Will Crypto and Regulators Ever Be Friends?

“Bitcoin vs. Regulation” by smillagoñi

Keeping up with regulations can be tough, especially in the crypto space where the rules can be complicated and unclear. This article seeks to consider regulation holistically rather than outlining the rules in any one system. If you’re looking for some things to keep in mind when trying to stay compliant, we’ve got some tips at the end of this article. Please note, this does not constitute legal or financial advice.

Bitcoin was first released less than 10 years ago and already we have hundreds of ICOs and over a thousand ‘altcoins’. Governments have tried to respond to this massive market movement but are still unsure how to react.

Attempts at regulation have frequently caused panic owing to confusion and misunderstanding of that regulation, the technology in general, and the rapidly changing blockchain space.

This doesn’t have to be the case, however. Regulation can be a useful tool in helping to provide clarity and legitimacy to an otherwise digital Wild West.

How Is Crypto Viewed Globally?

There have been relatively few international efforts towards global regulation, and most have occurred only in the last few years. In January, the International Monetary Fund (IMF) called for global regulation and there were discussions about crypto at the World Economic Forum — each resulting in no real regulatory movements.

Most recently, 19 countries — including the UK, US, Russia, South Korea, China — and the European Union discussed crypto at the G20, a forum dedicated to international financial cooperation. Though the G20 decided to “implement the Financial Action Task Force (FATF) standards as they apply to crypto assets,” it remains unclear what this entails.

The summit also agreed to “develop a menu of policy options for consideration,” but whether this will happen at their next meeting in July, if at all, and whether it will even be desirable is equally uncertain. The EU, however, stated that they will make a move towards creating regulation if there is no international agreement soon.

Individual countries have come to a variety of responses toward crypto, with some — Switzerland, Singapore, Denmark, and Estonia — taking a more enabling approach. Others such as China, India, and South Korea have responded in a less accepting manner, often banning large elements of the crypto market.

The United States

The US responded early in 2013 and, though was the first country to seriously consider crypto at a regulatory level, has still not created a clear and cohesive system for dealing with digital assets. US courts disagree whether Bitcoin is “money” though the Financial Crimes Enforcement Network (FinCEN) treats it as a currency. The IRS has said that Bitcoin is “property not currency,” but the Commodity Futures Trading Commission (CFTC) found that “Bitcoin and other virtual currencies are encompassed in the definition and properly defined as commodities.”

The fact that crypto doesn’t fit easily into existing regulation is not completely problematic as it is does different things depending on the type and the way it is obtained. The resulting confusion does however cause increased burden and cost for businesses and discourages individuals from legitimate use due to its complexity.

In March, a variety of US government committees gathered to learn more about crypto. Their views widely conflicted, ranging from “cryptocurrencies are a crock…” and should be stopped to ‘crypto is the future’ and any regulation would be a “wet blanket” on innovation.

Most encouragingly, ‘crypto dad’ CFTC Chairman Giancarlo said:

We owe it this new generation to respect their enthusiasm about virtual currencies with a thoughtful and balanced response, not a dismissive one.”

Others, such as SEC chairman Jay Clayton, have argued that “distributed ledger technology has incredible promise for the financial industry.”

Despite an increasingly positive attitude towards cryptocurrency, we continue to see regulators fail to properly understand and engage with the technology they are trying to regulate.

China

While Bitcoin and other digital assets are not technically illegal, the Chinese government has enforced a number of restrictions that make them exceedingly difficult to use.

In September of 2017, China banned ICOs and began investigating and shutting down exchanges. Some ICOs have stayed in China and just excluded Chinese investors while others continue in secret. Many miners and exchanges have since moved elsewhere and leaked documents that surfaced in January show there are clear government efforts to force miners out completely. In February, China announced it would also block all websites related to crypto, both foreign and domestic, further restricting most trading activity.

China, in particular, is an interesting example of the government-versus-crypto problem. While China is developing their own digitial currency using blockchain technology, they continue to restrict the use of global digital currencies such as Bitcoin and Ethereum. The government doesn’t hide the fact that the purpose of these restrictions is “to further intensify reform and innovation, solidly promote the R&D of the central bank’s digital currency”.

It is clear that a global currency could also very easily circumvent China’s strict policies regarding money moving out of the country and so a restriction on it is a clear effort to maintain control.

What Are the Various Concerns?

Regulation however doesn’t always centre on control but on a variety of reasons, though not all are persuasive.

1. Criminal exploitation

This is a very common argument by regulators and critics: criminals use bitcoin and other digital assets to buy illegal items, launder money, and evade tax, and because of this crypto should be banned.

However, these problems are not unique to crypto. Even in 1980, James S. Henry argued that big bills in the US were used for crime and tax evasion, the very things that regulators worry Bitcoin facilitates. While Europe has removed the €500 note for this very reason, and Sweden is actually becoming cashless too quickly, other countries have not followed suit.

A recent study argued that 25%–44% of Bitcoin transactions involve illegal activity, but Bitcoin and many other coins are not completely anonymous, and they create a mostly permanent digital trail.

