual from any trade or business carried on by the individual as other than an employee. 

Consequently, the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax. 

Furthermore, the virtual currency paid by an employer as remuneration for services constitute wages for employment tax purpose must constitute the medium in which remuneration for services is paid is immaterial to the determination of whether the remuneration constitutes wages for employment tax purposes. 

Consequently, the fair market value of virtual currency paid as wages is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported.

A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. 

For example, a person who in the course of a trade or business makes a payment of fixed and determinable income using virtual currency with a value of $600 or more to a U.S. non-exempt recipient in a taxable year is required to report the payment to the IRS and to the payee. 

Payments made using virtual currency are also subject to backup withholding to the same extent as other payments made in property. 

If a taxpayer treats a cryptocurrency transaction in a different way respect to the one indicated (property), it may be subject to penalty.

3. the process to obtain a licence 

The New York Department of Financial Services (NYDFS) is issuing licenses under which company would be allowed to licensed entities since June 2015. 

The New York State Department of Financial Services (“DFS”) issued its virtual currency regulation, 23 NYCRR Part 200, under the New York Financial Services Law. 

The  “Bit License” regulation or the limited purpose trust company provisions of the New York Banking Law, DFS has granted numerous virtual currency licenses and charters to ensure that New Yorkers have a well-regulated way to access the virtual currency marketplace and that New York remains at the centre of technological innovation and forward-looking regulation.

As stated in 23 NYCRR 200.3(a), “No Person shall, without a license obtained from the superintendent …, engage in any Virtual Currency Business Activity.”

23 NYCRR 200.2(q) provides, in part: "Virtual Currency Business Activity means the conduct of any one of the following types of activities involving New York or a New York Resident:

1. receiving Virtual Currency for Transmission or Transmitting Virtual Currency, except where the transaction is undertaken for non-financial purposes and does not involve the transfer of more than a nominal amount of Virtual Currency.
2. storing, holding, or maintaining custody or control of Virtual Currency on behalf of others.
3. buying and selling Virtual Currency as a customer business.
4. performing  Exchange Services as a customer business; or
5. controlling, administering, or issuing a Virtual Currency.”

What is virtual currency under the regulatory framework set by the New York department 

Under the regulatory framework presented by The New York Department of Financial Services (NYDFS), virtual currency means any type any type of digital unit that is used as a medium of exchange or a form of digitally stored value. 

Virtual currency shall be broadly construed to include: 

• digital units of exchange that have a centralized repository or administrator 
• or are decentralized and have no centralized repository or administrator
• or may be created or obtained by computing or manufacturing effort. 

At the contrary, Virtual currency shall not be construed to include any of the following digital units that:

• are used solely within online gaming platforms.
• have no market or application outside of those gaming platforms.
• cannot be converted into, or redeemed for, fiat currency or virtual currency; and
• may or may not be redeemable for real-world goods, services, discounts, or purchases.
•  digital units that can be redeemed for goods, services, discounts, or purchases as part of a customer affinity or rewards program with the issuer and/or other designated merchants or can be redeemed for digital units in another customer affinity or rewards program, but cannot be converted into, or redeemed for, fiat currency or virtual currency;
• digital units used as part of prepaid cards.

virtual currency business activity means the conduct of any one of the following types of activities involving New York or a New York resident:

• receiving virtual currency for transmission or transmitting virtual currency, except where the transaction is undertaken for non-financial purposes and does not involve the transfer of more than a nominal amount of virtual currency.
• or storing, holding, or maintaining custody or control of virtual currency on behalf of others.
• buying and selling virtual currency as a customer business.
• performing exchange services as a customer business; or
• controlling, administering, or issuing a virtual currency.

The development and dissemination of software in and of itself does not constitute virtual currency business activity.

Reading between the line of the legislation is easy to see that the cryptocurrency also if authorised have very limited usage and must be strictly controlled by the subject authorised. 

4. Procedure for the application in NY 

To conduct virtual currencybusiness activity in New York State, entities can either apply for a BitLicense or for a charter under the New York Banking Law (for example, as a New York State limited purpose trust company or New York State bank) with approval to conduct virtual currency business. 

While these forms of authorization are similar, a New York state limited purpose trust company charter may provide some additional benefits. 

For example, a limited purpose trust company can exercise fiduciary powers, while a BitLicensee cannot. 

In addition, a limited purpose trust company can engage in money transmission in New York without obtaining a separate New York money transmitter license. 

The Department of Financial Services uses the Nationwide Multistate Licensing System and Registry (NMLS) to manage the BitLicense. 

NMLS is a secure web-based system created by state regulators to provide efficiencies in the processing of state licenses and improve supervision of state-regulated industries. 

Through NMLS, companies maintain a single record to apply for, amend, surrender, and change license authorities in one or more states, and make reports conveniently and safely online.

To access NMLS for the first time, you must complete a Company Account Request Form and identify a Primary Account Administrator and a Secondary Account Administrator. 

This form can be submitted electronically through the NMLS website in the “Getting Started” section. 

This form needs to be submitted only once per company, regardless of the number of NMLS participating states in which you are licensed.

Within three days of completing and submitting the Company Account Request Form, the Primary Account Administrator will receive NMLS login information. 

The Primary Account Administrator will have full rights to access the system, submit information to this agency and other participating state regulators, and set up other company users in the system. 

Instructions and tutorials on how to access and use the system are also available in the NMLS Resource Center.

Each company holding a BitLicense who wishes to manage their license on NMLS must create a company record in the system (see above). 

Current New York State BitLicensees whose applications were submitted before the integration of the BitLicense into NMLS may transition their licenses to NMLS. 

See the DFS Virtual Currency Business Activity Company License Transition Checklist on the NMLS website for more information.

