China's regulators have attempted to take proactive measures towards growing cryptocurrency markets as counterparts in other major jurisdictions take their time to determine a firm stance.
On October 26, Reuters reported that China’s National People’s Congress passed legislation that would set standards for the application of cryptography and the management of passwords. While the legislation doesn’t directly mention cryptocurrencies, it focuses on one of their key components: blockchain. The legislation effectively brings cryptography into the legal realm, with several news sources – including Reuters and ABC – predicting that China is attempting to set the foundation for its upcoming national digital currency.
Meanwhile, US regulators have been hesitant to provide a cohesive regulatory regime prior to the crypto market truly taking off. Federal Reserve chairman Jerome Powell stated in July that the agency hasn’t seen “widespread adoption” of cryptocurrencies yet. This may well be changing, with calls from US representatives for the Federal Reserve to adopt a digital dollar, and Facebook-backed stablecoin Libra expected to launch in 2020. The daily trading volume of cryptocurrencies on October 26 reached a three-month high at $4.57bn, according to insights from The Block Genesis.
The people's currency
On the surface, China has a hostile history with cryptocurrencies. While the US and EU member states initially set out to define and regulate cryptos within financial terms the People’s Bank of China (PBoC) outright banned financial institutions (FI) from handling bitcoin transactions in 2013. It followed in 2014 by ordering commercial banks and payment companies to close bitcoin trading accounts, reported by the Wall Street Journal. In September 2017, the PBoC declared ICOs illegal. The BBC reported that the move shut down 173 ICO platforms, both exchanges and projects.
China has a long history of dealing in digital currencies. Q-coins, a currency linked to Chinese social media platform QQ, have been around since 2002, long before the idea of digital currency even entered into a western collective conscience. In an environment already comfortable with the concept of digital currencies and secondary economies, Bitcoin mining and trading was rife in China from the offset. Today, China is set to be the first country to launch a centralised digital currency, a project that has been in the works since 2014, Reuters reports.
Fed level guidance required?
Various US federal agencies have grappled with cryptos since Bitcoin's early days. In 2013, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) classified Bitcoin as decentralised “convertible virtual currency” (CVC), making it an unregulated, exchangeable digital currency. In May 2019, they published a guidance paper consolidating all existing regulations of CVCs, which included adherence to the Bank Secrecy Act (BSA), a piece of legislation intended to stop money laundering and fraud.
In 2014, the Internal Revenue Service (IRS) classified Bitcoin and other digital currencies as “property for US federal tax purposes”. In October this year, the agency published guidance addressing key issues arising from the taxing of cryptos, stating that new cryptocurrencies created from a “fork” of an existing blockchain will be taxed. It also clarified how taxpayers could determine the cost basis – or fair market value – of crypto coins when received as income, stating it would be calculated by summing up all the money spent to acquire the crypto.
In 2015, the Commodity Futures Trading Commission (CFTC) deemed digital currencies as commodities, held in the same regard as gold and oil - a stance which has not changed. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (Finra) published a joint statement earlier this year outlining compliance issues for cryptocurrency custodians. They did not believe crypto exchanges would be able to comply with the SEC’s Customer Protection Rule. The SEC is currently undergoing further investigations into the structures of initial coin offerings (ICO) – cryptocurrency’s version of an initial public offering (IPO). In April of this year, the agency published a guidance laying out the circumstances under which digital currencies would be considered securities. The SEC notes that the guidance is not law, but rather an “an analytical tool to help market participants assess whether the federal securities laws apply to the offer, sale, or resale of a particular digital asset”.
Some experts, including SEC commissioner Hester Pierce, believe the US risks falling behind in the race to regulate crypto.
In 2013, the European Central Bank (ECB) classified cryptocurrencies as a subset of virtual currencies, similar to FinCEN’s definition. Cryptocurrencies are legal across the EU bloc, with exchanges regulated differently by individual member states. Countries such as Malta and Belarus have emerged as leaders in crypto regulation, with Malta developing the Malta Digital Innovation Authority (MDIA) specifically for regulating the crypto market and creating policy. Countries with larger economies, however, have tended to apply existing regulations, which were not designed to cover cryptos.
A big regulatory shift occurred in 2015, when the Court of Justice of the EU ruled that the exchange of traditional currencies for units of bitcoin was exempt from VAT, meaning that member states must consider Bitcoin a currency as opposed to a commodity. The broader implications of this decision involve a European market ripe for virtual currency exchanges. Other regulations have centred around anti-money laundering (AML) directives. In 2016, a task force was put in place to monitor virtual currencies to combat money laundering and terrorism, a process which resulted in crypto to fiat currency exchanges falling under the EU’s AML legislation in 2018. This would require exchanges to perform know your customer (KYC) procedures on customers.
With increased pressure on US and EU regulators to tackle Libra, alongside calls for central banks to investigate their own digital currencies, it will be interesting to monitor these shifting dynamics as we move into 2020.