Is Regulation Cryptocurrencies’ Kryptonite?

By: Isaac Syed

Luke Pecunia walked up to the terminal to “cash out” after grabbing several souvenirs that could remind him of this exciting trip to Tokyo, Japan with his wife Vie. Pecunia always considered himself an early adopter of technology, as he turned his Apple Watch to a near field communication console with the transaction amount. Another quirk about Mr. Pecunia is that he is not much of a math wizard—which means that exchange rates can “drive him up a wall.” However, he didn’t have to worry about any exchange rate for his native Dollar to Yen. Instead, Pecunia’s wallet (really his electronic bank account sitting on the cloud) was filled with Ethereum, one of the many traded cryptocurrencies in circulation. Pecunia completed his transaction, ordered an Uber, and was on his way back to his Airbnb.

What may now be considered a standard trip and simple shopping experience was once unfathomable. Cryptocurrencies, despite their growing popularity, still seem to mystify individuals. Even more concerning to others is the idea that a currency can be virtually unregulated by any governing body. On the other hand, cryptos’ constituents believe that currencies such as Bitcoin, Ethereum, and Ripple should remain unregulated to effectuate market efficiency and because those currencies don’t originate under any traditional governing body. Before we can get into these arguments, first we must understand one simple question—what is a cryptocurrency?

Bitcoin may hold some of the most brand recognition among cryptocurrencies, but the crypto star was not the first to be developed. The first digital currency—eCash—was developed by cryptographer David Chaum. Chaum implemented this through Digicash, the only merchant of the currency, but would flop because merchants and consumers alike did not adopt the currency. Shortly after, Nick Szano created bit gold, another currency which focused less on the privacy aspects of currency. The currency floundered as well and was soon defunct followed by a period of digital currency silence. In 2009, the currency market would forever change as bitcoin.org was registered online. Its founder, Staoshi Nakamoto, may be more mysterious than the currency itself, as the name is a pseudonym and Nakamoto’s true identity still remains unknown.

The way Bitcoin is created, distributed, and processed can be perceived as a complicated process depending on who you ask. The details are not important, but what is important is the characteristics that Bitcoin is completely decentralized on an open network of public computers and where transactions are logged using blockchain technology to ensure verification. What this means is that transactions can be done in the utmost private (like cash) and transactions or the exchange itself is completely devoid of regulation from an oversight body.

Bitcoin, and other currencies, are growing in their popularity. Almost twenty-two million users hold bitcoin wallets and approximately thirteen million users are members of Coinbase, an exchange to trade cryptocurrencies such as Bitcoin. As time progresses, the number of bitcoin-adopting merchants and users increases. Not only are people increasing their use of the currency for speculation and investment, but users are also using the currency to make everyday purchases without the need for physical money.

This growth of demand for the use of cryptocurrencies has spurred a reaction of advocates calling for regulation of the different currencies. The reason behind regulation is because of the exponential rate that cryptos are increasing in volume and size in market capitalization. Regulation comes in two distinct forms. One way to regulate currencies like bitcoin is to enact a blockchain-enforced unchangeable code. This way, the regulation is still decentralized and doesn’t fall under the ambit of any specific power. The logical questions are who will impose such regulation—and why?

In certain places within the world, regulation has varied greatly. In China, the government has imposed some regulation and in other cases has actually halted trading, shut down initial coin offering (“ICO”) exchanges and created a task force to end certain crypto activities. The government alleges that such exchanges and mining consume large amounts of electricity and run risks to the economy because of the inability to manage the influx of new currency and (as a byproduct) exchange rates.

In the United States, cryptocurrencies are not regulated to the degree as other countries. Instead, the Securities and Exchange Commission (“SEC”) has issued warnings about the potential for fraud and misconduct by issues of ICOs. The reason why is that the SEC and U.S. legislators do not recognize bitcoin or ether as traditional securities using the Howey test. Despite Bitcoin remaining in a state of limbo within the domestic United States, a Bitcoin exchange traded fund (“ETF”) is expected to be approved by the SEC despite several past attempts to get the ETF on the market. In some regards the use of ICOs can resemble IPOs in which the SEC should regulate the money in a similar fashion. In other cases the ICOs resemble future or forward contracts in which they were not be subjected to the same stringent filing requirements and oversight. The distinction between security and commodity is a fine line––a line likely to be litigated in the projected future.

Other countries have taken a more progressive regulatory policy towards the relatively newfound technology. Specifically, French officials have suggested that the currency should remain relatively unregulated in its growth stage to promote adoption. They also advocate for rigorous adoption of the currency to stimulate growth. The thought is that the use of cryptocurrencies within the marketplace will make countries who accept the currency more desirable. Such policies can be well determined by France’s reduction of the tax rate upon the currency from forty-five percent down to nineteen percent.

Pundits fear that regulation of cryptocurrencies could stifle growth of an exciting new way for payments and economic growth. Concerned legislators on the other hand worry about the potential for crypto users to take advantage of the highly secure and private transaction blockchain technology to perform illegal transactions––possibly expanding markets into illegal substances or banned firearms (all of which would slip under the radar of the government). In other words, the benefits of secure transactions and anti-counterfeiting capabilities also makes transactions for criminals easier. However, the Federal Bureau of Investigation (FBI) has been using coders and academics to assist them with cracking blockchain encryptions and catching criminals performing illegal transactions. This has brought a new dynamic to the crypto atmosphere.

Another benefit and drawback of currencies like Bitcoin is the extreme volatility. Not only do sudden reports of overnight billionaires attract investors during bullish markets, but the same is true for shooing investors when the market is bearish. This volatility seems to be lessening over time but regulation could flatten crypto price curves more. Regulators must be cautious though because changes in the supervisory framework of cryptocurrency could reduce market-making activities.

Conversely the ambiguous nature and high volatility of cryptocurrencies won’t necessarily last into perpetuity. Universities are establishing ever-growing research programs into the technology of blockchain and digital currency. Sitting at the top is Cornell University, which has established a dedicated program called Cornell Blockchain—part of a larger enterprise called the Initiative for Cryptocurrencies and Contracts. Programs like these are working with other research universities to develop blockchain technology and create stable environments to use blockchain in a variety of settings––most notably digital currency. Coinbase, a predominant player in the cryptocurrency exchange market, records that top universities are offering additional courses in cryptos and blockchain with Stanford and Cornell leading the bunch. Universities providing a prolifera of courses isn’t just value-added to developing the technology itself, but also expanding the horizon of future adopters who believe that digital dollars are the future.

Cryptocurrencies undoubtedly hold a lot of speculation in terms of value and regulation alike. Not only does the new form of currency give promise of expanding growth but the high volatility and criminal concerns lead politicians to seek possible legislative matters to combat these ills and fully effectuate the benefits that digital currency provides. Therefore, regulation may demonstrate to be a complement to the propagation of the technology rather than its kryptonite.