The Future of Cryptocurrency Regulation: A Bright Spot or a Cloudy Outlook?

by Swatilekha Das

The surge in cryptocurrency scams, causing a staggering loss of over $10 billion in 2021, has prompted regulators to adopt measures to combat fraudulent activities.

There has been a worldwide uptick in crypto regulation.

While just a minority of nations established cryptocurrency regulations in 2018, by 2023, over a hundred had done so.

To combat criminal activities like money laundering and terrorism financing, anti-money laundering (AML) regulations are the most common and require exchanges and crypto firms to collect consumer data.

Regulators of financial markets all over the world are struggling to make sense of Bitcoin. This asset type is difficult to categorize, and the FTX crash of 2022 made the demand for more nuanced rules abundantly clear.

Although cryptocurrencies were designed to be decentralized, the current regulatory vacuum for digital assets is bad for business, innovation, and consumer security.

Since 2021, crypto assets have transitioned from obscurity to a legitimate choice for mainstream investors, hedgers, and potential payment systems. The expansion of crypto products, innovations, and transactions, coupled with failures and price drops, has intensified the push for stringent regulation.

Governments worldwide hold diverse views on categorizing and regulating cryptocurrencies.

Regulations are evolving in different places across regions.

While cryptocurrencies are perceived as operating beyond national oversight, governmental actions significantly influence their value, transactions, and user base.

National regulation is feasible due to dependencies on licensed financial institutions and fragmented markets across jurisdictions.

Government policies exert specific influences on cryptocurrencies:

• Taxation Impact: Cryptocurrency transactions can be taxed, influencing investment profitability.

• Capital Controls: Governments can limit cross-border capital flow, affecting crypto buying and selling.

• Money Laundering Rules: Regulations against crypto-based money laundering hinder illegal use.

• Exchange Restrictions: Governments can limit fiat-crypto exchange, impacting crypto accessibility.

Below let’s delve deep into the future of crypto regulations, whether it promises a beacon of hope or a descent into uncertainty.

Crypto Regulation: A Thorny Issue

Cryptocurrencies are difficult to regulate due to their decentralized nature, international reach, and rapid innovation.

Cryptocurrencies rely on centralized, government-monitored banks to trade for fiat currency. Due to the complexities of cryptocurrencies, users frequently rely on external, online crypto wallets. The ability to regulate these services, however, creates opportunities for market fragmentation and reduces the company’s global competitiveness.

The requirement of an offshore bank account can act as a barrier to entry into certain markets. Due to their dynamic nature and inexperience, existing regulations have difficulty being applied to crypto assets.

Authorities have a hard time keeping tabs on the crypto market because of all the different kinds of actors involved.

At first, efforts were directed at limiting illicit activities associated with crypto assets, such as money laundering.

The International Organization of Securities Commissions (IOSCO) provided recommendations to cryptocurrency exchanges, while the Financial Action Task Force (FATF) soon established a common framework for virtual asset providers.

The introduction of Libra, a “global stablecoin,” has bolstered calls for the establishment of strict cryptocurrency regulations.

Crypto Regulation: The Big Holes

Three key regulatory gaps in the cryptocurrency field were highlighted in 2022 by the Financial Stability Oversight Council of the United States Treasury Department.

1. Cryptocurrency exchanges, in contrast to traditional financial spot markets, lack government-regulated trading norms, which could lead to conflicts of interest and market manipulation due to a lack of transparency.

2. Due to the fragmented nature of cryptocurrency regulation, individuals might potentially game the system through the practice of regulatory arbitrage.

3. The centralized nature of cryptocurrency exchanges, in contrast to the dispersed nature of more traditional financial operations, can make them more susceptible to attack.

To promote openness, stability, and investor safety in the Bitcoin market, these gaps call for clearer and more extensive laws.

Crypto Regulation Around the World

In the US, the regulatory focus is on crypto platforms rather than cryptocurrencies. The government treats cryptocurrencies as traditional securities but restricts their functioning within financial markets as such.

Securities and Exchange Commission (SEC) Chair Gary Gensler stated unregulated platforms can’t serve as custodians for investment advisors.

The classification of crypto as a security or not is a contentious issue, highlighted by the SEC’s charges against FTX and CEO Sam Bankman-Fried for alleged investor fraud totaling $1.8 billion.

The UK’s approach to crypto regulation is similar to the US, fostering innovation while addressing concerns of money laundering and fraud.

The Financial Conduct Authority (FCA) banned all activity of Binance, the world’s largest crypto exchange, during the summer of 2021.

Canadian authorities aim to offer clarity and a regulatory framework for the crypto industry. In August 2022, OSFI issued federal rules for crypto, treating it as a commodity for income tax purposes, necessitating transaction reporting. The regulatory landscape in Canada is considered stricter than in the US, prompting FTX and Binance to withdraw from Ontario in 2021 due to onerous regulatory demands.

Brazil’s Real Digital project, led by the central bank, positions the country as a frontrunner in crypto policy.

