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What Are The Potential Legal Risks To Cryptocurrency Investors?

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In recent times we have experienced massive growing interest in Cryptocurrency by investors for short and long-term investing. It's proving to be a fancy new investment sector as a shortcut to getting rich by investing in great crypto projects.

With the increase in public interest, we are witnessing increased integration of crypto payments in day-to-day activities. Cryptocurrencies are here to stay for long as an easy alternative to the payment system and investing tool.

Since this is a relatively new sector and very different from traditional fiat currencies, rules and regulation regarding this keeps evolving. One must be up to date with the changing government policies so as to avoid legal problems.

Investors should be familiar with their crypto investment and their do's and don'ts. In this article, we are going to learn about the things that will help us avoid the potential legal risks while investing in cryptocurrencies.

Capital gain taxes on Cryptocurrency Investmensts

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Capital gain taxes on cryptocurrency investments must be duly paid like any other financial investment to avoid any kind of legal trouble. Since it’s a new sector people may misunderstand this as tax-free but it absolutely not.

According to the US federal income tax rule, Cryptocurrencies are categorized as a property and not a currency and cannot be used as Functional currency for the Internal Revenue Code. Therefore US citizens must report any transactions involving crypto in their annual tax returns.

In the USA, Cryptocurrencies are the same as any ordinary income and capital gain tax and are subject to anywhere between 10-37% according to one's tax bracket. It also depends upon short-term and long-term investment.

If you made a profit by holding your crypto investments for more than a year then you are obligated between 0-20% for capital gain tax. Similarly, if your crypto investment holding was less than a year then anywhere between 10-37% is owed to the government.

Any failure to pay your capital gain tax like any other taxes is a punishable event by the government. You may be liable to a huge fine and also have to serve jail time according to the amount of your failed payment.

IRS view on Cryptocurrency

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IRS's view on cryptocurrency is that they see cryptocurrencies as a digital asset i.e. any digital representation of value that is recorded cryptographically secured distributed ledger. It also includes other digital assets like NETs and stablecoins.

IRS currently forces cryptocurrency users to report their tax returns of any digital assets activities including trading cryptocurrency regardless of generating gain or loss. If your cryptos are stored in centralized exchanges then IRS can track it.

IF you fail to do so as per the instruction from the IRS then after 90 days of not submitting your crypto gains on Form 8938 then you could face a fine of up to $50,000. On top of that after each passing an additional 30 days you could face an additional $10,000 fine.

It is always good to have a  tax professional who is quite familiar with the regulations regarding cryptocurrency and up to date with changes. This will not only help to avoid legal trouble but you may also get ideas on legally reducing your tax obligations.

Many cryptocurrency traders got CP2000 audits because of their failure to report on their Cryptocurrency activities and failure to include  1099-K from a crypto exchange. A cp2000 is a proposal to adjust your income, credits, payments, etc.

The Lack of Central authority in Cryptocurrencies

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The lack of central authority in cryptocurrencies makes crypto a little bit complicated as there is no backing of central authority like in fiat currencies. These cryptocurrency's values are completely determined by agreement between buyer and seller.

Without any central authority backing the cryptocurrency’s value, there will always be a risk for investors when a complication with ownership or transaction arises. There is no legal means to resolve the dispute as of yet.

Another risk factor could be the decentralized nature of transaction. Some may see this as an advantage but when you become a victim of any kind of scam and financial fraud in these decentralized channels then there is practically zero chance to recover your assets.

You must be very particular and thorough about your transaction before sending it as it is nearly impossible to recover your funds if you send it to the wrong wallet address. There are no trusted financial institutes involved in settling deposits and debt claims.

The central authority will help protect investors as there are very few cases of fraud and scams in centralized exchanges. People lose a lot of money buying unknown cryptocurrency projects once it turns out to be a hoax but central authority will help prevent it.

Issues  Regarding Cryptocurrency Registration and Licensing

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Issues regarding cryptocurrency registration and licensing will always be tough because of its complex and evolving legal status. The area is relatively new and significantly less clear for business organizations that allow clients to use cryptos as a means of payment.

Those companies that only accept cryptocurrency as digital payments are not required to obtain any kind of license at all. However, they are required to submit considerations if the jurisdiction there are on demands of them.

