An Introductory Guide to Cryptocurrency Regulation

Right off the bat, this article has no intention of digging deep into the legal nature of cryptocurrencies or deconstructing specific national regulations, but rather it strives to paint a general picture of the regulatory approaches undertaken by governments all over the world, and the problems they’re currently facing.

More importantly, it aims to equip you with sufficient knowledge of the legal intricacies surrounding Distributed Ledger Technology frameworks, so you can get a general sense of the direction which government regulators are taking in regard to cryptocurrencies and distributed ledger technology.

Hopefully, this will allow you to better manage your expectations and predictions about the pace and direction this stochastic industry is about to take in its future development.

What is DLT?

Distributed ledger technology (DLT) and cryptocurrencies are the next big step forward in the new Digital Age. During the first few years after the introduction of Bitcoin, nobody expected it to take over the world at that unimaginable pace. Today, we’re witnessing first hand a new digital revolution, a paradigm shift in the way society operates.

The blockchain is a distributed, encrypted, immutable and incorruptible public database of information. For the first time in history, it’s now possible to transact value, or exchange information with unrelated people over the Internet without passing through a third trusted party.

Order out of chaos is a maxim we’ve all heard before.

In the simplest terms, the law is humanity’s way of dealing with chaos.

Having said that, just like the police in action movies, the law always arrives late on the scene. It’s an unwritten rule. The law eternally lags behind current technological and societal developments. To write “good” laws takes a special kind of government engagement and accountability, and this is especially true in today’s fast pacing world of tremendous and disruptive technological advancement.

He who fails to recognize the magnitude of change and disruption the DLT is about to generate is doomed to decay. The bandwagon has started rolling, and there are two positions you can take; either jump on board or get run over.

Why is There a Need for Regulation?

cryptocurrency regulation

At first glance, from a legal scholar’s point of view, a paragraph addressing this question might seem redundant. However, answering this question right from the beginning might be the most significant thing we can do, taking into consideration the demography of the community in the cryptocurrency world.

Bitcoin, the first and most widely accepted cryptocurrency in the world, was born out of the ideas incepted in the 80s and 90s cypherpunk movement. In 2009, Bitcoin was released, in a sense, as an act of rebellion, a reaction to the current state of affairs in the traditional financial markets. Since the very beginning, the community surrounding cryptocurrencies has mainly been composed out of people with libertarian and anti-establishment political stances. To them, the word “regulation” is the devil.

Decentralized cryptocurrencies are the purest form of Laissez-Faire Capitalism. They are the very embodiment of Hayek’s ideas in the “Denationalization of money.” As the cryptocurrency market grew with many institutional players entering it, Bitcoin became a worldwide superstar and the community’s demography diversified.

However, it’s still safe to say that the very notion of a stateless currency issued by “everyone and no one in particular” is what makes Bitcoin and other altcoins especially attractive to a certain demographic group. The very fact that no government body (or any other authority figure) has any power over it makes it a particularly strong alarm beep on the radar of people who hardly hold “reactionary” political views, to say the least.

Unfortunately, not everything we read in the blockchain news space is positive. Criminals are using cryptocurrencies for all sorts of illegal activities; the ICO space is full of scams and all sorts of a pyramid and pump-and-dump schemes. There is virtually zero consumer protection, or any form of legal security for that matter, associated with cryptocurrencies. Apropos, all of this “legal” insecurity stifles growth and innovation in the space.

On top of that, governments are faced with a reasonable fear of  “new generation” blockchains like Monero, Zcash or Dash that make transaction tracking very hard or virtually impossible and create a fertile ground for widespread tax evasion, leaving governments powerless. And nothing good ever comes out of a government in fear of losing its grip on the fundamental levers of control and power.

For these exact reasons, the cryptocurrency community needs to be cognizant of the fact that regulation is inevitable, especially in a domain that strives to redefine how commerce, the building block of civilization, is done.

Typology of Regulatory Approaches

At the present level of regulatory development in the cryptocurrency world, one cannot speak of any global harmonization of law and uniformization of practices. Their decentralized form of issuance coupled with the fact that they exist purely in the digital realm makes them a global phenomenon and therefore a real headache for any “one” sovereign that wishes to control them.

In hopes of taming this new disruptive form of currency, governments around the world have taken different regulatory approaches according to their legal traditions and practices.

