Top Stories of the Week - 4/26

This week in the newsletter, we write about Consensys vs. the SEC, new editors added to Bitcoin’s BIP repository, and the IRS’ new draft 1099 for digital assets.

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Consensys Joins Fight Against the SEC

Consensys files lawsuit against SEC over "unlawful seizure of authority" regarding ether. In a complaint filed on Thursday in the District Court for the Northern District of Texas, Consensys is challenging the SEC in its approach to regulate ETH as a security. The lawsuit revealed that Consensys had received a Wells notice from the SEC on April 10, indicating that the agency is preparing to bring charges against the company over its MetaMask wallet, which as the regulator alleges, has acted as an unlicensed broker for facilitating securities transactions via the Swaps and Staking products.

Consensys founder Joe Lubin explained in a blog post that the firm filed litigation against the SEC for two reasons: first, the SEC "should not be allowed to arbitrarily expand its jurisdiction to include regulating the future of the internet", and second, "the SEC’s reckless approach is bringing chaos to developers, market participants, institutions, and nations who are building or already managing critical systems running on Ethereum". Lubin added that Consensys aims to make clear that: (i) ether is not and should not be treated as a security, and (ii) wallet software like MetaMask that allow people to buy/sell/transfer ether are not securities brokers.

OUR TAKE:

Consensys joins a loaded field in fighting back against the SEC's overreach to regulate crypto, with the Ethereum-centric firm aiming to protect the broader Ethereum ecosystem in particular. Not only is Consensys behind crypto's most popular wallet (MetaMask), it also offers products such as Infura & Truffle (API and suite of developer tools), Besu & Teku (Ethereum clients), and Linea (emerging ZK rollup protocol). According to the filed complaint, however, it appears only MetaMask Swaps and MetaMask Staking products are targeted by the SEC at this time.

If the expected SEC charges are based around these MetaMask product offerings, then there is some precedence for these charges to at least be partially dismissed - on March 27, a federal judge dismissed the SEC's claim against Coinbase that the exchange acted as an unregistered broker through Coinbase Wallet, though the judge did rule to allow the SEC to move forward with its lawsuit against Coinbase over its staking program (see our previous newsletter for further details). Assuming MetaMask and Coinbase Wallet are similar in how they operate, along with both companies' respective staking programs, then we think it would be reasonable for any potential litigation against Consensys to move forward in a similar fashion to Coinbase.

In any case, Consensys is an important part of the Ethereum ecosystem, so any legal developments may be impactful for the broader crypto industry. As a result of Consensys' newest lawsuit, or any of the active crypto-related litigation between crypto firms and the SEC, a federal judge may soon declare whether ether is a security or not. - Charles Yu

Bitcoin Community Adds 5 New BIP Editors

The Bitcoin developer community recently appointed five new contributors as Bitcoin Improvement Proposal (BIP) editors. For background, BIPs are formal proposals to upgrade the Bitcoin protocol. These individuals, including Bryan “Kanzure” Bishop, Jon Atack, Mark “Murch” Erhardt, Olaoluwa “Roasbeef”, and Ruben Somsen, now play a crucial role in the BIP process. Their responsibilities include reviewing official drafts of proposed BIPs, providing feedback to the BIP author, and deciding whether a BIP should receive a formal number assignment. Once a BIP has sufficient technical documentation, the BIP editor merges the corresponding pull request into Bitcoin’s Github BIPs repository. The expansion of BIP editors marks a significant change from the previous setup, where Luke-Jr, a well-known but controversial Bitcoin Core developer, held sole authority to merge BIPs into the repository. Bitcoin’s Github BIPs repository serves as the primary database for tracking all pending upgrades to Bitcoin.

The addition of five new BIP editors marks the first time in Bitcoin history where more than one Bitcoin Core contributor served as a BIP editor. Longtime Bitcoin Core developer Ava Chow led the nomination process to select the five new BIP editors.

OUR TAKE:

Bitcoin protocol upgrades have a slower cadence than other blockchains by design due to the meticulous due diligence process carried out by the developer community. For example, the recent Taproot upgrade, activated in November 2021, underwent three years of rigorous review by developers before activation. This prolonged due diligence is partly attributed to the limited number of BIP editors authorized to merge pull requests into Bitcoin’s Github BIPs repository. Prior to the recent addition of new BIP editors, the assignment of one person as the sole BIP editor created a bottleneck that slowed down the BIP process over the years. As a result, assigning numbers for promising BIPs has been a major hurdle for BIP authors.

Improving the efficiency of the BIPs due diligence process while maintaining quality control is a positive step forward for the Bitcoin developer ecosystem. Recently, one of the five new BIP editors assigned BIP numbers for two highly discussed opcodes, OP_CAT and OP_TXHASH (BIP-347, BIP-346). Although the number assignment of BIPs and including it to the GitHub BIPs repository does not indicate a guaranteed path to activation, it helps bring visibility and attention to the BIP. Further, the number assignment for a BIP signals to the developer community that the BIP has undergone the preliminary stages of due diligence. Overall, the addition of five talented Bitcoin Core contributors with a history of GitHub commits will inevitably bring more efficiency and clarity to the entire BIPs process. - Gabe Parker

IRS Releases Draft of Crypto Broker Tax Form

On Friday, April 19, the U.S. Internal Revenue Service (IRS) shared an early release draft of Form 1099-DA, Digital Asset Proceeds From Broker Transactions. As the title suggests, Form 1099-DA is for brokers to report proceeds (and basis, as applicable) for digital asset sales and exchanges. The IRS alluded to this form last August when it, along with Treasury, released proposed broker reporting rules in a 282-page document detailing their interpretation of expanded duties and responsibilities as granted by President Biden’s “Infrastructure Bill”. Under the proposed rules, a broker is defined as any persons or entities that is “in the position to know the identity of the party” (i.e., user) and provides “facilitative services that effectuate the sales of digital assets by customers.” It was clear in August that this guidance impacts centralized cryptocurrency exchanges, custodians, and wallets. However, it was unclear the extent to which this guidance could also apply to non-custodial versions of these same services, as well as other types of decentralized applications such as non-fungible token (NFT) trading platforms and block explorers. (For a more detailed look at the IRS’ new broker rule, read our report from August). The IRS stated that digital asset brokers will be required to collect know-your-customer information (KYC) for all US users and include Form 1099-DA in their annual tax filings.

