A Global Guide for In-House Counsel: Doing business in a rapidly changing world

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Commercial – Crypto & NFTs

What are the biggest investment opportunities in digital -and how can clients decide on the best entry point for them?

Digital assets have been around for decades, but have recently become more popular. While digital assets come in many forms and vary in value (some possess tangible and intangible value), this sector includes a broad array of investment types, including but not limited to: Cryptocurrencies, DeFi platforms, decentralised applications, and non-fungible tokens (NFTs). These digital assets represent an attractive investment opportunity to diversify an investment portfolio representing about $3 trillion of global assets and is poised for further growth. When focusing on digital currencies, the best opportunities for investment include: saving; staking; farming; swapping; and trading.

Clients should consider whether these investments fit their portfolio goals, risk profile and personal convictions. In addition, it’s essential to get educated on the ins and outs of this fastgrowing industry before investing, and be prepared for volatility: the digital currency world is not for the faint of heart, it moves quickly and is known for being highly volatile.

Crypto can be a volatile market: how do you advise your clients to mitigate risk when trading in digital currencies?

Trading is currently the most common activity in the cryptoasset ecosystem. Nevertheless, consumers, investors, and businesses investing in cryptocurrencies are exposed to a variety of risks. Two of the main risks of digital currency are:

  • Volatility: Unexpected market changes can provoke significant and sudden moves in cryptocurrencies’ value.
  • Lack of regulation: as a decentralised currency, they lack uniform regulation, making the market lack certain protections and suspectable to fraud, scams or/and hacking from bad actors.

While this market continues to be underregulated, in the United States cryptocurrency transactions can be covered by the Bank Secrecy Act and anti-money-laundering laws. For example, the Anti-Money Laundering Act of 2020 codified prior FinCEN guidance by making all transactions in “value that substitutes for currency” (which includes digital currency) subject to reporting requirements and money transmitter registration. In 2015, the CFTC declared virtual currency a “commodity” subject to oversight under its authority under the Commodity Exchange Act (CEA). Hence, CFTC has jurisdiction to protect market users and their funds, consumers, and the public from fraud, manipulation, and abusive practices related to derivatives and other products that are subject to the CEA. Finally, financial intermediaries, such as broker-dealers, exchanges, transfer agents, and clearing agencies, that perform any of their activities in the digital asset context, may be subject to regulation under the Securities Exchange Act. Depending on the activities of the entity, compliance with the Securities Exchange Act may include obligations such as registration, capital requirements, reporting, disclosures, and filings of forms and policies with the SEC for approval.

Participants in the digital asset market should also review the guidance and interpretations concerning digital asset products and market participants provided by the CFTC, the SEC, FinCEN, the IRS, and state regulators such as the DFS.

Specifically to Puerto Rico, there are several legislative efforts currently underway looking to regulate certain activities at a local level. From the different bills presented, the most comprehensive one is House Bill 1425 which looks to create the “Act for the Promotion of Blockchain Products and Services of Puerto Rico”. If passed, this bill would amend existing statutes regarding IFE’s and Monetary Services in the Island.

How is your jurisdiction managing the legal challenges of NFTS: for instance, taxation on purchases, IP, ownership and theft?

The utility of blockchain technology has extended beyond cryptocurrencies to the creation, ownership, and sale of digital assets through tokenisation. These digital assets are referred to as non-fungible tokens (NFTs). Even though NFTs’ popularity has risen, the legal treatment of these tokens continues to evolve and is unsettled. Some of the legal issues concerning NFTs are: Intellectual Property Rights (IP) and taxing NFTs.

Intellectual Property At present, the most widespread use of NFTs is in the form of digital collectables, such as digital artwork. But the relationship between NFTs and the legal ownership of digital or physical property is unclear. This raises questions about IP rights protection.

Taxing NFTs The U.S. tax code doesn’t formally address how NFTs should be taxed. But this year the IRS issued tax guidelines stating that NFTs are taxed the same way as cryptocurrencies and stablecoins. Per IRS guidance, any crypto-to-crypto transaction is a taxable event, making the NFT activities taxable when said transactions are involved. However, this could apply depending on the use, purpose and actions an owner of an NFT takes with regards to this asset. In general terms, some NFTs are sold merely as tokenised art, while others are not.

Some jurisdictions have started taxing the sale of NFTs. Washington and Pennsylvania were the first two states to wade into NFT sales tax. In fact, both states could retroactively collect money related to NFT sales. This happened because, instead of enacting new legislation, they provided guidelines that interprets existing tax law.

In Puerto Rico, the Department of the Treasury recently published a draft with the purpose of including NFTs among the provisions of the Sales and Use Tax (IVU). According to the draft, the proposal would redefine the definition of “Specific Digital Products.” This would be defined as: “electronically transferred or delivered digital audiovisual works, digital audio works, or other digital products…including digital products in the format or medium of non-fungible token or ‘NFT’…”

The fact is that, although most states haven’t directly addressed the taxability of NFTs, multiple jurisdictions can impose sales tax on NFTs without enacting new legislation. However, there are many complexities when trying to apply sales tax to NFTs that are not present in normal physical transactions. States could expand current law to include taxation of NFTs. Allowing sellers to rely on their own research could make them run the risk of being held liable for non-collection of state sales tax.