How Can Governments Make Crypto Regulations?

Looking at the market cap of cryptocurrencies which is worth more than a couple of trillion dollars as of now, it indicates the momentous economic value of technological innovations underlying it such as the blockchain.

Apart from that, it also indicates the frivolity of the crypto environment with the stretched valuations of the crypto assets which is due to the extensive trading, buying and selling of crypto coins.

Whether it is due to COVID 19 pandemic or the latest threat imposed by the Omicron virus, such belligerent involvement of people in the crypto market space all over the world calls for some effective regulations so that things do not go out of hands of the governments.

In fact, the governments all over the world have started to realize the threats along with the pros and cons of cryptocurrencies.

Therefore, different governments of different countries are therefore taking careful steps with time to regulate the crypto industry.

They want the regulations to do good to both the crypto market space and the players within it as well.

They do not want to rush things right now but be informed and rest assured that the governments all over the world are seriously thinking of imposing some regulation in different aspects of cryptocurrencies.

They are also finding the best possible ways to make them work on a large and global scale.

At this point you should understand the pros and cons of this decentralized currency that are free from any intermediaries and regulations to understand whether it is a wildfire or a safe investment along with the need for such regulations.

The advantages provided by the decentralized cryptocurrencies include:

Faster and irreversible transactions that cannot be counterfeited
Anonymous transactions
Finite supply of coins that eliminates chances of inflation since mining becomes harder
Executable smart contracts by the investors without any third party involvement
Lower transaction costs
Less or no paperwork
Greater consumer choice
Reasonably high store of value and
Easy, anytime and universal access to coins and exchanges.

Moreover, ability to issue coins within dApps or for special privileges as well as other blockchain functions is an added benefit.

In comparison, perhaps the biggest issue with the existing fiscal policy is that the federal rates of interest are issued arbitrarily.

Also, the creditors do not seem to have any interest in controlling the supply of money.

However, the cryptocurrencies should not be considered to be the silver bullet yet because it too comes with some significant downsides, some of which are:

Price volatility in the market which affects its ability to act as a medium of exchange
Issues with scalability with several crypto coins
High speculation and
Artificial or manipulated pricing.

Sometimes, several blockchain networks cannot keep up with the demand as well.

Therefore, there is an immediate need for some regulations in crypto so that the craze does not go beyond bounds and disrupt the monetary policy of the globe completely.

However, with hundreds of new coins coming up every month, the effort to regulate crypto by the government is pretty tough and will be more of a cat and mouse game.

The policymakers of the world therefore struggle to monitor and comprehend the risks in financial stability offered by this emerging sector.

Still, the governments need to find out ways to crack down on crypto and some of these ways could be:

Taxing any use of fiat money when a digital currency is cashed out
Subpoena major crypto exchanges for indulging in suspicious or fraudulent activities and
Monitoring the ICOs or Initial Coin Offerings very closely.

Several experts and critics believe that these steps, for a start, will help the governments to eliminate the risks from the crypto assets to the traditional financial system overall.

However, determining valuation of crypto is not the only challenge that the regulators face considering the crypto ecosystem.

There are also several other major challenges to overcome which include and not limited to identification, monitoring and management.

Then, there are also the risks of financial as well as operational integrity from the crypto exchanges and wallets, issues with investor and consumer protection, inaccurate disclosure or inadequate reserves of stablecoin, and more.

All these risks, if not looked into seriously, may lead to replacement of traditional currency and also affect the capital account management mechanisms.

Uncoordinated and unregulated operations of the crypto exchanges may result in a probably damaging capital flow.

Therefore, all these underscore the need for a much more comprehensive and effective international regulatory standards in crypto.

This will address the risks completely and safeguard the traditional financial system from the threats from crypto assets and their related ecosystem.

This will also ensure a safer crypto environment and use of more useful crypto products and applications.

However, without creating a stable and powerful financial board nothing will be possible.

This board will be responsible for coordinating the role of the regulators in developing a global framework and standard for regulating crypto assets.

