Crypto Regulations: Reason to Fear?
There has been a lot of fear in the crypto space about government regulations. The information in the media generally follows a narrative of fear, since fear-based news gains the most attention. In this blog, we will try and paint a clearer picture and determine whether there is a real threat to the cryptocurrency markets.
In a recent interview filmed at the Bitcoin Conference in Miami and posted on the Yahoo Finance YouTube channel, Wyoming senator Caitlin Long discussed the states recent regulation proposal and helped to quell some of the fears surrounding this topic.
To begin with, decentralized blockchain technologies offer the promise of dispersing the functions and custodial powers of the centralized banking system. While this represents a threat to the central banking system, the need for basic regulations are apparent. Especially considering that there are a number of new companies, large investment firms, and enterprises entering the cryptocurrency industry. Their interest is generally fueled by new and exciting technology that has the potential to revolutionize supply chain management, financial payment systems, and artificial intelligence.
On the other side of the crypto movement is the central banking system, threatened by the development of decentralized financial systems which undermines their long-held power structure as a middle-man and custodian to every person’s financial assets globally. Their grip over our financial freedom is weakened by decentralized platforms and wallets, which allow investors to retain full control over their finances.
However, the power of the Federal Reserve should not be underestimated. Using the U.S. government as an example, the Federal Reserve is a privately owned organization that holds overt and vast legislative and economic power within this country. But this is what we can see. There is a tremendous amount of covert power held within our political system by the federal reserve and the rest of the central banking system. Lobbyists and political forces that hold enough legislative power to swing policies and laws in their favor.
The FinTech industry, which promotes technological innovation in blockchain research and development, is a complex system extending to cryptocurrency and other financial trading markets, supply chain management, enterprise systems adoption, and revolutionary innovations across various industries worldwide. With leading innovators in El Salvador and Paraguay leading the charge in Bitcoin adoption as a national currency, other countries such as China are developing the framework for a digital fiat currency, the digital yuan.
Legal Frameworks and Pre-Regulatory Dispositions
The SEC has an ongoing case against Ripple and this ruling could prove to be a landmark for the industry. Outside of this legal action, the regulations are generally vague and obscure. For example, Crypto exchanges have no overarching regulation, as equity markets do.
Even the centralized exchanges, upon which these assets are traded, are not really exchanges at all. Many are registered in most states with a money transmitter license, but not as exchanges, and have become the target of stringent regulations that can have vast negative consequences to the decentralized movement. While the Office of the Comptroller of Currency has granted national trust charters to a handful of exchanges, the new chief has called for a review of crypto rules.
Regulation working groups
The SEC and CFTC already have a cross-agency working group on crypto. The House of Representatives passed a bill in April to create a digital asset working group with the SEC and the Commodity Futures Trading Commission (CFTC). The group, which would include industry companies, would produce a report within a year on regulatory framework for digital assets. The fate of that bill in the Senate is unclear.
Current Position of Regulatory Forces
Securities and Exchange Commission (SEC): Tokens that act like securities could fall under the Securities and Exchange Commission. The SEC’s Gensler in his recent remarks said he was concerned about manipulation and is reviewing how to regulate crypto exchanges. Each time the SEC has rejected a bitcoin ETF, the reason is that they’re not confident in the integrity of the underlying foreign markets where they will be traded.
Commodity Futures Trading Commission (CFTC): The CFTC currently oversees foreign currency exchange markets and commodities futures markets. Is eager to keep its oversight of currency markets. The CFTC doesn’t have a permanent head yet, but Chris Brummer has reportedly been a lead candidate. He has a deep background in crypto and is well-liked in the crypto industry.
Internal Revenue Service (IRS): The IRS ensures transactions that result in gains are properly taxed. Recently proposed changes that will require disclosure of cryptocurrency transfers worth more than $10,000. Rep. Tom Emmer reintroduced a bill this week to require the IRS to create a safe harbor until it clarifies the issue of air drops and hard forks. A bill has been proposed that would make gains from cryptocurrency equal or less than $200 not taxable. This could apply not just to buying coffee with crypto that’s appreciated in value, but also for other uses of crypto that are not for buying goods, such as identity verification.
The Office of the Comptroller of Currency (OCC): The OCC released an order last July clarifying that federally chartered banks can custody cryptocurrency, which was seen as a positive step in mainstreaming the industry. Michael Hsu, who has been acting comptroller since May 10, said Wednesday that the OCC, the Federal Reserve and FDIC are in talks for an “interagency sprint team” on crypto regulatory issues. The OCC still doesn’t have a permanent leader. Michael Barr, a former Treasury department official and former Ripple adviser, was slated to be nominated but was reportedly dropped due to opposition from liberal Democrats.
