Written by: Jose Molinelli, Legislative Intern
Cryptocurrencies and digital assets have been a cause of growing fascination and concern since the emergence of large scale cryptocurrency markets in 2010. The lucrative yet volatile nature of cryptocurrencies have made trading them both an attractive and risky business; however, its growing adoption in commerce and government has led to an international patchwork of regulations targeting digital assets in various ways.
A cryptocurrency is a digital currency which cannot be counterfeited or twice-spent, and are often decentralized on a distributed digital ledger called a blockchain. This allows for transparent and evidenced-based information sharing within a business network. According to crypto researcher Jan Lansky, cryptocurrencies embody six key conditions: (1) it must be independent from a central authority; (2) its content and origins can’t be revised in the blockchain; (3) it can’t be duplicated; (4) it holds proof of ownership; (5) it is digitally transferable; and (6) it uses function prioritization, which allows the asset to rank operations in order of importance or urgency.
Cryptocurrencies being traded across a decentralized network of computers allow for cheaper and more expedited money transfers, and can facilitate a wider array of consumer choice. However, they are often highly volatile and consume much energy to mine. Moreover, its encrypted nature makes it an attractive tool for criminals aiming to conceal illicit financial transactions.
Digital Assets Through the Years
The concept of intangible assets dates back to the earliest days of credit and markets, but virtual currencies as we understand them today would not come to be until the invention of e-coins in 1983. This eventually morphed into the contemporary payment software which could move virtual cash in markets through a series of encrypted transactions. In 1998, Bitgold was developed for electronic currency systems which enabled currency trading and mining by means of a user-based proof of work function, which is a process where one party uses publicly available information to generate a unique sequence of numbers to guarantee to the world that a particular token has been expended for value, thereby lending to the currency’s legitimacy. Today, popular cryptocurrencies such as Bitcoin, Namecoin, and Peercoin amongst others have dominated the crypto market, albeit with drastic volatility.
Regulating Crypto in America
In the United States, cryptocurrency trading is taxed in relation to the market gains associated with such transactions. However, U.S. policymakers and regulators have taken various steps to rein in cryptocurrencies.
In November 2021, Congress passed, and President Biden signed the bipartisan Infrastructure Investment & Jobs Act, which includes certain reporting requirements for cryptocurrency trades by brokers in their annual tax reports (congressional ethics guidelines also generally require members to disclose their crypto asset holdings). Meanwhile, Sens. Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) continue to advance a bipartisan digital asset framework that primarily would define when a digital asset is a security or a commodity, and would establish stablecoin consumer protection rules, in addition to commissioning several studies on digital assets’ energy consumption and tax implications.
On the enforcement side, most U.S. regulations are applied to the gains associated with cryptocurrency exchanges in addition to virtual currencies deemed as commodities. In March 2022, President Joe Biden signed an executive order aiming to crack down on money laundering and other illicit uses of cryptocurrency. In that same year, the Treasury Department issued its first sanction against a virtual currency firm with supposed ties to North Korea. The Internal Revenue Service has stated that cryptocurrencies are a medium of exchange that must register as a money service business, but are nevertheless not legal tender within the U.S. currency system. The Securities and Exchange Commission (SEC) has had mixed success in getting crypto firms to register with the agency and has launched legal challenges against some firms for failing to do so.
At the state level, many government agencies have warned consumers about the risks associated with cryptocurrency trading. Recently, Michigan’s Attorney General issued a warning on the dangers of cryptocurrency and bitcoin scams, warning citizens on the prevalence fraudsters throughout virtual currency markets. The Vermont Department of Financial Regulation also issued an investor alert of crypto frauds, warning users to remain alert to ransomware. The Ohio Department of the Aging similarly warned older Ohioans and their caregivers to be on alert for scams of which they can be a favored target. However, these warning have not been translated into state legislation.
Regulating Crypto Around the World
Foreign governments have also taken a crack at addressing cryptocurrencies. In 2021, El Salvador made history as the first country to accept Bitcoin as legal tender, followed by Cuba. The Commonwealth of the Bahamas has even issued its own digital asset called the Sand Dollar which is issued by its central bank and is tied to the value of the Bahamian dollar. However, countries such as China have gone the other way in issuing a complete prohibition of the cryptocurrency.
In the European Union, cryptocurrencies were initially labeled as commodities, but their evident transactional value led to this year’s passage of the Market in Crypto-Assets rules (MICA) which requires cryptocurrency firms to register in the E.U. The E.U. also passed an anti-money laundering law to crack down on virtual currency financial crimes. These laws follow the release of a study commissioned by the E.U. parliament suggesting that legislation should be passed to treat all cryptocurrencies as transferable securities by default.
The varying regulatory approaches to cryptocurrencies signal an ongoing battle to reach consensus about its adoption. While some countries have shunned them for fear of their volatility, energy consumption, and embrace by money launderers, others have relied on it as a tool for decentralization and transactional efficiency. Countries also differ on whether to treat these assets as commodities or securities.
Ultimately, cryptocurrency’s adoption in financial markets will be driven largely by their level of ownership and both government and industry tolerance of associated risks.