Legal Risks Crypto Investors Need to Deal With

What legal risks do crypto investors need to deal with? Over the years, especially in the past couple of years the popularity of and the interest in crypto have grown significantly among people.

Individual investors as well as groups of people have made and are making a great deal of money by investing in one or different types of crypto coins over and above Bitcoin.

However, along with the grown interest there is one more need that rose significantly. It is the clarity about the legality and the implications of it related to crypto.

It is only when the investors have a better understanding of the meaning and nature of these digital currencies just as the regulators themselves, it will result in more of them putting their money into this market.

This will result in faster mass adoption of crypto, which, as most people say, is poised to replace the traditional financial system.

However, the murkiness regarding the legal standing of crypto seems to come in the way and it is mainly due to the fact that it is relatively new to the more traditional payment systems and currencies.

The investors can only assume that there is a certain amount of legal risks involved in buying and selling crypto coins.

But sadly, people dealing with this new currency, especially the investors and traders, till date, have very little knowledge about the technology that drives the central banks all over the world, the regulatory agencies, and the tax authorities as well as the intricacies related to it.

However, it is imperative the investors also know how these authorities are working. Well, this article will take care of all that.

What Legal Risks Do Crypto Investors Need to Deal With?

What Legal Risks Do Crypto Investors Need to Deal With

If you look at the crypto space closely you will see that albeit there are quite a few regulations imposed on it, everything remains in a pretty unsettled and unclear state.

Most importantly, the rules and regulations are not well-specified.

For example, it is only a wise crypto investor who knows that it is required to report their holdings to the IRS or the Internal Revenue Service as foreign assets and if there are any capital gains made while trading these digital assets.

However, even to them the requirements for it are still unclear.

Then, there are the risks in both legal and financial forms to the crypto owners simply because there is no centralized authority that can control, oversee and settle disputes that may arise should anything untoward and unexpected happen with their holdings.

While trading or investing in crypto has its fair share of risks, the fact that the owners of crypto wallets may also have to file the FinCEN Form 114 depending on specific conditions adds to the confusion.

This is because nothing is clear about the legal requirements and the risks in violating them or failing to report as a US taxpayer about the significant holdings in the foreign bank accounts.

However, one thing that is sure about crypto income is that any profits made in trading crypto coins are taxable in the United States as capital gains.

It is for this specific reason you should look up in the official websites of the government to know about the latest developments in the crypto sector and the changes in laws that are quite frequent and come with no or a very short notice.

As for knowing the specific legal risks that you may have to face and deal with as a crypto investor, here are some of the major and potential legal risks or issues compiled for your knowledge.

This will help you to avoid them and chances of being penalized.

Issues with Smart Contracts:

You may face some contractual issues while dealing with crypto. As you may know, one of the most significant features of cryptocurrency and the blockchain technology is the smart contract feature that can execute by itself.

These smart contracts are typically agreements between the parties involved in a transaction that includes a set of promises.

The terms of the contracts are usually in a particular digital format.

These contracts are only executed when the parties involved in a specific transaction fulfill the specific promises mentioned in the contract.

This means that it is only when the contractual duties are performed by the respective parties, the smart contract will pay the other party automatically.

However, the issues with the smart contracts are their inherent complexity and the unique nature and the inherent complexities.

This makes it pretty tricky to determine whether or not these smart contracts fit well within the existing legal framework of conventional contract law.

As such, The United States does not have any Federal Contract Law that may be applicable to the nation on the whole.

Therefore, the contract law of one state varies from that of the other state.

Apart from that, there is also no specific guidance or federal law that defines the smart contracts related to crypto explicitly in terms of its legal validity.

The entire thing is based on the Electronic Signatures in Global and National Commerce Act of 2000 solely.

According to this Act, limited legal validity is provided to the smart contracts.

Therefore, with the lack of a clear legal validity of the smart contracts it may result in a long and difficult litigation process in case there is any dispute regarding its execution.

Issues with Jurisdictions:

One of the main features of the blockchain technology underlying crypto, which can be its merit as well as a demerit, is that the transactions can be made anonymously.

This means that there is no way in which the actual location of the ledger can be determined precisely.

This is a significant benefit of it because all transactions made on the blockchain maintain absolute privacy which is found lacking in the traditional payment platforms.

However, this benefit poses a significant and pretty complicated jurisdictional challenge.

Firstly, as you may know, the entire blockchain network comprises several computers participating in it and all of these may not be located in one particular jurisdiction.

In fact, these are typically spread across several jurisdictions and in most cases these regions are subject to differing legal frameworks.

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Secondly, it is also pretty difficult to determine the ‘residence country’ of the specific crypto software.

Once again this is due to the absence of physical location of the ledger.

