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Why do we need immediate cryptocurrency regulation law?

11 min read
Cryptocurrency Law Insider

By Tanishka Tiwari

Published on: December 03, 2023 at 09:50 IST

Since its inception, cryptocurrency has emerged as a groundbreaking concept, disrupting established banking establishments and offering the potential for decentralized and borderless transactions.

As the inaugural and most renowned cryptocurrency, Bitcoin spearheaded the development of blockchain technology, which forms the fundamental basis of the entire crypto industry. Conversely, the rapid proliferation and utilisation of cryptocurrencies have generated many concerns, prompting demands for prompt regulatory measures.

While proponents advocate for the uninhibited nature of cryptocurrencies, there are compelling justifications for the necessity of regulatory frameworks within the contemporary financial prospect.

Cryptocurrencies are often assumed to operate outside the jurisdiction of national laws; however, their prices, transaction volumes, and user bases all exhibit significant responses to news regarding regulatory actions.

The extent of the impact varies depending on the specific regulatory category to which the news pertains. General prohibitions on cryptocurrencies or their treatment under securities legislation have the most pronounced negative effect, followed by information related to the fight against money laundering and the financing of terrorism, as well as limitations on the interoperability of cryptocurrencies with regulated markets.

The announcement of the establishment of specific legal frameworks tailored to cryptocurrencies and initial coin offerings coincides with substantial market gains.

These findings suggest that cryptocurrency markets rely on regulated financial institutions and are fragmented across different countries, falling under national legislation’s jurisdiction.

The blockchain is best recognised as the technology that underpins virtual cryptocurrencies such as Bitcoin, Litecoin, and Ethereum. Blockchain technology, a public record that monitors all transactions inside the network and is accessible to everyone, is utilised in a decentralised network such as Bitcoin. As a result, everyone on the web can access every account’s balance.

Every transaction is a file containing the sender’s and recipient’s public keys (wallet addresses) and the quantity of coins exchanged. The sender must additionally sign the transaction with their private key. All of this is fundamental cryptography. Finally, the transaction is broadcast across the network but must first be verified.

Cryptocurrencies include purchasing products, investing, mining, and conducting commercial operations. Because of the industry’s rapid expansion, governments and other stakeholders worldwide are paying closer attention.

Cryptocurrencies are getting increasingly popular. Worldwide, law enforcement agencies, tax officials, and legal regulators are attempting to comprehend the notion of cryptocurrencies and where they belong inside existing legislation and legal frameworks.

A plethora of issues will arise as a result of the rising trends in the realm of digital currency. The legal profession should be well prepared for potential challenges and endeavour to anticipate most of them and establish a capacity to address most of them. Legislators must solve legal concerns before the judiciary is swamped with cryptocurrencies-related cases.

Recently, there has been such a rapid rise in the value and popularity of cryptocurrencies that it can no longer be dismissed as a fleeting fad.

Cryptographic or cryptocurrencies have spawned diverse points of view since they have evolved as a digital alternative to more traditional ways of trade, such as cash or credit cards.

On the one hand, a school of thought views cryptocurrencies as a financial medium for fraudsters, terrorists, and criminals, particularly considering their role in ransomware schemes and Dark Web transactions.

On the other hand, recent increases in the value of various cryptocurrencies have established them as a viable investment that can positively impact mainstream investors’ wallets and trading practices worldwide with the help of positive hype surrounding blockchain technology.

According to predictions, cryptocurrency will become a common way for people to pay for products and services over the next decade. However, this depends on public knowledge and willingness to invest in cryptocurrencies.

Cryptocurrency markets are highly volatile, with significant price movements occurring often within short periods. This volatility places investors and consumers at significant financial risk.

In contrast to traditional financial markets, the absence of regulation exposes investors to fraud, market manipulation, and scams.

Due to the lack of strong rules, pump-and-dump scams, fraudulent Initial Coin Offerings (ICOs), and Ponzi schemes have developed. A solid regulatory framework would protect investors and consumers by safeguarding against fraudulent practices.

Cryptocurrencies’ anonymity and decentralised nature have made them appealing to criminals for money laundering, terrorism financing, and other illegal acts.

The anonymity provided by several cryptocurrencies has aided the spread of ransomware attacks, dark web activities, and illegal money transfers.

Implementing cryptocurrency legislation such as Know Your Customer (KYC) and Anti-Money Laundering (AML) standards can assist authorities in tracking and identifying questionable transactions, reducing financial crime.

A lack of governmental control exacerbates the bitcoin market’s inherent volatility. Price manipulation, excessive speculation, and a lack of investor safeguards can all contribute to market disruptions and systemic hazards.

Regulatory action can create market discipline, increase transparency, and discourage manipulation. Setting trading rules, enforcing reporting requirements for exchanges, and establishing investor protection measures can all help to make the bitcoin market more stable and dependable.

