Bitcoin Has A Regulation Problem

Regulation is among the most important factors affecting bitcoin price. The cryptocurrency’s rise has been arrested every time a government has cracked the policy whip. For example, several observers attributed the recent crash in cryptocurrency markets to government action by South Korea and China. Bitcoin’s most recent price slump is being blamed on banks in India, which have tightened the screws on cryptocurrency exchanges. (See also: Bitcoin Regulation Around The World). 

By their very nature, cryptocurrencies are freewheeling, not beholden to country borders or specific agencies within a government. But this nature presents a problem to policymakers used to dealing with clear-cut definitions for assets. Here are two unresolved questions relating to bitcoin regulation.  

Nothing is more symptomatic of confusion about cryptocurrencies than its classification by U.S. regulatory agencies. The CFTC treats bitcoin as a commodity while the IRS treats it as property. 

But the difference in classification has not solved underlying problems relating to cryptocurrency taxation. “The problem is a technical one,” explains Perry Woodin, CEO of Node40, a Software-as-a-Service (SaaS) company for cryptocurrency tax reporting. “It’s not possible to calculate your cryptocurrency tax liability without sophisticated software.”

According to Woodin, tracking the cost basis and days carried for the software needs a “deep understanding” of how blockchain works. “Simply recording transactions in an Excel spreadsheet is not sufficient for calculating tax liability (for cryptocurrencies),” he says. (See also: How The New Tax Law Affects Cryptocurrencies).     

There is also a disparity in state and federal responses to the cryptocurrency. While states have moved with alacrity and formulated rules for initial coin offerings (ICOs) and smart contracts, the federal response to digital coins still has to move beyond platitudes about “working groups.” For example, FinTech startups in New York are required to obtain a BitLicense, which has stringent requirements regarding disclosures, before an ICO. Similarly, Arizona recognizes smart contracts. 

The unique characteristics and global portability of cryptocurrencies presents another problem for regulators. 

For example, there are broadly two different types of tokens being traded on exchanges. As their name indicates, utility tokens serve an underlying purpose on a platform. For example, Augur, which is a prediction market, is a utility token on ethereum’s blockchain. Such tokens are not subject to the SEC’s disclosure rules. On the other hand, security tokens represent equity or share in a company and fall under SEC purview.

Not surprisingly, several tokens have circumvented existing regulations by declaring themselves utility tokens. The agency’s chief has publicly rebuked such startups, but that has not stopped tokens with questionable business models from being listed on exchanges outside their native countries. The case of bitcoin exchanges in China, which promptly relocated to neighboring countries and Hong Kong following a trading ban, is also illustrative of the problems faced by regulators.   

In response, international agencies such as the IMF have called for an international discussion and cooperation among regulators as far as cryptocurrencies are concerned. The EU, which has been welcoming of the cryptocurrency revolution, may possess an advantage over other territories because it controls a 28-member bloc.

In the United States, a non-profit, the Uniform Law Commission, formulated the Virtual Currency Businesses Act (VCBA) in an attempt to unify disparate state laws and provide entrepreneurs with “certain assurances with respect to the regulatory landscape.” But no state has committed to adopting VCBA, so far.   

In an interview with American Banker, Marco Santori, head of blockchain practice at law firm Cooley, called bitcoin a “regulatory platypus,” one that doesn’t fit neatly into established asset categories. But the platypus may not be such a big problem for taxation purposes within the United States.

As Perry Woodin from Node40 points out, publicly-listed stocks are also managed by multiple agencies. “Government authorities can and should apply existing regulations to cryptocurrency,” he says. “But I don’t see a need to create cryptocurrency specific regulation.” 

Some countries, notably in Asia, are pointers in ways to deal with cryptocurrencies. South Korea, where cryptocurrency trading is mostly tax-free, is considering revising that stance. The clearest indication of future policy regarding regulation may come from Japan, which legalized cryptocurrencies as legal tender in 2017.  

The Japanese government passed a Virtual Currency Act, which defines and describes cryptocurrencies. They are treated as assets for accounting purposes. As part of the act, the government issues a list of approved virtual currencies, which are considered legitimate and can be transacted on (i.e., traded, sold, or promoted to the public). While there were concerns initially that altcoins might be left out of the official list, that has not happened.

Startups planning an ICO are also required to obtain a license that establishes a minimum set of requirements and disclosures for the offering. Finally, exchanges are also subject to capital requirements, strict IT compliance checks, and regulations pertaining to KYC (Know Your Customer). To achieve these changes, Japan amended its Payment Service Act. To be sure, the task is much easier in Japan since the country has only one agency, the Financial Services Agency, to operationalize the changes.

Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns small amounts of bitcoin.