Does Crypto Need Regulation?

Authored by Makara
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Makara

Published August 4, 20218 min
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Regulations are a lot like braces. You may not like getting them, and adjusting them can be painful, but the outcome is typically worth it. Without regulations, we wouldn’t have seat belts, or clinical trials for medications, or football helmets. The ozone layer would be so thin you could get a sunburn in Washington, D.C., in just 5 minutes. People would still die from drinking milk.

Crypto, of course, was conceived to function outside of governments and government regulation. What regulations exist are built in by design: algorithmic safeguards that make it impossible or unreasonably costly to cheat. But criminals are opportunists, and while there are not many, the system has allowed hackers to make crypto their ransom currency of choice, not to mention become a haven for tax cheats, drug kingpins, and market manipulators

In June, after the U.S. Congress’s first hearing on opportunities in digital currencies, Chair of Senate banking and finance subcommittees Elizabeth Warren compared the world of cryptocurrencies to “the Wild West.” She followed this comment with a call for regulation, part of an increasingly voluble chorus that includes the U.S. Justice Department, the U.S. Treasury, new acting comptroller of the currency Michael Hsu, and President Joe Biden. At the annual blockchain virtual summit REDeFiNE TOMORROW 2021 in July, Binance CEO Changpeng Zhao said “it’s clear that heavy regulations should be expected” in the crypto industry, which is a pretty good sign the government plans to step in soon. The questions that remain are when it will happen, what governments will do, and how much it will actually affect retail investors.

The Case for Regulating Crypto

After Congress’s first hearing, Warren said that she would be interested in spreading regulatory authority over the digital wild west to multiple sheriffs. The SEC, for example, could protect investors against possible pump-and-dump schemes and other scams, allowing people to invest as safely in crypto markets as they can in stocks. Bank regulators, meanwhile, might oversee crypto’s integration with the U.S. monetary system so that we don’t see instabilities that could lead to a repeat of the 2008 financial crash. The Treasury Department recently published a tax plan with a section focusing on ways the IRS can catch those who are using cryptocurrencies to avoid taxes. And the Biden administration plans to more thoroughly investigate cryptocurrency payments in ransomware attacks. Regulation appears to be coming for crypto exchanges as well.

It’s hard to say that any of these things would be bad ideas. Halting illegal or predatory activities would add legitimacy to the entire asset class, making it clear that crypto is an opportunity for everyone and possibly encouraging more mainstream adoption. Wary investors would be emboldened to invest greater amounts of money, and developers using crypto systems to develop the tools of tomorrow could be certain they were working on steady infrastructure. And traditional banks that are currently tiptoeing into crypto markets might be reassured by rules that prevent them from inadvertently getting into trouble. 

The Case for Not Regulating Crypto

While it is unlikely that international governments will try to ban cryptocurrencies entirely, they could change or curtail some of the freedoms granted by decentralization. One of the original ideas behind creating a bank-free financial space was to prevent greedy gatekeepers from making a profit at the expense of ordinary investors. How well cryptocurrencies have managed to do that is up for debate, but the idea remains a compelling one, particularly to the early adopters who have championed the system to this point.

For example: Developers using crypto infrastructure to form a base for a future, more equitable internet, often called Web 3.0, hope to wrest control from the big four tech companies (Amazon, Apple, Facebook, and Google), which they argue have attained monopoly power. New regulations should be careful not to jeopardize such a system. Developers in particular hope any new rules can maintain the user-owned, open-to-all nature the creators of early coins imagined. As for anonymity, we don’t have to identify ourselves when we use cash to pay for things. Why should the digital equivalent? 

The Case for Letting Crypto Users Take Another Shot at Regulating Themselves

Several crypto companies are beginning to change their operating plans to make their own systems safer before governments come in and do it themselves. Crypto exchange FTX, for example, decided recently to limit the amount of trading users could do with borrowed money. Called margin trading, this practice allows individual investors to risk 100x (or more) of their actual investment. Such leverage can cause liquidations that lead to price crashes. Crypto exchanges Gemini, Coinbase, and Kraken, meanwhile, have been focusing more on legal gray areas, rooting out fraud and manipulation, self-auditing, and expanding compliance operations in advance of any outside scrutiny. Possibly the most controversial development has been decentralized exchange Uniswap removing support for more than 100 coins on its main interface. The announcement didn’t explain why they chose the specific coins, but users have pointed out that many of them were synthetic versions of offline or online equities (Gold Tether, Synth Microsoft, Mirrored Tesla) that could be subject to securities regulations.

Crypto companies’ efforts may not be enough to hold off the government, but they are a good sign that the holders of the reins in crypto understand the need and inevitability of regulation. Making the system more fair and removing the small but nefarious element that has crept in is good for the average investor. It makes the space more welcoming to more people and businesses, helping crypto get even closer to reaching mass adoption. And that benefits us all.