The draft version of Form 1099-DA collects standard information about the filer including their name, address, identification number, and most notably, the nature of their broker business. The form offers five boxes for which a filer can self-declare what “type” of broker they are. The options include:

• Kiosk Operator

• Digital Asset Payment Processor

• Hosted Wallet Provider

• Unhosted Wallet Provider

• Other

Further down the form, the filer must include the transaction IDs or hashes and on-chain account addresses for all digital asset transactions facilitated by the broker. Additionally, filers are required to report details about the “number of units” transferred in a transaction and any “accrued market discount” or “wash sale loss disallowed” impacting transaction costs and proceeds. The draft version is marked at the top with a tax-year date of 2025, which may suggest the IRS is seeking to finalize the broker reporting rules sometime before the end of this year. The IRS is presently accepting comments and feedback about the early release draft of Form 1099-DA. Several crypto industry advocates have spoken out against the draft, noting the detrimental impacts it could have on crypto user privacy and accessibility. Earlier this year, a bipartisan group of 9 Members of Congress also spoke out against the IRS’ proposed rules regarding tax reporting requirements for digital asset brokers.

OUR TAKE:

The good news is that the proposed broker reporting rules are not yet finalized and still subject to change. The bad news is that the IRS does not appear to be listening to the concerns of crypto industry advocate and legal experts. Over 40,000 comments were submitted during the public comment period for the IRS’ proposed ruling between August 2023 and November 2023. Galaxy Research, Coin Center, A16z, among many others pushed back on the excessively broad definition for brokers that would create a major setback for users and developers of blockchain-based services, and likely trigger the wholesale relocation of specifically decentralized finance (DeFi) services outside the U.S.

Despite the pushback, the IRS appears to be moving forward with its proposed rules for digital asset brokers. The release of draft Form 1099-DA confirms the industry’s fears that what constitutes a broker may include non-custodial digital asset wallets and the majority of DeFi apps. The inclusion of “unhosted wallet providers” as a recognized type of digital asset broker in the eyes of the IRS suggests that “other” types of digital asset services that facilitate the sale or exchange of digital assets, regardless of whether they are operated by a centralized entity or function primarily through self-executing (smart contract) code, will be subject to the same rules.

If the draft Form 1099-DA and the proposed broker reporting rules are finalized in their current form, DeFi developers, along with other types of open-source software developers in the crypto industry, will have to reckon with the enforcement of these rules and consider choosing one of three options:

• Compliance, the implementation of KYC measures and annual reporting through Form 1099-DA

• Blocking U.S. users, the banning of U.S. IP addresses from website front-ends that is most likely impossible at the smart contract level without enacting full address whitelisting.

• Full decentralization, the decision to abandon application upgradeability, front-ends, and fees such that the service, nor its creators, is not in a position to know, let alone report, on the identity of its users.

Again, the good news is that the IRS’ proposed rules for digital asset brokers are not yet finalized and there is a new comment period for the early release draft of Form 1099-DA that industry stakeholders can use to voice their concerns one more time. No opportunity, however small the opportunity may appear to be, should be wasted given the potentially broad impact of these rules on the crypto industry. For more information about the IRS broker rules and its potential impact on crypto, read this Galaxy Research report. - Christine Kim

Charts of the Week

Last week we noted a record high share of addresses using multiple Layer 2s (L2s) on a daily basis, suggesting inflated top line, unfiltered daily active address figures across the observed L2s combined. The chart below goes a step further and identifies the number of daily active addresses that have been active for five or more days in the past. This pool of addresses is less mercenary and is more indicative of the core set of active L2 addresses.

Using the 30-day moving average (MA), there are 814,320 daily active addresses that have transacted more than five days in their lifetime. This compares to 1.19m deduplicated daily active addresses and 1.53m unfiltered daily active addresses across the observed seven L2s (as of April 25, 2024). This highlights that 68% of the deduplicated daily active addresses and 53% of the commonly cited unfiltered daily active addresses are more consistently active.

Additionally, the founders of Bitcoin whirlpool service Samourai were charged with money laundering and unlicensed money transmitting offenses this week. Over its lifetime, the service has seen 44,900 BTC worth of deposits, totaling $2.87 billion at a BTC market price of $64,000, across 79,700 individual transactions. The service saw its first deposit in April 2019. (Thanks to Clark Moody for the data).

Other News

• Stripe to enable USDC payments starting this summer

• ViaBTC's 'epic sat' from fourth Bitcoin halving block sells for 33.3 BTC ($2.13 million)

• Worldcoin's developer wants to partner with PayPal and OpenAI

• Franklin Templeton enables peer-to-peer transfers for its on-chain US Government Money Fund

• CryptoPunk sells for 4,000 ETH ($12.41 million), sixth-most expensive ever

• Bitcoin mining difficulty rises for first time immediately after a halving amid Runes fee frenzy

• EU's anti-money laundering bill passes final vote

• Renzo's ezETH depegs 18.3% following REZ tokenomics announcement on Binance

• Samourai Wallet founders arrested by DOJ on federal money laundering charges