Balancing act: A report into the future of US crypto regulation
The need for new laws governing crypto is gaining support, amid confusion and uncertainty
- Stablecoins: Too big to fail?
- No clear party lines
- State of confusion
- The future of crypto tax regulation
- US crypto regulation: round-up
While digital asset innovation continues at breakneck speed, the debate surrounding the future of crypto regulation in the United States continues. Should consumer protection outweigh entrepreneurial freedom? What should be done about stablecoins? Are the regulators equipped with sufficient understanding of the underlying technology?
At the recent CryptoCompare Digital Asset Summit, held in London, Kathy Kraninger, vice-president of regulatory affairs at the New York-based crypto-intelligence firm Soldius Labs, sought to put an end to the “Wild West” narrative plaguing the industry. Spurred by the mass adoption of digital assets around the world, Kraninger painted a picture of regulators scrambling to make heads and tails of blockchain technology, and implementing regulations accordingly.
So what does the future holds for US crypto regulation?
Stablecoins: Too big to fail?
Ever since Tether attracted scrutiny from the Securities and Exchange Commission (SEC) over its ambiguous custodial practices and suspicious business relationship with the Bitfinex exchange in 2021, the $180bn stablecoin sector has found itself front and centre of the US cryptocurrency regulation debate.
With stablecoins playing such an integral role in the decentralised finance (DeFi) due to their (usually) non-volatile nature, some analysts believe that separate regulatory guidance will be needed to keep the sector in good health. Particularly at the Federal level, firm regulatory guidelines are needed, “rather than leaving prudential concerns to inconsistent state approaches applied to money-transmitter businesses,” according to Carol Goforth, a professor at the University of Arkansas School of Law and author of Regulation of Cryptotransactions.
Sections of the US government seem to be in agreement, to some extent. In April 2022, Republican senator Patrick Toomey proposed the Stablecoin Transparency of Reserves and Uniform Safe Transactions Act of 2022 (TRUST Act for short), a three-pronged approach to consolidating different agencies’ approach to stablecoin issuers. The proposal came after a convention in July 2021 by the President’s Working Group on Financial Markets to discuss this very issue.
Concurrently, the Stablecoin Transparency Act proposed by Republican politicians Representative Trey Hollingworth and Senator Bill Hagerty has, as the name suggests, transparency and disclosure requirements in its crosshairs. Introduced to the senate on 31 March, the bill seeks to “establish reporting requirements for issuers of fiat currency-backed stablecoins”. If passed, the bill will have a significant impact on stablecoin issuers who, surprisingly, are not currently required under law to disclose attestation reports proving the quality of their reserves, even after the furore surrounding Tether.
While many are welcoming these efforts to clarify the regulatory framework surrounding stablecoins, the fast-paced nature of the sector will undoubtedly throw up significant stumbling blocks. For instance, it is unclear if politicians understand the difference between fiat-backed stablecoins and algorithmic stablecoins such as the $18bn TerraUSD (UST) coin, which by their very nature are not backed by any real-world assets.
Neither the TRUST Act nor the Stablecoin Transparency Act mention algorithmic stablecoins in their proposals, leaving uncertainty over how these uncollateralised entities could comply with any future disclosure requirements. Though given the recent $182m attack on the Beanstalk algorithmic stablecoin, lawmakers will likely be shifting their attention. But the question remains: now do you regulate a self-adjusting stablecoin operated by a computer program rather than a centralised body?
Regardless, it seems inevitable that stablecoins will continue to be a focal point in the future of US cryptocurrency regulation.
No clear party lines
With Republican-led proposals on one side and President Joe Biden’s working group and executive orders on the other, the importance of clear US crypto regulation is clearly being felt on both sides of the US political scene, albeit from different perspectives.
Gabriella Kusz, chief executive of the US-based Global Digital Asset and Cryptocurrency Association, sees a higher impetus among Democratic politicians “to support the industry from a perspective of offering greater financial inclusion, access to finance and opportunity for traditionally underbanked or unbanked populations.”
On the other hand, Kusz believes that Republican politicians have a “greater degree of alignment and understanding of the power of cryptocurrency to stimulate needed domestic industry innovation, job creation and economic growth.”
However, Goforth believes that Democrats and Republicans are both “as concerned that we not drive the technology away or lose our role as innovators in this space.”
The likely point of contention in future debates surrounding US crypto laws will be in balancing the need for industry innovation with consumer protections. If and when this balance between economic and societal factors is achieved, the US as whole will be in an enviable position, Kusz said: “It wins in terms of national security and global positioning, it wins in terms of domestic industry development and job creation, and it wins in terms of social outcomes that benefit those most in need.”
State of confusion
One problem is what Goforth described as “an ever-growing number of agencies and regulators expressing interest/concern over crypto”, listing a head-spinning smorgasbord of acronyms including FinCEN (Financial Crimes Enforcement Network); the SEC (Securities and Exchange Commission); the CFTC (Commodity Futures Trading Commission); the IRS (Inland Revenue Service); the CFPB (Consumer Financial Protection Bureau); the FTC (Federal Trade Commission); the OCC (Office of the Comptroller of the Currency); FDIC (Federal Deposit Insurance Corporation); the DoJ (Department of Justice); the Secretary of the Treasury; and finally OFAC (Office of Foreign Assets Control).