Thirdly, the transnational nature of the blockchain network makes it pretty difficult to determine the specific laws that may be applicable for a specific dispute.

Moreover, it is also very difficult to select the exact jurisdiction for the disputes on the blockchain.

All these factors not pose a significant challenge for the crypto investors in general only but also make it pretty tough for the national regulators while enforcing laws and regulations for the blockchain users, the transactions made on it, or the projects.

This is all due to the cross-border reach of blockchain technology.

Issues with Financial Fraud and Data Theft:

Another significant risk of crypto is financial frauds and data theft that may happen on the blockchain, and otherwise.

These specific kinds of additional issues are considered to be some of the most pressing legal worries surrounding crypto.

Typically, the blockchain technology guarantees anonymity and freedom from intermediaries and regulations, though apparently.

However, it is this particular attribute of it that may allure several users who are typically involved in illegal activities and cyber crimes to use crypto to launder money and make other financial transactions to their benefit.

These bad actors or hackers can exploit the security flaws and other vulnerabilities on a blockchain network and put multiples of millions of dollars at risk.

Not only that, personal data such as email addresses, postal addresses, names and phone numbers can also be stolen by the hackers in a data security breach.

It is true that the crypto exchanges are trying hard to ensure that their individual platforms are safe and secure to use.

However, in case anything unpleasant ever happens, it is not very clear whether or not the current data security laws will be able to address such financial frauds and data thefts that may originate from crypto transactions made on the blockchain.

Privacy Concerns:

Though this is quite closely linked with data theft, privacy concerns in the crypto space needs a special mention with respect to legal risks to the crypto users.

As you may know already, one of the most significant reasons to introduce crypto coins such as Bitcoin to the world is to offer a payment system that will allow making anonymous transactions between users.

However, it is a proven fact that such anonymity can be threatened due to the continual step up of the blockchain analytic tools.

These tools are now capable of tracing transactions, which makes the ‘privacy coins’ concept a misnomer.

With respect to the judicial system of the United States, there is no precise and concrete framework for federal data protection as such.

Rather, privacy and data security rules and regulations here are applied based on the specific sector.

Some of these sector specific laws and regulations for data security and privacy are:

  • The Gramm-Leach-Bliley Act
  • The California Consumer Privacy Act or CCPA and
  • The Health Insurance Portability and Accountability Act, commonly known as HIPAA.

Most importantly, despite its nomenclature, the current privacy and data security laws and regulations of the United States do not deal with the privacy issues that may have occurred in the blockchain network.

For example, the distributed P2P network architecture of the blockchain technology is generally considered to disagree with the traditional notion of the CCPA of a controller based and centralized system for data processing.

That means, in simple words, that the assumption of CCPA of such a data processing system is generally not applicable when it comes to crypto because it is decentralized in nature and will disregard this particular aspect of this new technology if it is applied.

Issues Regarding Money Laundering:

A lot of crypto analysts opine that crypto offers the criminals and criminal organizations a new way and a safer and more efficient platform to launder money, commit different types of financial frauds, and a wide range of other types of financial frauds.

This possibility, once again, arises from the fact that the blockchain technology ensures that every transaction made on it remains completely anonymous.

Without any doubt, this allows using the crypto coins in those ‘dark-market sites’ more extensively.

These are those specific websites where the criminals can buy or sell illegal substances very easily and not need to worry about being identified or the chances of getting caught.

There are several government agencies that have in fact labeled those drug dealers as the ‘new generation of criminals’ that specifically trade drugs for crypto.

The criminal activities on the crypto blockchain have increased manifolds over the past couple of years costing billions of dollars.

The exchanges that allow these criminals to convert their ill-gotten crypto to cash are subject to AML or Anti-Money-Laundering rules and may face strict sanctions.

According to these rules all crypto exchanges now need to identify the customers properly before allowing them to transact on their platforms.

However, there is no stopping the criminals. Several research reports suggest that the criminals have found a newer and more effective way to get around these rules and regulations by using OTC or Over the Counter trading options.

As of now, there has been no new framework designed to deal with this.

And, as it is with other issues, there is no specific legal framework that will offer recourse.

Though fraud, money laundering, and a wide range of other financial crimes do not impact the crypto investors directly, they might end up being a victim of such crimes.

If a crypto investor happens to be in such an unfortunate position it is less likely to have the same legal options for recourse as any other traditional victims of financial frauds would.

This means that if, for example, the crypto exchange is hacked and funds are stolen by the bad actors, there are no standard practices or legal procedures that will help in recovering the funds missing.

Tax Implications:

There are also some tax implications that all crypto investors should be aware of or run into the risk of being penalized both financially and legally.

According to the US federal income tax rules, cryptocurrencies are considered as property and not as currencies, despite the term ‘currency’ in it.

