2019 Cryptocurrency Regulations – A Primer and What to Expect Throughout the Year

Matt Stankiewicz, Senior Counsel at The Volkov Law Group, rejoins us for an interesting posting on 2019 cryptocurrency trends and regulations. Matt can be contacted at mstankiewicz@volkovlaw.com.

You’ve heard this before, but it still holds true – cryptocurrency regulations are coming.  Everyone knows they’re inevitable, and there has been some trepidation amongst investors that regulations will disrupt innovation and just generally cause a mess within the industry.  But make no mistake, they’re on their way whether they’re welcomed or not.  Despite the fast movement of the markets and the technology, law and policy moves at the speed of government and are taking their sweet old time.  The slow pace of regulations only brings more concern and uncertainty within the industry.  With the technology accelerating daily, many expect that laws and regulations will be out-of-date before they’re even able to come into effect. 

However, the lack of urgency may actually bode well for the industry.  It’s very clear that governments have a focus on cryptocurrency: highlighting it in major reports, developing working papers to seek commentary, holding public committee hearings, or listing it as an “examination priority.”  New York is even establishing a Crypto Task Force to better understand it.  Governments and their respective agencies, at both the state and federal levels, are doing their due diligence and gathering information before making their moves. 

Does this mean everything will be rosy? No, of course not. Expecting the council of ancients to fully understand the intricacies and nuances of the blockchain is a fool’s game.  That said, I hold out hope that this extended information gathering session will yield a fair and balanced approach that will protect consumers, foster innovation and evolution, and punish con-men for their malfeasance, despite surely presenting some speed bumps along the way.  With that background, here are the areas where I expect governments to be most active in 2019.

Cryptocurrency Exchanges

The lack of regulation here is actually bad for the consumer.  Fly-by-night exchanges pop up overnight, start taking funds from its users, and then are hacked into oblivion.  It now seems that every month, some exchange is hacked and its users suffer the consequences of lost funds.  It’ll be a long time before the Mt. Gox disaster is forgotten.  An independent report suspects that merely two groups are responsible for hacking over $1 billion out of various exchanges.  Without knowing how those groups operated, it’s impossible to know if regulations would have prevented all of these hacks.  However, it is very likely that certain requirements surely could have helped –cybersecurity controls, minimum insurance requirements, periodic audits, safeguards against market manipulation, and more.  While this certainly increases the entry barriers for new exchanges, it also would prevent any more Bitgrails from popping up.

Before we even see a standardized framework for operation, I would first expect clarity on who is actually overseeing the regulation of cryptocurrency exchanges within the US.  Both the SEC and the CFTC seem to have some authority of certain aspects of exchanges, and both will swoop in for enforcement against egregious operations.  However, both seem to dance around the issue as neither have direct enforcement powers.  At the moment, most exchanges fall under the ambit of money transmitters, which are subject to convoluted state-level frameworks for operation. 

I hope to see Congress step in and place one or the other in charge, or simply create a new agency tasked solely with regulating cryptocurrency.  Due to the unknown federal landscape, many exchanges simply avoid operating in the US until they receive more clarity on regulations.  That means that US consumers, ironically, are unable to access some of the more careful and diligent exchanges.  

Money Laundering and Privacy

I would assume unanimous support for certain themes here.  No one wants organized crime syndicates to launder their funds through cryptocurrency.  No one wants terrorist cells to fund their attacks and murders.  No one wants to see James Bond-esque villains have a means to sow discord and evil throughout the world.  I realize that’s sensationalized, but the dangers are real and no one in the crypto-world wants any of that.  However, the desire to prevent these dangers will lead to the largest battle between regulators and the cryptocurrency industry.  How can that be?

Privacy.  A foundational tenet for crypto-enthusiasts is the overarching concept of privacy. Hence, the cryptographical underpinnings – the desire to create a currency with no central authority, guaranteeing users an anonymous exchange of funds.  Bitcoin itself saw initial growth due to its popularity on Silk Road and the dark web as a way to anonymously purchase illicit goods.  Cryptocurrencies such as Monero are seeing success by offering a stronger level of anonymity than even the mighty Bitcoin can offer.  However, it isn’t difficult to see how this conflicts with current anti-money laundering laws and the desire for governments and law enforcement to be able to “follow the money.”

Crypto-specific regulations in this area are virtually certain in 2019.  A consortium of countries are already planning to abide by the framework in development by the Financial Action Task Force.  This group is planning a June 2019 release of a proposed regulatory plan, and will then be tasked with enforcing it.  Member states who fail to meet specific criteria may be restricted from accessing the global financial system.  Such regulations may endanger privacy coins in the name of anti-terrorism and anti-money laundering.  This also doesn’t even address the tax implications of privacy coins.  The IRS always gets its money, and people attempting to hide or circumvent tax laws through cryptocurrency will only cause the agency to strengthen its resolve.

That said, technology always seems to be one step ahead.  It remains to be seen whether the US Government could even stop these privacy coins if they wanted to.  Without having the ability to identify parties on either side of the transaction, it’s difficult to prosecute anyone who would hold such coins.  The primary target of enforcement would likely be against the exchanges or other services facilitating their transfer.  Again, expect this to be an area of focus in 2019.

ICOs

Let’s all agree to never have another Bitconnect again.  The memes are great and all, but it’s just not worth the black eye it leaves on the industry.  While most know the story behind the company, for those that don’t, Bitconnect was an obvious scam from the start.  The company promised guaranteed returns (hello Ponzi scheme) and used an actual picture of a pyramid to describe its referral program in its official investor presentation.  And yet it had a nearly $3 billion market cap at its peak.  Yes, billion.  It has unsurprisingly tanked to near oblivion, and a lot of people lost their money.

I believe governments will seek to allow ICOs to operate in some form.  The positive fundraising elements are too important and too useful to ignore.  However, many of the securities regulations in place – the ones that ICOs are currently attempting to circumvent – are ultimately in place to protect unwitting consumers from themselves.  We saw those results during the last bull rush.  Investors in crypto were throwing money at hype without any regards to the underlying product.  Coins without an actual working blockchain, with nothing but a mediocre white paper and a team of “advisors” that may or may not have had anything to do with the product in the first place, were raising hundreds of millions of dollars within days. 

That said, the hope is that regulations don’t swing the pendulum too far to the other side.  Right now, that current “accredited investors” standard would bar most current crypto investors from partaking in an ICO.  Eliminating that demographic from the ICO investor pool would certainly harm the growth of crypto.  I also expect companies to embrace securities regulations and we see the highly predicted rise of security tokens and their related offerings.

Conclusions

2019 will certainly be a defining year for cryptocurrency regulations.  Countries such as Malta and Switzerland have embraced the technology, developed pro-crypto regulatory frameworks, and have reaped the rewards.  Various countries around the world are now beginning to follow suit – the United Kingdom, India, and even Iran.  Let’s hope the US follows suit with a balanced approach that fosters more industry growth.

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