Beginners Guide To Crypto Regulation – Forbes

There is a common misperception that the digital-assets industry is not regulated. In the U.S. alone, federal agencies and regulators such as the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC) and the Treasury have all issued rules and guidance about how crypto falls under their respective remits. This does not even touch on various state regulators and law-enforcement bodies that have undertaken similar initiatives nor on multiple efforts from financial regulators around the world.

However, crypto regulation has been difficult. This is because digital assets break the mold when it comes to traditional classifications. Ether, the native token to the multipurpose blockchain Ethereum, has or had characteristics of a commodity, currency and a security. Additionally, there are plenty of examples where regulators argue over jurisdiction. At the start of 2023, the SEC and CFTC are at odds regarding whether ether is a security or commodity, which would determine which is the primary regulator. This is an unfortunate consequence of crypto’s novelty because at nearly $1 trillion in total market capitalization, many people’s economic livelihoods are tied to the digital asset ecosystem.

Why Do We Need Regulation?

The cypherpunk ethos revolves around using cryptography to protect people’s privacy and security against governments and corporations. Because crypto was born out of this community, many early entrants have a laissez-faire approach to investing and building in the sector.

Still, this ethos is having to come to terms with the fact that institutions that exist for consumer protection will have a hard time standing by as some take advantage of unwitting investors in what has become a $1 trillion industry. To a great extent, regulators are warranted in stepping in to provide restrictions due to initial coin offering scams, Ponzi-based projects, misrepresentations and faulty token designs that can cost investors billions dollars. The recent string of bankruptcies, highlighted by the collapse of FTX, underscores the need to protect consumers in this volatile industry.

Past Attempts At Regulation

Previous stabs at regulation, or even just classification, demonstrate the complexity of the challenge. Take bitcoin as an example. The asset was defined as a virtual currency and payment system by the U.S. Treasury as early as 2013. It was then considered a commodity under the Commodities Exchange Act by the CFTC in 2014. If that was not confusing enough, it was also classified as property by the Internal Revenue Service for income tax purposes that year. Then, in 2021, an infrastructure bill passed by Congress treated bitcoin as physical cash, mandating reporting of transactions over $10,000 in value.

These multiple classifications put bitcoin holders in a precarious position. Capital gains tax is required when selling bitcoin for a gain due to the property classification, but would a holder have to disclose to the IRS when they tip someone $1 through the Lightning Network? The technical answer is yes, though this contradicts the crypto’s status as money.

Congress has introduced over 50 bills regarding digital asset taxation, classification, regulatory treatment, stablecoins and central bank digital currencies (CBDCs). Prominent examples include the 21st Century Dollar Act (H.R. 3506), the Keep Innovation in America Act (H.R. 6006), and the Blockchain Regulatory Certainty Act (H.R. 5045). In June, two senators, Cynthia Lummis (R-Wyo.) and Senator Kirsten Gillibrand (D-N.Y.), submitted landmark legislation aimed to provide specific solutions to most of crypto’s quagmires, such as differentiating a security token from a digital commodity and providing clear tax policies, called the Responsible Financial Innovation Act of 2022 (RFIA). In addition, Congress held at least 15 hearings focused on cryptocurrency and blockchain policy in 2022. The most active committees were the Senate Banking Committee and House Financial Services Committee.

In fact, in part a reaction to the FTX collapse and reflection of the industry’s potential, the House Financial Services Committee under Chairperson Patrick McHenry (R-N.C.) created the first body dedicated to digital assets. Dubbed the House Subcommittee on Digital Assets, Financial Technology, and Inclusion, it will be led by Representative French Hill (R-Ark). In an exclusive interview with Forbes, Hill said that one of his first priorities is going to be stablecoins, building on what he calls a very “cooperative effort last summer and early fall between House Democrats, House Republicans and the Biden administration, in thinking through the right approach.”

Regarding the White House, on March 9, 2022, President Joe Biden signed the Executive Order on Ensuring Responsible Development of Digital Assets. This became a whole-of-government effort in which the administration sought to define how the U.S. should approach digital assets. The order required multiple cabinet-level departments to conduct investigations into the risks and opportunities of digital assets to their remits.

The hope in the industry is that Congress and the White House will work together on a productive approach to shepherding the way for digital assets. However, when things get dicey and investors get hurt, as in the case with 2022’s myriad bankruptcies, blame can be thrown around. “Washington loves to find a scapegoat,” said former congressman and acting White House Chief of Staff Mick Mulvaney in an interview with Forbes. These comments came on the back of a statement issued by the White House in late January accusing Congress of dropping the ball when it comes to crypto regulation.

What To Expect In 2023

The White House and Congress are largely saying the right things when it comes to setting crypto’s rules of the road. In fact, Hill and Mulvaney agree that even in this divided political climate, crypto is one issue with bipartisan support and interest. However, in the weeks or months before any legislation gets passed the industry is likely to see a continuation in the rise of enforcement actions against key players in the space that regulators feel are not playing by the rules.

In the past few weeks the SEC has issued Wells Notices notifying companies they are under investigation and announced settlements against crypto exchange Kraken (alleging that its ether staking program is a security), New York trust company Paxos (accusing it of issuing a Binance-branded stablecoin that is also a security), and Terraform Labs (the founding company behind the stablecoin terraUSD and its associated governance token luna that collapsed in May 2022). The CFTC has been filing similar suits against actors in the industry and key banking regulators such as the FDIC, Federal Reserve and the Office of the Comptroller of the Currency are cautioning banks under their supervision to avoid too much exposure to crypto, whose volatile nature could lead to rapid and large inflows and outflows of deposits.

The industry would much more prefer a piece of legislation that sets the rules of the road than a mix of executive orders and enforcement actions (which by definition are not precedent-setting as they only apply to the exact circumstances of a case). However, it may be left with reading the tea leaves for a little while longer.