The Evolving Cryptocurrency Regulatory Landscape

The U.S. regulatory environment for cryptocurrencies and digital assets has been largely unclear due to a lack of definitive regulations, classifications or guidelines by the SEC or IRS. However, recent developments are beginning to indicate what the future of the regulatory landscape might look like.

Regulatory questions persist following ambiguous statements by the SEC on how to classify cryptocurrencies and the confusion over the operational status of exchanges at the state and federal levels. Comparatively, more defined regulatory frameworks are emerging in countries like Malta that are becoming known as blockchain safe havens. The success of these initiatives is clearly demonstrated with the influx of blockchain, crypto, and digital asset companies descending on Malta.

All of this has led to a growing sentiment that investment in blockchain technology and the subsequent innovation that follows will leave the U.S. if the regulatory uncertainty continues. While clarity has been lacking with both the SEC and IRS, recent developments are potentially revealing of how the evolving regulatory landscape might play out.

A History of Developments

Following a series of Bitcoin ETF rejections by the SEC in August — citing lack of exposure, liquidity, and investor protections — it seemed unlikely that there would be any decisive regulatory action in the U.S. until early 2019. Since then, there has been a spate of relevant news directly tied to legal considerations of cryptocurrencies, exchanges, and institutional financial involvement in the space.

The recent report from the New York Office of the Attorney General (OAG) in mid-September highlighted concerns about potential manipulation of U.S. cryptocurrency exchanges due to a lack of market surveillance capacities. It also uncovered information regarding the extent of self-trading on several platforms, including Coinbase:

“Coinbase disclosed that almost 20 percent of executed volume on its platform was attributable to its own trading.”

Notably, the report — the Virtual Markets Integrity Initiative Report — initially set out to seek voluntary participation from 13 different exchanges, some of them not even based in the U.S. However, Binance and other exchanges — including U.S.-based Kraken — refused to participate, with Kraken heavily criticizing the report and the NYOAG’s actions in general.

This is important because it represents an initiative by a state government to reel in virtual currency exchanges under the premise of the exchanges potentially operating under their jurisdiction. This mirrors similar behavior by the U.S. Federal Government going after crypto companies and exchanges which it deems under its authority despite the entities existing outside of the country. Stated by Galiano Tiramani, CEO of the OTC Trading Desk TirexTrading:

“The bottom line when it comes to the US government is that no one is out of their reach. Even if your business is overseas, if you serve US customers, even by accident, the US gov will reach across the world and crush you. A great example of this is BTCe, the government painted their ‘no KYC policy’ as a tailor-made service for criminals, and proceeded to take all users’ funds and shut down the site.”

While this type of extensible activity has popped up with U.S. regulators’ subpoena to Bitfinex and Tether, it is not indicative of any domestic clarity, which has become frustrating for many investors and community participants. Galiano continues:

“One aspect that’s unfortunate about how regulation is rolled out in the USA is that the government waits until it sees it something it doesn’t like, prosecutes, then rules are changed accordingly. Everyone would be better off if clear rules were established at the beginning instead of handing down harsh sentences for violating grey areas.”

The dilemma at hand with the regulatory environment in the U.S. is how to deal with a novel technology and its accompanying class of assets in a prudent regulatory manner without compromising innovation or growth. The dilemma has stifled action by the SEC or IRS, with even congressional lawmakers penning an open letter to the IRS to elucidate its position on virtual currencies.

Building Momentum to Clarity

More recently, there has been more decisive action at the federal level stemming from the judicial branch. Federal Judge Rya Zobel ruled last week that virtual currencies are commodities, citing 3 previously related cases as a precedent for their classification as commodities. The motion was confirmed by CFTC Chairman Chris Giancarlo, as commodities fall under the CFTC’s jurisdiction to prosecute fraud involving virtual currencies. He even elaborated on the enforcement actions taken in the last year alone.

Further, the SEC seems more open to a potential Bitcoin ETF, with a recent request for further comment on the previous 9 rejected Bitcoin ETF proposals, signaling a more discerning approach than before. Panelists at a recent CFTC meeting even pushed for increased self-regulation in cryptocurrencies, marking a tempered approach to regulation that should alleviate concerns of over-regulation.

Other relevant developments come in the form of the looming entrance of institutional finance into the cryptocurrency space. Gemini — the Winklevoss twin exchange and digital asset custodian — just secured insurance for its custodial assets, as orchestrated by Aon. This is a significant step towards providing assurances for institutional investors as custodial coverage is ubiquitous in traditional finance but largely absent in crypto.

Similarly, Coinbase recently brought on Chris Dodds — a sitting Charles Schwab board member — as a Coinbase board member as part of a broader initiative to attract the favor of legacy finance and regulators. Gemini also brought on former NYSE Chief Information Officer Robert Cornish as part of a comparable effort. Gemini also recently released their regulated stablecoin called Gemini Dollars, the first regulated stablecoin, which is under the oversight of the New York Department of Financial Services. The NYDFS is the same department that created the controversial BitLicense, perhaps revealing a softened stance on cryptocurrencies.

Circle — the crypto investing, payment, and trading app — who recently acquired U.S. cryptocurrency exchange Poloniex, is planning on acquiring company SeedInvest. The move is mainly seen as an attempt to work closely with the government to allow startups to raise funds by selling digital tokens via its platform.

Outside of the positive implications of crypto-focused companies working more closely with regulators, Gemini and Coinbase’s recent activities and targeted initiatives towards legacy financial institutions also have profound consequences. The impending entrance of institutional money into digital assets is more of a question of when than if at this point. The gears are in motion, and milestones like custodial insurance are considerable steps in the right direction.

This is vital to gauging the evolving regulatory landscape because institutional investment entering crypto should bring with it a more friendly regulatory approach by the government. If institutions were to reject crypto and digital assets outright, the regulatory picture would be drastically different. The notion that the money will enter once the right frameworks and protections are in place is well-founded, and cooperation between digital asset exchanges, regulators, and institutions is clearly improving.

Since their inception, cryptocurrencies have come a long way in recognized legitimacy in the eyes of regulators, the public, and institutions. While decisive clarity on the current regulatory environment of crypto in the U.S. is undoubtedly missing, there are numerous indications that it will change soon, and with a positive spin.

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