It is only then that the objective of creating a more coordinated and comprehensive approach to manage the risks to the market and financial stability will be fulfilled.

It will also ensure that the regulations are applied consistently and more effectively across different jurisdictions and at the same time minimize the potential for regulatory arbitrage and move and monitor crypto activity with more ease.

However, there is one more thing to take into account at this point.

It is the cross-border and cross-sector remit of crypto which restricts the efficacy of these regulations and the national approaches.

Therefore, different countries and governments need to follow different strategies.

This is because the existing laws and uniform regulations may not be able to cover all the elements of the crypto ecosystem and its products most comprehensively.

Moreover, since most of the crypto exchanges and service providers operate across the border, it makes the job of supervising their activities quite difficult.

It also makes enforcing the regulations more difficult due to different socio-economic, political and other diplomatic aspects.

Can Governments Really Regulate Cryptocurrencies?

Therefore, all these can make you ask whether or not the regulatory and standard-setting bodies of the government can really regulate cryptocurrencies for the better of the investors, society, environment, financial system and the crypto market as well.

These agencies have been responsible for providing varying levels of regulation and guidance to different markets and products including some in the field of crypto.

For example, the intergovernmental organization FATF or The Financial Action Task Force, which is also identified by its French name, Groupe d’action financière, has issued several guidelines to mitigate the risks to financial integrity from digital assets and its service providers.

Other regulatory bodies of the world have also set a broad range of rules and principles for specific types of crypto coins in order to mitigate the exposure risks of the regulated entities due to these unregulated crypto market space.

These bodies have also set up several information exchange networks that are pretty useful to coordinate a global framework to manage the risks to different aspects of the financial system such as:

Financial integrity
Financial stability
Market integrity and
Investor and consumer protection.

However, in spite of all these efforts made by the governments, a few mainstream crypto investors as well as a few hardcore crypto advocates doubt whether the government will be able to regulate cryptocurrencies.

Why?

This is because most crypto coins including those tokens issued via ICOs are decentralized. This means that the supply of these coins is not controlled by the governments or is not set by any central authority.

Another reason is the nature of cryptocurrencies which are considered to be a reliable medium of exchange due to its store of value.

Also, the transactions involving crypto coins are done mainly by using the blockchain technology.

It is conducted, validated, and recorded in a distributed public ledger and the entire process does not really need any interference of a third party.

This means that regulating crypto will really be a problem for the government.

Even if the government takes a hard line stance like the Chinese government and shuts down crypto exchanges and bans the use and sale of cryptocurrencies it may not have the effect as desired.

China has not only banned use and sale of crypto in their country but has also escorted miners out of the country citing land use regulations.

However, this has not been able to cause any dramatic impact on the use and sale of crypto in the world.

It has neither caused any significant fall in the price of crypto assets or has had any effect on the speculative boom worldwide.

There is another problem that does not allow the regulations to be as effective as expected.

It is that transactions of cryptocurrencies can be carried out over a P2P network and via direct transactions by using a crypto wallet. And, there are so many crypto coins.

Therefore, the government needs to take a well-calculated and more result-driven approach so that both ends are met.

Regulations Around the World

However, this does not mean the government cannot do anything about it and are completely helpless in this regard.

There are several governments of several different countries who have managed crypto well until now and hope to manage in a much better and more controlled way in the future. And, for that, all of them have taken their own ways.

Here are some of the ways followed by major economies to regulate cryptocurrencies.

United Kingdom:

As of now, like most of the countries, the United Kingdom does not have an all-inclusive regulation or legislation related to cryptocurrencies.

However, according to their current system, it is the FCA or the Financial Conduct Authority that is vested with the responsibility of granting licenses to companies willing to conduct crypto related business in the country.

The FCA also authorizes the crypto exchanges that wish to do business in the United Kingdom.

It makes sure that these businesses abide by the strict set of rules imposed by them with regards to crypto, which are even stricter for those companies that want to deal with crypto options trading and futures trading.

When it comes to the tax implications of crypto trading in the United Kingdom it is pretty much the same as capital gains made from any other form of currency trading. All fall under their specific corporate tax rules.

