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Crypto Regulation or Crypto Extinction?

Crypto Regulation or Crypto Extinction?

The last few weeks have seen a full court press on blockchain regulation by US bank and securities regulators. The timing of the bank regulatory announcements is telling. The proposed rules come when the industry needs clear consumer protection and money laundering rules. But it is really underlying inflation that is the silent threat that could lead to virtual elimination by regulation of Cryptocurrencies.

The proposed rules come when investors are fleeing a depreciating dollar because the central government has set off a hyperinflation scare, which is rapidly becoming a reality. Cryptocurrency regulation is likely to come in the middle of the Covid wars to defend a depreciating dollar.

Protecting against the depreciation of the dollar from inflation was one of the core reasons for the original creation of Cryptocurrencies. The jury is still out as to whether Crypto is an effective dollar hedge.

Defending the dollar

The current surge in regulatory interest arises because the widespread adoption of Cryptocurrency blockchain technology is beginning to create a domestic challenge to the U.S. dollar. The regulators have indicated that they intend to have a very heavy hand in the regulation of blockchain technologies and particularly cryptocurrency.

The scope of the Crypto regulation is important to pricing Cryptocurrencies as well as protecting the dollar. We can expect that the efforts of the government will vary in proportion to the problems with the dollar. Aggressive new regulations are not inevitable. But, if inflation remains in its current level or even higher, many more investors may well abandon the dollar for Crypto. Then, regulators will move aggressively.

The Administration wants action now

The growth of crypto assets has received broad recognition by bank regulators including the OCC, the Federal Reserve, and the FDIC. These agencies have collaborated on a Digital Assets Policy Initiative. Bank regulators recognize that the banks, like the economy as a whole, are getting deeply involved with Crypto assets.

The regulators recognize that blockchain innovation canvasses a wide range of traditional banking functions. A laundry list of fintech products on the list for regulation include payment products, application programming interfaces, data aggregation and payment devices. Distributed ledger applications and digital assets like stable coins and Crypto assets get special mention.

A project like the Digital Assets Policy Initiative will focus on the potential problems created by Crypto. Still the regulators are giving the innovations a chilly regulatory welcome. As the report says,

“The OCC is approaching crypto-related activities in the federal banking system very carefully with a high degree of caution and expects its supervised institutions to the do the same. OCC supervised institutions should reach out to the appropriate OCC supervisory office before engaging in crypto-related activity.”[1]

In addition to bank regulation, tax related rules are also in the works. The Administration unveiled its Crypto tax initiatives on May 20,2021. In the plan, the US Treasury announced tax and reporting rules for Crypto trades totaling more than $10,000.We should expect that some variation of these tax rules will make it into law.

Crypto coins get special treatment

The central government has taken a targeted approach for Crypto coins. These, of course, are the most direct technical challenge to the dollar. As a result, the government will impose the tightest rules on them. It is not inconceivable that they will in large part be banned. The Chinese model, which banned Crypto, is never far out of mind. Fed President Powell stated the current government position.

“Stablecoins can certainly be a useful, efficient, consumer-serving part of the financial system if they’re properly regulated," Federal Reserve Chairman Jerome Powell said at the Federal Market Open Committee (FOMC) press conference on Wednesday. "And right now, they aren’t.”[2]

The Financial Stability Oversight Council 2021 Annual Report proposes a regulatory process, which will be slow and lengthy. The process is also likely to increase systemic risk rather than reduce it. And while the emphasis is on Stablecoins, the definition of a digital asset in the Annual Report makes the scope of the forthcoming regulation broad indeed. The definitions in the report include all manner of recent technologies.

“A digital asset is an electronic representation of value that may be issued or transferred using distributed ledger technology, including blockchain technology. Ownership may be established through cryptographic means. Digital assets include instruments that may qualify under applicable U.S. laws as securities, commodities, and security- or commodity-based instruments such as futures or Glossary 185 swaps. Other industry terms used for these assets include cryptocurrencies, crypto assets, virtual currencies, digital currencies, Stablecoins, and crypto tokens.”[3]

How far should the defense of the dollar go

Two issues confront the Crypto industry in this regulatory discussion.

1. How far can the government legally go in defending the dollar

2. How far should the government go

1. We have been there before. The actions of the Federal government in the Great Depression may come into play as the Pandemic drags on. And we learned that the government could act without restraint in a currency crisis. Contracts and contract law do not bar the Government from acting to defend the dollar.

2. Problems with the dollar have come from the US policy.

The dollar’s relative value against other fiat currencies like the Euro are not necessarily a good guide in inflationary times like these. It is the dollar’s value relative to goods which is the problem. Restricting innovations in money and banking is not the solution if the dollar gets into a problem.

The banking and monetary system should act to restrict the worst natural tendency for manipulation and abuse in Crypto. The regulators, on the other hand, should act to add redundancy to the monetary system from private actors with blockchain technologies.

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[1] Office of the Comptroller of Currency, "Semiannual Risk Perspective from the National Risk Committee," (Washington, DC: GPO: Fall 2021), p. 19.

[2] Grace O'Donnell,"Stablecoins could be super useful — 'if they’re properly regulated,' according to Fed Chair Powell," Yahoo! Finance, December 19, 2021.

[3] Financial Stability Oversight Council, "2021 Financial Stability Oversight Council Annual Report," (Washington, DC: GPO: 2021), p. 184-185.

This article is not intended as investment, tax, or financial advice. Contact a licensed professional for advice concerning any specific situation.