‘Uncharted Territory’ for Crypto Come Tax Season: EY Blockchain Head

Most everyone in crypto is waiting for a regulatory crackdown. 

Financial regulators, especially in the US, namely the CFTC and SEC, were already playing a game with steep stakes — rule-making catch-up — before FTX cratered. Its demise has given fresh ammunition to lawmakers who started calling for more stringent investor protection safeguards earlier this year, when the stablecoin UST depegged and digital asset lending lost its mooring.

The question now is not if, but when. And the outcome has massive implications for the industry — especially how the cryptoassets of individual traders and firms are accounted for come tax season. 

Blockworks sat down with Paul Brody, EY’s global blockchain leader, to discuss his roadmap for regulation in the coming months, as well as how the tax landscape is shifting, plus the evolving relationship of TradFi and digital assets — a relationship, in some ways, abruptly reset by recent events. 

Blockworks: First, give me your big-picture take on the last few weeks. 

Brody: So, my general take on the last [few] weeks is that what we are seeing here is there’s no happy middle in this blockchain ecosystem.

There seem to be two extremes that work well. One extreme is you’re a fully on-chain, fully transparent, fully decentralized entity. So, those entities seem to have fared pretty well, and you will hear a lot of people say, “The key lesson from [recent] weeks is that DeFi works, and CeFi doesn’t.” And I will at least buy into the part that fully on-chain, fully transparent, fully visible DeFi has seemed to fare very well. 

That doesn’t mean people didn’t lose lots of money, but it means that they didn’t lose their money to miss-allocation or a lack of business controls. 

Of course, there’s another extreme, which is the fully traditional, fully regulated and intensively audited side. You’re a publicly traded entity. You’re regulated by the SEC; you’re audited by a big four firm; you’re subject to really, really big, very traditional financial services business controls — the kind that all banks and brokerages have been subject to for a very long time.

We know who those players are. They’ve also fared fairly well through this crisis, right? The people who have done poorly are the people in the middle. They’re not fully regulated, audited and rigorously inspected in a traditional model, nor are they fully transparent in the new model. They fall into this gray area. And that lack of supervision appears to be the gateway to temptation to fix problems without actually fixing problems, taking advantage of a lack of business controls — over and over, again. 

Blockworks: So, two models. OK. Is overlap possible? And what do the twin models mean for auditing and oversight more broadly?

Brody: So, my problem is, you’re either one extreme or the other, but not a happy one in the middle. And I would go one step further. 

I would say, ‘If you have to choose between the two, the fully regulated TradFi model is actually a lower risk model.’ And the reason it’s a low-risk model — and I feel like this is gonna’ make me somewhat unpopular with a lot of crypto purists — starts with thinking about some of the really excellent firms on the DeFi side. I admire what they’re doing greatly. And I’m very impressed. 

However, they’re entering uncharted territory. We don’t have a couple of centuries of auditing and banking and checklists for a pure DeFi ecosystem. We have a couple centuries of supervision history to know how to make the checklist if you come to EY and say, ‘Hey, I would like to be audited by EY.’ 

We have a very lengthy checklist of all the things you need to do to prepare for an audit. That’s an excellent guide…There is no DeFi equivalent. So, how do we be the most rigorous possible on the DeFi ecosystem?…We know how to do that in TradFi. We’re [working on it] when it comes to DeFi. 

Whereas, if you want to be an SEC-regulated audit client, you have this checklist, and if you follow the checklist, you’re going to implement a lot of good, basic business controls.

Blockworks: Are you seeing a slowdown when it comes to TradFi firms you deal with looking to do business in crypto? Given the last few months…

Brody: None of our clients are deterred from crypto. It’s a fact, because 100% of the family offices and 100% of the high net-worth individuals [we deal with] have some form of crypto. Nobody wants to be out of this business. They know, now, market goes up, market goes down. That’s probably here to stay. 

But [there’s a difference] between what you do immediately versus what you plan to do in the near future. 

There’s definitely some reticence, and the larger banks are much more careful and conservative. But mid-sized banks are a bit more adventurous. They are ready. They’re very close to going live with multiple products, especially things like stablecoins. 

Yeah, they’re waiting for regulatory approval. And this is where [it boils down to the] unfortunate mess of the last six months. There are some people who say, ‘Great. We didn’t really allow crypto into the regulated model.’ 

I actually take a slightly different perspective, which is that the lack of rules has meant that some of the really top-quality firms that are highly regulated have stayed out. And it’s possible, therefore, that bad actors ended up with a larger share of the market than they would have otherwise — right in a period of high market uncertainty. 

People tend to want to migrate. They feel there’s a flight to quality. They want to migrate to what they perceive as the lowest risk player. And, maybe, if there were some of the more blue-chip names in this business that offered services, they would have a bigger share. 

And some of the less well-documented and regulated players would have a smaller share. And maybe the damage from some of these insolvencies would actually be smaller.

Brody, a principal at EY, heads the accounting firm’s blockchain business lines, encompassing consulting, audit and tax. He has about 20 years of professional experience, including spending more than 12 years at IBM in executive roles.

This interview has been edited for brevity and clarity. Brody declined to discuss specific EY clients, citing privacy concerns.

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