The FCA also issues warnings from time to time for the investors in the United Kingdom to make them aware of the inherent risks in crypto and ask them to invest with caution.

United States:

In the United States, however, there is a dual legislative system.

In this system both the Central Government as well as the State Governments has the power to impose regulations and legislation separately on crypto.

Therefore, you will find that the regulations may vary from one state to another in the United States.

New York, for example, has a more favorable legislative environment for crypto.

The authorities there launched a framework back in 2016 for licensing crypto exchanges and businesses.

This is called the BitLicense. According to this legislation, the companies that want to buy, sell, hold or transmit crypto coins will have to obtain the necessary license from the New York State Department of Financial Services.

On the other hand, if you look at the regulatory implications of Wyoming, another state in the United States, you will see that the sellers and developers of crypto coins are exempted from securities laws.

However, for that they will need to meet some particular conditions as set way back in 2018.

However, the overall ruling of the country seems to favor crypto activities and is more liberal in allowing the crypto exchanges and people to get indulged in such activities.

European Union:

Crypto legislation in the European Union is quite a complex subject.

This is because there are a few specific aspects of crypto that are handled by the member nations of the EU while a few specific aspects are typically sorted at the consolidated Union level.

Earlier each country in the European Union regulated cryptocurrencies in their own ways and most of them chose to follow a softer and more liberal regulatory framework.

However, on and from 2020, the EU decided to look into the matter and take it in their hands.

They now have set up a more consolidated regulatory structure on cryptocurrencies.

For example, in September 2020, the European Commission formulated a legislation called the Markets in Crypto Assets Regulation, which is more commonly known as MiCA.

According to this draft of the EU all cryptocurrencies will be considered as a regulated financial instrument just like any other financial instrument.

This includes any form of crypto trading, firm holding, providing investments advice and services as well as offering brokerage service.

All crypto companies now will need to obtain an approval from the regulators before providing any such services to the people.

The most interesting aspect of the draft is that different types of crypto coins and assets are taken into cognizance such as utility tokens, e-money tokens, and asset-based tokens. For each of these tokens there is a separate and unique set of rules proposed by the European Union.

China:

When you look at the regulatory efforts of China in terms of cryptocurrencies, you will see that it is more of a roller-coaster ride.

At first, the Chinese government welcomed all crypto related activities with more emphasis on crypto mining.

In fact, total crypto mining activities in China in September 2019 accounted for nearly 75% of that of the whole world.

However, later on, they maintained a strict stance on the crypto market there and in June 2021 crypto mining was banned in China.

This resulted in a fall in crypto mining operations and output in the world by nearly 40%, according to some reports.

Moreover, the Chinese government held a completely different viewpoint regarding the ICOs or Initial Coin Offerings and it seemed to be their primary bone of contention.

They banned everything related to it in 2017. It also ordered closure of the crypto exchanges.

However, China does not totally discourage the use of blockchain technology and, in fact, encourages the growth of startups related to this specific technology.

Going a step further, it arguably is one of the pioneers to bring out its own official digital fiat cryptocurrency called the digital Yuan.

Add to that, the Chinese government has also started experimenting with several real-world trials of the digital currency that will function much differently in comparison to the standard fiat currency but everything is regulated centrally.

Requirements to Make it Work in a Large Scale

The proposed crypto regulations, at least the major part of them, are pondered by the critics and crypto experts all over the world in fear.

They fear that there will be a perilous speculative bubble which may harm the economy of the entire nation if the crypto commodities topple.

As of now, regulating cryptocurrencies is the responsibility of the SEC that looks into crypto investments, the CTFC that looks after crimes that may affect interstate commerce, and the IRS that looks after the tax implications and compliance considering crypto as an income or capital gains.

The SEC is playing its role quite well and it has not been approving any other futures ETFs or Exchange Traded Funds at this time.

Though there are several applications that are pending with them, they have only approved a Bitcoin futures ETF over the CME and one over the CBOE.

