Bitcoin and cryptocurrency have become more mainstream and widely accepted as an investment and means of payment. PayPal now offers cryptocurrency and Mastercard plans to bring crypto into its payment network.
Despite the growing popularity, there are few consumer protections and regulations for cryptocurrency. Generally speaking, the Commodities Futures Exchange Commission (CFTC) regulates the trading of cryptocurrency futures and spot markets, while the Securities and Exchange Commission (SEC) monitors emerging cryptocurrency, including initial coin offerings (ICOs), to make sure they are not designed as securities. We'll take a look at the issues involved in cryptocurrency laws, and what's in the wings for regulation.
What Is Cryptocurrency?
Cryptocurrency is virtual money that can be used for payments, and other financial transactions. Bitcoin, arguably the most recognized cryptocurrency, was introduced in 2009. Today there are more than 4,400 cryptocurrencies available on the market. Bitcoin, however, is still by far the most popular with a market share around five times the size of its nearest competitor.
Cryptocurrency is bought, sold, and transferred online and held in digital wallets. Digital wallets can be hosted by an exchange or other financial service that handles cryptocurrency payments, purchases, and sales. Digital wallets can also be unhosted, enabling the owner to send cryptocurrency payments directly from one party's wallet to the other. There are no banks, or other financial intermediaries involved in unhosted transactions and the transactions are largely anonymous.
Investors can hold cryptocurrency directly in a digital wallet, or indirectly by purchasing a security like the Grayscale Bitcoin Trust.
Current and Proposed Cryptocurrency Regulations
At present in the United States, regulations regarding cryptocurrency are mainly only proposals and are based on the Bank Secrecy Act (BSA) of 1970 and the Patriot Act.
The BSA requires U.S. financial institutions to assist in the detection and prevention of money laundering and terrorist financing.
In the wake of the 2001 attacks on the World Trade Center, U.S. financial institutions were required by amendments to BSA and Title III of the Patriot Act to actively identify, report and deter terrorist-orchestrated money laundering activities.
The Financial Crimes Enforcement Network (FinCen) is the U.S. Treasury agency responsible for administering the Bank Secrecy Act and collecting and sharing financial-crime intelligence.
FinCen issued guidance in 2013 to include cryptocurrency exchanges (places where you can buy and sell crypto) within the definition of a money transmitter, making them subject to BSA and Patriot Act rules.
In 2019, $119 billion of suspicious cryptocurrency transactions were reported to FinCen.
In December of 2020, FinCen proposed new rules aimed at cryptocurrency money laundering. The new rules would require money transmitters to identify and keep records of all parties in cryptocurrency transactions of more than $3,000 with an unhosted wallet, or a wallet that is hosted in a "problematic" country listed by FinCen. If the transaction is greater than $10,000, the transmitter has to report the names and addresses of all payors and recipients to FinCen. The proposed rules are very similar to the rules for bank wires.
The Biden administration has frozen all pending rule changes, so there has been no further action on the FinCen proposal. However, in a February 2021 interview with CNBC, Treasury Secretary Janet Yellen expressed concerns that Bitcoin is “inefficient,” and that it may be used “often for illicit finance,” so it would seem likely that there will be additional regulation of cryptocurrency at some point.
Legal Concerns Around Cryptocurrency Use
The U.S. Attorney General's cyber-digital task force 2020 report identified three areas of concern with cryptocurrency use:
- Direct use of cryptocurrency commit crimes and finance terrorism
- Using cryptocurrency to launder money and evade taxes
- Cryptocurrency theft and investment fraud.
In general, a common legal concern about cryptocurrency is the certain level of anonymity cryptocurrency can offer because they create a perfect environment for criminal activities. Cryptocurrency developers are now offering anonymity enhanced cryptocoins (AECs) like Monero, Zcash, and Dash specifically to make tracking transactions more difficult.
One of the most well-known examples of how cryptocurrency can be used to commit crimes is the infamous dark-web marketplace Silk Road. The site operated from 2011 to 2013 as a marketplace for drugs, forged documents, ransomware, and other illicit goods and services. The site was specifically designed to use bitcoin as the means of payment in order to hide user identities. Ross Ulbricht, Silk Road’s founder, was convicted in 2015 of multiple charges, including narcotics distribution and conspiring to commit money laundering.
Cause for Caution With Crypto Investing
The same features that make cryptocurrency so attractive are also why investors need to be cautious. The anonymous nature of transactions can make cryptocurrency exchanges a target for hackers because it is difficult to track and recover bitcoin if it's stolen.
The Mount Gox cryptocurrency exchange was hacked in 2014 and investors lost hundreds of millions of dollars of bitcoin. Those who held their crypto on the exchange were left with little recourse.
Cryptocurrency is not legal tender anywhere in the United States and isn’t backed by the government or a central bank. Its value is based largely on demand. As an investment, cryptocurrency like bitcoin has produced substantial returns, however, cryptocurrency is also extremely volatile, which makes its value as a currency questionable.
Finally, if FinCen’s proposed regulations go through, cryptocurrency exchanges would be regulated as money transmitters, and consumer protections are at the state level. Federal regulation of money transmitters is primarily directed at money laundering and terrorist financing. There are no state or federal financial guarantors for cryptocurrency exchanges like the FDIC.
North American Association of Securities Regulators identified cryptocurrency as a threat to investors in 2018.
The Commodities Futures Trading Commission, SEC, and FINRA have published fraud warnings about cryptocurrency initial coin offerings, and other cryptocurrency investments. The New York State Attorney General bluntly warned investors in March 2021 that "cryptocurrencies are high-risk, unstable investments that could result in devastating losses just as quickly as they can provide gains.”
- While Bitcoin and other cryptocurrencies have generated dizzying returns for investors, there are significant risks and regulatory issues to consider. There are very few consumer and investor protections that address cryptocurrency, and the exchanges that deal in it.
- U.S. regulators and law enforcement are concerned about anonymous cryptocurrency transactions. The proposed FinCen regulations focus on the use of ‘unhosted’ digital wallets, which has no impact on the average investor. They're intended to deter the criminal use of cryptocurrency via exchanges.
- As cryptocurrency continues to gain wider acceptance and use within the financial system, concerns of the Biden administration and law enforcement will likely translate into additional regulation.