Regulation of the Unregulated: About the Future of Cryptocurrency

It is very difficult for governments and central banks to regulate digital decentralized systems, which were created to avoid state control and were specifically designed to exclude government agencies and banks from their circuit of "money" circulation and confirmation of transactions and rights. About how different countries are trying to regulate the unregulated, writes Alexander Losev, General Director of Sputnik - Capital Management Management Company JSC.

In the second decade of their existence, cryptocurrencies have turned from an IT phenomenon into a popular class of digital assets and are beginning to occupy a special place in the global economy and global finance, competing with banks and payment systems in the field of cross-border payments, diverting investment capital from the traditional stock market and even claiming to be "digital gold", although cryptocurrencies do not perform all the basic functions of money.

Cryptocurrencies are digitally encrypted transaction verification codes (tokens) in their distributed blockchain-based network. A blockchain is a tool for accounting and registration, and a token (or coin - “coin”) is a new word in accounting after debit and credit. Unlike other digital technologies such as 3D printing, industrial control systems, digital communications, or digital photos and videos, blockchain is not a production technology. In addition, the technologies of blockchain

networks and distributed registries are disastrously behind the energy efficiency of traditional digital payment technologies. As of January 2022, one transaction in bitcoin used 2.3 MWh of electricity, while for 100 thousand payments in the VISA system only shortly 149 kWh. The difference is nine orders of magnitude.

And there are also risks that “crypto” – a super-popular way of earning easy income in the world – may become a “digital graveyard” for investors’ money if regulators fail to curb the elements of the crypto market. Asset bubbles have already begun to deflate, and raising interest rates by the US Federal Reserve and other central banks will only speed up this process. And there is also a danger that quantum computers soon will put a fat cross on the cryptographic foundations of “cryptocurrencies”.

And if international rules and regulatory practices are not developed and a global regulatory environment does not emerge, then the rapid spread, high volatility of the value, and growing volumes of the crypto market can become a real threat to the stability of global finance and create serious problems for regulators and tax authorities in many countries.

Financial, Environmental and Criminal Risks from Crypto Assets

The International Monetary Fund notes on its website that “cryptocurrency” - the process of transferring funds from the national currency to cryptocurrency - can reduce the ability of central banks to effectively manage monetary policy. It could also pose a risk to financial stability in emerging markets and developing economies. 

These are systematic risks. The increasing demand for crypto assets is contributing to the capital outflow, which affects the forex market. According to IMF experts, the anonymity of (fake) crypto assets creates data gaps for regulators and can open unwanted doors for money laundering as well as terrorist financing. Contributing to the tax evasion of crypto assets can increase the threat to the monetary policy of countries. 

The operational and financial risks associated with the exchange of crypto assets, crypto exchanges, and wallets in the crypto market are much higher than in the regulated financial market. Risks in the field of protecting the rights of investors and consumers remain significant for all economies in the world. And all this underlines the need to develop comprehensive international standards for regulating the crypto market.

"Mining" of the crypt, which requires colossal energy costs and diverts real resources from the world economy at a time when Europe and Southeast Asia are experiencing serious energy crises, causes rejection and criticism not only among the adherents of the "green transformation", but also among the governments of countries, following the principles of sustainable development, and responsible investors committed to the principles of ESG. Mining cryptocurrencies creates a huge carbon footprint, overloads the grid and generating capacity, and this can no longer be ignored.

Cryptocurrencies that allow anonymous payments are a real boon for criminal groups involved in drug trafficking, extortion, trafficking in human organs, and other illegal operations. Electronic bitcoin wallets were found by terrorists in Syria, Iraq, Libya, and Afghanistan. Global Drug Survey statistics show a sharp increase in the use of cryptocurrencies to buy drugs in EU countries.

A report issued by the US Government Accountability Office on January 10, 2022, indicates that cryptocurrencies are increasingly being used for human and drug trafficking. A. The U.S. Accounts Chamber and Congressional Investigation Unit point to a five-fold increase in the number of suspicious activity reports filed with the Financial Crime Enforcement Network (FinCEN) over the past 5 years.

Central Bank Advisor Nikolai Silin on cryptocurrencies in international finance

Regulation of the unregulated

It is very difficult for governments and central banks to regulate digital decentralized systems, which were created to avoid state control and were specifically designed to exclude government agencies and banks from their circuit of "money" circulation and confirmation of transactions and rights.

The IMF further warns that some countries may be tempted to accept crypto assets as additional national currencies because many cryptocurrencies are relatively safe and easy to trade. But in most cases, the risks and costs outweigh the potential benefits. Financial soundness will be damaged and domestic prices will become very volatile. The IMF document does not mention penalizing countries that legalize cryptocurrencies as legal tenders, but central banks are unlikely to risk opposing the IMF's position.

The Financial Action Task Force has set a standard for controlling virtual assets and related service providers to take action against money laundering and reduce risk. But while not all countries comply with this standard, it can create problems due to the cross-border nature of transactions with crypto assets.

