Fast-evolving cryptocurrencies challenge lawyers

New leadership in the White House has meant a lot of noisy changes, but some of the quieter and more far-reaching ones might be occurring in the area of digital assets, where the first president to launch his own meme coin seems to be charting a course to more crypto-friendly waters.

The move could represent a significant shift from the previous administration’s less trusting approach toward the unusual and controversial asset class.

Whatever the future might bring, the industry is still young, and the legal guidelines remain very murky as President Donald Trump begins his second term.

“There is not an overarching set of regulations for crypto as there are for securities,” said Stephen Bell of Mincey, Bell, Milnor, a Wilmington, North Carolina, boutique subsidiary of Cranfill Sumner that deals with white-collar issues and regulatory enforcement matters. “What the [Securities and Exchange Commission] had essentially done under [then-President Joe] Biden is make the rules up as they go through enforcement actions. They’d go after something they thought was a bad actor and then seek a judgment, and that judgment would essentially be precedent for the next time they run into bad conduct.”

‘Howey test’

Known as “regulation by enforcement,” this elastic philosophy allowed the SEC wide discretion under Depression-era securities laws to pursue cases against crypto platforms in a volatile industry that has become known for booms, busts and occasional scandals. However, it also engendered criticism from blockchain enthusiasts who felt that the SEC was unclear about the rules of the road and was misusing early 20th-century regulatory scaffolding to manage modern financial products that would have been inconceivable in that era. At the heart of the issue is a debate over exactly what crypto is and whether it qualifies as a security or a commodity — a difference that can have a significant impact on which laws apply and what regulatory agencies hold the authority to make decisions.

It also can be an important distinction for attorneys. Graham Newman of Chappell, Chappell & Newman in Columbia, South Carolina, was recently involved in a case where he represented an investor who alleged that a devalued crypto product was an unregistered security, a definition that, thanks to the Securities Act of 1933, might allow him to gain financial recompense for a price collapse.

Newman said the crux of the industrywide dispute revolves around whether crypto meets the U.S. Supreme Court’s four-pronged “Howey test” meant to determine what qualifies as an investment contract. The high court’s groundbreaking 1946 decision in SEC v. W.J. Howey Co. outlined that such a contract means money must be invested with an expectation of profits in a common enterprise, the success of which depends on the efforts of others.

Does crypto meet those criteria?

“If so, there is not much difference between a coin and a stock certificate,” said Newman, who is an alumni adviser to the Blockchain Law Society at the University of South Carolina and chair of the Consumer & Securities Law Section of the South Carolina Association of Justice.

During the Biden years, the SEC seemed to agree with that formulation and launched various actions targeting crypto-affiliated enterprises. However, the commission’s interest in such matters has waned sharply since the transfer of power and a wave of stories appearing in crypto media outlets in February reported that investigations were being dropped against crypto company Uniswap Labs, NFT marketplace OpenSea, and the Robinhood trading platform.

The SEC also seems to have waved the white flag in a high-profile court battle raging since 2023 against the Coinbase exchange, which declared victory late last month over the regulatory body’s efforts to define it as an “unregistered securities exchange”.

“I think it’s a really important signal that, [after] a small group of activists in this prior administration who tried to unlawfully attack this industry, we’re going to be able to turn the page on that and finally get some regulatory clarity in America,” Coinbase CEO Brian Armstrong told CNBC saying he hopes the regulator dismisses all the “bogus cases.”

Growth vs. fraud

But, even with the SEC’s crackdown easing, legal clarity remains elusive, and efforts in Congress have borne little fruit, leaving the executive branch to fill the resulting legislative vacuum.

Bell, who regularly advises litigants, stakeholders and whistleblowers in blockchain- and cryptocurrency-related matters, said that the Trump administration has tasked a working group to deliver recommendations on a comprehensive regulatory framework at the federal level, including presumably figuring out who precisely would be in charge of such a framework when it comes time to prosecute prohibited activity.

“You had different agencies essentially competing to enforce,” Bell said of the current situation. “It is bad for everybody. It is bad for industry. It is bad for government. It is bad for individuals involved in these businesses because nobody knows where to turn to make sure they are doing things the right way.”

Bell feels that if the president’s task force succeeds, it could point to more industry growth in the long term. Still, the risk of fraud remains an issue as guardrails come down in a nascent field continuing to suffer from the taint of scammers and illegality.

“The goal here is for anybody who is going to be a player in this industry to know what laws govern them so they can comply and, if they don’t comply, to make sure there is a means and mechanism to hold them accountable,” he said.

Bell said that he’s been advising clients interested in starting blockchain enterprises that they might want to wait six months until word is due from the president’s task force. At the moment, it simply isn’t clear what boxes have to be checked to make sure one is operating a given enterprise legally.