Law enforcement is slowly learning how to track blockchain transactions and catch perpetrators. There are already tools such as Chainalysis that help law enforcement find suspicious activity like money laundering. Not only this, but there are already widely used techniques available to detect suspicious activity which help to catch criminals when they try to convert their crypto to fiat, and even some new techniques such as Know Your Transaction. While it may take time, stopping illegal activity using crypto is not impossible.

In any case, criminals are always the first to adopt new technology. From the “Bonnot Gang” — who were the first to use cars while police chased them on bicycles or horses — to ICOs, criminals will always take advantage of the unknown. This is not, however, a good reason to stop legitimate use as criminal activity will always happen. Developing clear regulation and guidance will help to reduce the number of grey areas which can be exploited and encourage legitimate use.

2. Individuals need to be protected

No one knows what the ‘right price’ for bitcoin might be. Of course, it’s value is whatever people will pay for it, but some consistently claim it’s a ‘bubble’ or that it has ‘died’ and so has no value while others suggest it is nowhere near its true price. Since it’s unclear what the ‘right price’ is, regulators argue that there needs to be a system in place to protect individuals from the huge fluctuations in price. It is not the government’s place to ‘protect’ to those who have the capability to make informed decisions and fail to, so this is not a particularly strong argument.

For banks, on the other hand, the decisions made by individuals affect them greatly and so they have a valid reason to vary their policy based on how individuals act. Rather than following the most important rule in investing, never invest more than you can afford to lose,” many people have spent their life savings, mortgaged their homes, and bought crypto on credit — some with terrible consequences. Many major banks in the UK and US have banned purchases of crypto made using credit cards to help reduce the impact of any poor decisions, which is well within their remit.

Protecting individuals investing in ICOs is a very different argument from protecting individuals from themselves.

Though it has become a norm to release a white paper when launching an ICO, these often include no subtantive value. Without regulations, industry standards, or fundraising experience, these white papers are mainly perfunctory and offer little practical information. Not only that, but many ICOs are “‘intentionally non-transparent”, with many removing the white papers and any relevant information, such as roadmaps, from their website after the sale.

Not only this, but investors rarely read — or even understand — their blockchain investments, instead waiting to sell once their cryptocurrency is tradable and at its perceived peak in value. Some people have taken advantage of this by offering simple copies of existing projects or completely fraudulent schemes, only to escape with millions.

China’s response to ICOs is one example of a good practical legal solution, particularly when considering that many copycat schemes originated in China. Blocking ICOs helps to stop fraudulent projects, however this extreme measure should only be temporary as more nuanced regulation is put into place.

Technology companies such as Google, Facebook, Twitter, and LinkedIn have banned ICO advertisements on their platforms around the world without needing a push from governments. This has also been a welcome decision as these advertisements encouraged hype and focused on creating new investors to exploit.

3. Challenges the established system

Governments are unable to control crypto and instead watch as it gains popularity around the world. Crypto doesn’t necessitate intermediaries, and thus, there are less actors taking fees and tracking transactions, affording individuals greater privacy.

“Issuing money has down the ages been regarded as the essential prerogative of government.” Frederick Soddy, Wealth, Virtual Wealth and Debt, p. 163

Governments also have less power over the circulation of its currencies, hence the strong restrictions in China. This lack of control has benefited individuals, however. In Venezuela, the inflation rate was 10501% as of the 11th of April and crypto is preferred over the nearly worthless Bolivar. Crypto also offers a cheaper and faster alternative to established remittance services that charged an average 7.45% of the $429 billion transferred overseas. These are only a few of the benefits provided by a global currency and already show how these are more important than government concerns for control.

Not only this, but regulators seem to be worried that crypto could overtake the existing financial systems entirely. This seems unlikely as there is a very small percentage of the world that actually owns any cryptocurrencies and few places accept it for buying goods and services. Moreso, cryptocurrencies such as Bitcoin were never made to be used for everyday local payments, but as a global currency which can facilitate payments and activity online without the friction of different currencies and intermediaries.

While there are some valid concerns about crypto, they are few and are mostly outweighed by the benefits to individuals and society as a whole.

Where Should We Go From Here?

Many people are reluctant for regulation. I find this really unfortunate, particularly in the context of crypto, as regulation can help to reduce bad actors and provide credibility to the space. Regulation can also help to promote legitimate innovation and create a profitable market for emerging businesses which is important to promote growth.

This is not to say that any regulation at all is welcome. Regulation must be rooted in an understanding of how the technology works and how it is used. It must also be clear in what is expected and be globally cohesive.

ICO regulation

As we’ve seen, ICOs have been particularly difficult recently. The problem mainly comes from finding how the tokens sold as part of these ICOs fit into the existing framework. The tokens are not quite commodities but they’re not quite securities. They’re not quite ‘money’ but also not ‘money’.

One option would be to choose whether all tokens are securities, which seems to be the SEC’s opinion, or that some are completely exempt, which is the position taken in Wyoming’s new bill. One proposal is that all tokens are securities until the network launch at which point the utility tokens are commodities.

