Treasury and IRS Proposed Broker Rulemaking; Grayscale Wins Over SEC

Treasury and IRS Proposed Broker Rulemaking

What happened?

Last week, the US Treasury Department and the Internal Revenue Service (IRS) proposed a rulemaking that would implement the Infrastructure Investment and Jobs Act’s amended definition of “broker” that would include “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.”

DeFi protocols and frontends would be included under the proposed interpretation of a broker. To do so, the proposal redefines the word “effect” to include persons that “provide facilitative services” and are “in a position to know information about the identity of a customer” rather than solely those who “ordinarily would know such information.” According to the proposal, such revision would include systems that do not currently request customer information but “have the ability to obtain information… by updating their protocols as they do with other upgrades to their platforms.”

Under these proposed regulations, all who fall under the definition of a broker would be required to report the names, addresses, and taxpayer identification number of customers; the name or type of digital asset sold and number of units, sale date and time, and gross proceeds of the sale; as well as the transaction (block) hash associated with the sale, the wallet address, and what was received in return for those digital assets (cash, digital assets, other property, or services).

What does this mean?

The proposed rulemaking is an overbroad redefinition of “broker” that is designed to create brokers where there aren’t any. The statutory definition of broker on which this proposal is based (quoted in the first paragraph above) cannot be stretched in practice to include persons not engaged in broker activity and who merely provide “facilitative services” and are in a position to potentially collect information about third parties.

This tension is reflected in the proposal itself. Indeed, it recognizes that “only” the users of wallets have the keys “necessary” to effect transactions on their own behalf. Notwithstanding this fact, it still attempts to find third-parties “responsible for effectuating transfers on behalf of” those same wallet users. Can effect mean two different things in the same rulemaking? We don’t think so, and we will be submitting comments to the Treasury and IRS expressing our concerns—stay tuned.

Grayscale’s Big Win

What happened?

On Monday, the US Court of Appeals for the DC circuit ruled in favor of Grayscale in its petition for review of an order of the Securities and Exchange Commission (SEC) for Grayscale’s proposed Bitcoin exchange traded product (ETP). The SEC has denied spot ETPs while approving Bitcoin futures ETPs. Grayscale challenged that disparate treatment, asserting that the SEC “failed to treat like cases alike” in this matter. The Court agreed with Grayscale and found the SEC’s actions to be “arbitrary and capricious,” meaning without rational and legal basis.

Grayscale's petition hinged on a compelling argument: the surveillance arrangements governing bitcoin futures ETPs should also be acceptable in the context of spot ETPs. Grayscale maintained that both ETPs rely on the underlying price of bitcoin, and thus the same surveillance arrangements should be deemed satisfactory.

The Court’s verdict highlighted the "materially similar" nature of Grayscale's proposed bitcoin ETP and the approved bitcoin futures ETPs. This similarity stems from the close correlation between the underlying assets—bitcoin and bitcoin futures. Additionally, the surveillance sharing agreements with the Chicago Mercantile Exchange (CME) were deemed "identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin."

What does this mean?

This three judge panel—Carter, Obama, and Trump appointees—unanimously found the SEC’s actions with respect to Grayscale to be unlawful. The ball is now in the SEC’s court, and we’ll have more clarity on what this opinion means in the weeks ahead.

Script:

Treasury and IRS Broker Rulemaking

Last week, the US Treasury Department and the Internal Revenue Service (IRS) proposed a rulemaking that would redefine a “broker” to include DeFi protocols and frontend websites, requiring each to report users’ personal identifying information to the IRS.

Under the proposed definition, a “broker” would be stretched to include persons that “provide facilitative services” and are “in a position to know information about the identity of a customer” rather than solely those who “ordinarily would know such information.” The proposal argues that because a protocol has the ability to upgrade to fulfill these requirements it is in a position to know a customer’s identity.

However, the proposal ignores its own recognition that users of unhosted wallets effectuate trades on their own behalf with their public and private keys, and attempts to create brokers where there aren’t any. For this reason, DEF will be submitting comments to the Treasury and IRS expressing our concerns. Stay tuned!

Grayscale’s Big Win

On Monday, the US court of appeals for the DC circuit ruled in favor of Grayscale in its petition against the Securities and Exchange Commission’s (SEC) denial of their Bitcoin exchange traded product (ETP). The petition came as a result of the SEC’s approval of two other Bitcoin futures ETPs, which Grayscale argued “failed to treat like cases alike.”

The three judge panel unanimously found Grayscale’s Bitcoin ETPs to be “materially similar” to the approped Bitcoin futures ETPs and the SEC’s actions with respect to Grayscale to be unlawful.