On March 7, 2023, Federal Reserve Chairman Jerome Powell said that the crypto space “needs to be monitored closely because it is full of turmoil—but not at the cost of stifling innovation in the world's biggest economy.”
His statement sums up the current dilemma for regulators and cryptocurrency advocates.
- "Someone" needs to be monitoring the space, said the head of the Fed, the regulatory agency charged with "monitoring financial system risks and engaging at home and abroad to help ensure the system supports a healthy economy for US households, communities, and businesses."
- Second, although crypto-literacy is improving, the space is still poorly understood by most people. This is challenging for crypto advocates because it means the politicians charged with crypto regulation may not fully understand it. Even if they do, their constituents, who have been watching years of headlines about crypto fraud and failure, may not trust cryptocurrency. As crypto regulation moves onto Congress’ plate, the crypto industry has to factor in politics and posturing.
- Third, cryptocurrency is a source of unprecedented innovation in the financial sector. The US government wants to retain that leadership, yet it is also charged with maintaining the stability of our fiat currency, not to mention the primacy of the USD as the world’s global standard for currency reserves. Bitcoin, fully unleashed, could topple the USD’s already shaky status. How can the government curb and encourage innovation at the same time?
In some countries, bitcoin provides financial inclusion and access to capital for people outside the traditional financial (TradFi) system. In developed economies like the US, many investors seized on bitcoin and cryptocurrencies not for an alternative payment system but as a speculative asset. Criminal groups and other dubious types pounced on cryptocurrency for money laundering and black market activities.
As financial crimes, scams, and market caps ballooned, crypto finally began to attract regulatory attention. The US Congress has taken a piecemeal approach to crypto regulation, leaving it to the SEC, IRS, other agencies, and individual states to decide how to regulate a new form of money that threatens TradFi and could potentially rival the US dollar.
A complete breakdown of a crypto crystal ball divination could fill a book. In this post, we offer an overview and take a closer look at some hot-button topics. Cryptocurrency regulation is evolving in real time. Companies, investors, and stakeholders should always check with qualified legal counsel for the most up-to-date information.
The Crypto Industry POV on Regulation
In a perfect world, crypto industry advocates propose the following as a reasonable framework for crypto regulation:
- Improve oversight of stablecoin reserves
- Separate trading and custody
- Require digital-asset exchanges to be 100% digital
- Regulate digital-asset exchanges' use of omnibus wallets
- Define securities for the digital era
One major problem with a logical list occurred when the crypto, TradFi, and political worlds collided big time with the FTX implosion.
Challenges for the Future of US Cryptocurrency Regulations
Today we are seeing calls from related agencies and leadership, from President Biden on down, to pass the buck (or should we say bitcoin?) on US crypto regulation back to where it should have started in the first place: Congress.
Crypto advocates claim that the lack of congressional action on crypto regulation has contributed to the scale of the current problems.
Enter FTX. Prior to its spectacular collapse, FTX had spent a lot of time and money cultivating legislators. In some ways, FTX became a proxy on the Hill for the broader crypto issue. As of January 2023, one-third of the congressional membership had accepted donations from FTX.
The FTX collapse embarrassed many members of Congress and eroded their trust in crypto executives and stakeholders. While FTX’s downfall isn't the only reason Congress struggles with a coherent approach to crypto regulation, it certainly did not help.
Another challenge is that crypto has grown into a dragon with several heads – there isn't a one-size-fits-all solution. Some coins are a form of digital money, yet people also use them as an investment vehicle. NFTs (crypto tokens used to identify unique digital assets) exploded on the scene in 2021. When all of the above intersects with fiat, we have taxable events on our hands.
Broadly speaking, in US TradFi, the Fed and banks deal with money. The SEC deals with securities and investments. The IRS deals with taxes. No one had dealt with NFTs because almost no one had heard of them until 2021.
In Dec 2022, the Financial Stability Oversight Council (FSOC) – which includes Treasury Secretary Janet Yellen, Federal Reserve Chair Jerome Powell, and the heads of several other regulatory agencies, said once again that only Congress could give the agencies the powers they need to establish a set of rules that covers the entire crypto industry.