We can classify most of the strategies undertaken by governments in four different categories: the wait-and-see (or the do-nothing approach), the sandboxing approach, issuance of new affirmative legislation, and the outright ban approach.

  • The wait-and-see approach

wait and see

The wait-and-see approach is currently the predominant strategy of choice regarding the regulation of blockchain technology and cryptocurrencies in the world. The underlying idea of this approach is to let a novel phenomenon unfold while paying close attention to the direction it’s taking and the problems it solves or creates.

This method gives lawmakers time to educate themselves and truly understand the underpinnings of the phenomena under investigation. Blockchain technology is evolving at a stupendous rate, with more than 1000 different cryptocurrencies on the market and many different models of blockchain solutions with diverse purposes and implication

The wait-and-see method has been widely adopted historically and proven successful in dealing with emergent technologies. If regulators were to warrant any form of stringent regulatory measures at this point of time, the need for amendment shortly after the announcement is almost guaranteed.

The wait-and-see approach, however, needs to be accompanied by the issuance of formal or informal guidance, opinions, and statements as to how the existing legal frameworks may apply to Initial Coin Offerings, the legal classification of cryptocurrencies, and to the blockchain technology in general. The general guidelines as to how the existing legal frameworks apply need to be clear and decisive, leaving no room for public uncertainty, ambiguity and misinformation.

The European Union, with the exception of the 5th Anti Money Laundering Directive, has endorsed the wait-and-see approach. The European Commission issued an initiative to create an EU Blockchain Observatory and Forum with the aim of identifying and providing analysis of the technological and organizational trends in the blockchain industry. The EU is aware of the fact that this issue needs to be addressed at the “federal” level, and plans to do so in the near future.

  • The sandboxing approach

sandbox

The sandboxing approach is a regulatory strategy that allows lawgivers to create a fertile testing environment for innovators in the FinTech world, designed to support safe experimentation with technologies that are not regulated by any existing laws or supervised by any regulatory institutions at the moment.

Here are some countries which follow suit:

The United Kingdom pioneered this approach in 2015, and since then many jurisdictions followed. In fact, several jurisdictions now use the sandboxing method as a means of attracting key players within the blockchain industry and allowing them to innovate and operate “without disruptions” on their territory.

Likewise, Ukraine recently drafted a law exempting cryptocurrency income and profits from taxation “in order to create an effective mechanism for stimulating the market of cryptocurrency in Ukraine.”

The “Zug Cryptovalley” is an initiative of the Swiss canton Zug that aims to attract innovators with low taxes and friendly regulations.

Kazakhstan signed Innovation Pact in order to create the most favorable conditions for the development of Blockchain technologies and fuel further innovation in the industry.

Sandboxing is one of the most suitable regulatory approaches in dealing with novel technologies and markets. It’s beneficiary to both the regulators and the regulated. For the regulators, it provides time for further observation and learning from the recent developments in the field, while maintaining the dialogue between the industry’s stakeholders and the lawgivers. As for the innovators, this strategy produces legal security within certain boundaries of the existing legal framework.

Governments that are cognizant of the economic benefits distributed ledger technology can bring to their country are racing to become the world’s first blockchain capital of the world. Those who fear the technology, on the other hand, may miss on this one-time opportunity.

  • New affirmative legislation

affirmative

Several jurisdictions have now issued new blockchain-friendly legislation with the aim of attracting new blockchain capital and innovation. The underlying idea behind the issuance of new affirmative regulations at such early and chaotic times is to create legal certainty and affirm the government’s welcoming stance on DLTs and cryptocurrencies.

Japan, for example, became the first country in the world to make Bitcoin legal tender.

Meanwhile, Russia is creating an all-encompassing legal framework regulating every aspect of DLT, cryptocurrencies, ICOs, trading, and crypto-exchanges.

Arizona issued State legislation that qualifies signatures secured through blockchains and smart contracts as electronic signatures.

In Germany, BaFin (the German Federal Financial Supervisory Authority) opinionated that ICO Tokens are considered “units of account” within the meaning of the German Banking Act. This basically means that they’re out of securities regulation and hence, they’re VAT exempted.

This progressive strategy may, however, create adverse effects. The industry is still evolving in an unpredictable manner, and issuing rules that are too detailed and complicated can deter start-ups from entering the market and hold them from experimenting with the technology. In addition, constant amendments to the already existing laws and regulations are harmful to the economy and compromise the legal certainty in the country. Issuing new regulation, even with the best intentions, may be counterproductive at this point in time.

