AML and Taxes in Web3 Are Extremely Boring. How Can We Get Rid of Them?

What do you think crypto investors spend most of their time on? Straight away, images of deep technical analysis come to mind, or perhaps laborious market research at two o’clock in the morning.

But, you might be surprised to know that the front runners are studying up-to-date tax laws, digging out documentation for banks looking to make sure that there’s no money laundering or terrorist financing taking place behind the curtain. 

Having a good grasp of crypto tax law can be challenging; there’s still a lack of coherent regulation surrounding the world of cryptocurrency.

Moreover, laws vary depending on the jurisdiction and are constantly in a state of flux.

Cryptocurrency is a relatively new and complex technology, and the tax laws that apply to it may not always be clear or well-established.

Additionally, it’s essential to stay up-to-date with the latest developments and guidance from tax authorities. For example, the taxation of cryptocurrencies in the United States is a complex topic.

In general, the Internal Revenue Service (IRS) treats cryptocurrencies as property for tax purposes, rather than as currency. This means that any transactions involving cryptocurrencies may be subject to capital gains tax.

But, the volatility complicates the tracking of net gains and losses for tax purposes, especially for those who trade actively.

“It's not easy to feel comfortable with crypto taxation, as it varies from country to country and depends on various factors. The legislation in this field is still evolving, new tax laws come into force every year. The specific tax implications of a transaction will depend on a number of factors, including the type of cryptocurrency, the length of time it was held, and the amount of the gain or loss,” notes Dmitry Machikhin from BitOK, an Israeli-based crypto asset tracker with additional tax and AML functionalities.

According to BitOK, they witnessed an increasing number of subscribers in recent months. Whenever there’s a new crypto-exchange hack or an algo-stablecoin crumble, new regulatory departments magically appear with the aim of detecting tax evaders or suspending cryptocurrency-related transactions. 

“Typically, investors come to us for three reasons. The first one is they are tired of strict regulatory requirements. The second reason is they have problems, for example, with funds being frozen. The third reason is that they don’t want to waste time in the future and are predicting the problems aforementioned.”

The second reason is not as rare as it might seem at first glance. Typically, banks freeze accounts if they suspect illegal activity, such as money laundering or fraud.

If a bank has concerns about the legitimacy of the transaction or the source of funds, it may take steps to protect itself and its customers by blocking the account.

It would seem that if cryptocurrencies are not associated with fraud and money laundering, then there should be no problems. However, for many banks, cryptocurrency is like a red rag to a bull.

Financial institutions believe that transactions with cryptocurrencies come with increased risks of money laundering, and simply block such accounts. This can be called a presumption of guilt for all owners of cryptocurrencies.

To prove the origin of funds to a bank, the account holder may need to provide documentation that shows where the money came from. This could include documents such as receipts, invoices, contracts, or bank statements.

Moreover, banks may request additional information about the sources of the funds, such as whether they were earned from employment, investments, gifts, etc. This can be a challenging task when it comes to crypto.

“As a rule, accounts are blocked by banks if fraud, money laundering or terrorist financing is suspected, but sometimes, crypto exchanges act the same way. We had a client with a frozen account at a major crypto exchange who tirelessly tried every trick in the book to unfreeze his account. Then, he used a service for generating documentation on our platform. As a result, the account was unblocked in a couple of days…” reveals Dmitry Machikhin, a recent addition to the 40 most prominent blockchain entrepreneurs by Forbes.

Another headache for cryptocurrency investors is verifying that coins are not connected with illicit activities.

This headache is usually managed by centralized banks in the traditional world of finance, but in the decentralized world of Web3, this responsibility falls on the heads of the crypto holders.

This is somewhat similar to how entrepreneurs are forced to conduct CDD on counterparties. In the case of cryptocurrencies, even retail investors have to do this work.

After all, even a couple of toxic coins can infect the entire wallet.

To detect illicit funds, there are various on-chain analytics tools, including those from such major players as Chainalysis.

This spring, the company, known for its contracts with the CIA, released two tools to check if a wallet address is on any sanctions list.

However, in addition to the sanctions lists, there are also lists of wallets associated with hacker attacks. Moreover, buying coins from such wallets is also a big risk.

Perhaps someday, all these operations will be streamlined.

But right now, investors are frustrated when they are faced with piles of regulatory requirements; they need to somehow conduct their own degree of AML checks.

They need a one-stop-shop service that will help with all this boring, but very important routine.