In the last few months, we’ve seen an established stablecoin with an $18B market cap de-peg to 0.
We’ve seen centralized crypto lending apps like Celsius, BlockFi, and Voyager become insolvent and lose users’ funds due to poor risk management. We’ve also seen $14 billion+ lost in scams, hacks, and exploits over the last year.
It’s now completely clear that crypto regulation is coming, and likely sooner than we think.
In this article, I will explore the following
• What are regulators concerned about
• Why is regulation bullish?
• Wen regulation?
- What kind of regulation can we expect?
1. Tax Evasion / Money Laundering
Governments want their taxes.
But wallets don’t have to be associated with a person’s identity.
This makes it hard for governments to enforce the prevention of money laundering through crypto because they don’t have the data to connect a wallet to an individual.
Currently, the KYC data from centralized exchanges and services offering Crypto onramp and offramps is the most obvious way to connect a wallet to an individual.
But it still leaves a lot of room for improvement.
So how much money laundering is really going on?
• An estimated $800B — $2T of fiat currency is laundered every year. (not exclusively crypto)
• According to a @chainalysis report, cyber criminals laundered an estimated $8.6 billion worth of crypto in 2021.
Crypto is used for less than 1% of total money laundered every year.
• Only an estimated 0.05% of all crypto transaction volume in 2021 was involved in money laundering.
2. Financing Illegal Activities (drugs, terrorism, etc)
On a related note, governments are concerned about crypto being used to finance illegal activities.
Similar to the money laundering problem, governments are also worried about people using crypto to finance illegal activities like drugs, weapons, gambling, trafficking, etc.
Recently, the US government sanctioned @TornadoCash, and its developer was arrested.
Tornado Cash is a crypto mixer that helps people conceal or mask the source of their funds. This makes it particularly difficult for governments to figure out where funds are coming from.
Privacy-focused crypto projects have had a target on their back for a long time.
This sanction on Tornado Cash is a very clear indication from the government that they intend to crack down on money laundering while also demanding accounting transparency so they can prevent the financing of illegal activities through crypto.
3. Protecting Citizens
In 2021, $14B was lost to crypto scams.
Governments obviously don’t want their population to lose money to scams, ponzis, false promises, and poor risk management.
This is particularly important because the speculative (degen) side of crypto investing is often portrayed as a get-rich-quick scheme.
We’ve all heard this one, for example:
“[Name] bought this meme coin in 2017, and is now worth $100M”
Stories like this appeal more to the economically weaker section of society, making them even more susceptible to losing more money in crypto by gambling on random meme coins, falling prey to pump and dumps, or trading call groups.
Governments want to regulate this space, to ensure safety for their citizens. No one wants to live in a world where tens of billions of $ are stolen from innocent citizens every year.
This is a major hurdle for mass adoption, scaring away investors, users, and regulators. I’ll be writing more about this next week on my substack.
Retail investors are held back by the lack of regulatory clarity.
Maybe the ambiguity doesn’t hold you degens back, but conservative investors don’t want to touch an asset that has regulatory ambiguity.
Taxes are also very complicated, creating an additional barrier to overcome for all investors.
Institutions have a lot of regulatory and compliance restrictions, which hinder them from investing in alternative assets like crypto.
Even if executives want to invest in Crypto, how do they justify such an investment to their board and shareholders when even the government’s position isn’t clear?
Crypto ETFs unlock the doors for a lot of funds and everyday investors to take a position in crypto.
It will make investment access to crypto much easier for the masses, and will also allow retirement funds, pension funds, and endowments to get exposure to crypto.
Crypto ETFs have been rejected by the SEC multiple times in the past, but they’re more likely to be approved after concrete regulations come in.
Central Bank Digital Currencies or CBDCs deserve a much more detailed explanation (for another blog post), but the gist is this:
Stablecoins are the most obviously useful crypto product.
- Merchants have to pay 2–4% to credit card processors.
- Cross-border payments are slow and expensive.
Central Banks around the world are looking to create their own CBDCs because CBDCs give them:
• Perfect visibility into all transactions
• Granular control over financial levers (interest rates, )
• Ability to prevent illegal activities, money laundering & tax evasion by phasing out cash from the economy.
CBDCs mean mass crypto adoption facilitated by governments.
Bullish, right? Not necessarily.
But governments aren’t building decentralized solutions where you own and control your money.
CBDCs will give governments even more power over your money.
I’m not here to debate whether that’s good or bad. That’s for you to decide.
Founders & Investors
It’s a big leap for founders and investors to bet on upcoming technology.
Imagine spending years of your life building a crypto startup only to then have your government ban crypto or impose massive taxes and disrupt your business.
This fear prevents a lot of brainpower and investor capital from entering the industry.
Regulatory clarity can encourage a bigger wave of talent and capital to enter web3. The results from this have a long lag time though — could take years for anything to materialize from new companies.
@POTUS put out an executive order in March 2022, asking different government organizations to come together to figure out how to regulate Crypto effectively.
It takes time for regulation to actually materialize, but I would wager that we’ll see some concrete regulations in 2023 or perhaps even sooner.
I imagine that the recent debacles with Luna, 3AC, Celsius, etc have only increased the urgency of regulating the industry.
Here are my speculative musings on what kind of regulations we are likely to see from the US government in the coming months:
- Stablecoins will have a high bar for safety, transparency, and auditing.
- DeFi protocols will be required to collect KYC information from users.
- Crypto companies (CeFi & DeFi) might be required to get special licenses.
- Centralized crypto companies will be restricted in what they can do with user funds.
- More compliance and auditing requirements will be imposed on all CeFi and DeFi companies.
- Privacy-focused networks and apps will have severe restrictions, and will possibly even be banned.
- New tax codes for DeFi / Crypto income.
Some of the regulations that will be introduced might not be fun for those of us used to the wild west landscape of crypto.
They might also impose hurdles for founders, making it even harder to build a successful business in the industry.
The US government has been relatively pro-crypto, presumably to keep innovative builders and companies as a part of the US economy, instead of driving out talent. US regulation will set the tone for many other governments to find the right balance for their citizens.