  • The outright ban approach

outright ban approach

Needless to say, there will always be governments that will push towards the outright banning of cryptocurrencies. Countries like Morocco, Bangladesh, Ecuador, Bolivia, Kyrgyzstan, and Nepal have all outlawed cryptocurrencies. Due to the decentralized nature of cryptocurrencies, their actions have, of course, proven to be futile. It seems like ‘somebody’ didn’t learn the lesson from the war on drugs or the war on alcohol during the prohibition era.

Banning Bitcoin in hopes of stopping people from using it, is the equivalent of putting a band-aid on a bullet wound and hoping it will stop the bleeding. Fortunately, cryptocurrencies are out of any governments control. They are decentralized, encrypted, and recognize no state boundaries. They’re essentially just bits of information. They’re nothing but code – and the code is nothing but language. And if history has taught us anything, it’s that you can’t police the use of language. You can’t kill an idea.

Regulatory issues surrounding cryptocurrencies

anonymity

There is no doubt that blockchain technology and cryptocurrencies as methods of transacting value peer-to-peer over the Internet are here to stay. However, as we move further into uncharted territory, more and more problems arise out of the ocean of technological innovation.

One of the biggest concerns for governments in regards to cryptocurrencies is the “problem” of user anonymity. Bitcoin may not be the best example, as the Bitcoin blockchain is public and consequently every transaction can be tracked back in time fairly easy, and the average Bitcoin wallet owner can be identified without immense difficulty.

However, many other forms of cryptocurrencies have emerged on the market recently that are not as easy to deal with when it comes to this particular issue. Monero, Zcash, Dash and few other altcoins make user identity tracking virtually impossible. Attempts at stopping money laundering and other forms of illicit activities made using these currencies is a very resource-intensive and expensive task and, as stated previously, outlawing them won’t have any effect concerning the volume of their use.

Another big problem that governments are facing is the problem of tax collection. Cryptocurrency transactions are independent of any form of financial intermediary, thus completely circumventing the traditional financial systems and making their monitoring and control protocols almost impossible to implement. Taxes are the primary source of government funding, and specific cryptocurrencies made money laundering and tax evasion easier than ever before. Although various government bureaus and independent legal scholars have addressed this issue many times before, it looks like we’re far from finding an adequate solution to the problem.

Countless problems of legal, economic and social nature remain unsolved. In fact, economists and legal scholars can’t reach a consensus on the most basic questions concerning the nature of cryptocurrencies. Are they a currency, security or a commodity?  Can we categorize all of the thousands of cryptocurrency tokens in one legal or economic category? If not, how do we analyze them one by one? Do we need to create and implement new, unprecedented legal categories like cryptosecurities, cryptocommodities or cryptoassets? If we know we can’t outlaw them, how do we proceed to regulate them?

The Future of Cryptocurrency Regulations

future

With the emergence of Bitcoin in 2009, humanity took a decisive step in the direction of creating “one global currency” of the world. A currency that aspires to become the dominant currency of international commerce needs to satisfy a very diverging set of criteria. It needs to be scarce, liquid, portable, fungible, durable, divisible, malleable, recognizable, easily transferable, secure and incorruptible.

However, the embodiment of all of these characteristics is not a guarantee of success. Furthermore, nobody can predict whether cryptocurrencies will become the dominant form of money on a global scale — and even if they do, which one will prevail?

There is one thing everyone can be certain of; the battle between the decentralized, cryptographically secured form of money and government-issued fiat money has just begun. The situation is unprecedented, so the process of resolving it is bound to be long, chaotic and exhausting for all involved parties.

For the first time in history, we’re experiencing a competition between various currencies with different monetary policies, technological properties, and philosophies. This process of competition breeds immense innovation and, sooner or later, one currency that’s vastly better than anything we’ve ever seen before will rise to the occasion and conquer the world.

In thirty years from now, national currencies will be relics from the past. Paper will be an extinct, primitive form of money.

So brace yourselves; the currency wars have only begun, and it’s time for governments all around the world to rise to the occasion and provide adequate regulatory solutions to the problems arising out of this groundbreaking technology.

What’s your take on the cryptocurrency regulation? Leave a comment below!

Featured image by Magey Woong

Image sources – 12, 3, 4, 5, 6, 7

 

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