Regulatory Clarity For Cryptocurrency
Updated: Feb 6, 2022
Given the uncertainty created by unclear definitions, unrelenting innovation and the absence of regulatory clarity, the early evolution of the cryptocurrency market has been left open to fraud and wild speculation. This negative perspective is the main cause of 'drag' on crypto mass-adoption.
Crypto enthusiasts and believers would point out that this unregulated state has led to the emergence of some extremely interesting and progressive projects, which has delivered some 'real-world' success stories. Out of chaos comes order and progress, right?
That is certainly the dream - but how does crypto transition from a rogue asset class into a mature, stable and investable one?
The SEC, FINMA and IRS are all trying to get to grips with this brave new world - but there is still no clear and defined legal or regulatory framework in place to define the way forward and provide certainty to potential crypto traders and investors. It is also fair to say that, driven by a lack of understanding and the crypto market's 'Wild West' reputation, there are many that rightly or wrongly retain a healthy dose of scepticism.
The ongoing lack of regulatory clarity is undoubtedly continuing to have a negative impact on the rate of adoption for the most viable crypto 'projects'. You only need to look at the ongoing battle between Ripple and the SEC for evidence of that!
A flash of regulatory certainty would certainly place rocket-boosters under the boots of the more reputable crypto projects and, maybe more importantly, be a nail in the coffin for those less-than-reputable crypto projects.
It will come, eventually. Not all at once, but slowly over time. And when it does, regulatory clarity will undoubtedly be a critical juncture in the evolution of crypto - a critical 'fork' in the road if you will - and will enforce a survival of the fittest regime through the cryptosphere.
Those pioneering 'projects' at the tip of the crypto sword are leading the way by educating and working with those in positions of power at the world's various regulatory bodies. This concerted effort is likely to go under-appreciated for the time-being and will be drowned-out by the noise - which is a shame. But hopefully, with the advantage of hindsight, history will be kinder.
Our view at BullsEye continues to be that until regulatory certainty is achieved through the introduction of a regulatory framework, crypto's reputation will continue to hinder real-world adoption, support toxic crypto navel-gazing and the wild speculation will continue unabated.
For the time-being we need to try make sense of the uncertainty where possible and remain patient. After all, as much as well thought-out regulation would be enormously helpful, a rushed and ill-judged crypto regulatory framework could be disastrous.
So (whilst we wait) in this BullsEye Insights article we explore the existing state of play and examine the current set of definitions that help make sense of it all.
Let's start with the basics.
What is a cryptocurrency?
Cryptocurrencies are the digital representation of decentralised value on a shared peer-to-peer blockchain whose transfer is based on cryptography and whose emission rules are based on an open source algorithm.
Cryptography refers to the use of encryption techniques to secure and verify the transfer of value - transactions - occurring on the blockchain. Bitcoin represents the first decentralised cryptocurrency, which is powered by a public ledger that records and validates all transactions chronologically, called the Blockchain.
Below is an overview of how the blockchain works:
(Source: The Bernie Group)
Cryptocurrencies are typically classified into one of two main categories:
Bitcoin and hard-fork variants of Bitcoin - As the first of its kind, Bitcoin is its own category. And there are those cryptocurrencies that are descendants of Bitcoin, where the code has been changed to provide Bitcoin 'forks', such as Litecoin (LTC) and Dogecoin (DOGE).
Altcoins - these are cryptocurrencies based on other blockchains, such as Ethereum (ETH), Solana (SOL), Cardano (ADA) and XRP (XRP).
Further categories and sub-categories have since been created using the “classic” cryptocurrencies, driven by functional evolution of and for technological evolutions. Among these, are crypto tokens, which can be defined as a subset of cryptocurrencies that are not based on their own blockchain, but ones that make use of other blockchains.
Crypto tokens - is it an asset, utility, equity or security?
As you'd guess from the name itself, asset tokens represent the right of ownership of a certain underlying asset (be it material or immaterial).