None of these options are particularly satisfactory but neither is creating an entirely new regulation to cover ICOs — which was the option chosen by public consultation responders in France. This is because new regulation doesn’t come with the same clarity of existing regulation which has been explored in a variety of circumstances in courts.

The confusion over how ICOs are regulated and what they need to do to be compliant leaves many businesses afraid of regulatory crackdown, especially with the SEC issuing subpoenas for information. Individuals are also left worried about the legitimacy of the project in which they are involved, which isn’t helped by the lack of regulator clarity regarding Ethereum’s status as a security at this time. Even ICOs such as Savedroid are calling for regulation and making efforts to help provide industry standards.

“If we don’t go for better regulation, we believe that [ICO scams] could bring the whole market down.”
Clarification

It cannot be overstated, regulatory grey areas generate unease and provide opportunities for exploitation. Clarification as to what is expected and the reasoning for such regulation is needed to provide the certainty for legitimate actions — and this clarification is sorely needed in US tax law.

The US taxes crypto as property, not currency. This means that the gain or loss on every purchase, exchange, or use of the asset is a ‘taxable event’. Whether you use bitcoin to buy a $2 cup of coffee, purchase a house, or exchange it for that new shiny asset, you pay tax on the gain or loss at the rate of your ordinary income which could be up to 37%. If you hold that asset for over a year, however, the long-term capital gains rate applies which is has a maximum of only 20%.

This system encourages long-term investment as the tax is greatly reduced and also discourages generating multiple and/or small transactions because of the burden to record and report every taxable event.

This cannot be what is desired, especially if there is any hope for crypto to be used as it was intended. Those who wish to stay compliant will use crypto mainly as an investment and those who want to use it, for example, as a global currency might be inclined to do less or not report it.

Unfortunately, the IRS hasn’t issued any further guidance since their initial statement in 2014 to explain their position and has instead taken steps, such as with the court summons to Coinbase, to find those who aren’t paying tax on their gains.

If and once this tax position is changed, we are likely to see crypto flourish and benefit more than wealthy investors.

Global regulation

Regulation of a global asset is only effective if there is global regulation. Unfortunately, it is unlikely that we will see this in the next year or two as governments still need to learn about the technology and how it is used to develop effective regulation.

Its likely that the industry itself will begin to self-regulate more widely and effectively. There are already a number of self-regulatory bodies — such as DABFI, Crypto UK, Croatian UBIK, and a group of 16 crypto-exchanges in Japan yet unnamed — which work to help the industry generally. There are other organisations which focus on developing best practices for ICOs such as the Token Alliance and the ICO Governance Foundation. These efforts have so far been small, largely national, and generally just focus on providing information rather than enforcing community standards. This doesn’t mean they aren’t useful as they do provide as an important first step in developing effective self-regulation.

Individuals

It is incredibly important to learn what the rules are in your country, especially those that keep the tax man happy.

Start by keeping track of your crypto ‘events’. You can do this in a simple excel sheet by noting dates, the value for each asset at the time of the trade, and any gains or losses. There are some great free websites such as CoinTracking.info which can help you get started and even generate tax reports for you, though you might want to consider a paid option if you’re an active trader. There are many resources out there so find a system or product that makes it simple for you.

Keep in mind that nearly everything you do with your crypto is considered a ‘taxable event’ — this includes purchasing crypto, trading between coins, buying coffee, and even airdrops and forks (which can be taxed as income immediately). Consider speaking to an accountant to better understand your tax obligations, particularly if you have high volume of and/or large value transactions.

The need to understand the regulations is especially pertinent if you are investing in an ICO or trading tokens from any recent projects. This is due to the increase in regulatory crackdowns. As you might know, many ICOs already exclude American citizens or those who reside in the US due to the strict regulations regarding securities. Some businesses, such as Shapeshift are starting to take that a step further and changing their offerings based on your location and the relevant regulations in that country. While the onus for securities regulation compliance is on businesses and not individuals, these rules affect how you can use your assets so it is best to stay on top of any developments.

Coin Center, Cointelegraph, and CoinDesk can be useful to follow regulatory developments around the world, but for any specific legal advice it is best to consult legal counsel.

Concluding Thoughts

Governments aren’t sure what to do with crypto, but that doesn’t mean they should ban it. It also doesn’t mean they shouldn’t intervene and contribute, however.

While we are seeing the blockchain space grow and develop rapidly in a number of creative and innovative ways, so too are the criminal exploitations of ignorance and legal grey areas. Regulation can help to provide clarity and legitimacy but only if it is effective, and we can’t forget that.

What do you think?

Do you agree with the concerns and positions taken by governments? What regulations have you found interesting or want to learn more about? How do you comply with the rules in your country?

Please reserve the Medium comments section for lively and honest discussion about the article! If you have technical issues with Exodus, our Community Support team will be happy to speedily assist you. Just send a descriptive email to: support@exodus.io