Uncharted Waters

Introduction

Nearly 10 years have passed since the quiet release of Bitcoin, the cryptocurrency that set off a worldwide frenzy for alternative currencies. Cryptocurrencies such as Bitcoin hold the potential to reshape the global financial system by creating decentralized means of exchange that do not require government intervention or intermediaries, while also affording a degree of anonymity. Attracted by this promise, investors, entrepreneurs, speculators, and criminals have flocked to this financial technology. But today Bitcoin and the hundreds of other virtual currencies that it inspired remain at the fringes of regulation around the world. Delayed and contradictory regulatory responses have no doubt encouraged innovation and disruption in the financial sector, but they have concurrently abetted financial crime and national security threats, including terrorism. (See, for example, the report “Terrorist Use of Virtual Currencies,” published by the Center for a New American Security in May 2017.) Virtual currencies have yet to scale to a point where this lack of oversight and regulation poses existential risks in the form of terrorist financing. However, if the growth continues without concerted international efforts to address the risks, countries will face the reality of an ungoverned, shadow financial system able to aid and abet worldwide terrorism, sanctions evasion, and money laundering.

This paper maps the diverse regulatory responses to virtual currency around the world in order to identify trends and patterns in the laws. Part I offers a picture of the state of regulation of cryptocurrencies in a wide array of countries, including many of the most significant global financial centers and those that have crafted distinctive policy responses to the rise of cryptocurrency. Part II covers the different approaches taken by U.S. regulatory and enforcement agencies. Part III offers a glossary of relevant terms to help bridge the expertise gap between the different constituencies active in the virtual currency space.

Part I discusses the approaches various countries have taken in defining and regulating virtual currencies and suggests how countries have differed on even the most basic questions. Specifically, Part I characterizes a country’s regulatory approach through three categories: its definition of a virtual currency, the target of regulation, and regulatory actions and policies. A first step in regulating cryptocurrency is determining what exactly this new technology is. For this reason, this section identifies how each country has chosen to define virtual currencies. On the most permissive end of the spectrum, countries have defined cryptocurrency as a legal form of payment. More conservative regulators have categorized it as an asset or commodity, akin to a work of art or a glass bead rather than money. These attempts across and within governments to define cryptocurrency reflect the central challenge to its regulation: Virtual currencies possess attributes of cash, currency, property, and even securities, but they cannot be regulated as any one of these categories exclusively. In many cases, regulators have simply found it useful to identify what cryptocurrency is not and ruled out its status as legal tender.

Second, this section classifies a country’s approach toward virtual currencies based on its target of regulation. Bitcoin and its peers have inspired an ecosystem of institutions and intermediaries to facilitate their use. For example, exchanges have sprung up to ease the conversion of fiat currencies into virtual currencies. As governments have adapted their regulatory frame- works, they have chosen different targets, including the cryptocurrencies themselves, specific new enablers such as exchanges, or even financial institutions writ large.

Finally, Part I lists significant regulatory and policy actions that suggest the direction and rationale behind a country’s approach to virtual currencies. While most nations are only beginning to craft regulatory responses to the rise of virtual currencies, these early enforcement decisions and regulatory pronouncements can serve as valuable precedents to distinguish between different governments’ emerging approaches. The research in Part I finds that among nations that have begun experimenting with regulatory approaches to cryptocurrency, efforts have largely tracked along three vectors: taxation, anti-money laundering (AML), and securities law considerations around initial coin offerings (ICOs). (See Glossary for additional information.) These regulatory streams address the challenges that have arisen from the cash- like, commodity-like, and security-like characteristics of cryptocurrency. The uncertain definition of virtual currencies has spurred authorities’ attempts to provide holders with clarity around their tax treatment, accounting for the first regulatory vector. These tax-related efforts have occurred in a number of countries where regulators have otherwise been silent on cryptocurrencies.

The second, less common, regulatory vector has responded to some of the unique risks posed by virtual currencies. Though not necessarily intended for criminal use, virtual currencies can entail serious financial integrity risks, primarily as a result of their lack of transparency. Some cryptocurrencies, such as Monero, inherently achieve cash’s near-total anonymity. But even Bitcoin, which only provides a layer of privacy by assigning participants pseudonyms, can be made nearly anonymous with services designed to make Bitcoin transactions nearly untraceable for law enforcement. Recognizing these cryptocurrencies’ illicit finance risk, governments including the European Union and United States have explicitly extended AML regulations to include parties dealing in virtual currencies. Other countries have pointed to AML programs as a reason to ban the use of cryptocurrency altogether.

The last regulatory theme has focused on the surging ICO market, which collectively fundraised more than $4 billion in 2017 alone. In ICOs, the tokens awarded to investors are similar to securities released in an initial public offering – but, due to the unregulated nature of cryptocurrencies, the ICO market around the world has been ridden with fraud. In the wake of a Chinese ban on ICOs in October 2017, many regulators have prohibited, applied greater scrutiny, or warned investors against the cryptocurrency fundraising mechanism.

As of this paper’s publication, a number of countries remain locked in internal debates about the future of virtual currency regulation. As the world’s largest economy and the central node of the global financial system, the United States has the unequaled ability to set standards and precedents that inform global norms on virtual currencies. Thus, Part II details the approach taken by different regulators in the United States. U.S. resolution of some of these debates is likely to influence rule-making elsewhere and perhaps even serve as the basis of a more globalized approach to virtual currency regulation. Moreover, the United States has one of the world’s most comprehensive regulatory apparatuses and, consequently, the ability to consider attendant technical matters in depth. For these reasons, Washington and state-level policymakers are standard-setters in confronting the myriad challenges and conflicts that the regulation of virtual currencies will raise in disparate fields. U.S. regulatory dominance in this space, however, is not guaranteed; some Asian countries in particular have responded to the growth of virtual currencies with more speed and clarity. Part II offers both insight into what may be a harbinger of the global regulatory framework around virtual currencies and a case study in the complexities of creating a cogent virtual currency regulatory framework at the nation-state level.

Though regulators around the world may be facing many of the same challenges raised by cryptocurrency, there is little coordination or consensus among and within nations on the regulatory path forward. Ultimately, greater uniformity in the regulation of virtual currencies would help ease compliance burdens on companies, prevent crime, and accelerate innovation.