Hedging issues raised by cryptocurrency | kennedy

Insurers and consumers are seeing the emergence of cryptocurrency in their daily lives. As an increasing number of businesses around the world begin to use bitcoin and other digital assets for investment, operational and transactional purposes, this raises an important question: how is cryptocurrency defined in purposes of insurance coverage?

What is Cryptocurrency? An introduction

As a commonly adopted definition, cryptocurrency is a software object with units or “tokens” that can be securely and verifiably transferred from one owner to another. Transactions are recorded in a public and widely distributed database (a “blockchain”). Cryptocurrencies were designed to serve as currencies, but, as detailed in the cases below, they do not yet fulfill the central functions of money. (A “fiat currency” is any currency declared by a government to be legal tender). However, many argue that Bitcoin is a homogeneous virtual good that is entirely identical across all online marketplaces in which it is sold.

In the crypto industry, platforms are careful to distinguish cryptocurrency from traditional money. Additionally, cryptocurrency is not backed by the government and the IRS has gone so far as to designate it as property. In 2014, the IRS issued Notice 2014-21, 2014-16 IRB 938, explaining that virtual currency is treated as property for federal income tax purposes and providing examples of how Long-standing tax principles applicable to transactions involving property apply to virtual currency. In short, a uniform approach to how to designate cryptocurrency is still evolving.

Recent holdings involving the designation “Crypto”

For being such a popular topic, few courts have addressed the issue of the definitive definition of cryptocurrency for hedging purposes. In fact, the main current case on the subject Kimmelmann v. Wayne Ins. Band, No. 18 CV 1041, 2018 WL 11417314 (Ohio Com.Pl. Sept. 25, 2018), remained the only known case on the issue for more than four years. In Kimmelman, an Ohio District Court judge considered bitcoin to be “property” and not cash as part of a home insurance policy.

In the background, the insured, James Kimmelman, submitted an insurance claim to his insurer, reporting that approximately $16,000.00 worth of Bitcoin was stolen from his digital wallet. The insurer investigated the claim and made a payment of $200.00 to Kimmelman, determining that the bitcoin was “money” and governed by a sub-limit in the policy. Kimmelman sued the insurer, asserting claims of breach of contract and bad faith. The Insurer requested judgment on the pleadings, which the court addressed in its order dated September 25, 2018.

The insurer argued that Bitcoin is generally recognized as “currency”, citing articles from CNN, CNET and The New York Times. The insurer also cited IRS Notice 2014-21, which subscribed the term “virtual currency” to Bitcoin. As a result, the court held that the only authority it could “rely on to determine the status of Bit[c]oin is” IRS Notice 2014-21. Under the notice, ”[f]or for federal tax purposes, virtual currency is treated as property. Id. p. 3 (citing IRS Notice 2014-21). Even though the IRS used the term “virtual currency,” the court found that the IRS recognizes Bitcoin as property and, therefore, the court also recognized Bitcoin as property for the purposes of the policy’s available coverage limits.

Some courts even go beyond the characterization of money or property and consider bitcoin to be something else altogether. In Commodity Futures Trading Commission v. McDonnell, 287 F. Supp.3d 213 (EDNY 2018), the U.S. District Court for the Eastern District of New York ruled that virtual currencies are commodities under the Commodity Exchange Act (CEA) and therefore subject to Commodity Futures Trading Commission (CFTC) anti-fraud and manipulation authority. Accepting the CFTC’s request for a preliminary injunction against defendants who allegedly engaged in deception and fraud involving virtual currency spot markets, Judge Weinstein noted that “[u]Until Congress clarifies the matter,” the CFTC has “concurrent authority” with other state and federal administrative agencies and civil and criminal courts over virtual currency transactions.

According to the court, virtual currencies are “‘goods’ traded in a market for uniform quality and value”. As such, the court found that they “fit well” within the common definition of merchandise as well as the CEA’s broad definition, which includes “all other goods and articles…and all services, rights and interests… . . in which contracts for future delivery are now or in the future concluded.”

As evidenced by the holdings above, cryptocurrencies and blockchain technologies present both emerging risks and opportunities, for insurers and consumers. As these technologies continue to grow, evolve, and become more pervasive in our economy and daily lives, the impact of forensic interpretations of cryptocurrency will also become central to the conversation.

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