The Rising Tide of Cryptocurrency Regulation in the United States
Around the world, the advent of cryptocurrency and blockchain technology has been met with both enthusiasm and derision. Where some countries have fully adopted Bitcoin as legal tender,[1] others have banned the use of cryptocurrency outright.[2] The vast majority of states, however, are somewhere in the middle – slowly implementing laws to permit its use, yet not fully accepting it as a traditional fiat currency.[3] The United States is currently in this middle ground. This blog post seeks to give an overview of the current state of cryptocurrency regulations within the United States and highlight two areas at the forefront of the regulatory conversation.
Legislation
Thus far, cryptocurrency regulation in the United States has been a disjointed, ad-hoc endeavor. Federal agencies and state governments have issued individual and at times conflicting regulations without the aid of centralized direction.[4] Recognizing the need for uniform federal guidance, members of Congress from both sides of the aisle have introduced eighteen bills over the course of this legislative year in an attempt to regulate different aspects of the cryptocurrency space.[5]
Most notably, H.R. 3684 (also known as the Infrastructure Investment and Jobs Act), which was recently signed into law, contains a significant provision dedicated to cryptocurrency.[6] The provision in question, Section 80603, is primarily focused on regulating the trading of cryptocurrencies, or as Congress defines them, digital assets.[7] More specifically, the bill broadens the language of Section 6045(c)(1) of the Internal Revenue Code to classify digital asset exchanges (i.e. entities that facilitate the trading of cryptocurrencies or digital assets between buyers and sellers) as traditional brokers.[8] This classification will require digital asset exchanges like Coinbase and Gemini to provide more information about their users’ personal information and trading history for tax purposes.[9] Greater disclosure will enable the IRS to clamp down on tax evasion and other illegal activity.[10]
The next most significant bill in the legislative pipeline is H.R. 1602, also known as the Eliminate Barriers to Innovation Act of 2021, which has passed the House.[11] Introduced by Rep. Patrick McHenry of North Carolina, Section 2 of this bill requires that the SEC and CFTC establish a working group to publish a report on the impact of regulation on digital assets and provide recommendations to improve the fairness and integrity of the digital asset market.[12]
The remaining sixteen bills focus on a range of issues from consumer protection regulations to determining whether the United States should develop its own national cryptocurrency.[13] These bills, however, have made little progress in Congress and have yet to be voted on in either the House or Senate.[footnote]Id.[/footnote].
Regulation
In addition to these pieces of potential legislation, the federal government has been particularly interested in two cryptocurrency related assets: cryptocurrency ETFs and stablecoins.[14]
Lets begin with cryptocurrency ETF’s. An ETF, or exchange-traded fund, is a type of security that tracks an index, sector, commodity, or other asset.[15] For years, the SEC rejected the trading of cryptocurrency ETF’s.[16] However, in October 2021, the SEC changed its position by tacitly approving the trading of futures-based ETF’s, while still maintaining its ban on physical ETF’s.[17] The distinction between the two is slight but important. A physical ETF holds the underlying asset or security upon which it is based, in other words a physical Bitcoin ETF would hold Bitcoin; whereas a futures-based ETF tracks futures contracts of the asset without taking direct ownership, thus a futures-based Bitcoin ETF tracks futures contracts of Bitcoin.[18] The decision to permit futures-based ETF’s stems from the SEC’s belief that futures-based products guarantee stronger investor protections due to the laws under which they operate.[19] At the present moment, it seems unlikely that the SEC will greenlight physical Bitcoin ETF’s within the year, yet it is possible that approval will be granted in 2022.[20]
In addition to cryptocurrency ETF’s, federal regulators have spent a considerable amount of time and energy discussing stablecoins.[21] Stablecoins are a class of cryptocurrencies that are pegged to the value of an existing asset, such as the U.S. dollar or commodity.[22] In theory, stablecoins offer the best of both worlds: the private, secure processing of cryptocurrency and the volatility-free stability of the pegged asset.[23] Whereas popular cryptocurrencies like Bitcoin and Ether can have double digit price swings in a short period of time, stablecoins are supposed to remain relatively consistent to serve as a stable medium of monetary exchange making them more suitable for everyday use by the public.[24] In order to achieve this stability, stablecoins hold a bundle of assets in reserve, predominately the specific asset they are pegged to, but also short-term securities such as cash, government debt, or commercial paper.[25]
In practice, however, nascent stablecoins have proven to be risky investments primarily because stablecoins are not transparent about the reserves they hold.[26] Both Tether and Circle have misrepresented the extent to which their coins were backed by traditional assets like U.S. Treasury bonds and municipal debt.[27] Stablecoins have evaded regulatory oversight because agencies have been unable to determine which agency has proper jurisdiction over this unique asset.[28] The President’s Working Group on Financial Markets, led by the Treasury, recently released a report suggesting that Congress pass legislation to regulate issuers of stablecoins in the same way that it regulates traditional banks and financial institutions.[29] More specifically, the working group suggested regulating stablecoin entities by requiring them to hold sufficient reserves to ensure they can meet the demands of customers to cash out quickly.[30]
While federal agencies and lawmakers continue to carve up the cryptocurrency space, it remains to be seen if the federal government will create a more standardized process to deal with new issues and asset classes that will inevitably arise. Ultimately, it might be worth considering a proposal offered by Coinbase, the largest cryptocurrency exchange in the United States, who recommended that the federal government simply create a new regulatory agency exclusively for cryptocurrency.[31]. Although somewhat radical, greater centralized federal regulation may be most conducive to monitoring the rapidly expanding and dynamic world of cryptocurrency and blockchain technology.
Footnotes