The point is abundantly clear. With so many agencies with disparate opinions and concerns all attempting to assert jurisdiction, “we have nothing like a consistent or scheduled approach to crypto regulation,” Goforth said.
For its part, the US government recognises this and looks to be taking steps to consolidate and clarify US crypto laws. On 9 March, President Biden filed the Executive Order on Ensuring Responsible Development of Digital Assets. The order has given key agencies and regulators between six and 10 months to report key findings on national security, consumer and investor protection, financial inclusion, illicit financial practices, and technological and economic competitiveness, among other hot-button issues.
The outcomes of these findings are anyone’s guess, but stakeholders can at least agree on one thing. Just as underregulation will continue to favour illicit actors and fraudsters in the crypto sector, “overregulation will backfire as well,” according to Julius de Kempenaer, senior technical analyst at StockCharts.com. De Kempenaer said: “Just like any financial market, the amount of regulation is walking a fine line between protecting market participants on one hand and allowing them to trade freely on the other."
Hardly a controversial viewpoint, but as is increasingly common among Western democracies, these bipartisan measures are seeing resistance from a vocal minority. Some representatives believe public safety should take a backseat to facilitating technology and entrepreneurship in the sector, according to Goforth. And they are coming “armed with analytical data suggesting that fraud as a percent of all crypto transactions is at an all-time low".
But this neoloberal viewpoint is not without a bit of merit. Some, including Goforth, fear that an overregulated cryptocurrency sector will push the technology “to jurisdictions where we have no control and no influence”. On the flipside, “crypto is so inherently global that the US cannot keep acting on its own,” Goforth said.
Some are wary of broad-stroke regulatory changes that are “not tailored to the nuances of the technological innovations it seeks to address,” according to Darren Sandler, lead counsel of the Republic Crypto advisory arm. Sandler contended that “there is an undeniable new paradigm that has obviated the need for laws that were enacted to regulate obsolete middlemen. Attempting to squeeze crypto into the existing frameworks without amendments will not solve the problem.”
The future of crypto tax regulation
Legislators and regulators are similarly locking horns in regards to crypto tax laws in the United States. While the IRS firmly believes that digital assets should remain classified as income, the SEC is pushing to reclassify them as securities. Such a move would significantly alter the crypto tax landscape.
Clarity around the subject is a pressing topic for US regulators, and one that stakeholders are keenly following. But according to Mark Kobal, head of investor relations at the Rockaway Blockchain Fund, “rather than producing proactive guidance, the SEC seems content with setting a precedent through enforcement actions.”
Ripple Labs, developer of the $30bn-plus XRP cryptocurrency, is bearing the brunt of the SEC’s hawkish attitude in a prolonged legal battle launched by the commission in December 2020. The commission contends that Ripple Labs raised $1.3bn in 2013 “through an unregistered, ongoing digital asset securities offering”
The hearings, which have been pushed back to 2023, could have dramatic consequences for the classification of digital assets and their tax status.
Stakeholders are also eager to simplify tax-reporting requirements, which are currently opaque and unevenly enforced. They might get their wish. Starting from 2023, President Biden’s Infrastructure Investment and Jobs Act will require all centralised exchanges to adopt know-your-customer (KYC) measures. Exchanges will also be required to report tax-related user information to the IRS.
US crypto regulation: round-up
Although more robust US crypto regulations have cross-party support, politicians and representatives on both sides of the bench have conflicting opinions on how to clarify and streamline the current system. Will the future of US crypto laws lean towards consumer protection or free-market fundamentalism? Furthermore, do the politicians have a sufficient grasp on the technology to make informed decisions?
Without a crystal ball, there is no way of knowing, but what is clear among stakeholders is that a balancing act is essential for the US to remain at the forefront of this developing, changing technological revolution.
Perhaps the key to sustainable progress is listening to the stakeholders with the greatest understanding of this burgeoning sector. Or, as Sandler bluntly put it: “Listen to the smallest voices, the perspectives of those who are closest to the technology on the ground – and abandon partisan ideology."
A vast array of regulatory bodies continue to fight for jurisdiction over US regulation on cryptocurrency, leading to substantial confusion for stakeholders. Currently, digital assets fall under the classification of income and are regulated as such (to an extent). However, the SEC continues to fight to reclassify digital assets as securities, bringing large-scale enforcement actions against major enterprises including Ripple Labs. Both the Biden administration and Republican politicians are working to clarify the murky regulatory status of digital assets, albeit from different perspectives.
A long list of regulatory bodies are attempting to assert jurisdiction over the US cryptocurrency sector. FinCEn, the IRS, the CFTC and the SEC are the main bodies with authority over the crypto sector, although executive orders issued by the Biden administration will likely have an effect on the regulatory landscape.
Yes, government bodies often work with forensic blockchain analysts to trace and blacklist illicit cryptocurrency transactions. While “tumblers” and privacy coins such as Monero can obfuscate transactions, they have not proved to be foolproof.