Members of our Digital Assets Group recently attended Permissionless II, one of the largest DeFi events in the industry. We walked away with many great insights, but most importantly, the conference highlighted some key trends and issues that stand to greatly impact the digital assets space. Below are our five takeaways to keep on your radar.
The industry as a whole is asking for enforcement agencies and regulators to provide more clarity on the principles that lie behind their enforcement actions and lawsuits. For example, when an industry participant decides to make an investment in a digital asset, they need to understand the tax consequences and characteristics, which regulatory body is overseeing the asset and which laws govern all facets of the asset.
Without clear guidance from regulatory bodies in the U.S., innovation is often pushed offshore, which causes a variety of other issues. Asset managers going outside of U.S. borders now have to comply with international securities laws, assessing the permissibility of their investment in the various available tokens, and invest in foreign jurisdictions that may not have the appropriate level of oversight to keep investors safe.
As many innovative products in the digital asset space are built using nascent technologies that inherently lack clear regulatory guidance, it is increasingly important for regulators to not only track these new developments but to provide timely commentary, and ultimately regulation, on how to treat these products from an accounting, tax and legal perspective.
The future of real world asset tokenization is a recurring headline in the industry, but today the stablecoin remains the only tokenized real world asset widely used, and most experts believe it will remain that way for a few years yet.
Some have experimented with tokenized real estate funds, real estate property deals, closed-end asset management partnership interests and other similar experimental instances. We expect to see a steady increase in the adoption of real world assets in a variety of asset classes. It’s important for asset managers in particular to keep an eye on this trend, as it has the ability to significantly disrupt investment operations in a relatively short period of time.
The macro-economic environment introduces a significant level of uncertainty to digital assets in the short and long term. Opportunity cost of capital remains a relevant issue for any asset class, and digital assets are not completely immune.
Asset managers must continually assess the resilience of their business in the event of a prolonged bear market and be prepared to weather the storm until they can push through the current economic environment. Economic conditions have a direct impact on portfolio companies, in the instance of venture capital firms, and the investment of new dollars into liquid tokens, for liquid hedge funds. Operating overhead at the general partner level should be assessed conservatively as the market continues to mature.
Crypto miners as well as other market players must pay close attention to miners as the halving approaches. The halving cuts the block reward for miners in half, which, in turn, also cuts their top line revenue in half. With miners being some of the largest holders of Bitcoin, the health of their businesses directly correlates to the price of Bitcoin. And in the past, the halving has caused a supply squeeze and driven up the price.
However, with the current macroeconomic environment as well as the oldest of finance philosophies telling us trends do not continue forever, market participants must be aware of this risk, as disruption to the miner operating model could place significant strain on the digital asset market overall.
A newly proposed regulation put forth by the Treasury department creates a potentially burdensome requirement on all businesses considered to be broker-dealers to produce tax reporting for those who trade with them or on their platforms. The confusion comes into play when you have established businesses that have standardized reporting but DeFi protocols that may not even have any employees. It is difficult, if not impossible, to account for a holder’s basis when they transfer from a DeFi protocol to a Centralized exchange or vice versa.
However, there are many areas this bill adequately addresses that are much needed, and it’s great to see regulators who thoroughly understand the subject matter producing rules that help prevent bad actors in the space and address AML concerns, to name a couple.
The Treasury department’s comment period on the proposed regulation ends October 30, 2023. All digital asset stakeholders are strongly encouraged to read the regulation and submit any comments.
Each of these areas has a great level of significance to both the current and future state of the digital assets industry. Work closely with your advisers to evaluate their impact and strategically address any risks that might arise from emerging trends and topics.
Contact Mike Dellavalle at mdellavalle@cohenco.com or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.