The currency may only be digital, but the IRS is figuratively swimming in seized crypto — a situation that some believe could influence the cryptocurrency market itself.
The IRS Criminal Investigation division has brought in billions in crypto seizures in recent years, following several years of struggling to fully grasp the phenomenon of digital assets and recovering only paltry amounts.
While in fiscal 2019 the IRS seized only about $700,000 worth of cryptocurrency, that figure jumped to $100 million in 2020 and has now reached billions of dollars annually. In its most recent annual report, CI quoted over $7 billion in asset seizures, fueled primarily by cryptocurrencies. And CI is already on track to surpass that amount in its current fiscal year, a division official recently reported.
But the continued seizures have come amid a period of market volatility for most cryptocurrencies, and notably, CI’s cryptocurrency seizure reports and even the annual report couch the numbers in terms of value at the time of seizure.
Thus, as progress continues to be made in seizing digital currencies, an important consideration arises not just for CI but also for other government agencies involved in collecting and selling the assets: With an ever-greater amount of cryptocurrency to dispose of, could the government inadvertently affect crypto markets as it sells off ill-gotten digital assets?
Coordinated Effort
When the IRS seizes cryptocurrency, it works to ensure that the assets are carefully tracked until they’re out of the government’s possession, according to Kathy Enstrom of Moore Tax Law Group LLC, who oversaw some of the first plans for seizing cryptocurrency when she was at CI.
Enstrom told Tax Notes that beginning about 2018 and continuing to the end of her term as director of operations in 2021, CI worked to ensure that it had a system of clear checks and balances. That’s because it knew both that it would be seizing cryptocurrency assets and that other law enforcement agencies encountered problems when dishonest agents appropriated seized assets.
That original plan involved depositing each seizure in a previously unused — or “cold” — digital wallet that would be stored in a secure location with a full chain-of-custody log, according to Enstrom. Separate wallets for each seizure were meant to facilitate the tracking and chain-of-custody data collection, she said.
During the forfeiture procedure, the Treasury Executive Office for Asset Forfeiture (TEOAF) held the assets until a judge entered a forfeiture order, according to Enstrom. The IRS sent all its seizures to TEOAF rather than to the Justice Department’s separate seizure fund, she noted.
After a judge ordered the seized cryptocurrency forfeited, the U.S. Marshals Service (USMS) would take over and convert seized cryptocurrency to fiat currency that it then returned to TEOAF, according to Enstrom. It’s rumored that the marshals use Coinbase Inc.’s cryptocurrency exchange, she said.
A USMS spokesperson confirmed that the service uses exchanges to liquidate cryptocurrency.
“The digital assets have public blockchains, and the exchanges have strict ‘know your customer’ and anti-money-laundering requirements for individuals utilizing their venue to purchase cryptocurrency,” the official told Tax Notes.
Market Watch
As of August 23, the approximate market capitalization of bitcoin, arguably the most prominent cryptocurrency, is $504 billion.
Travis W. Thompson of Sideman & Bancroft LLP said that the effect of a large cryptocurrency sale by CI would depend on investor confidence. The question is whether the large transaction could make the market seem even more volatile, he said.
According to Enstrom, if the government were to sell $10 billion worth of bitcoin, it might move the market briefly, but the effect wouldn’t be permanent. The market movement from a sale of 2 percent to 10 percent of an outstanding cryptocurrency might last only a day or two, she said.
While private companies accepting payment in cryptocurrency might want to offload the volatile assets immediately to avoid risk of loss, the government possibly having to replace seized assets makes it more concerned about large upswings, Enstrom added.
Don Fort of Kostelanetz LLP, a former CI chief, said he isn’t aware of seizing agencies having much say on when the auction of seized assets occurs. And Alex C. Lakatos of Mayer Brown said that for government authorities, whether an auction affects the market isn’t the top priority when it seeks to liquidate illicitly gained cryptocurrencies.
“It’s important to remember the federal government only wants one thing when they conduct an auction: U.S. dollars,” Lakatos said. “They’re not interested in rupees or rubles, let alone crypto.”
The USMS acknowledged the potential for conflict between the government’s liquidation incentive and concern for market disruptions.
“All assets managed and disposed of by the USMS, to include cryptocurrency assets, are valued at forfeiture and are liquidated promptly upon receiving proper authorization . . . without regard to current market conditions,” the USMS official said. “Our goal is to dispose of assets in a timely manner at fair market value. Depending on the type and amount of cryptocurrency being liquidated, the USMS does take additional steps to ensure the market is not adversely impacted.”
The official declined to elaborate on those additional steps, saying that information fell “under an internal business practice we do not disclose.”
TEOAF couldn’t be reached for comment.