The cannabis industry needs a banking solution and cryptocurrencies—blockchain-based digital tokens or coins that enable transactions without government or other intermediary—are gaining popularity. Though a decentralized currency untethered to a bank or government seems like an attractive alternative to using cash, cryptocurrencies are unlikely to be the knight in shining armor to rescue the cannabis industry due to their high risk and low viability. There has been no widespread adoption of any particular cannabis coin in the industry, and even if there were, cryptocurrencies in the cannabis space are too unstable to be used to replace dollars in everyday transactions.
“For a cryptocurrency to be viable, it must be widely accepted and used by nearly all players in its business network. In the cannabis space that includes customers, retailers, cultivators, manufacturers, landlords, attorneys, doctors and taxing agencies.”
The problems and risks inherent in cryptocurrencies increase when cannabis is added to the mix. The federal government treats transactions involving cryptocurrency and controlled substances harshly, as demonstrated by the prosecution of Silk Road’s alleged creator Ross Ulbricht, who is currently serving a life sentence without the possibility of parole.
The Dangers of Cryptocurrency
Cryptocurrencies can be purchased on the secondary market via exchanges and initial coin offerings (ICOs), which companies are increasingly using to raise capital. Many ICOs follow the same pattern: (1) create a media blitz using a social media “influencer” to hype the crypto, (2) release a whitepaper touting a yet-to-be-built ecosystem where the token will be utilized and emphasizing secondary market trading potential for the token, (3) at the peak of the hype, open the token sale to raise money, and (4) enable trade on secondary markets.
Cryptocurrency markets provide substantially less investor protection than traditional securities markets, with correspondingly greater opportunities for fraud and manipulation. Cryptocurrencies are highly volatile and risky—a $1,000 investment can become $100,000 overnight, but the reverse is also true.
The Internal Revenue Service (IRS) and the U.S. Securities and Exchange Commission (SEC) are zeroing in on ICOs and investors. In December, the SEC halted an ICO by Munchee Inc. for securities law violations.
Companies issuing ICOs typically claim that their tokens do not implicate securities laws violations because they are utilities rather than securities under a Howey Test. However, the economic realities and not the label determine whether an offering is a security and according to the SEC, most ICOs carry the key hallmarks of securities offerings. Because no ICO has registered with the SEC as of December 2017, many ICOs have run afoul of securities laws.
The IRS treats cryptocurrencies as property, not currency, and it is monitoring cryptocurrency exchanges to ensure investors are reporting and paying taxes on cryptocurrency gains. In November 2017, a federal court ordered popular cryptocurrency exchange Coinbase to provide the IRS identifying information for investors with more than $20,000 in annual transactions on its platform.
Cannabis Cryptocurrencies are not a Viable Banking Solution for the Cannabis Industry
Cryptocurrencies in the cannabis space include PotCoin, CannabisCoin, DopeCoin and Paragon Coin, among others. Some are actively traded on the secondary market while others are in their infancy.
Nearly all cannabis cryptocurrency companies claim to be developing an ecosystem where their coin will be the preferred or only method of payment. PotCoin explains to retailers that its networks will grow as the coin becomes more widely adopted, with the goal of using only PotCoin for transactions with customers and vendors. DopeCoin claims its own version will be the industry’s preferred token, because it provides a unique advertising solution that can only be accessed using DopeCoin. Paragon Coin contends its coin will be the coin of choice because of its ParagonCoin-only niche real-estate solution.
We have identified only one retailer that accepts payment via a cannabis cryptocurrency—an internet seller of vaping products that accepts payment via DopeCoin, Litecoin and Bitcoin. If other cannabis companies are using and accepting cannabis cryptocurrency, they’re not sharing it publicly. Some retailers with whom we’ve spoken state they will not touch cryptocurrencies for fear of scrutiny from state and federal regulators.
For a cryptocurrency to be viable, it must be widely accepted and used by nearly all players in its business network. In the cannabis space that includes customers, retailers, cultivators, manufacturers, landlords, attorneys, doctors and taxing agencies. If it is not widely accepted, its users are limited to exchanging it among themselves. That could work if the value of the cryptocurrency is stable enough to reliably convert to dollars for parties who don’t use the cryptocurrency. But given the dramatic fluctuations in the cryptocurrency market over the past several months, it seems unlikely cryptocurrencies will soon stabilize in value.
The value of a cryptocurrency is speculative and ultimately depends on the viability of its ecosystem. On the secondary market, a coin’s value is mostly tied to hype and to speculation that a certain ecosystem will succeed. If an ecosystem never comes to fruition or the coin cannot gain sufficient market share, the coin will have little actual value.
Before purchasing cryptocurrency or an ICO interest, the SEC recommends you ask (1) whether those promoting the project have been paid to do so, (2) what legal recourse an investor has if something goes wrong, and (3) whether new investment proceeds are used to cash out other investors—which would indicate a Ponzi scheme.
Cryptocurrency traders make and lose a lot of money on cryptocurrency exchanges. Pump and dump schemes and hacks are commonplace, leading to big losses for some investors. Take for example the recent hacks of South Korean exchange Youbit, which resulted in the loss of one-fifth of its clients’ holdings and the exchange filing for bankruptcy. Investors should proceed with caution, and be sure to track and report any gains in compliance with IRS guidelines.
Given cryptocurrency’s high risk and low viability, the cannabis industry needs to look elsewhere to solve its banking crisis. Following the bipartisan uproar in response to Attorney General Jeff Sessions’ recently released memo that solution could come from congressional action. Stay tuned.