Welcome to the last Crypto for Advisors newsletter for 2023. Thank you to all the contributors who have shared their knowledge and guidance for advisors this year.
I wish everyone a happy new year. All signs are pointing to an exciting 2024 in the crypto space.
As we embarked on 2023, the crypto world was still grappling with the fallout from the FTX debacle and Terra LUNA’s collapse in 2022. These events catalyzed a contagion in the industry, leading to a significant loss of trust, liquidity issues and market instability. Despite these challenges, Bitcoin price demonstrated remarkable resilience up ~150% YTD by the final week of 2023 per CoinDesk charts – Bitcoin YTD growth as of Dec 26, 2023. This growth underscores the robustness and potential of digital assets, even in the face of adversity.
However, despite this growth and resilience, several myths continue to plague the digital asset ecosystem. These misconceptions are often fueled by a lack of understanding, biased perceptions, and persistent stereotypes. As we see increased interest from investors and the looming possibility of a spot bitcoin ETF in the U.S., it’s imperative for financial advisors to provide educated and unbiased responses to these myths. While I cannot cover all the myths in this article, I will address the most prominent one for bitcoin i.e. bitcoin is mainly used for illegal activities and money laundering.
In bitcoin’s early days, a small but visionary group of individuals and organizations recognized its potential and the revolutionary technology underpinning it. As bitcoin gained broader adoption and its value increased, it inevitably caught the attention of criminals, leading to its use in illicit activities, including the infamous darknet marketplace Silk Road, which accounted for nearly 20% of total bitcoin economic activity at its peak in 2013. Additionally, bitcoin became the preferred currency for ransomware attacks. These developments contributed to bitcoin’s reputation as a “criminal currency,” a perception that still persists to this day.
At a high level, combating financial crime and money laundering relies on three key pillars – technology infrastructure, regulation and law enforcement. Bad actors are always looking for new ways when one or more of these pillars is missing or not evolved yet.
Acknowledging the above, it is important to note that bitcoin’s early adoption among illicit users was not due to its alleged untraceable and anonymous nature of bitcoin technology but rather the lack of sophisticated crypto intelligence and analysis infrastructure, as well as lack of applicable regulations at the time. Contrary to popular belief, bitcoin is pseudonymous, not anonymous.
With fiat currency, three pillars have evolved over decades with the broad adoption of the internet and continue to evolve to this day with enhanced compliance requirements to capture the evolving threats landscape. However, having these three pillars in place doesn’t guarantee the prevention and detection of all illicit activities. In fact, according to a 2022 report by the U.S. Department of Treasury, key weaknesses within the U.S. Anti-Money Laundering and Combating the Financing of Terrorism (AML/CTF) regulatory regime include a lack of timely access to beneficial ownership information of legal entities and lack of transparency in non-financed real estate transactions, and use of virtual assets for money laundering remains far below that of fiat currency and more traditional methods. Expecting an emerging technology and users to have all pillars figured out from inception isn’t reasonable. Now let’s break these pillars down for bitcoin as it stands today:
Technology Infrastructure
Since 2014, there has been a significant effort to develop and implement infrastructure to prevent, detect and investigate bitcoin and other crypto transactions. Today, there are numerous tools available for financial institutions, regulators, law enforcement and virtual asset service providers (VASPs) that enable advanced techniques and tools to track and analyze bitcoin and crypto transactions, leading to the identification and apprehension of criminals in various cases. The level of traceability in bitcoin is actually higher than in many other financial systems, especially cash where transactions can be much more opaque.
While there are improvements underway to enable advanced techniques for crypto activities outside of bitcoin, such as privacy coins, stablecoins and DeFi, these are already quite mature for transaction monitoring and reporting crypto institutions.
The view that bitcoin and other crypto assets are unregulated is a major misconception. It’s a known fact that regulations follow innovation, as regulators need to undergo a comprehensive administrative process to understand the impact and regulate accordingly. In fact, the U.S. was one of the first countries to subject crypto exchanges to registration, reporting and recordkeeping requirements for AML/CTF purposes when FinCEN classified these as Money Services Businesses (MSB) in 2013. Many other countries, including Japan and South Korea, followed suit during the Initial Coin Offering (ICO) boom in 2017/ 2018. In 2019, Financial Action Task Force (FATF) issued comprehensive guidance that outlines the need for countries and VASPs, and other entities involved in crypto asset activities, to understand the AML/CTF risks associated with their activities and take appropriate mitigating measures to address them. These have been periodically updated since then.
As of today, 83% of G20 nations and major financial centers have enacted or are developing national crypto laws. An important distinction to note in the bitcoin world is that while there’s a reactive component to regulation, there’s also a significant proactive effort to understand and regulate this rapidly evolving technology.
Between 2013 and 2023, approximately $8.496 billion in crypto and fiat have been seized as a result of law enforcement actions, as well as numerous bad actors that enabled have been charged per the Chainalysis Myth-Busting Report (2023). We’ve also seen a number of enforcement actions globally for non-compliance of AML/CTF regulations – most recently with the Binance settlement worth over $4 billion. Global collaboration across law enforcement agencies and public-private partnerships is enabling identification and investigation of financial crime in a much more efficient way given the underlying technology and unique characteristics of bitcoin.
Overall, the key takeaway is that with every technological advancement, there’s a period of adaptation where benefits are harnessed, and risks are mitigated through new regulations, enhanced technology infrastructure and law enforcement actions. In the case of bitcoin, it’s happening at an unprecedented pace and the illicit actors are realizing that bitcoin is not a good instrument for money laundering given the current stature of the three pillars discussed above.
Q. What tax related items should investors be cognizant of?
Investors should pay attention to whether or not they have realized or unrealized gains or losses in their crypto trading accounts. Each carries unique implications that could greatly impact the next tax year.
Realized gains – If you have realized gains from selling digital assets this year make sure you segregate enough money to pay your capital gains taxes next April. Tax brackets will vary depending on the individual. Be careful when reinvesting proceeds from trades that made you a lot of money. You will owe taxes and if your new investments lose a lot of their principal you won’t be able to cover your future tax bill.
Unrealized gains – Keep in mind that crypto is volatile, and with the end of the calendar year so close it may be beneficial for you to hold off selling your winners until 2024 depending on your situation. That is because any gains made in 2023 have cap gains taxes due in April 2024. If you wait just one week and sell, the taxes won’t need to be paid until April 2025. That means you are free to reinvest and earn a return for an additional year. The opportunity to compound interest in this space could be extremely beneficial if you wait until the new year.
Realized losses – Realized crypto losses can be offset against other capital gains. Keep in mind that your losses can be carried forward indefinitely for future years and while the losses primarily offset capital gains they can be used to offset ordinary income from your work (up to $3000 per year)
Unrealized losses – Unrealized losses are currently a unique benefit to crypto investors. For stocks, bonds, ETFs, and mutual funds investors are bound to what is known as the wash-sale rule. This means that if you sell one of these securities at a loss you must wait 30 days before you can repurchase it. This rule does not apply to cryptocurrencies yet. If you have a digital asset with an unrealized loss, it is an option to sell and rebuy immediately. Having that capital loss to carry forward (called tax loss harvesting) can be extremely beneficial even if you can’t offset it against a gain this year. Note that with exchange fees, slippage, and general market volatility you won’t guarantee you’ll have the same number of units when you re-buy. Until this rule is applied to cryptocurrency it is a benefit that only direct holders will have. Spot bitcoin ETF holders will be bound to wash-sale rules as they will hold a security, not a digital asset.
