News headlines continue to discuss the popular topic of cryptocurrencies. Whether it’s bitcoin or blockchain, the emerging technologies and concepts continue to impact and complicate the business world. Due to the foreign structure and financial context, many government agencies struggle to find a solution for regulating cryptocurrencies.
With the great deal of confusion and complexity surrounding the regulation issues, it helps to understand the fundamentals of cryptocurrencies.
What is Cryptocurrency?
According to NASDAQ, a cryptocurrency is a digital currency that is secured using cryptography. Cryptocurrencies are not created and distributed by any government, but in fact computer programs and algorithms. All transactions and currency released are determined and recorded based on algorithms. The unusual decentralized system where transactions occur make cryptocurrencies extremely secure and hard to counterfeit.
There are over 1,300 cryptocurrencies in the world today, however the ones most commonly used are Bitcoin, Ethereum, Litecoin and Ripple.
- Bitcoin – The most well-known, Bitcoin was created in 2009 and was one of the first cryptocurrencies
- Ethereum – Also known as Ether, Ethereum uses ‘smart contracts’ for party agreements, removing any manual paper contracts
- Litecoin – Similar to Bitcoin, Litecoin is designed for consumer use and allows for faster and more frequent transactions
- Ripple – Designed for transactions between financial institutions, Ripple payments are more extensive to process compared to others, such as Litecoin
Just as one might exchange 10 US dollars for 8 Euros, individuals can also exchange their cryptocurrencies. Cryptocurrency exchanges or digital currency exchanges (DCE) are businesses that provide exchanging services for trading digital currencies for assets such as conventional money or other cryptocurrencies. Some of the most popular exchange platforms include, Bitfinex, KRAKEN, Bittrex, and POLONIEX.
While the cryptocurrency market grows tremendously, with an estimated total market cap of over half a trillion dollars, there are still many inherent problems.
Regulating Cryptocurrencies: Challenges & Security Issues
Since cryptocurrencies are not issued by the government, the lack of central authority and unregulated environment create many risks and compliance concerns. Without any government interference, cryptocurrencies can be used for illicit activities such as, tax evasion, and money laundering. For those who properly use cryptocurrencies, the unregulated territory and nature of the market make cryptocurrency exchanges increasingly susceptible to hacks.
Since all transactions are final, hackers can steal considerable amounts without any consequences. Both Mt. Gox and Bitfinex, two of the leading exchanges have fallen victim to crypto hacks, both losing over 1 billion dollars in Bitcoin (BTC). Most crypto assets cannot be recovered or frozen due to the need for consensus when rejecting transactions. Therefore, exchange trading platforms must constantly improve security policies and procedures to assure their customers’ assets are safe.
To help secure exchanges, control initial coin offerings (ICOs), and protect consumers, government agencies are working together to develop an effective, comprehensive approach for regulating these markets.
Many US government agencies are implementing or looking to implement new policies thus creating a patchwork of regulations for both ICOs and exchange platforms. Most agencies agree for the need of regulatory oversight, yet each has a slightly different approach.
Securities and Exchange Commission (SEC)
The Securities and Exchange Commission (SEC) aims to crackdown on ICOs by issuing subpoenas for fraudulent or illegal token sales. For exchanges and other digital asset services, the agency as indicated they intend to create securities laws. With more regulation, the SEC wants to increase clarity and fairness within the cryptocurrency market. In the meantime, the SEC continues to warn investors of the risks associated with cryptocurrencies.
Commodity Futures Trading Commission (CFTC)
According to the Commodity Futures Trading Commission (CFTC), cryptocurrencies classify as a commodity. The CFTC recommends implementing self-regulatory standards and best practices for controlling the market but are open to possible government regulatory action. The agency has demanded that any regulation enforced should be developed for the specific gaps in the current regulatory framework.
Internal Revenue Service (IRS)
The Internal Revenue Service (IRS) has categorized cryptocurrencies as property and not actually currency, which makes it subjected to taxes. The IRS released a guidance in 2014 on the how general tax principles apply to cryptocurrencies.
The following are some of the taxable events involving cryptocurrencies:
- Selling cryptocurrencies for a gain
- Converting cryptocurrencies to cash
- Trading cryptocurrencies for another cryptocurrency
- Using cryptocurrencies for purchase after the value increased since initial investment
The Road Ahead
With the constant flux value and the continuous emerging technologies, regulating the cryptocurrency market will not be easy, but the road to regulation could prove to stabilize the market. For organizations utilizing cryptocurrency in their day to day activities, it is important to ensure that your organization is protected and able to comply with future regulations. Financial best practices still apply to cryptocurrency, although creativity may be needed in order to apply it to the specific use cases of the cryptocurrencies.