Contrary to widespread assumption, a well-crafted regulatory framework may stimulate innovation in the cryptocurrency field.

Clear legislation may give firms and startups legal clarity, encouraging them to invest in blockchain technology and explore creative use cases.

Furthermore, regulation can increase institutional engagement by providing legitimacy and security, which are frequently missing in an uncontrolled environment. This might open the door for cryptocurrencies and blockchain-based solutions to be widely used across sectors.

Because of the need for more transparent laws in cryptocurrency, governments have found it difficult to impose and collect taxes on crypto-related operations.

Regulation would allow governments to tax cryptocurrency transactions, capital gains, and revenue derived by crypto-related enterprises. This can significantly increase government income, assisting in funding public services and infrastructure development.

Cryptocurrencies are global, transcending territorial borders. As a result, legislation established in one country may have cross-border repercussions.

Coordinated efforts across governments to build a unified regulatory framework for cryptocurrencies can make cross-border transactions more seamless and prevent regulatory arbitrage. This partnership would enhance confidence and standardisation in the global cryptocurrency ecosystem.

Determining price is one of many difficulties in the crypto ecosystem: authorities and corporations need help identifying, monitoring, and managing hazards. These include operational and financial integrity issues posed by crypto-asset exchanges and wallets, investor protection, insufficient reserves, and misleading information for some stablecoins.

Furthermore, the arrival of crypto might hasten what we term “cryptoization” in emerging markets and developing economies, when digital assets supplant native currency and avoid exchange controls and capital account management regulations.

Such risks highlight the need for comprehensive international standards that address the risks to the financial system posed by crypto assets, their associated ecosystem, and related transactions while providing an enabling environment for useful crypto asset products and applications.

In its coordinating position, the Financial Stability Board should create a worldwide framework for crypto asset regulation.

The goal should be to provide a comprehensive and coordinated approach to managing risks to financial stability and market conduct that can be applied consistently across jurisdictions while minimising the possibility of regulatory arbitrage or shifting activity to jurisdictions with less stringent requirements.

The cross-sector and cross-border scope of crypto restricts the effectiveness of national responses. Countries are pursuing vastly varied strategies, and existing rules and regulations may preclude national methods encompassing all aspects of these assets.

Many crypto service providers operate across countries, complicating monitoring and enforcement. Uncoordinated regulatory actions may allow potentially destabilising financial flows to occur.

Standard-setting bodies in charge of various goods and markets have offered diverse degrees of direction. For example, the Financial Action Task Force has recommended a risk-based strategy to minimise financial integrity threats posed by virtual assets and their service providers.

Money should be used for three primary purposes:

  • It should be widely recognised as a form of payment: A suitable medium of exchange should make it as easy to exchange things as feasible. As a result, the expenses of conserving the currency must be modest, which means that when the money changes hands, it should stay the same (paper notes, for example, are not well qualified on this point because their physical quality deteriorates when used). It must be simple to carry the money to pay for commodities wherever they are required, which means the commodity must have a high market value relative to its volume and weight. It must be divisible to trade the exact value quantity for the good. Cryptocurrencies perform well as a means of trade. Because they exist solely in digital form, they are, by definition, nonperishable. Cryptocurrencies have a high divisibility and fungibility. Because transactions are conducted over the Internet, there are no transportation charges, as opposed to gold and cash. Finally, because of the technological architecture and usage of encryption, they cannot be counterfeited.
  • It should be a unit of account, allowing us to compare the prices of goods and services across time and among vendors. This indicates that money is the standard for measuring pricing. Currently, the value of cryptocurrencies is very volatile, making them unsuitable as a unit of account.
  • It should be a steady repository of value throughout time. Money must be able to be saved and used at a later date while preserving its worth. The value must stay the same for it to preserve its worth. Because of price swings, cryptocurrencies receive a mediocre rating in this category. Because of these price changes, it does not qualify as a good store of value. However, owing to their digital nature, cryptocurrencies may be preserved well and not die.

Thus, regardless of its legal origin, an item capable of fulfilling all three roles would be considered money from an economic standpoint. Cryptocurrencies, such as Bitcoin, confront a systemic economic challenge.

Only 21 million Bitcoins can be issued, with no further increase permitted until 2140. If such cryptocurrencies are successful and substitute sovereign fiat currencies, the economy will experience deflation since the money supply will not expand with economic development.

Bitcoin and gold have many parallels. First and foremost, both are governed by one government. Second, the quantity of Bitcoin will run out in 2140, indicating that they both have a finite supply, whereas currencies can always be issued by their respective governments. Finally, in terms of volatility, the price of gold swings far more than that of currencies since demand fluctuates against a finite supply, much like cryptocurrencies.

