Bitcoin, based on new blockchain technology, has exploded in the past weeks and has at times been trading above $16,000 per coin. Demand for the virtual currency is so high that the debut session of Bitcoin futures—something seemingly even more volatile than Bitcoin itself—crashed the website of the Chicago Board Options Exchange’s (CBOE), the world’s largest options market, within minutes.
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Many are comparing this surge in demand to the internet bubble of the late Nineties. Like the early internet, the nature of blockchain regulation (or the lack thereof) will shape its success. Regulators around the globe need to quickly assess how to best regulate this technology. Specifically, they must decide whether to take a hands-off approach or choose a heavy-handed approach in light of the feared instability. Whatever path they choose, they need to learn from America’s recent missteps in this area.
Until regulators figure out a coherent response to blockchain technology, each regulatory agency may move independently and inconsistently to apply their own interpretation. This is where the U.S. response to this technology has been most problematic.
The U.S. Internal Revenue Service (IRS) demands that currency brokers disclose the identity of those who trade Bitcoin like a currency. It has also decided that it will tax cryptocurrency transactions like property transactions. In contrast, if you create a business that transacts in cryptocurrencies, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) may penalize you for failing to comply with their intricate anti-money laundering regulations.
The U.S. Commodity Futures Trading Commission considers cryptocurrencies to be commodities and under their jurisdiction. Whereas bankruptcy courts have claimed that cryptocurrencies do not fall within the more protected class of currency, but rather are a less protected asset, property. And, the U.S. Securities and Exchange Commission (SEC) convinced a Federal Magistrate that cryptocurrencies are securities that fall under the SEC’s jurisdiction. The only regulatory body who wants in on this trend is the United States Federal Reserve which sees cryptocurrencies entirely outside of their domain.
Although the technology underlying the blockchain concept is complex, it is sufficient to appreciate only a few key elements: A blockchain is effectively an interconnected distributed infrastructure, like the internet. Similar to wikis (most famously Wikipedia) that provide for the sharing of user-inputted information via a system that tracks all said inputs, blockchains are secure, time-stamped, global, immutable, auditable, cryptographically sealed, distributed data ledgers of information.
The need for some regulation is obviated by the small number of Initial Coin Offerings (ICO) that have already burned investors. ICOs are an unregulated blockchain workaround to raise money quickly and outside of standard channels. The U.S. Securities and Exchange Commission has charged a number of companies with defrauding investors via ICOs including REcoin Group Foundation and DRC World. Similarly, another blockchain company, Paycoin, admitted to operating a multi-million dollar fraud scheme. And, most recently, Confido, a blockchain based app developer disappeared after raising thousands via an ICO. Nevertheless, while most stakeholders in blockchain are well-intentioned—there were over 230 ICOs in 2017 raising more than $3.6 billion, and most were not like Confido—incidents such as those above will scare skittish investors, or worse, force regulators to regulate impulsively, hindering innovation.
The blockchain is not without the potential downsides. Increased popularity in cryptocurrencies will make the setting and enforcement of monetary policy more difficult. Regulations that protect investors from malicious actors will be circumvented through blockchain based financial tools, and trust in governments and institutions will fall as we shift to blockchains based trust systems.
As Bitcoin and other aspects of blockchain become more prevalent and infiltrate sectors beyond finance, regulatory uncertainty becomes more of a burden for innovators and their investors. Perhaps now is the time for reguators around the globe to formulate an intelligent coherent national policies before an incoherent one is created organically.
Dov Greenbaum, JD-PhD, is the director of the Zvi Meitar Institute for Legal Implications of Emerging Technologies at the Radzyner Law School, at the Interdisciplinary Center in Herzliya.