Due to this distinction made by the IRS the US taxpayers or crypto investors cannot use crypto coins according to the Internal Revenue Code purposes as a functional currency.

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Add to that, the US taxpayers are liable to report any transaction that involves crypto in US dollars to the IRS in their annual tax file.

This specific necessity means that it is the responsibility of the US taxpayers to determine the fair market value of the crypto.

This is typically done by converting the digital currency to its equivalent value in US dollars. Every time a crypto transaction is made such conversions are needed to be made by the crypto user.

As a result, it is quite onerous for the individual US taxpayers to make all these calculations accurately and report it properly to the IRS.

This is because they will need to keep a proper record of the market price at which the crypto was bought as well as the price on the day when it was sold. The difference between these two prices will give the actual profit figure.

Moreover, the fact that the cryptocurrencies are considered as capital assets in the United States, the individual crypto investors are obliged to pay taxes on the profits realized through crypto according to the capital gains tax rules.

However, all crypto investors may not be obligated to pay such capital gains taxes.

This is especially applicable based on whether or not the investors bought the crypto from another country or from the United States.

Nonetheless, whether or not the US investor who bought the crypto coins from abroad on foreign exchanges are needed to meet the added reporting necessities of the IRS while filing their tax returns are not very clear.

This translates into the risk of running into violating the rules, though unknowingly.

Crypto and taxes are therefore one of the most significant legal considerations to make for any crypto investor because the government tax authorities view crypto holdings in a completely different way.

Things become all the more complicated for an average crypto investor because these views of the IRS are evolving continually.

That is why a crypto investor needs to lookout for the attest developments and pronouncements regarding this particular aspect of tax.

Issues Related to Intellectual Property:

Strange as it may sound, there are also a few specific legal risks related to intellectual property that you as a crypto investor should be aware of before investing in it.

Use of crypto, over the past couple of years has become quite popular in the intellectual property sector.

This wide range of sectors includes and is not limited to:

  • Automotive industry
  • Pharmaceutical sector
  • Luxury goods and
  • Consumer products industries.

In all these specific sectors the traceability factor of goods manufactured is very important.

Add to that, there are lots of chances of fake or gray goods being made which is another significant concern.

When cryptocurrencies are used in these specific IP-intensive businesses, there are specific concerns that are raised such as:

  • Intellectual property ownership
  • Intellectual property authorship and
  • Tracking and controlling the distribution of both registered as well as unregistered intellectual properties.

Add to that it is also very hard, if not impossible to establish and enforce intellectual property licenses, agreements, and select distribution networks via smart contracts.

However, the legality issues lies in the fact that it is quite hard to determine who exactly owns the crypto coins due to the significant uncertainty surrounding the anonymity maintained in the transactions made on the blockchain networks.

Issues Related to Foreign Bank Account Regulations:

It is required by a crypto investor to know about the issues related to crypto and Foreign Bank Account Regulations or FBAR.

It is important because in most cases dealing with crypto involves foreign accounts where you may hold your assets.

As of January 2022, no foreign crypto account is viewed by the federal law as a kind of ‘reportable account.’

This means that, if you are a crypto account holder of any foreign bank you are not liable to file disclosures regarding your account to the FinCEN or the Financial Crimes Enforcement Network.

This, however, is an agency of the US Treasury Department.

The version of the tax agency of FBAR of the FinCEN is the Form 8938 of the IRS.

It is also known as FATCA or the Foreign Account Tax Compliance Act.

According to the IRS guidelines, every taxpayer having a considerable amount of funds stored in foreign bank accounts need to file the FBAR as well as this Statement of Specified Foreign Financial Assets.

However, whether the crypto wallet owners need to declare about their holdings in the Form 8938 cannot be said for sure.

However, there is a FinCEN Form 114 which every crypto investor should fill up properly who holds substantial amounts in the overseas accounts.

The good news as of now is that crypto wallets are not included as a requirement in that form but things can change any time.

And, things are not very clear and therefore this possibility cannot be ruled out completely.

This is because the FinCEN is already thinking of making amendments in their filing form and requirements and include crypto holdings in the foreign bank accounts as well.

There is an ongoing debate among the lawyers, accountants, and the crypto investors over whether or not a wallet is a financial institution and does the IRS think it is.

Experts however urge the crypto investors to use their common sense during tax compliance and should file both the FBAR as well as the FATCA.

This will save them from the penalties if, in case, they are found to have violated the rules.

Penalties can be very severe in this case often to the tune of up to $10,000 cash fine or half of the value held in the foreign accounts. Sometimes, criminal penalties are also imposed on the violators of the rule.

Therefore, you must make sure that such changes have not been made yet or else you may run into financial and legal risks due to violation of the law.

