The state of crypto: Making sense of US cryptocurrency regulations

The cryptocurrency ecosystem has experienced explosive growth since Bitcoin was introduced in 2009. Today, thousands of cryptocurrencies (or cryptos) are in circulation, many of which have skyrocketed in value, while others have been abandoned by developers or exposed as scams.

Most businesses and retail stores don’t yet accept crypto as a form of payment, but decentralized digital currencies are gaining broader acceptance. The online payment service PayPal allows customers to buy and sell using bitcoin, and credit card company Visa recently announced it would recognize cryptos as a method of payment. Amazon plans to issue its own cryptocurrency, which customers can use to pay for goods and services on the site. Cryptos can also be used for low-cost money transfers, non-cash remittances to select nations, and anonymous financial transactions.

Progress towards acceptance of its use on financial markets has been uneven. In early June, El Salvador moved to accept bitcoin as legal tender. Later that month, however, the U.K. banned the cryptocurrency exchange Binance from regulated activities in its markets.

What is the state of cryptocurrency today?

The top cryptocurrencies by market cap include Bitcoin, Ethereum, Tether and Binance Coin, but thousands of different digital tokens, the virtual money used to perform financial transactions online, are available on the market today. In the United States, cryptocurrency is not legal tender and isn’t backed by the Federal Deposit Insurance Corporation (FDIC).

Blockchains and cryptocurrency exchanges

Cryptocurrencies are enabled by a technology called blockchain, a type of database that stores data in sequenced blocks and that links new data to preceding blocks of information. A blockchain can store different types of information, but its most popular use is as a ledger to record financial transactions. The technology is decentralized and accessible so that no single person or entity controls the data. Data entered into a blockchain are permanently recorded and unalterable.

Buying and selling cryptos requires a digital wallet. Creating an account on a cryptocurrency exchange—for example, Coinbase—allows you to buy cryptocurrency and transfer it to another digital wallet. The process is largely anonymous, and traditional banks or financial institutions don’t need to be involved in the transaction (other than the initial funding transfer to the service).

While people use cryptocurrency for many legitimate purposes bad actors can take advantage of the anonymity of crypto transactions to fund illicit activities, including the financing of terrorism, money laundering, tax evasion, and investment fraud. The growing popularity of cryptocurrency has drawn the attention of U.S. regulators and law enforcement agencies. Concerns over the growth of crypto crime, combined with wild swings in crypto valuation, have renewed calls among lawmakers and investors for stricter regulation.

Crypto regulations in the United States

As investor interest in Bitcoin and other cryptocurrencies continues to surge, the regulatory environment for digital assets remains confusing and uncertain. The complex nature of cryptos has led to different interpretations of how cryptocurrency should be understood or regulated, leading to varying proposals from the Securities and Exchange Commission (SEC) and the Commodities Futures Exchange Commission (CFTC), among others.

The SEC sees cryptos as securities and regulates initial coin offerings (ICOs), the cryptocurrency industry’s equivalent of an initial public offering (IPO), through which new companies attempt to raise funds. The CFTC, which oversees both foreign currency exchange markets and commodities futures markets, refers to cryptos as commodities, while the Internal Revenue Service (IRS) treats them as taxable assets. In fact, the Treasury Department now requires any cryptocurrency transfer worth $10,000 or more to be reported to the IRS.

The Financial Action Task Force (FATF), an intergovernmental organization that sets international standards for preventing money laundering and terrorist financing, recently released new draft guidance on regulating cryptos and other virtual assets. If adopted, the guidelines would require the identification of parties involved in virtual asset transactions. FATF has long advocated for a more stringent approach to regulating the crypto sector.

As players in the financial services and crypto industries seek more regulatory clarity from the SEC, CFTC, Treasury, and Federal Reserve, friction among regulators is a key obstacle to a quick rollout of new regulations in the U.S.

