In a virtual meeting hosted by the USC Gould School of Law on Tuesday, the Internal Revenue Service (IRS) tackled the subject of fraud in the crypto space. Ryan Korner, special IRS agent for its criminal division in Los Angeles, sees an avalanche of fraud in crypto markets.
“We’re just seeing mountains and mountains of fraud in this area,”
IRS agent Ryan Korner, as reported by Bloomberg.
The agent’s particular focus was non-fungible tokens (NFTs). NFTs have surged in popularity and value over the last year and they are on the way to decoupling from the crypto market, market data suggests.
Over the last month, Bitcoin dropped by 26% along with most cryptocurrencies and the wider stock market. Meanwhile, January saw $5.1 billion in NFT traffic, which is a 60% increase from the August peak at $3.2 billion.
This could be the mountain that agent Korner was referencing. He described the new digital class as more speculative than regular cryptocurrencies because they are easily boosted by social media campaigns. We have already seen this phenomenon with meme coins.
Are NFTs More Prone to Scams?
Elon Musk specifically has been in news for spawning an entire family of dog coins: SHIB, BabyDoge, ELON, DOE, SHIBELON, SHIBEV, EDOGE, and ESHIB in response to his tweets.
Dogecoin (DOGE), the progenitor with the largest market cap, also has tended to rally behind the “Dogefather” himself. One could say meme coins could be used for daily transactions and thus they have at least one use case.
However, they rely on memetic forces to gain value instead of relying on any underlying utility. This makes them vulnerable to marketing campaigns and pump-and-dump schemes.
In the same perspective, NFTs could be viewed as concentrated meme assets, many relying on celebrity/artist social status and social media boosts. In turn, this attracts scammers in droves. They have been known to impersonate artists to sell NFTs.
Although there are curated NFT marketplaces, the bulk of the traffic happens on ones that allow anyone to mint anything, such as Rarible or OpenSea. In other words, NFTs may be great as a vehicle for wider crypto adoption, but they inevitably lead to scam spam.
Moreover, celebrities themselves can be drawn into shady crypto schemes. The two most notable ones involved pro boxer Floyd Mayweather Jr. and music producer DJ Khaled for unlawful Initial Coin Offering (ICO). When it comes to NFTs, the terrain is even more treacherous.
Even if the celebrities are not accused of outright fraud, copyright remains a heated subject in this segment. Take for example Quentin Tarantino, the director of iconic movies such as Pulp Fiction and Kill Bill. After minting the original handwritten Pulp Fiction script as NFT, Miramax sued Tarantino for copyright infringement.
Regarding outright fraud, the crypto portion is still minor. In 2020, $4.2 billion was lost in online fraud, which was 0.022% of the total USD supply. Comparatively, the DeFi sector lost $154 million out of $130 billion, which is 0.11%. In 2021, IRS agents seized $3.5 billion worth of cryptocurrencies.
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IRS’ Relationship with Crypto Explained
Seeing NFTs rising on the horizon, special agent Korner noted that IRS plans to intensify their training to tackle this market because “this space is the future“. Likewise, the agency should collaborate more with other federal agencies. We have seen this cooperation in action with seized bitcoins.
Illicitly gained crypto funds are taken into the custody of the US Marshals Service, estimated to have already sold over 185,000 BTC at a discount. Fortunately, they are selling off BTC in spurts so as to not upset the market, according to Jarod Koopman, director of the IRS’ cybercrime unit. Although Bitcoin is called a cryptocurrency, it is pseudonymous rather than anonymous.
This happened for the simple reason that crypto exchanges were required to implement Know-Your-Customer (KYC) protocols. Therefore, whenever people trade Bitcoins on such exchanges, their wallet address is tied to their real identity, which translates to IRS reporting obligations. For this reason, the IRS is not a fan of privacy coins like Monero (XMR).
In September 2020, agent Korner’s division—IRS CI (Criminal Investigation) —issued a $625k bounty to crack Monero’s native encryption. Suffice to say, because we haven’t heard of Monero’s price collapse yet, its privacy feature remains intact, still remaining true to its vision of protecting the privacy of all transactions on its network.
As for the IRS crypto reporting itself, the agency treats both NFTs and cryptocurrencies as commodities, similar to stocks. Thus far, these types of transactions trigger taxable events:
- Exchange for one cryptocurrency for another.
- Buying goods with cryptocurrencies.
- Conversion from cryptocurrency to USD.
However, except for selling crypto/NFT for a profit, these events don’t necessarily lead to paying taxes. For example, when artist Mike Winkelmann, aka Beeple, sold his NFT for $69 million, he was due to pay federal and state ordinary income taxes. Interestingly, the Singapore-based buyer, under the pseudonym Metakovan, is free from paying taxes because capital gains tax on such transactions is not applicable in Singapore.
If he had been a US citizen, the IRS would’ve charged Metakovan at least $10 million. Outside of such capital gains scenarios, the IRS requires for those taxable events to be reported. For long-term HODLers (over one year), which make up 60% of Bitcoin supply, no reporting is necessary.
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About the author
Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird’s US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.