Consumer Financial Protection Bureau (CFPB): The CFPB in 2019 released a Compliance Assistance Sandbox to give companies safe harbor and clarity on new FinTech products or features. Under this program it has issued approvals for PayActiv, Synchrony Bank and others. In October 2020, the CFPB announced plans to pass Section 1033, which will determine consumers’ access to and control of their financial data. The CFPB is interested in how data is produced from financial services, how consumers can access it and how they can authorize third parties to access it. While the CFPB remained neutral during the Trump Administration, the recent nomination of Rohit Chopra to head the CFPB is expected to bring more focus on protecting consumers. “The expectation is a stronger focus on consumer protection and a stronger focus on using the authority that CFPB has to the fullest extent in order to protect consumers,” said John Pitts, policy lead at Plaid and former CFPB deputy assistant director for intergovernmental affairs.
Changes to Section 1033 could affect what financial data a consumer could send to apply for a loan, or clarify what protections consumers have when using this data. “If something goes wrong, what happens and what protections do people have?” Pitts said. Changes could also benefit minorities and underrepresented groups — a Biden administration priority.
For example, some fintech apps analyze consumers’ cash flow in their checking accounts, rather than a credit score, to underwrite loans. (Companies such as Plaid help facilitate this.) This helps minorities and underrepresented groups that haven’t been able to build up a traditional credit file. But for this to happen, banks need to allow consumers to share this data, which a new Section 1033 rule could do.
The Financial Action Task Force (FATF), a group of 200 countries and jurisdictions that sets international standards related to money laundering and terrorist financing released a draft of new guidance on regulating digital assets in March 2021, which would require crypto companies to collect and report detailed, personally identifiable information about their customers’ counterparties, which other types of financial firms are not required to do, the firm said. “Such an ill-advised regulation will have many foreseeable and unintended negative consequences.”
Financial Crimes Enforcement Network (FinCEN), operating under the Treasury Department, requires only those controlling the assets be regulated as money transmitters. The most recent draft guidelines suggest prohibiting peer-to-peer cryptocurrencies and privacy coins. The guidelines would also add counter-party identification, similar to what FinCEN recently proposed in a rule that was hotly contested by Coinbase and others. FinCEN hasn’t made a decision on that proposed rule yet.
China’s regulators effectively banned financial institutions and payment companies from most uses of cryptocurrencies. Chinese citizens can still trade crypto, but often need to do it through offshore exchanges. Yet the country remains interested in digital currencies, including the creation of a digital yuan. However, Bitcoin miners are leaving the country in droves, seeking asylum in westernized nations where mining can proceed uninterrupted.
Policy: Digital Commodity Exchange Act (DCEA)
Last year, then-Rep. Mike Conaway proposed the Digital Commodity Exchange Act, which calls for the creation of new regulations targeting “digital commodity exchanges”. Under the DCE, crypto exchanges could opt in to fall under the CFTC’s new regulation. The DCEA bill would resolve the concern over Bitcoin ETF’s, because the ETFs could trade on a CFTC-supervised market,
The bill also would allow token sales to proceed as regulated securities under the SEC’s purview and then, if they pass a certain test, become commodities overseen by the CFTC. This could resolve questions about when a SAFT (project that raises capital for a future planned token as a security offering) — later becomes a commodity that can be freely traded.
A Reason to Fear?
While this is a brief overview of the current regulatory narrative surrounding the crypto space, the general theme is consumer protection and targeting market manipulation. The safety of the common investor is really the reason for many of these regulations and, while there may be a negative impact to short-term price action, the long-term goal is to make crypto investing more secure for investors.
It is important that investors do their research before investing in cryptocurrencies. These markets are highly volatile and, with the regulatory narrative getting stronger by the day, the impact to short-term price action may bring even greater volatility. New investors should never invest more than they can afford to lose. Beyond this, the prognosis for the crypto industry over the long run is good. With technological innovations being released all the time, blockchain technology will continue to find its way into our everyday lives.
For myself and other crypto investors, we are all early adopters in the future of this technology. And “early” is a good time to invest in sound technologies that have strong fundamentals and legitimate business use cases (utility) that can be used for solving real enterprise problems. Two sound blockchain projects immediately come to mind: Cardano and Vechain. These two unrelated projects have sound fundamentals, many government and enterprise partnerships, and well-known experienced teams that will continue to give them an edge in user adoption over the long run.
