Cryptocurrency: Is it too hot to handle? Four key investor concerns
By Harvey Knight, partner, Lauren Rapeport, associate, Elisa Wahnon, associate, Richard Brown, associate, Withers – The first month of 2021 saw more than its fair share of turbulence: alongside the pandemic we saw a new breed of activist investors organising on social media forums, causing havoc for hedge funds.
There has been a matching extraordinary price increase in one of the most volatile investment asset classes: cryptocurrencies, and especially bitcoin. Here we consider four important questions for cryptocurrency investors and some of the fundamental legal and regulatory crypto issues.
1. I recently invested GBP10,000 in a basket of different cryptocurrencies via a cryptocurrency exchange (eg Coinbase, Binance, Kraken, eToro). What happens if my investments become worthless?
UK investors have flooded the market since bitcoin started rallying in December, many of whom are novice retail crypto-investors not wanting to miss out on the proverbial gold rush.
The Financial Conduct Authority ('FCA') raised the alarm on 11 January warning that investing in crypto assets, or investments and lending linked to them, generally involved taking very high risks and investors should be prepared to lose all their money. The FCA also reminded investors that they will not be protected by the Financial Services Compensation Scheme ('FSCS') in most cases.
Should the value of your crypto investment fall, you may still be able to crystallise your losses by making a negligible value claim to HMRC (which you can then set off against any other gains you may have made) if you can establish that your cryptoassets are no longer able to fetch a price on an open market.
2. I tried to sell a number of bitcoin after the price went up in January but due to delays with the broker I could not liquidate my position before the price dropped again. Do I have any recourse against the broker?
It has been frequently reported that some users experience delays cashing out their cryptocurrency, particularly at times of high market activity. When you create an account with an exchange you agree to their User Terms. Many of the popular exchanges used in the UK expressly limit their liability in respect of delays or service problems.
Coinbase suffered 'performance degradation' on 29 January after the price of bitcoin surged by 20 per cent. Coinbase expressly states in its User Terms that access to its services 'may become degraded or unavailable during times of significant volatility or volume' and does not guarantee that orders will be executed or even that accounts will remain open.
Kraken suffered a similar service outage and its User Terms also limit liability for 'failure of performance'. With Kraken, the maximum you can claim is the aggregate of the fees you paid to them in the preceding 12 months.
Starting legal proceedings against an exchange can be costly and difficult. For example, to bring a claim against Kraken you would need to start arbitration proceedings in California. If you plan on investing a significant amount in cryptocurrencies, a number of different exchanges could be used to protect your position in the event that one of them suffers a service failure.
3. I recently transferred some cryptocurrency to my partner as a gift. Do I need to report it?
Most, if not all, cryptocurrencies, will be assets for tax purposes, since they are not classified as legal tender or as a form of currency. Generally, this means that cryptocurrencies are potentially taxable whenever they are disposed of or received in return.
If you and your partner are married, then the gift to your partner is exempt from UK inheritance tax (IHT) and UK capital gains tax (CGT). If you are not married, a possible CGT charge arises on the gift if the value of your cryptocurrency has gone up since you bought it. All UK residents have an annual CGT allowance (currently GBP12,300 for the 2020/21 tax year) and anything outside that needs to be declared as a taxable gain (at either 10 per cent or 20 per cent depending on your income level).
There may also be an IHT charge of up to 40 per cent if you do not survive the gift by seven years, and the total value of your estate plus all you made gifts in the previous seven years exceeds the nil rate band (currently £325,000).
4. I am an experienced crypto-investor and want to try to make a living out of full-time crypto-trading. I sometimes trade on behalf of friends and family as well. Do I need to be regulated to do this? What can I do to protect myself?
Some crypto assets are directly regulated by the FCA, and so a full application to be an FCA authorised firm may be required. If you want to operate a crypto asset business that does not require direct FCA authorisation, you must at least be registered with the FCA under the Money Laundering Regulations ('MLRs').
Fundamentally, if your activities could be regarded as a business (such as looking to profit from managing the investments of others) then take advice on whether you need FCA authorisation. The regulations in this area can extend to trading on behalf of friends and family and so you should be aware of the requirements before doing so.
If you are planning on making crypto-trading your day job, it is worth setting up a limited company and a company account. This means that if things go wrong and someone tries to bring a claim against you, they could only enforce against the company's assets rather than your personal assets eg your home.
If you are trading on behalf of others you should agree the terms of your service. Your customers should agree that profits are not guaranteed and they stand to lose the amount they invested.
From a tax point of view, if you are earning a living from trading, your profits will be subject to income tax (currently up to 45 per cent), rather than CGT (up to 20 per cent) like most non-professional investors. This is, however, highly fact dependent. If you form a company for trading the profits will be subject to corporation tax instead (currently, 19 per cent).