Over recent weeks, the spotlight of regulation has once again fallen on the cryptocurrency space. At the end of June, UK Financial Conduct Authority ordered exchange behemoth Binance to cease all regulated activity in the country, resulting in users reporting that their bank accounts had halted transfers to exchanges.
In the US, always a hotbed of speculation when it comes to cryptocurrency laws, Securities and Exchange Commission Chief Gary Gensler has called on Congress to support stricter regulations for cryptocurrency exchanges.
Meanwhile, newly appointed acting comptroller of the currency Michael Hsu told the Financial Times that he’d like lawmakers to establish a “regulatory perimeter” around cryptocurrencies. It’s a marked change in attitude from his predecessor, Brian Brooks, who made it lawful for banks to custody cryptocurrencies, and in his current role, is the CEO of Binance US.
Calling for stricter regulations or banning a single cryptocurrency exchange is one thing. But regulators have spent years grappling with the peculiarities of digital assets.
Particularly in the United States, there’s an understandable reluctance to move in the direction of an outright ban, given that it will likely be accompanied by an exodus of innovation and investment.
On the other hand, US lawmakers can’t shake the feeling that they should be doing something about cryptocurrencies. But what?
Zachary Figueroa, Counsel at bitFlyer US, believes the precarious regulatory situation is putting unnecessary pressure on operators in the crypto space. Speaking on the matter, he stated:
“One of the biggest issues for the cryptocurrency industry today is regulatory uncertainty. We’re left with a situation where even the most proactive operators are at risk of non-compliance due to a lack of clarity in how existing laws apply to this new technology. These regulated operators are fairly prepared, and they have already spent extensive resources to navigate these uncertainties.”
As in the case of Binance in the UK, exchanges represent low-hanging fruit for regulators seeking to cut crypto off at the source. BitMEX is perhaps the most well-known example in the US, with former CEO Arthur Hayes surrendering to police in Hawaii in April this year after the CTFC launched a suit against the firm.
However, BitMEX’s rival Bybit has also found itself under fire from regulators, despite ongoing attempts to block users from countries like the US, Canada, and the UK, where cryptocurrency derivatives are either banned or subject to securities legislation.
This underscores perhaps the most significant challenge facing regulators and cryptocurrency exchanges alike. The user base is global, and the markets are entirely digital. Cryptocurrency exchanges block users based on their IP addresses, but users bypass these geoblockers with VPN services.
Bybit is also ramping up its KYC rules in an attempt to demonstrate its willingness to ensure compliance. However, once again, the issue comes back to a lack of clarity as to whether KYC by itself is enough to satisfy lawmakers in a nebulous regulatory landscape.
CoinZoom is on the other end of the spectrum. Being based in the US, the exchange has gone all out to demonstrate compliance in a bid to keep regulators happy and give customers peace of mind. It holds a Money Service Business license to operate in all 50 states of the US, but the company also has customers in 140 countries and strives to ensure compliance with each jurisdiction.
However, the approach is about more than just caution – CoinZoom’s prudence in financial regulation has allowed the company to expand its range of crypto-related services. For instance, it recently launched an investing platform that pays yield to long-term holders.
DeFi Braces for Scrutiny
As much as they’re currently in the crosshairs, exchanges are only one component of the burgeoning crypto sector. DeFi is a new segment, but since it started gaining popularity in the summer of 2020, it’s raised plenty of questions about whether or not regulators would ultimately stamp down.
And while the early days of the space have been characterized by issues such as buggy code and so-called “rug pulls,” there are still signs that operators are prepared for regulation to swing in the direction of DeFi at some point.
For instance, last summer, DeFi platform Aave became the first of its kind to receive an Electronic Money License from the UK Financial Conduct Authority. Similarly, Alkemi is a protocol aiming to bring DeFi to institutions with a compliant hybrid CeFi approach.
It will operate a decentralized non-custodial lending protocol but with permissioned pools. Participants will be required to undergo KYC before they can trade on the platform, but ultimately it aims to provide DeFi’s liquidity to professionals, but in a compliant way.
It seems Aave and Alkemi could be well ahead of the curve, as the International Organization of Securities Commissions recently hosted an event where DeFi luminaries were invited to present their innovations.
Here Comes the Taxman
There is one area of regulation that’s already well and truly nailed down – tax. Across the globe, many nations have jumped on the opportunity to apply capital gains and income tax to cryptocurrency portfolios.
Typically, the US Internal Revenue Service has been one of the most robust – and things look set to get more severe. The Biden administration has announced plans to introduce a hike on capital gains tax for high earners, which is likely to disproportionately affect cryptocurrency users who’ve made bank from the recent bull market.
However, tax is perhaps the only area that provides a blueprint for how the cryptocurrency industry responds in the face of strict regulations. Services like Crypto Tax Calculator allows users in 21 jurisdictions to connect to exchanges, wallets, and DeFi protocols to streamline and automate their tax reporting.
It’s also interoperable across blockchains, having recently integrated support for the Polygon network and now offering users the ability to track transactions in MATIC tokens and across all Polygon-based DeFi applications.
Many users may not realize it, but even a crypto-to-crypto transaction is a taxable event in the US, meaning that they could otherwise be in for a surprise if it weren’t for the fact that entrepreneurs have stepped in to fill this gap with automated tax solutions.
Atani takes the idea a step further, providing an all-in-one cryptocurrency trading platform that provides secure access to trading and portfolio tracking across more than 20 exchanges. When it comes to tax season, the user can simply export their transactions using a built-in, one-click tax reporting system with no extra cost.
A Careful Balance
It’s evident that when the need is there, the crypto industry can step up and, in many cases, is pre-emptively preparing for regulation. So if US lawmakers did introduce cryptocurrency regulation, what would good look like?
To answer this question, we went back to Zachary Figueroa from bitFlyer US, who had this to say:
“It is not so much a consideration of whether regulation is “bad” or “good”. Rather, it’s about striking a balance between fostering innovation while ensuring a reasonable degree of consumer and investor protection is in place and preventing illegal use of funds. Some of the efforts for Federal cryptocurrency exchange license or special purpose charter have been the most intriguing in moving regulation forward.”
However, given the glacial pace of developments, it seems that cryptocurrency operators could have some time to wait before anything concrete emerges.