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Despite recent stalls, digital asset revenue is projected to grow at a compound annual rate of 14% between now and 2027. Non-fungible token (NFT) revenue is expected to surge at an annually-compounded 19% during the same period. As more individuals and organizations hold cryptocurrencies, and as digital assets are traded in more contexts, regulatory bodies are jostling for who should regulate them and how to enforce their use.
Preparing for New Digital Asset Rules and Guidance
In response to the growing presence of digital assets, organizations across the government should be preparing for new digital asset rules and guidance. This includes agencies and IT leaders who need to consider key issues, especially around data structures, in order to effectively regulate and enforce digital asset transactions.
The Journey to Crypto Legislation
The path towards crypto legislation has been progressing in recent months. In early July, the Senate Finance Committee launched an effort to address uncertainties around the tax treatment of digital assets. The committee is seeking input from industry stakeholders on how the federal tax code can provide clearer guidance on particular transactions involving digital assets.
Legislation to create a comprehensive regulatory framework for crypto assets was reintroduced by Sens. Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) the following day. The revised bill would add anti-money laundering provisions and set aside new resources for enforcement. While the bill is unlikely to become law as it stands, it should drive conversations in Congress on how provisions in other legislation could address industry issues.
In late July, the House Financial Services and Agriculture Committees both endorsed the Financial Innovation Technology for the 21st Century Act, which would create a regulatory framework for digital assets. The advancement of this legislation was seen as a victory for the industry, as it would more clearly define the Securities and Exchange Commission’s jurisdiction on crypto matters. However, the bill is likely to face challenges in the Senate.
Most recently, on August 25, 2023, the Treasury announced proposed regulations on the sale and exchange of digital assets by brokers. This is a significant milestone in the regulation of digital assets. The proposed regulations provide clarity on who qualifies as a digital asset broker, which sales and exchanges must be reported, and how they must be reported to the IRS. The proposed regulations will be open for comment until October 29, 2023, and a public hearing will be held on November 7, 2023, before the Treasury finalizes the regulations.
Enforcement Actions and the Need for Regulation
On the enforcement front, there have been several high-profile cases and actions taken by regulatory bodies. Since the FTX Trading collapse in November 2022, the Securities and Exchange Commission (SEC) has filed charges or taken other action in nearly two dozen crypto-related cases. The Internal Revenue Service (IRS) has also seized some $10 billion in crypto assets since it began investigating digital asset crimes a few years ago.
The intent of Congress to establish a framework for the regulation of crypto assets is a positive development for the industry. It should relieve some of the enforcement pressure brought by the SEC and the Commodity Futures Trading Commission (CFTC). Additionally, it will provide clarity for relevant agencies on the rules and accountabilities surrounding digital asset transactions. However, once legislation is enacted, agencies will face challenges relating to people, processes, and technology.
Managing Crypto Data Formats
Agencies will need to consider how to manage and analyze digital asset data in order to enforce regulatory requirements. Currently, digital asset data exists in disparate, nonstandard formats. Centralized exchanges such as Coinbase and Kraken use proprietary data structures that may differ depending on their reporting requirements. Participants in decentralized finance (DeFi) and non-fungible tokens (NFTs) also have unique data formats.
The primary issue is the lack of standards for accessing, capturing, and reporting this data. Regulatory bodies have dictated a standard for data formatting in some cases, but it may be more ideal for regulators to specify the data they require and allow the industry to determine the standards.
The Infrastructure Investment and Jobs Act (IIJA) could play a role in driving crypto data standardization. Signed into law in 2021, the IIJA includes provisions that expand tax reporting requirements for certain digital asset transactions. The Treasury’s recent regulations will likely require industry participants to modify their systems to comply with these reporting requirements. This may lead to the push for data standardization.
Standardizing the types of data required by the IRS will likely align with the needs of other agencies such as the SEC and CFTC. Depending on the scope of entities or platforms the new tax regulations will apply to, the new regulations may align with other legislation passed for non-tax rules. This would result in de facto data standardization.
Modernizing for Crypto Data Management
Relevant agencies such as the IRS, SEC, CFTC, and Justice Department will need to be able to receive, validate, correlate, and analyze data from a variety of sources. Data standardization will help with this process, but data received from different sources will still need to be validated and correlated into a holistic data set for analysis. Legacy technology used by various agencies may struggle to efficiently handle this data in the short term.
Digital asset data is digitally-native, meaning it is received through cloud-based services or API connections. While this makes data transmission and management easier over time, legacy systems may still struggle to integrate with this new data. Creative solutions will be needed to connect digital asset data with legacy systems where non-digital-asset data is stored and analyzed.
There are also cybersecurity concerns associated with managing digital asset data. While data received by agencies into their own ecosystems or secure cloud-based systems can be easily secured, connecting directly to open-source blockchain networks may present cybersecurity risks. Agencies may need to partner with vendors that have expertise in managing secure government cloud environments to ensure data security.
The fast-paced evolution of the digital asset ecosystem poses additional challenges for agencies. Blockchain networks can change rapidly, and understanding the nuanced technological differences between networks can be overwhelming. Partnering with a vendor that can operate in a secure cloud environment and manage on-chain data may be the simplest strategy for agencies.
Conclusion
Agencies must prepare for new digital asset rules and guidance as the industry continues to grow. The journey towards crypto legislation is progressing, and agencies need to consider key issues, especially regarding data structures and management. Data standardization will be crucial for effective regulation and enforcement, and agencies will need to modernize their systems and technology to handle digital asset data. Partnering with vendors that have expertise in managing secure government cloud environments may be the best approach for agencies. By taking a proactive and forward-looking approach, agencies can fulfill their data needs and maintain their compliance and enforcement missions in the evolving landscape of cryptocurrency regulation news.
