Crypto regulation is coming and it is a double-edged sword. The question is: Will it strangle growth or provide stability?
The crypto winter is coming to an end. Banks and governments alike are slowly coming to terms with the fact that cryptocurrency is here to stay.
There are recent signs that cryptocurrency acceptance among established institutions is increasing. For example:
- Research by Fidelity shows that an increasing number of institutional investors believe that digital assets should be included in their portfolios.
- The US government has ruled that federally-chartered banks may provide cryptocurrency custody services.
- Ether futures are now available on the Chicago Mercantile Exchange (CME).
If cryptocurrency is to obtain mainstream adoption, some regulation is necessary. But how much and what form it takes could have repercussions on the sector for years to come.
Why Is Crypto Regulation Such a Challenge?
By its nature, cryptocurrency has disruptive characteristics. Crypto and decentralization enthusiasts want to remove power from centralized authorities and entrust it to communities. On the other hand, governments are wary about ceding control to an unproven system that may have immense repercussions for their own role in the world.
There are countless reasons that governments are wary of crypto but the main ones are:
- Money Laundering and Terrorism: There have been rising concerns about cryptocurrency’s utility as a vehicle for money laundering — particularly “privacy coins” like Monero.
- Taxation: Many governments are uncertain about how to tax cryptocurrency. They are concerned that relative anonymity may make it challenging to prevent tax evasion.
- Currency Legitimacy: There are concerns that allowing Bitcoin and other cryptocurrencies to be used in lieu of fiat currency could undermine the legitimacy of national currencies.
- Legal Definitions: There is significant international disagreement surrounding whether cryptocurrencies are assets, currencies proper, or something in between. This makes legislation particularly tricky given crypto’s global nature.
- Security: There are concerns surrounding the security of blockchain technology itself. The most well-known example is that Chinese miners theoretically have control of more than 50% of Bitcoin’s consensus systems, which could allow the Chinese government to shut down the entire system.
Crypto enthusiasts also have severe misgivings of their own. Cryptocurrency has functioned without government regulation in the past and many think government interference would go against crypto’s core ideology.
From the business side, there are concerns that unnecessary regulations could stifle crypto innovation and put brakes on one of the most dynamic sectors.
Some Countries Are Warming to Crypto but Not All
These problems, alongside myriad others, mean that there is little to no international consensus on how to regulate cryptocurrency. This has led to a fractured system of regulations globally and left a big question mark hanging over the crypto community.
Some countries, such as Singapore and Switzerland, have opted for very crypto-friendly regulations. In January 2020, Singapore enacted the Payment Services Act (PSA). Cryptocurrency isn’t considered legal tender, but it is legal and treated as a good. The law applies existing legal frameworks to crypto exchanges.
Other nations have taken a more combative approach. India in particular has made numerous attempts to ban cryptocurrency, despite a thriving domestic crypto industry. The government has raised concerns about money laundering. It is particularly worried that cryptocurrency could undo all the government’s efforts to combat tax evasion at a high economic cost.
Crypto Middle-Ground in US and Canada
The US and Canada have taken a middle-ground approach. Because the US government in July 2020 allowed banks to become cryptocurrency custodians, many hope that additional positive trends for digital assets will occur during Biden’s administration.
Canada also allows cryptocurrency but any trades are considered barter transactions. Despite these positive actions, both Canada and the US have recently raised the hackles of the crypto community.
Demands for Consumer Data From Exchanges Brings Privacy Into Question
As it often does, the big problem comes down to taxation. In late 2020, both the Internal Revenue Service (IRS) and the Canadian Revenue Agency (CRA) have demanded that locally based exchanges hand over their user lists.
The IRS was targeting a single user of California based exchange Coinbase. The IRS argues that they need to be able to check whether the user, William Zietzke, properly reported his taxes in 2016. However, Mr Zietzke has claimed that the information requested is too broad. In this case, the IRS is technically acting within its right and is not collecting more information than it already has access to.
In Canada the situation is a little more concerning. Where the IRS was seeking one individual, the CRA has requested information on every user of Toronto based Coinsquare.
The regulator argues that this information is necessary in order to prevent tax evasion in Canada. The CRA has made similar requests in the past but this is the first time it has ever made such a sweeping demand from Coinsquare.
The problem with the approach taken by the CRA, and to a lesser extent, the IRS is that it could deter customers from using blockchain legally. There are any number of moral and practical reasons an individual might not want the government to know every transaction that they have ever made.
Additionally, it might encourage customers to start looking for exchanges in jurisdictions that are more privacy-friendly. This could damage trust and make sensible crypto legislation more difficult.
The Legislation Challenge Needs to Be Met Head-On
Cryptocurrency is new technology and legislators are naturally behind the curve. Cryptocurrency and blockchain technology itself are not inherently incompatible with existing systems. It is exceedingly difficult to forge transactions on a blockchain, so with the right checks and balances in place, cryptocurrency could even become an asset to governments looking to prevent tax avoidance.
The key will be for both cryptocurrency advocates and government officials to build an atmosphere of mutual trust. If this can be done successfully, sensible legislation will follow. As a result, the world could more rapidly gain the benefits of blockchain technology.