Below the documentation utilised to obtain the licence:

• https://www.dfs.ny.gov/docs/banking/ialfsari.pdf
• https://www.dfs.ny.gov/docs/banking/ialfsfs.pdf
• https://www.dfs.ny.gov/docs/banking/ialicensee_contact.pdf
• https://www.dfs.ny.gov/apps_and_licensing/fingerprinting_procedure
• https://mortgage.nationwidelicensingsystem.org/slr/PublishedStateDocuments/NY_Virtual_Currency_New_Application_Checklist.pdf

5. After approval is granted

The VC Entity must ensure that: Its board of directors or an equivalent governing authority approves the coin-listing policy;

Its board of directors or an equivalent governing authority reviews and independently makes decisions to approve or disapprove each new coin.

Any actual or potential conflicts of interest in connection with the review and decision-making process have been assessed and effectively addressed, whether such actual or potential conflicts of interest are related to the VC Entity, its owners, principals, employees, their respective families, or any other party;

It keeps records, readily available for DFS’s review, of the coin-listing policy’s application to each coin. 

This includes board of directors or equivalent governing authority minutes, including the names of the participants and all documents the participants reviewed in connection with each coin’s approval or disapproval, such as reviews and sign-offs by all the VC Entity’s stakeholders, such as the legal, compliance, cybersecurity, and operations teams, including an assessment of all associated material risks;

Its board of directors or an equivalent authority reviews, at least annually, its coin-listing policy to ensure that it continues to properly identify, assess, and mitigate the relevant risks and to ensure the robustness of the governance, monitoring and oversight framework;

It informs DFS immediately if, at any time after DFS approval of its coin-listing policy, the VC Entity’s coin-listing policy ceases to comply with the general framework laid out in this Guidance; and

It does not make any changes or revisions to its DFS-approved coin-listing policy without the prior written approval of DFS.

The VC Entity must perform a comprehensive risk assessment designed to ensure that the coin and the uses for which it is being considered are consistent with the consumer protection and other standards embodied in 23 NYCRR Part 200 and with the safety and soundness of the VC Entity. 

The risks to be assessed include, but are not limited to, the following: 

Risks associated with a new coin’s creation or issuance, governance, usage, or design.  

The VC Entity must conduct a thorough due diligence process to ensure that the coin is created or issued by a legitimate and reputable entity or entities for lawful and legitimate purposes, and not for evading compliance with applicable laws and regulations (e.g., by facilitating money laundering or other illegal activities); and that the process is subject to a strong governance and control framework;

Operational risks associated with a new coin, including the resulting demands on the VC Entity’s resources, infrastructure, and personnel, as well as its operational capacity for continued customer on-boarding and customer support based on reasonable forecasts considering the overall operations of the VC Entity;

Risks associated with any technology or systems enhancements or modification requirements necessary to ensure timely adoption or listing of any new coin.

Cybersecurity risk: Risk of malfeasance, including, for example, theft.

Market risks, including concentration of coin holdings or control by a small number of individuals or entities, price manipulation, and fraud, and the impact of the coin’s wider or narrower adoption on market risks.

Risks relating to code defects and breaches and other threats concerning any new coin and its supporting blockchain, or the practices and protocols that apply to them. 

Mitigation should include, among other things, an escalation process to report such defects, breaches and threats to senior management and the board of directors or an equivalent governing authority for further action.

Risks relating to potential non-compliance with the requirements of the VC Entity’s supervisory agreement with DFS as a result of the adoption of new coins, including the VC Entity’s capital requirement in accordance with 23 NYCRR 200.8;

Legal risks associated with any new coin, including any pending or potential civil, regulatory, criminal, or enforcement action relating to the issuance, distribution, or use of the new coin;

Risks associated with actual or potential conflicts of interest: the VC entity must have effective policies and procedures to prevent such conflicts from affecting the VC Entity’s use or offering of the coin, and must also have effective requirements for the disclosure of such conflicts to customers; and,

Regulatory risks: Each coin must comply with all applicable laws, rules, regulations, and regulatory guidance, such as those of the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN), the U.S. Commodity Futures Trading Commission (CFTC), and the U.S. Securities and Exchange Commission (SEC), including, if applicable, whether a regulator has determined that the coin is a security.

Once a VC Entity begins using a new coin, the VC Entity should have policies and procedures in place to monitor the coin to ensure the VC Entity’s continued use of the coin remains prudent. 

This includes:

• Periodic re-evaluation of the coin, including whether material changes have occurred, with a frequency and level of scrutiny tailored to the risk level of the particular coin, provided that the frequency of re-evaluation must not be less than annual;
• Adoption, documentation, and implementation of control measures to manage risks associated with the coin; and 
• The existence of a process for de-listing the coin, with respect to some or all Virtual Currency Business Activity of the VC Entity, including notice to affected customers and counterparties in the case of such de-listing.

Once a VC Entity’s coin-listing policy is approved by DFS, the VC Entity will be able to self-certify to DFS that its proposed use of a new coin complies with the requirements of its DFS-approved coin-listing policy. 

Prior to using the coin, the VC Entity will provide written notice to DFS of its intent to use the coin, including details of its specific use and purpose. 

In such case, no prior approval from DFS will be required, only prior notice to DFS. VC Entities are also required to keep DFS informed, no later than at the time of their next quarterly filing, of all coins used or offered in connection with their Virtual Currency Business Activity.

A VC Entity that does not have a DFS-approved coin-listing policy is required to seek DFS’s prior approval with respect to any coin it wishes to use.

Finally, VC Entities must provide their customers appropriate written disclosures regarding the coins they offer for use and must indicate to their customers whether a coin is drawn from the Greenlist, added through self-certification, or added through specific DFS approval.

A complete set of information is available here

October 2020

by Daniele Lupi