That includes state-level regulations. What are the rules? What licenses might be required? Who issues them? And who enforces them? Everything is fact-specific, and there are no blanket answers.

“Right now, the way this industry is set up, it is almost a deterrent and barrier to market entry for those companies just to get the legal opinions they need on whether or not their proposed business complies with the law,” he said. “That’s something that we see every day. Clients have a really good idea to enter the crypto space and the blockchain world, but they can’t afford the legal advice to get set up.”

Of additional concern, Bell, who often represents federal whistleblowers, including those related to SEC cases, said new untraceable “privacy coins” and “mixer services” that obfuscate the source of funds are continuing to checker the reputation of a financial asset class that’s already strongly associated by many with unsavory activities due to the dark side of its anonymous and decentralized nature.

“Crypto is commonly used in fraud,” Bell said bluntly. “It is commonly used to launder money.”

Volatility and valuation

Newman, who has a certificate in blockchain technology management from the University of California, says that he hears from scam victims frequently related to crypto. However, there’s not much he can do besides expressing sympathy.

“Unfortunately, it is really difficult to get that money back because it is probably sitting in a jurisdiction that is not subject to the Hague Convention and certainly not U.S. jurisdiction,” he said.

He feels there are a few questions that the nation is going to have to answer about such products.

“Number one, what are the best use cases for crypto, and number two, what sort of regulation, if any, do you want to put on crypto in order to promote those use cases?” he said. “Number three, how are you going to protect the investing public from bad actors?”

Regardless, he believes that a working knowledge of crypto might become increasingly important for attorneys in any area of civil practice as the asset becomes more common.

“The lawyers that are learning it right now,” he said, “in particular, the younger generation, they are going to have not just a leg up. They are going to have the ability to dominate the space.”

That dominance also might bleed over into more mundane areas of the legal field.

“It is coming up more and more all the time,” family law attorney Amanda Mason of Mason, Mason & Smith in Wilmington said.

That’s because assets frequently have to be valued and divided during divorces.

“The problem with cryptocurrency is that, unlike traditional assets, it is very volatile. One day to the next, it can have wild swings in valuations,” she noted. “That makes it hard for a family law attorney to advise a client. If he is going to keep the cryptocurrency, are you getting something of equivalent value from another financial account?”

Regardless, before you value it, you have to know it exists and figure out where it is. Crypto could be used to hide marital assets, or one partner might be buying such products without the other’s knowledge.

“When that happens sometimes it can be very difficult to track it down, particularly if we are talking about a dependent spouse that doesn’t have a lot of financial resources to hire forensic accountants and the experts who go in and find the crypto,” she said.

Wills, taxes and inheritances

Of course, missing digital assets aren’t always hidden. Sometimes, they are simply misplaced.

“That’s the thing about crypto,” said Blair Streitenberger, the founder of Lowcountry Legal Solutions in Hilton Head, South Carolina, who deals in trusts and estates. “It can be a bearer instrument, meaning that if you control your private keys to the cryptocurrency, you control the asset. If you lose your private keys, that asset is effectively lost.”

Indeed, one 2023 study from Unchained Capital found that as much as 19% of all Bitcoin is simply gone, trapped on discarded hard drives or in dead accounts.

As Columbia’s Newman notes, it isn’t just about what a relative leaves you in his will.

“How are you going to find it?” he said. “Did he leave his password behind?”

Knowing where the currency keys are is vital. Is the crypto in an offline hardware wallet, an exchange, or a “hot wallet” online?

“There are also custodial wallets which allow a third-party custodian to control the key,” said Tom Zamadics Jr., a Womble Bond Dickinson trusts and estates attorney in Charleston. “In my opinion, understanding a client’s access to his or her cryptocurrency is the first step in being able to incorporate the cryptocurrency into the client’s estate plan.”

Despite its name, Zamadics said that cryptocurrency is considered property and not currency for tax purposes.

“For example, when an owner sells cryptocurrency, the owner recognizes capital gain or loss on the sale,” he said. “On a federal estate tax return, cryptocurrency is listed under Schedule F — Other Miscellaneous Property. Cryptocurrency can also be a volatile asset, which could influence the potential estate tax liability for certain individuals.”

Streitenberger said that when it comes to inheritances, a digital asset is generally counted on a stepped-up cost basis. That is, when you sell it and pay taxes on the profit, you can do some research and find out what it was worth the day you inherited it. That will determine what the IRS wants from you.

Of course, if you are the one who originally purchased the asset, it is important to know what you paid.

“Do you have good records of what the cost basis of the crypto was?” he asked.