The SEC is also very strict about the ICOs and has stopped one already for conducting deceptive transactions.

Considering the same note, the CTFC also is playing its role quite well. It has subpoenaed some of the major crypto exchanges for disputes regarding their cash reserves.

However, there is no doubt that crypto regulations should be much more comprehensive and consistent.

Moreover, everything should be well coordinated to make it work on a large scale.

For that, it is required to ensure that the regulatory framework provides a level playing field to the participants in the crypto space all over the world but at the same time take care of the risk spectrum.

Crypto critics and experts believe that if the governments across the globe want to make the regulatory measure on crypto work on a large scale, it should typically have three basic elements.

One:

It is needed to ensure that all service providers that offer critical functions related to crypto should be authorized and licensed by a central authority of the country. These activities could be anything such as:

Crypto storage
Crypto trading and transfer
Settlement
Custody of crypto reserves and
Crypto assets.

The rules should be similar to those applicable to any type of financial service provider.

Moreover, the process for authorizing and licensing should be clear and well articulated.

The responsible authorities should also be designated and there should be proper mechanisms for a more comprehensive coordination and all these should be well defined.

Two:

The requirements must be limited to the major use cases related to crypto assets, especially stablecoin. This means that every type of services and products should have a different regulator to oversee the activities. For example:

The products and services related to crypto investments should have similar requirements as that of the securities dealers and brokers and their activities must be administered by the securities regulator.
The products and services related to crypto payments should have similar requirements as that of the bank deposits and their activities must be administered either by the payments supervision authority or the central bank.

However, irrespective of the type of authority approving the crypto products or services initially, all of these overseers are required to coordinate well with each other.

Whether it is the central bank or the banking regulators, everyone should be on the same page so that the different inherent risks of crypto can be addressed properly, quickly, and efficiently even if it arises from diverse and changing uses.

And three:

All responsible authorities must ensure that proper requirements are made clear to the regulated financial institutions and others concerned regarding their engagement with as well as their exposure to crypto.

This means that relevant banking, insurance, securities, and pension regulators all of them ought to specify the liquidity and capital requirements. They must also stipulate the confines on exposure to different types of crypto assets.

Risk assessments and investor suitability factors must also be taken into consideration for ensuring smooth operations.

Especially, when any regulated entity wishes to provide reserve custody services it is required to clarify the risks involved in those functions along with the requirements that will address those particular risks.

One of the most significant, acute, and more immediate risks that the emerging markets and a few developing economies may face due to substitution of fiat currency with crypto assets is cryptoization.

In such situations, the capital flow management mechanisms should be fine-tuned so that it can face such issues properly.

All these are necessary because it is very challenging to apply the regulatory tools and measures as established and as they are desired to function.

These approaches will help in managing the capital flows and at the same time ensure that proper value is conveyed through the new channels, new instruments, and even the new service providers and entities that are not regulated.

In addition to that, more effective cross-border collaboration is also needed along with better coordination and cooperation among the different authorities that impose regulatory measures.

This will help them together to deal with different other aspects and challenges of crypto transactions which include and are not limited to technological, regulatory, legal and supervisory challenges.

And, whatever that is required to be done should be done immediately in order to accomplish the objectives of the policy and to maintain financial stability.

This will eventually benefit the crypto users and all others associated with it due to the underlying technological innovations that the crypto space comes with.

There is no doubt that crypto assets are changing the financial system and the international monetary system fast and quite intensively.

Responding to these changes, the IMF or International Monetary Fund has built a strategy that will help it to deliver on its mandate.

The IMF is working directly with the Financial Stability Board as well as other members of different international regulatory communities in order to build up a much more effective and well-planned regulatory framework for the use of crypto assets.

Conclusion

Some governments have taken a traditional move toward crypto while others have taken the other route. However, there is a need to regulate crypto in the global scale so that it does not have any bad effect while cheering the use of it.

Dominic Mondal

I have special interest in crypto and intend to help common people to gain knowledge about the digital asset as well as its potential. Follow Me at Linkedin.