The Crypto Industry and the Incoming Regulations

The Crypto Industry and the Incoming Regulations | AdaPulse
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Human beings are essentially social, and we have always had rules to order our relationships. Thousands of years ago, primitive human tribes already had laws, but of course, not as sophisticated and complex as our modern legislative systems.

Imagine not having clear rules of the game. Imagine that a group of people considered that it was right to take over the land where another group takes its food, water, and develops its needs of life, and therefore attacked that group mortally to expel it and achieve its goal. Well, that happened throughout the history of mankind, and that is how the laws were established, the rules of relationship outside a social group, and inside. 

And yes, violence was the way to establish laws. 

Politics is the science of designing regulations. Regulations are the set of procedures and rules adopted by society and its institutions to implement responsibilities. 

Charles Hoskinson, CEO of IOHK, and co-founder of Cardano, said in minute 34 of the Surprise AMA 06/05/2020 video: “Crypto is a political movement. Crypto is as political as possible, always, never forget that. We’re going to reinvent the concept of money and take it out of the hands of the government and control it ourselves, and isn’t that a political act?”

Hoskinson emphasized that the cryptocurrency phenomenon is especially political in nature because of the creative destruction it seeks to wreak on monetary commodities and politics, and asserted that “money is the greatest influence in all of politics.”

What are the Limits of Regulations?

It is clear that the crypto industry has its regulations, and that there will be more and more of them. The question then is not whether it will have them, but how many regulations there will be.

In most Western countries, Roman or common law principles predominate, in which private property is protected. It is enshrined in most national constitutions, and refers to the rights of individuals and companies to obtain, own, control, use, dispose of and inherit capital.

The political philosophy of economic liberalism advocates the defense of private property as an engine for increasing the wealth of societies. All this, basing the economic model on the action of the private sector. The public sector, therefore, must protect this right and ensure the exploitation of private resources and means of production within a framework of legality.

In contrast to this position, we find socialism or communism, theories proclaiming the right to state or communal property, which consider that private ownership of the means of production leads to inequality in the distribution of wealth.

The right to privacy of individuals has evolved to protect the freedom of individuals to perform certain actions. Privacy is a fundamental right, enshrined in numerous human rights treaties, and forms the basis of any democratic society. In addition, privacy supports and strengthens other rights, such as freedom of expression, information, and association.

Activities that restrict the right to privacy, such as surveillance and censorship, can only be justified when they are established by law, necessary to achieve a legitimate objective, and proportionate to the end pursued.

Thus, in the West, in modern democratic societies, the right to property and privacy of individuals are the limits to regulations, and of course, also applicable to those implemented in the crypto industry.

Cryptoeconomics and its Ecosystems

The cryptoeconomics, as a concept of technological evolution applied to the economy, also has its rules, for now minimal in relation to the traditional economy, since few people interact with it (it is estimated that less than 2% of the world’s population has cryptocurrencies).

However, in the last two years, the number of cryptocurrency users in the world has almost tripled. Estimates, according to the website Statista, show the United States, Russia and Nigeria as the top countries in the world for Bitcoin trading, with transactions generated in the United States worth twice as much as Russia and Nigeria combined.

An estimated 101 million people, worldwide, are cryptocurrency users.

The cryptoeconomics is composed of different ecosystems, which for the study of regulations, and the focus of attention, we could divide it by:

  • its form, as cryptographic economic and financial instruments designed in blockchain, be they cryptocurrencies, stablecoins and decentralized finance (DeFi), and
  • its development, such as production and trading.

The different cryptocurrencies, which today exist by the thousands, have different utilities, but all of them are based on their monetary policy, whether it is scarcity or not, while stablecoins are based on the backing with fiat currencies to avoid fluctuations in the price. Decentralized finance uses cryptocurrencies and stablecoins to develop the activity.

The production of cryptocurrencies is given by mining, in the case of PoW consensus, such as Bitcoin, or by programmed issuance with block validation, in the PoS consensus, such as Cardano, or also in the minting of tokens backed with fiat currencies, in the case of stablecoins.

The production in DeFi is the design of financial instruments, based on smart contracts, mainly, on protocols for cryptocurrency exchange or protocols for peer-to-peer lending.

On the other hand, trading can be supported on centralized platforms, CEX, or on decentralized platforms, DEX, but also p2p, i.e. between peers and without intermediaries or platforms.

Crypto Regulations

Recently, in June, the Legislative Assembly of El Salvador passed a law that turned bitcoin into a legal currency, just like the dollar and the colón, its official currency, of very little use in the country’s economy. A milestone for the industry.

Globally we see the advance of government regulators, and everyone is equally interested in having information about the economy that develops in this digital cryptographic model, which runs parallel to the traditional and formal economy recognized by the States. 

In this sense, anti-money laundering (AML), anti-terrorist financing (CFT) and tax evasion regulations are their main concerns. So is the protection of citizens against fraud and, last but not least, stablecoins as a quasi-monetary government issue.