The Anti-Money Laundering Act of 2020 

The Anti-Money Laundering Act of 2020 (AMLA 2020) amends and updates the Bank Secrecy Act (BSA) and represents the most significant overhaul in decades. In addition to modernizing AML and counterterrorism financing (CTF) laws and regulations, the AMLA 2020 transforms the way the federal government and private sector respond to emerging threats.

Codifying prior guidance from the Financial Crimes Enforcement Network (FinCEN), the AMLA 2020 requires entities that exchange or transmit virtual currency to register as money services businesses (MSBs). Under the new law, these entities must now meet BSA registration and compliance requirements. In addition, cryptocurrency-to-cryptocurrency transactions fall under the scope of the AMLA 2020 reporting requirements. Forthcoming regulations will provide further guidance.

The act also directs federal financial regulators to study cryptocurrencies and other emerging payment systems and to report on their use in money laundering and illicit activities to Congress. The goal is to use the findings to adapt regulatory frameworks to address emerging fintech technologies.

What’s next in cryptocurrency regulations

Recently, FinCEN, an agency of the U.S. Treasury Department, issued a notice of proposed rulemaking that establishes requirements for transactions involving legal tender digital assets or convertible cryptocurrency. Under the new rules, banks and MSBs would be required to verify the identities of customers, submit reports, and keep records on transactions of greater than $3,000 that involve digital wallets that are either not hosted by a financial institution or hosted by one located in a high-risk jurisdiction.

Reports would need to include the name and address of each party involved in the transaction, the time of the transaction, the type of cryptocurrency used, and the assessed value of the transaction in U.S. dollars. FinCEN argues that the reporting is necessary for national security and will allow law enforcement agencies to more quickly track and stop the funding of cybercrime, drug and human trafficking, and terrorist attacks.

How the SEC Chair sees crypto regulation

The Biden administration has frozen the FinCEN proposal, but Gary Gensler, the president’s appointed chair of the SEC, said at a recent House committee hearing that the crypto industry could come under greater regulation. Allowing the SEC to regulate cryptocurrency exchanges, he said, would help protect investors and prevent crypto market manipulation.

Gensler, who researched and taught courses about cryptocurrencies and blockchain technology at the Massachusetts Institute of Technology, is seen as a crypto-friendly regulator, but the CFTC and FinCEN will also play a role in shaping future regulations.

Treasury Secretary Yellen calls for a regulatory framework

Treasury Secretary Janet Yellen is more of a crypto skeptic and has referred to bitcoin as a highly speculative asset that can be extremely volatile. In her confirmation hearings, she voiced concerns over the potential use of cryptocurrencies for money laundering and terrorism financing. However, she also said the U.S. needs to encourage the use of cryptos for legitimate activities. She intends to work closely with the Federal Reserve Board and the other regulators on how to implement an effective regulatory framework for these and other fintech innovations.

As the Biden administration and federal regulators work to reach a consensus on new regulations, cryptocurrency companies are scrambling to influence the rules and policies that will shape the course of this rapidly evolving industry.

The future of cryptocurrencies and the digital dollar

The framework for a regulatory system remains uncertain, even as multiple federal agencies and departments continue to grapple with questions related to tokens—the cryptocurrencies themselves—and the exchanges or platforms on which people buy and sell digital assets. In the long term, more stringent regulation could add further legitimacy to cryptocurrencies and protect both exchanges and investors.

In the meantime, Jerome Powell, the chair of the Federal Reserve, has expressed interest in developing a Federal Reserve-issued digital dollar but points out that significant technical and policy questions remain.

The Digital Dollar Project, an organization led by former U.S. regulators and consulting firm executives, is studying the creation of a central bank-issued, tokenized form of U.S. currency. The organization recently announced its intention of launching pilot projects that will test how a Federal Reserve-issued central bank digital currency (CBDC) may operate.

In the twenty-first century, the financial world revolves around emerging technologies. The cryptocurrency industry is one more part of the ever-changing fintech landscape.