On the other hand, utility tokens serve as a means of accessing goods or services via a blockchain-based infrastructure. They have typically been used to finance projects, mostly blockchain-related ones. A classic example of this is the utility tokens that are typically launched by ICOs - think Binance Coin (BNB).
Equity tokens basically represent the ownership of the underlying company, sharing its fortunes and possible failures - much like a traditional equity share you might trade on the stock exchange, as the name suggests. And, like the ownership of Amazon or Google shares, the rights and various subcategories of shareholders are defined by the company’s instrument of incorporation and its amendments.Unlike the traditional system in which shares are recorded in a database accompanied by a paper certificate, equity tokens are recorded on the blockchain referring to the company’s ownership.
According to the company’s needs, much has been heard recently about ETOs (Equity Token Offerings). A practical example is the case of the German company Neufund, which has proved to be a true pioneer for this hybrid model of fundraising.
Security or not, this is a hot topic of debate amongst regulatory experts ! This is the centre of the crypto regulatory debate at the moment.
Security tokens are real financial investment products for which the holder holds part of the value of the underlying, which is created by a third party. The SEC, in order to understand if a token is a security, uses the Howey test (a judicial case between the SEC and W.J. Howey Co.), which is a compound test stating that a financial product counts as a security if it involves a consumer investing money in a joint venture with the expectation of profit derived mainly from the efforts of others.
A subcategory of security tokens is debt tokens, which represent debt and therefore will be valued on the basis of the amount of the capital/principal, of its interest and of the reliability of the debtor; that which in the traditional finance is represented by bonds or mortgages.
Let's not forget about stablecoins!
Stable coins are tokens designed to minimise price volatility, anchoring its value to fiat currencies or scarce commodities, such as gold with a one-to-one ratio. One of the main stablecoin examples is Tether (USDT). Moreover, decentralised stable coins have recently entered the scene, supported by cryptocurrencies, that is with a collateral that, instead of being a fiat or a raw material, is a cryptocurrency: in this case, the collateralisation is done on-chain (i.e. on the blockchain).
And Non-Fungible Tokens (NFTs)?
An ecosystem apart is made up by NFTs, non-fungible tokens that, unlike Bitcoin and other cryptocurrencies, is not interchangeable (or fungible).
NFTs are also called collectable tokens or "crypto-game" tokens. The most famous is CryptoKitties that uses NFTs on the Ethereum blockchain.
Patience is a virtue
Phew. That's a lot to take in. As you can see, there's a lot of work required to implement the kind of regulatory framework needed to provide clarity and facilitate crypto adoption. And there's the immediate need for the regulators to play catch-up first. If my experience of working in the heavily-regulated financial sector is anything to go by, and if the introduction of crypto-regulation is to be done well, these things take time. A. Lot. Of. Time.
You need to remember, regulators aren't known for their innovation and are often found behind the curve. It's not necessarily their fault - that's just the way the world works. And then by the time they have caught-up, the world has moved on. And as we know, the crypto world moves fast. Be patient, it will come.
Our advice: remember why you're here
The crypto world is made up a wonderful mix of people, with varying motives. There are those who are here because they truly believe that the future lies with blockchain technology and the evolution of a decentralised digital form of currency. They long to take power away from the centralised institutions, as they see it. Then there are those that are driven by intrigue and a desire to seek-out volatile markets to trade for a profit. At least that's the idea! There are those who have been sucked into the hype-vortex that is swirling around the 'next big thing' - after all, we all wish we could have invested in Apple, Google, Microsoft, Amazon or more recently Netflix, before they became the household juggernauts that they are today.
But whatever your reason for being here, remember one thing at all times - why you are here.
The principles for investing - be it stocks, commodities, foreign exchange or cryptocurrency - remain largely the same. Over the long-term, those investments that deliver real-world value will also offer real-world returns for investors. Seek out value and be patient enough to reap the rewards!