At the very least, you should consult a tax professional who is familiar with crypto and the tax rules regarding crypto.

Their advice will be of great help when it is time to file your taxes and save you from legal and financial hassles.

Issues with Transactions and Value for the Decentralized Nature:

The decentralized nature of crypto is perhaps one of the biggest draws of it. However, this is also one of the most potential risk factors for any individual crypto investor.

The decentralized nature of cryptocurrencies means that there is no central authority backing the coins and there is no physical presence of the coins as well.

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Therefore, these digital coins are not affected by or attached to any institution or jurisdiction though governments all over the world have now started to avow their regulatory power on them some way or the other.

This is particularly seen in the case of coins like BTC and others of its likes.

This means that the crypto investors are free from being obliged to the financial institutions but, on the other hand, this particular aspect can also result in some serious legal complications.

As you may know, the value of the crypto coins is mainly dependent on the sentiment of the market as well as the value ascribed to them by the crypto investors and owners.

This is the same theory that applies to fiat currencies as well. Therefore, when there is no central agency backing the digital coins, this also affects the value of the crypto coins.

This may leave the crypto investors in the lurch if any complications arise during transactions or in the ownership of the coins.

The decentralized nature of crypto may also cause another significant issue which is in relation to the details of the transactions made on the blockchain.

As an essential feature of the blockchain technology, transfer of funds or any crypto transaction does not involve actual change of hands as it is in the case of currencies that have physical presence.

All transactions that are made electronically usually involve a trusted financial institution that is responsible to create and settle deposits and debt claims. In the case of crypto, this is also not applicable.

Due to these fundamental differences in transactions and value of the coins there may be a lot of confusion arising between the parties taking part in different types of transactions involving digital currencies.

And, in such situations, it may be very difficult, if not impossible, to assess and access the path of legal recourse, once again due to the decentralized nature of these digital currencies.

Issues with Registration and Licensing:

There can also be some issues with the registration and licensing of the crypto exchanges which may affect the investing process and put the crypto investors at legal risks.

Over the years, a large number of businesses have taken on digital currencies as a mode of payment and the number is rising every day.

In 2022, this is not restricted to Starbucks any more.

Now you can use your crypto coins such as Bitcoin at Whole Foods, Home Depot, and even at the Xbox store of Microsoft.

However, just like it is required by any other businesses engaged with dealing with any other financial products in other areas, these crypto businesses are also obligated to get them registered.

It is essential that they acquire valid licenses to operate in particular jurisdictions and perform specific activities.

However, this specific area is not quite clear for the businesses that wish to operate in the crypto market due to the complexities involved with digital currencies as well as the ever evolving legal status.

For example, if a company accepts only cryptocurrencies, they may not need to obtain a license for it or even register themselves for that matter.

On the other hand, if they want to operate in some specific jurisdictions they may have to obtain the same and also get them registered with the relevant authority for special considerations.

Therefore, the onus of accountability falls on the owners of these businesses and their managers.

They need to ensure that appropriate legal procedures are followed by them while performing their activities both at the local as well as at the state levels.

At the federal level, for example, all these companies and financial institutions dealing with digital currencies need to maintain specific protection measures that will prevent frauds and money laundering while transferring funds.

This requirement is also applicable to the companies dealing with transfer of fiat currencies.

The Digital Security Issue:

Since digital security is very fragile and can be breached any time when it is least expected by the hackers, this causes a huge concern for the crypto investors, who have little or no recourse legally in these matters.

The startups and the developers related to crypto are doing the best they can by emphasizing a great deal on the security aspect to ensure that the digital coins and holdings of their users are safe.

However, it is the new types of wallets that are being created and launched every day in the market that complicates the situation.

Therefore, the crypto investors have not been able to completely eliminate the legal risks involved with crypto in spite of the ever-improving security measures of the crypto exchanges.

And, it is less likely that they ever will.

So, the gist of the matter is:

In the United States, cryptocurrencies especially Bitcoin are considered to be legal by the IRS since February 2020, as it is in most of the other developed countries of the world such as:

  • Japan
  • The United Kingdom and
  • Canada.

However, the legal implications and lack of clarity still remains and the fact that there is no central authority in crypto, there is no intermediary to help you out in case of theft of funds or frauds occurring on the blockchain.

Therefore, you will have no legal avenue to recompense your losses.

Therefore, in order to make it easy for crypto to hit mainstream and promote mass adoption such legal risks along with other issues in crypto transactions should be considered and addressed efficiently.

This will save the funds of the investors and allow the crypto traders to make guaranteed profits.


There are lots of legal challenges the crypto investors, as well as the traders, have to face as pointed out in this article.

And, these legal risks seem to become more pronounced due to the absence of intermediaries or authorities in the crypto space.