The rule known as KYC, Know Your Customer, has as its main objective to confirm the identity of customers and verify that they have not been part of criminal activities, such as corruption, money laundering and terrorist financing. KYC policies have become a fundamental tool for combating illegal transactions in the field of international finance. It is applied in the vast majority of countries, including those considered “tax havens”, and obliges banking and financial institutions to verify the identity of their clients. 

The delicate balance between the use and abuse of this rule can affect the right to privacy.

Blockchains with low or no traceability of their operations, turn on the alerts. They are not well received by regulators, as it inhibits their control. The best known are Monero (XMR), ZCash (ZEC), PIVX (PIVX), Horizen (ZEN), or Verge (XVG). Bitcoin or Cardano, on the other hand, are considered pseudo-anonymous, since they allow tracing the route of transactions, their amounts and dates, leaving only their holders to be identified, thus enabling the authorities’ control task.

Regulatory moves by South Korean regulators illustrate this point. At the end of 2020, the local government banned exchanges of these assets, which it considers “dark currencies”. This is representative of an ongoing trend, to stifle anonymity-centric innovation.

As cryptocurrency trading and production platforms are global, jurisdiction is a problem for regulators. There are suggestions of supranational bodies, and agreements between countries, but there is not (yet) the possibility of a global regulator with the power to act.

The regulator can impose rules only when the author of the token can be determined, or where it is traded.

China is a clear example of extreme regulation, going as far as prohibition. In the case of token production, it banned Bitcoin mining in several provinces, arguing high energy consumption and has also banned financial institutions and payment companies from providing services related to cryptocurrency transactions, and has warned investors against speculative trading of cryptocurrencies.

The Financial Action Task Force, or FATF, is an intergovernmental institution created in 1989 by the then G8. The purpose of the FATF is to develop policies to help combat money laundering and terrorist financing. The FATF Secretariat is based at the OECD headquarters in Paris.

The FATF published in June 2015 the report entitled: “Guidance for a Risk-Based Approach to Virtual currencies“, where it contemplated a series of specific suggestions framed within its already well-known 40 Recommendations. In 2019 it published an update of this guide, where its main objective was “the traveler rule”, and although this imposition was already included in Recommendation 16 for financial institutions, it incorporated the obligation for virtual currency trading services, to identify all customers who transfer securities to another platform, for amounts greater than USD 1,000.

Another supranational organization showing signs of an increasingly unified and broad participation in this industry is the European Union. Until recently, it was the responsibility of individual countries within the Union to issue cryptocurrency guidelines. In September 2020, the European Commission announced the creation of the Digital Finance Package (DFP) for the “Regulation on Markets in Crypto Assets” (MiCA), which when implemented in 2024, will constitute the most comprehensive and far-reaching regulation in the cryptocurrency world to date.

There is also great concern about stablecoins, since by trading like government currencies, and having unit-of-measurement stability behavior, these private token-issuing entities end up acting, in effect, as currency issuers. Most governments consider fungible native tokens on blockchains as cryptoassets and not cryptocurrencies, thus detracting from their monetary power. It considers the payments as a payment in kind, and thus being taxable, not so if it were currency.

Finally, the issue of synthetic assets has aroused the interest of the authorities. A synthetic asset is a financial asset that represents and behaves like another asset, called the underlying. The synthetic asset replicates the behavior of the underlying asset (profit or loss), but adapted to a market with certain needs. Some centralized exchanges, such as Binance, and some DEX protocols, such as Uniswap, which operates on the Ethereum blockchain, trade synthetic assets of shares of companies listed on the Stock Exchange, and because the underlying securities are regulated, synthetics must also conform to their rules, and therefore only be traded if authorized. Thus it was that Binance, the world’s largest cryptocurrency operator, announced on July 16 that it will stop offering digital securities linked to company shares amid pressure from regulators in several countries, mainly the UK.

Also Uniswap Labs excluded synthetic tokens from access to its protocol, heeding the July 21 speech by Gary Gensler, Chairman of the US Securities and Exchange Commission, who spoke about the derivatives and futures control agenda to be implemented in the USA during 2021.

Final Words

The creation of cryptocurrencies had its roots in the cypherpunk philosophy, for the total independence of individuals, privacy, and the break with the pre-existing financial world, but the evolution of the ecosystem, for its usefulness has been transformed into crypto-financial industry, which leads unfailingly to massiveness. Therefore, regulations are necessary. 

Legislating to integrate the crypto industry into the formal economic system, so that public and private institutions, as well as individuals, can participate, is to give it the space it needs for growth. 

To do otherwise would be grounds for marginalization, as the lack of such regulations would prevent certain economic actors from participating in the benefits of this innovative technology.

Excessive regulations, and at an extreme, prohibitive ones, will be detrimental to the crypto industry.

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