The project aims to create a digital real while retaining current deposit regulations and involving large banks as stablecoin issuers. It prioritizes data privacy, security, and anti-money laundering practices. This reflects a global trend of big countries exploring national digital currencies, with their widespread adoption and citizen trust yet to be determined.

Germany’s regulatory environment is lauded for its clarity.

Federal Financial Supervisory Authority (BaFin) has set medium-term goals until 2025 to enhance DeFi regulation and protect consumers from unknown risks. Moreover, Germany offers favorable tax regulations, allowing tax-free sale of purchased bitcoin and ether after one year for private individuals since May 2022.

India initially banned cryptocurrency, but the Supreme Court overturned the ban in 2020. However, regulators remain dismissive of crypto. The Reserve Bank of India barred banks from serving crypto-related firms in 2018.

The government and central bank consistently warn the public against crypto, with a panel recommending potential 10-year jail terms for individuals dealing in digital currencies.

In the 2022 South Korean Presidential election, Yoon Suk-yeol advocated for crypto regulation.

The Financial Services Commission (FSC) is now developing the Digital Asset Basic Act, set to be introduced in 2023, aiming to curb crypto crime and provide clarity for legitimate players in the industry.

Will Increased Regulation Kill Crypto?

The rapid and impressive ascent of cryptocurrencies, evolving from a novelty to a distinct asset class, has prompted governments worldwide to consider ways to manage their highly fluctuating prices.

These governments and regulatory bodies face the challenge of striking a balance between fostering innovation, protecting investors and buyers, and safeguarding the overall financial system.

Some lawmakers have raised apprehensions that increased oversight could lead to a shift in trading activity towards regions with less stringent regulations, potentially stifling the growth of this exciting new financial asset.

On the other hand, there are also proponents who believe that regulatory actions may encourage market participants by providing them with greater certainty and stability.

Experts generally believe that cryptocurrencies currently do not pose significant threats to financial stability. While crypto-assets may not be a major avenue for money laundering, new products like crypto-funds and derivatives increase connections to the monetary system. If faith in crypto markets wanes, it could impact trust in the entire financial system. Vigilance is essential to monitor trends and address future risks, even though crypto-assets are not currently a risk to global financial stability.

Some governments have outright banned cryptocurrency use and possession, while others actively support crypto firms as a means of growing their local markets. This asymmetrical approach distorts competition and may spark a race to the bottom as crypto actors look for the least restrictive jurisdictions.

When China hinted at stronger regulation in January 2017, Bitcoin trading shifted to other Asian currencies. This is an example of how national regulatory actions can have international implications.

The “Kimchi Premium” refers to the higher pricing of cryptocurrencies on South Korean exchanges compared to international markets.

Despite its global prevalence, the value of Bitcoin in Korea is consistently over 50% greater than in the US. China’s rules also contribute to price discrepancies.

Governments are making moves; some, like Japan and Switzerland, have already passed crypto laws, while others, like the European Union, the United Arab Emirates, the United Kingdom, and the United States, are drafting legislation. However, national governments’ responses to crypto legislation are all over the map.

Regulatory measures in one country can have repercussions in another country even if the market in question is governed by a distinct set of rules. Regulations in one nation can lead businesses to transfer to other countries with less stringent standards, especially when the market expands and more banks and funds participate in cross-border activities. It has been established that anti-money laundering (AML) rules are more effective when agencies work together. Cryptocurrencies should also be treated consistently across countries in terms of their function and risk level in order to get the greatest results and close any potential loopholes.

Authorities should define cryptocurrency activities in legal and market terms, focusing on economic goals over technology. In a similar vein, redrawing national regulatory boundaries might be necessary to clarify responsibilities.

The Future of Crypto: Regulation or Revolution?

The Financial Stability Board (FSB) has begun monitoring the cryptocurrency market and publishing principles to guide the regulatory treatment of global stablecoins, and it is also developing guidelines for the entire spectrum of cryptocurrencies, including unbacked cryptocurrencies.

Prudential management of banks’ exposures to crypto assets is now being worked on by the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions (IOSCO), with additional standard-setters following suit.

The IMF is pushing for a global solution that is coordinated to fix the regulatory gaps caused by crypto’s inherent cross-sector and cross-border nature; consistent to conform to industry and risk-standard regulatory practices; and comprehensive to include all participants and aspects of the crypto ecosystem.

If the Bitcoin market is properly regulated, it may become a hub for innovation.

Stability in the markets, increased consumer confidence, clearly defined norms of behavior, and a safe setting in which creative innovation can flourish are all benefits that could result from a global cryptocurrency regulatory framework.

When crafting a framework to regulate players and operations in the crypto ecosystem, governments around the world may have to balance the energy intensity of “mining” specific crypto assets against other public policy goals.

Businesses have long complained about sluggish and opaque regulatory decisions. Regulators struggle to keep up with fast-paced changes and lack the knowledge and instruments for successful policymaking.

Companies working with digital assets may expect stronger rules like financial services. Early change is eagerly anticipated by stakeholders.