Likely areas of upcoming and future regulation include:
- Bank custody of crypto assets
- Stablecoin issuance and regulation
- Rules for holding crypto as a balance sheet
- Crypto asset sales by banks and financial service companies
- Crypto as collateral for bank loans
- Closing the wash sales tax loophole for cryptocurrency
- New accounting and disclosure requirements from the SEC
- A myriad of state legislative proposals
Let's look at three high-profile areas that will affect the future of cryptocurrency regulation - the SEC, Stablecoins, and the CBDC.
Upping the Ante: The SEC and Crypto Regulation
The SEC has had a controversial relationship with crypto regulation from the beginning. Crypto advocates claim SEC Chairman Gary Gensler (Democrat) is unfairly targeting the industry. They feel that instead of issuing clear rules, he is using litigation and a series of high-profile enforcement actions to expand SEC powers, and as a vehicle for personal advancement.
For his part, Chairman Gensler says that securities law is already clear, cryptocurrencies are not special snowflakes, they are securities, and the litigation is a result of most crypto firms’ refusal to comply.
Healthy tension exists among the SEC commissioners. Republicans Mark Uyeda and Hester Peirce have disagreed with Chairman Gensler and advocate for curbing what they perceive as government overreach, especially with cryptocurrency.
Whatever his motivation, the Chairman seems to have the administration's ear, with President Biden supporting a $2.4 billion funding requisition for the agency.
Gensler says the funding will allow the agency to double its headcount and to investigate misconduct on a larger scale, which will be a balm for the bruised egos in Congress and a major migraine for the crypto industry.
Action on Stablecoins Sooner Rather Than Later
After TerraUSD's May 2022 collapse, Treasury Secretary Janet Yellen, who had previously warned about stablecoins' fragmented oversight, said it was "highly appropriate" to pass legislation addressing stablecoins and the need for “a consistent federal framework."
In April 2022, Pat Toomey (R-Pa) introduced the Stablecoin TRUST Act, allowing the Federal Reserve to license stablecoin issuers. The bill was updated in Dec. 2022, clarifying reserves and who could issue stablecoins.
To understand the actions behind the rhetoric and posturing, stakeholders should be asking themselves about cryptocurrency (in general), and specifically, about stablecoins - how would privately issued stablecoins affect the USD position?
Do stablecoins open up new markets or are they privately owned competition for the USD? Does it serve the best interest of the US economy to enable large sectors of the marketplace to use privately issued stablecoins (or any crypto) for fiat instead of the USD?
Some industry insiders believe that Congress will take action on stablecoin legislation this year because it is easier to address a narrow scope of the sector rather than trying to regulate the entire sector all at once.
As the idea of stablecoins begins to circulate more widely, we can also expect to see more questions about a central bank digital currency.
Central Bank Digital Currency is the Long Game
In a March 2022 Executive Order dealing with cryptocurrencies, President Biden directed the Federal Reserve to continue researching the creation of a US Central Bank Digital Currency, or CBDC.
Some experts believe CBDCs could smooth volatility and inject trust in cryptocurrencies, providing a secure, efficient, inclusive, and liquid form of central bank money. Advocates say CBDCs could stabilize the digital currency sector as a whole, clearing the way for other cryptocurrencies to integrate into payment and settlement systems.
CBDCs are not a risk-free solution. For example, they represent a potential gateway to state surveillance and social control. Advocates of stablecoins also worry that a CBDC would be too strong a competitor for stablecoins, undermining the adoption of regulated, private stablecoins.
Developing and implementing a successful CBDC is incredibly complex. While President Biden has directed the Fed to continue further research, the odds are slim that the Fed will implement a CBDC in the near future.
So what has the Fed been up to in the face of crypto competition?
The Fed is moving to co-opt some of cryptocurrencies’ benefits for the USD. For example, the agency is launching its FedNow service in July to "facilitate nationwide reach of instant payment services by financial institutions — regardless of size or geographic location — around the clock, every day of the year."
From a broader perspective, the FedNow service raises an important question for people trying to divine cryptocurrency's future.
As we move toward mainstream adoption of digital currency, if central banks and TradFi institutions can adapt fiat to provide the inclusion, speed, convenience and cost savings of crypto, without the risk, does the general public care enough about decentralization for cryptocurrency to survive?
For now, if you trade cryptocurrencies or other crypto assets, ZenLedger can help you keep everything organized for tax time. You can automatically aggregate transactions across exchanges and wallets, compute your capital gain or loss, and auto-populate the IRS forms you need.
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax or other advice specific to your particular situation.