From a legal standpoint, cryptocurrencies meet the legal definition of a commodity under US law.

Furthermore, cryptocurrencies are tangible, even if they are not physical coins in the hands of investors. In light of the preceding, there may be as many classifications as there are uses of Bitcoin.

Government regulators should provide guidelines on exactly how each regulatory framework will apply and co-exist without impeding the promising growth potential of this innovative financial technology.

The financial elements of cryptocurrencies have also piqued the interest of authorities. The legal classification of cryptocurrencies is critical in establishing their tax implications. The primary distinction is whether bitcoin is a commodity (capital asset such as stock), in which case capital gains regulations apply or whether it is a currency.

Cryptocurrency transactions, like any other asset or money, are taxed. Transactions using cryptocurrency may be subject to capital gains, income, transaction, and wealth tax. Even if a Bitcoin transaction is invalid and unlawful, the tax law allows for the taxation of such transactions.

Even though Bitcoin functions as a medium of exchange, a unit of account, and a store of value and operates in some environments like real currency, the Internal Revenue Service in the United States ruled in March 2014 that Bitcoin will be treated as property rather than currency for tax purposes. This means that Bitcoin will be taxed on capital gains.

On a global scale, certain governments have focused on which category Bitcoin should fit under. For example, Canada determined that, in the lack of a legal tender feature, Bitcoin fails the currency test and should thus be classified as a commodity for tax purposes.

In particular, the Canadian Revenue Agency affirmed in January 2014 that when purchasing products or services with Bitcoin, “transactions involving bitcoins should be reported as any other barter transaction.”

Finally, Germany and the United Kingdom have agreed to modify their tax systems based on what is economically sustainable. Indeed, although Bitcoin is not a currency since it has been denationalised, Germany elected to recognise Bitcoin as an equivalent to private money and, as a result, gave it currency taxation.

As a result, cryptocurrencies might be regarded as a means of exchange, a negotiable instrument, a property, or a contract subject. Thus, it may rely on the type of the transaction and the legislative authority to tax such transactions. Property tax, inheritance tax, transaction tax, service tax, value-added tax (VAT), gift tax, wealth tax, capital gain tax, income tax, and many others may be attractive to cryptocurrencies.

The global regulatory framework should ensure a fair playing field across the range of activity and risk. We feel it should include three elements, for example:

  • Critical functions provided by crypto-asset service providers should be licenced or licenced. These would encompass, among other things, the storage, transfer, settlement, and custody of reserves and assets comparable to existing requirements for financial service providers. The licencing and permission requirements should be clearly described, the competent authorities identified, and coordination methods established.
  • The crypto assets and stablecoins requirements should suit critical use cases. For example, investment services and products should be subject to the same regulations as securities brokers and dealers, which the securities regulator monitors. Payment services and products should be subject to the same regulations as bank deposits and should be monitored by the central bank or the payments oversight body. Regardless of who has the first power to approve crypto services and products, all overseers—from central banks to securities and banking regulators—must work together to handle the many dangers of varied and evolving usage.
  • Authorities should impose explicit standards on licenced financial institutions regarding crypto exposure and involvement. For example, the proper banking, securities, insurance, and pension authorities should specify capital and liquidity requirements, as well as restrictions on exposure to various forms of these assets, as well as investor suitability and risk assessments. If the regulated companies provide custodial services, the procedures for dealing with the risks associated with such duties should be defined.

Some emerging markets and developing economies face more immediate and severe currency replacement concerns via crypto assets, a process known as cryptoization. In the face of cryptoisation, capital flow management mechanisms must be fine-tuned.

This is because using conventional regulatory mechanisms to monitor capital flows may be more difficult when value is communicated through non-regulated instruments, channels, and service providers.

Cross-border collaboration and cooperation are urgently needed to meet technical, legal, regulatory, and supervisory concerns. Establishing a comprehensive, uniform, and coordinated regulatory strategy for cryptocurrency is a tremendous endeavour. However, if we begin now, we can fulfill the policy aim of maintaining financial stability while reaping the advantages of underlying technical advancements.

Crypto assets have the potential to alter the global monetary and financial system profoundly. The IMF has devised a plan to continue fulfilling its purpose in the digital era. To create a practical regulatory approach to crypto assets, the Fund will collaborate closely with the Financial Stability Board and other members of the international regulatory community.

In summary, while unregulated and decentralised money appeals to some, the lack of cryptocurrency regulation poses significant risks to investors, consumers, and the larger financial system.

Cryptocurrency regulatory legislation must be implemented immediately to safeguard stakeholders, decrease financial crime, ensure market stability, enhance innovation, ease taxation, and promote global collaboration. To fully fulfil the potential of cryptocurrencies in a secure and long-term manner, a balanced regulatory policy that encourages innovation while protecting against risks is essential.