With a current market capitalization above $400bn, the dramatic rise of cryptocurrencies has captured imaginations the world over. Officials are endeavoring to understand the currencies’ various applications in an effort to provide greater regulatory clarity. We believe they will favor regulations that prioritize consumer protections against untoward activity, such as money laundering, terrorism financing and tax avoidance.
Looking ahead, we anticipate 2018 will continue to be a volatile year following the launch of Bitcoin futures trading on two of the world’s largest derivatives exchanges, with the expectation that additional trading vehicles will be brought to market. Financial regulators are keen to monitor these developments as they assess the liquidity and price stability of cryptocurrencies and enforce regulations. The rules of engagement are being written in uncharted legal waters. What follows is a review of the regulatory posture for major nation states.
The U.S. federal government has not formally imposed a national regulatory framework around cryptocurrencies. According to the IRS, cryptocurrencies are treated as property for U.S. federal tax purposes. The U.S. appears to be ahead of most other countries by regulating Bitcoin trading in the derivatives market. The CFTC formally approved the CBOE and CME to begin trading Bitcoin futures before year end, with the Nasdaq provisionally scheduled for the first half of 2018. We will observe whether the decentralized nature of Bitcoin will complicate price discovery, hedging and risk management.
During the European Parliament’s recent Committee on Economic and Monetary Affairs meeting, ECB President Mario Draghi stated that cryptocurrencies do not fall under the regulatory purview of the agency. While the ECB believes that cryptocurrencies do not currently pose a real threat to monetary policy, they are concerned with the risk of cyber attacks. ECB officials are generally wary of cryptocurrencies, calling on commercial banks to provide an alternative by embracing instant payments.
Officials recognize Bitcoin as a form of private money – or a “unit of account” – and allow its use in commercial and private sales. The country’s top financial regulator declared that cryptocurrencies are not legal tender and therefore do not need to be centrally regulated. The regulator’s hands-off approach may come under pressure from increasing demand for more concrete oversight in the near term, such as specific legal guidelines around treatment of the asset.
Switzerland has openly embraced the emergence of cryptocurrencies. Swiss regulatory authorities have been developing a lightweight regulatory system that enables the market to thrive without hindering innovation. The country’s willingness to experiment with cryptocurrencies as payment for municipal services has elevated possibilities for greater integration of cryptocurrency as a payment option in the future.
Officials have been proactive and forward-thinking in their efforts to support and regulate cryptocurrency trading platforms. As a result of a recent ruling, they will now need to perform KYC/AML due diligence similar to traditional financial institutions. Some platforms have already adopted best practices and other UK bitcoin businesses are moving in this direction.
Japan has demonstrated a progressive approach to cryptocurrency regulation. Regulators have approved four new cryptocurrency exchanges, which are likely to be launched early next year. Specifically, Japan’s support for the local Bitcoin industry has boosted the country’s Bitcoin volume to account for nearly half of the global Bitcoin trade volume. Officials also recognize Bitcoin as a means of payment. Many companies are integrating Bitcoin payments into their services and betting on the success of derivative contracts like the “Bitcoin bond”, which debuted in August 2017. Japan’s recognition of Bitcoin as a financial product would be favorable for cryptocurrency debt issuance, but we think this recognition remains far-fetched. Officials are wary of Initial Coin Offerings (ICOs), citing price volatility and potential fraud as primary concerns.
Officials have enforced their position that the government should assume full control of cryptocurrency issuance. China cracked down on domestic cryptocurrency exchanges earlier this year and outlawed ICOs. Despite China’s ban on cryptocurrency trading through exchanges, Chinese investors’ appetite continues to increase. A large volume of BTC/CNY trading has migrated offshore to international over-the-counter exchanges. The Chinese government is experimenting with further development of cryptocurrency applications, although there have been no definitive plans around when they would be issued to the public.
India does not formally recognize cryptocurrencies as legal tender and there is also no existing legal framework around cryptocurrencies. The Reserve Bank of India has issued several warnings cautioning users, holders and traders of cryptocurrencies against the potential economic, financial, operational, legal, customer protection and security-related risks. For now, the government is adopting a “wait and watch” policy.
Officials are proposing stricter regulation to curb rising cryptocurrency speculation. Trading will be restricted to qualified exchanges that uphold investor protection and trade transparency. Minors and non-resident foreigners will be prohibited from trading on exchanges, while financial institutions will not be able to hold or invest in cryptocurrencies. Currently, the government considers cryptocurrencies to be neither money nor currency nor financial product and has banned ICOs. Regulators also announced that Bitcoin derivatives trading would not be permitted.
Officials are unlikely to legalize the use of Bitcoin in the near term. There have, however, been extensive discussions among governmental bodies about the country’s legislative approach to cryptocurrencies. Moscow Exchange, the largest stock exchange in Russia, has been building an infrastructure for cryptocurrency trading. The exchange is unlikely to launch Bitcoin futures until Russia has implemented a formal cryptocurrency regulatory framework. At the same time, officials announced that they are endorsing a digital form of a state-backed currency, which would be circulated and controlled by the federal government.
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