Exercise real control over coding

USA

In the United States, cryptocurrencies are at the center of attention of several federal agencies at the same time: the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CAEC), the Internal Revenue Service (IRS), and the Office of Foreign Exchange Control (OCC).

At the same time, in the United States, there is no single definition of what a cryptocurrency is. In terms of legal practice, the use of ambiguous definitions (“digital assets”) gives lawmakers and regulators more freedom to control and regulate. Primary power rests with the Securities and Exchange Commission, which regulates the issuance and resale of any digital asset.

 Under United States law, the concept of "security" includes "investment agreement," which, as defined by the United States Supreme Court, refers to an investment in any enterprise, including the reasonable expectation of profit from the commercial or administrative endeavors of others. 

The SSC believes that any issued token has "usability", which means that it is considered secure and monitored. And if this is "security", then the issuer of the crypto-token is obliged to register its version. The Securities and Exchange Commission has the authority to register and refuse registration. For example, Telegram and Kick Interactive Inc. and Meta (Facebook).

The Financial Crimes Enforcement Network monitors financial service providers for the exchange and storage of crypto assets. There are restrictions on non-compliance with FinCEN rules, including fines and criminal justice, and these restrictions may apply to aliens. It is monitored by the US Treasury Department of Foreign Assets Control (OFAC).

For example, FinCEN has imposed a civil fine of $100 million on BitMEX, one of the largest virtual currency derivatives exchanges, for violating the Banking Secrecy Act (BSA) and FinCEN regulations.

The IRS treats crypto assets as assets that are taxed on crypto earnings, no matter how hypo

ethical.

China

Chinese authorities have banned cryptocurrency financial transactions and are waging a relentless battle against digital asset mining. In September 2021, the People's Bank of China declared all cryptocurrency transactions to be illegal. The Chinese regulator believes that such activity "seriously threatens the security of human property". A statement issued by the People's Bank of China stressed that virtual currency-related trading activities are "illegal financial activity" and are not acceptable.

China's National Development and Reform Commission (NDRC) has issued a notice that the country will crackdown on crypto mining as part of its efforts to reduce carbon emissions. The NDRC ruling states that mining activities and any mining projects must be marked “canceled.”

At the same time, China is preparing to introduce the digital yuan, which will be one of the forms of China's national currency, along with the monetary and monetary yuan.

European Union

Cryptocurrency is a legal asset of the European Union which has separate rules for its member states. Cryptocurrency taxes are different in each country, and the tax rate on income received ranges from 0 to 50 percent. In 2015, the European Court of Justice ruled that exchanges between traditional currencies and cryptocurrencies or virtual currencies would be exempted from VAT because cryptocurrencies are a service, not a product.

 In 2021, the European Commission released a package of legal proposals to regulate the transfer of money and certain crypto assets to protect EU citizens and financial systems from money laundering and terrorist financing. Following the FATF recommendation, the European Union has set a threshold of 1,000 euros for the transfer of information related to transactions with crypto assets.

The European Union is proposing to introduce a special system for crypto asset providers in line with the MiCA and Digital Markets Regulation.

Operational Flexibility Act (DORA). The European Council stated on its website that MICA's goal is to create a regulatory framework for crypto assets to support market innovation and exploit the potential of crypto assets in a way that maintains financial stability and protects investors.

The purpose of DORA is to create a regulatory framework for digital operational resilience in which all businesses must ensure that they can withstand all ICT-related barriers and threats to prevent and mitigate cyber threats. Once these laws and regulations are passed, only authorized service providers will be able to offer cryptocurrency and conduct cryptocurrency exchanges in the European Union.

Japan

Japanese law defines "crypto-assets" as a form of payment that is not marked on the Fiat currency and can be used by anyone. There are no restrictions on owning and investing in cryptocurrencies. In Japan, crypto-asset exchange service providers are regulated by the Financial Services Agency (FSA). The FSA also works with two self-regulatory bodies in the cryptocurrency industry:

 the Japan Virtual Currency Exchange Association (JVCEA) and the Japan Securities Token Offering Association (JSTOA). JSTOA focuses on token issuance projects and crowdfunding activities. JVCEA authorizes the creation of rules applicable to cryptocurrency exchanges. Since 2021, crypto-assets in Japan have been subject to anti-money laundering regulations, and cryptocurrencies have been subject to anti-money laundering laws.

To produce

There is currently no single way to control crypto resources. The regulatory standards applicable to crypto-assets in different countries are mainly limited to money laundering advice and monitoring of financial risks. The Global Financial Governance Authority emphasizes the introduction of unified standards for securities, exchange, and banking activities in the cryptocurrency space and the application of existing regulations.

In addition, central banks in developed countries will soon start offering digital versions of their fiat currency (national digital currency, or central bank digital currency, central bank currency) and cannot tolerate cryptocurrency competition. Next, the global financial community will follow the path of banning cryptocurrencies, following the example of the People's Bank of China or Bank of Russia.