Will Overregulation Stifle the Good of Cryptocurrencies?
Cryptocurrency and FinTech companies have been longing to establish themselves as a mainstream investment. Luckily (so far), the government has yet to pass any legislation that has worked against the organic growth of this newer segment of the financial sector. This may change shortly, however, as Rep. Warren Davidson (R-OH) recently announced a plan to introduce legislation that would regulate cryptocurrencies and Initial Coin Offerings (ICO). Despite the resolve of legislative bodies to regulate these new digital assets, there are two major obstacles that must be addressed before an efficient legislation can be put in place. The first obstacle is the creation of a regulatory framework that works across all levels of government. The second, and perhaps more challenging obstacle, is to monitor the usage of cryptocurrencies for illegal activity.
Before going into the challenges of regulating cryptocurrencies, it is important to understand what cryptocurrencies are and how they work. A cryptocurrency is defined as a digital asset that can be used as a payment method to purchase goods and services. To keep track of transactions, cryptocurrencies use a technology known as the blockchain. A blockchain works as a distributed ledger in a peer-to-peer network where crypto transactions are recorded and validated. This means cryptocurrency transactions are decentralized and do not need a financial institution such as a bank, as the middleman. Both cryptocurrencies and the blockchain are protected by strong cryptographic algorithms.
Before 2016, cryptocurrency and blockchain technology were at the fringe of the investment world. It was only after Bitcoin, the most popular and widely used cryptocurrency, reached a high-value of almost $20,000 per unit that digital currencies started making headlines in mainstream news outlets.
It created a gold-rush fever among investors and speculators hoping to find the next exciting monetary concept. While Bitcoin prices crashed throughout 2018, there is still interest among investors in cryptocurrencies and the technology behind it. However, the conflicting guidelines among government institutions and the lack of security for investors makes it somewhat unattractive as an investment vehicle.
One of the main issues surrounding the regulation of cryptocurrency is its classification as an asset. Are cryptocurrencies a commodity, security, or property? Whose jurisdiction does it fall under? The answer depends on which regulatory body you ask. Financial organizations across the federal government have different stances on how to classify the digital asset.
The Securities and Exchange Commission (SEC) considers cryptocurrencies acquired during crowdfunding campaigns, aka ICOs, as securities and subject to their regulations. On the other hand, the Commodity Futures Trading Commission (CFTC) classifies cryptocurrencies as a commodity. The Internal Revenue Service (IRS) categorizes and taxes cryptocurrency as property. Lastly, the Financial Crimes Enforcement Network (FINCEN) and the U.S. Office of Foreign Asset Control (OFAC) view crypto as a fiat currency.
The lack of clarity in how to approach cryptocurrencies as an investment can result in loopholes that could allow individuals to commit fraud or unintentional transgressions by investors seeking to comply with the law. Congress has previously asked the SEC to clarify its regulations on cryptocurrencies. It has also asked the IRS for more comprehensive guidelines on how to report profits earned on cryptocurrency. The lag in clearly defining parameters may cause legitimate blockchain innovators to take their ventures abroad. If the federal government decides to intervene, will they be able to devise a framework for regulation that is clearly defined and consistent across the board?
Another major issue that investors face is the use of cryptocurrency for illegal activities. While many are attracted to the decentralized and anonymous nature of cryptocurrencies, these same qualities can make them a double-edged sword when it comes to regulatory compliance. Cryptocurrencies have gained a reputation as facilitators of illegal purchases on the internet’s “black market.” They can also be used to launder money and evade taxes. To this end, the government has started investing in tools that will help track cryptocurrency transactions.
There are also hackers who utilize malware to illegally obtain cryptocurrency. One example of this, is when bad actors utilize crypto-jacking malware, which uses the processing power of another computer to mine cryptocurrencies. It is expected that the usage of this malware will rise throughout 2019. In other instances, hackers utilize ransomware threats, which are a form of malware that encrypts files on an infected PC and make demands for the victimized user to pay a ransom fee in cryptocurrency. This method is also expected to be prevalent throughout 2019.
We also must ask, what can be done to better secure cryptocurrency exchanges? We have already seen cases where exchanges have been breached by hackers resulting in the loss of millions of dollars in cryptocurrencies.
For better or worse, the government now seems intent on helping to bring cryptocurrencies into the mainstream as a legitimate investment. However, if the aforementioned issues are not addressed, prospective investors may shy away from cryptocurrencies. Conversely, overregulating the crypto market may also push away investment, so any new laws must toe the line between necessity and redundancy. Furthermore, needless regulation may compel fintech innovators to implement their technology in other countries if our cryptocurrency laws become too stringent or convoluted.