The sole legal obligation of crypto transactions falls upon the shoulders of the manager or business owners to make sure everything is done by the book on both local and international levels.

A Growing number of business organizations are in the race to accept cryptocurrencies as a mode of payment. This number is likely to grow year after year after the licensing and registration process becomes relatively simple and easily accessible.

Here are some big organizations that do take cryptocurrencies as a mode of payment:

  • Overstock.com: This company started accepting Bitcoin as early as 2014 when the concept of crypto was very new. It currently has a partnership crypto exchange platform Coinbase to accept payments on its platform.
  • Travala.com: This is an online travel company that accepts a lot of crypto as a mode of payment including Dogecoin, Cardano, Ethereum, Bitcoin, etc. It is partnered with Crypto.com and Binance Pay so that clients can pay through this exchange’s app.
  • Paypal: US PayPal allows you not only to buy and sell crypto but also can be used as a mode of payment as long as you hold enough crypto in your wallet.  The major cryptos accepted are Bitcoin, Ethereum, Bitcoin Cash, and litecoin.
  • Starbucks: Yes, now you can buy your morning coffee using cryptocurrency as Starbucks also have started accepting it. Starbucks is partnered with the Bakkt app which helps allow customers to pay for Starbucks.
  • AT&T: In 2019 AT&T announced that they were the first mobile carrier to accept cryptocurrency as a form of payment. They use BitPay as a third-party payment processor to oversee the transaction as customers use their Bitcoin to make payments.
  • Dallas Mavericks: Mark Cuban being one of the whales of the crypto ecosystem has been accepting payment in crypto payments for more than two years now in his NBA team. Fans now are able to pay with cryptos to buy match tickets and team merchandise.

Contractual issues in Cryptocurrencies

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Contractual issues in cryptocurrencies may not arise often because it is known to be self-executing “smart contracts”. These contracts automatically pay the other party after they complete their contractual duties needing no human involvement as are middle man.

Since the unique nature and inherent complexity of these smart contracts, it is still difficult to determine  whether they fit into traditional contractual law and legal framework. This makes it difficult to regulate these contract obligations.

We know that the USA has no federal contract law that is applicable throughout the country as it varies from state to state. More on that since October 2020, no federal law has explicitly defined these smart contracts and their legal validation.

The only way that provides limited legal validity of these smart contracts is “The Electronic Signatures in Global and National Commerce Act of 2000”. But still, these are likely to result in very lengthy litigation processes due to their unclear validity.

Jurisdictional issues with Cryptocurrencies

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Jurisdictional issues with cryptocurrencies are one of the biggest legal challenges associated with blockchain and smart contract technology. Since the technology is global, it becomes very difficult to determine which jurisdiction it comes under at the time of dispute.

The main point behind blockchain technology and cryptocurrency is that it involves no particular way to pinpoint a ledger’s actual locations. Since it offers greater privacy than traditional platforms it is even tougher to resolve jurisdiction issues.

Since there is no way to pinpoint the transaction's physical locations and blockchain transnational nature it is very difficult to choose whose jurisdiction it comes under. This is mainly because of the technology's broader reach.

In the Telegram Group Inc. vs. the SEC case, The SEC accused that Telegram had violated the securities law while issuing ICO and this promoted the court to whether or not US securities law could be applied. This was because the company was based in the British Virgin Islands.

Fraud and Money Laundering Issues regarding Cryptocurrencies

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Fraud and Money laundering issues regarding cryptocurrencies have proven to become quite a headache for the regulatory agencies. Given it’s anonymous in nature tracking the main source is still a challenge since it’s done via a decentralized platform.

There are still wild theories and beliefs among many people that cryptocurrencies provide criminal organizations a ground to commit fraud, money laundering schemes, and financial crimes.

This may not be the case of concern to crypto investors who do not use these tools to aid financial crime and money laundering but there are certain unaware individuals being victims of such crimes. When such crimes happen, there are no legal options to seek help.

Once you are scammed off then it is almost impossible to recover those funds. We often hear news about hackers scheming millions of dollars and vanishing into thin air kind of situation.

This issue also can be because of the decentralized status of various digital currencies. Once your digital assets are hacked and stolen there are no standard ways to recover those lost items.