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Published October 27, 2022

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The gray area of cryptocurrency regulation is a double-edged sword for investors and service providers. On one hand, cryptocurrency offers financial freedom and anonymity to users, but also presents risks to those who don’t have a good grasp of the technology.

As cryptocurrency markets mature, the industry is approaching an inflection point as governments across the world seek to develop regulatory frameworks for the digital financial space. Some countries accept cryptocurrency, while others have imposed blanket bans. A handful of governments have implemented heavy taxes on cryptocurrency, while others have taken a laissez-faire approach.

Cryptocurrency Regulations in the US

Crypto regulation in the US

Cryptocurrencies are subject to a variety of regulations in the United States, depending on the regulatory body. The US Securities and Exchange Commission (SEC) considers the majority of cryptocurrencies to be securities and applies existing securities laws. Investors must disclose any gains or losses in annual tax returns, and cryptocurrency service providers must register with the SEC.

The Commodity Futures Trading Commission (CFTC) considers cryptocurrencies to be commodities. It regulates bitcoin derivatives trading and requires cryptocurrency exchanges in the United States to comply with Anti-Money Laundering and Know Your Customer laws.

In March 2022, US President Joe Biden pushed forward an executive order for cryptocurrency that covers six areas: consumer and investor/consumer protection, financial stability, illicit finance, US oversight in the financial system of the world and economic competitiveness, financial inclusion and leading smart innovation in the space.

Stabenow-Boozeman’s DCCPA

There’s been a lot of talk surrounding a recently-proposed crypto regulation bill that’s raising questions about the future of decentralized finance (DeFi). The US crypto bill in question is Senators Debbie Stabenow and John Boozman’s Digital Commodities Consumer Production Act (DCCPA). 

So first of all: What is the DCCPA?

DCCPA details information on what are deemed digital commodities, brokers, custodians, dealers and platforms. It also specifies rules and guidelines that would oversee various entities in the crypto space.

One key set of players that remains untouched by the bill, however, are software developers, leaving free development open to them to create new innovation.

According to the US crypto bill, Bitcoin and Ethereum would be classified as commodities rather than securities, making these digital assets more akin to owning gold or oil as opposed to shares of a company’s stock. This would give oversight over to the Commodity Futures Trading Commission (CFTC) rather than the Securities and Exchange Commission (SEC) – a move that the majority of industry proponents are a fan of. 

The issue that many have expressed with the bill is that it introduces a requirement for human intervention – a critical crutch against proper decentralization. This would imply that DeFi protocols would have to work within the framework of the bill, which could stifle innovation in the space.

While Sam Bankman-Fried is a supporter of DCCPA, he insists that the bill offers more customer protection on centralized exchanges without sacrificing any freedom for DeFi, blockchains, and cryptocurrency software.

The bill seeks to address not DeFi itself, and imposes no requirements on DeFi developers, smart contracts, or validators, but rather the touchpoints at which centralized entities and crypto exchanges like FTX interface with digital assets. 

He thinks that proper crypto regulation should be good for the honest actors in the DeFi space, while punishing the bad ones. It should maintain the freedom of peer-to-peer transactions and decentralized blockchains. Specifically, he thinks this can be achieved through a blocklist policy. With blocklists, regulators would be able to prevent illegal transfers of funds associated with financial crimes while otherwise allowing free flow of commerce.

He believes the DCCPA should be able to achieve these outcomes assuming the finalized wording aligns with these measures. At the end of the day, the balance of upholding personal financial freedom while dissuading bad actors is of primary importance for crypto regulation.

OFAC Sanctions

Another key component of US crypto regulation is the state of Office of Foreign Assets Control (OFAC) sanctions and their implementation in the crypto space.

TRM Labs, a digital asset compliance and risk management firm that serves FTX US, Binance, and other major crypto entities, shed some light on OFAC’s effect on the decentralized ecosystem as a whole in light of the recent sanctions placed on Tornado Cash.

First, let’s give a brief overview of what happened with Tornado Cash for context.

Tornado Cash is a popular cryptocurrency “mixing” service that people would use to essentially wash off identities attached to any cryptocurrency flowing through the ecosystem. As each transaction is linked with a wallet address, authorities have been able to trace these cryptocurrencies to corresponding owners. While Tornado Cash can be used for plenty of non-nefarious reasons, bad actors have grown fond of the platform for being able to walk away unscathed from crypto financial crimes as they laundered money through its platform.

In light of these criminal instances, OFAC placed sanctions on Tornado Cash, which requires any and all property that’s associated with Tornado Cash and owned by US citizens to be blocked or reported to OFAC. This is the first instance in the US in which OFAC directly sanctioned smart contracts on the Ethereum blockchain.

With OFAC, all covered DeFi entities are required to abide by US sanctions, lest they face punishment otherwise. This has spurred many DeFi entities to introduce sanctions compliance programs that institute policies for functioning within this framework.

In the case of TRM Labs, they have worked with many DeFi protocols such as AAVE to implement a blocklist on addresses that have transacted with sanctioned addresses. If data from an address checks one of the boxes specified below, they may be subject to TRM’s blocklist:

On-chain risks presented by TRM

After the implementation of the Merge, an increasing amount of Ethereum blocks being produced are OFAC compliant, meaning that sanctioned addresses’ transactions are not included in those blocks.

As of now, more than half of Ethereum’s blocks are OFAC compliant.

More than half of Ethereum blocks are OFAC compliant

The question naturally emerges, then, as to how regulations on the crypto space are becoming a censoring, and thus centralizing, force for major blockchains like Ethereum.

Some critics of Sam Bankman-Fried’s comments on implementing blocklist policies suggest that he wants blockchains and validators themselves to essentially police the network. However, Sam Bankman-Fried reinforces that validators have a sole duty to correctly validate blocks, not determine their legality. The compromise, he thinks, should be to make a clear distinction between US-based DeFi frontends and the validators/smart contracts that they operate on. This way, blockchains can preserve their core freedoms while US-based entities operating on them steer clear of fueling illicit financial activity.

What Cryptocurrency Regulations Are Already in Place?

Let’s review how different economies across the world treat cryptocurrencies as of April 2022: 

  1. Australia is relatively friendly towards cryptocurrencies. It treats bitcoin and other cryptocurrencies as property and taxes them as Capital Gains. Service providers must comply with the Anti-Money Laundering and Counter-Terrorism Financing Act (AML/CTF 2006).
  2. China’s central bank imposed a blanket ban on any cryptocurrency-related activity.  
  3. In June 2021, El Salvador became the first country to designate bitcoin as legal tender.  In April 2022, The Central African Republic (CAR) followed up to become the second country to legalize bitcoin as legal tender.
  4. Germany is developing regulations for cryptocurrencies. The government introduced the Fund Allocation Act that allows Special Alternative Investment Funds (S-AIFs) to allocate up to 20% of funds under their management towards cryptocurrency assets. 
  5. The Indian government previously had a ban on cryptocurrency transactions, which was overturned by their Supreme Court, and declared a flat 30% tax on any income generated from selling cryptocurrency assets. Traders will also have to pay a second tax of 1%, which will be deducted at the source on all transactions. 
  6. Kazakhstan retains lax laws on cryptocurrency transactions. Bitcoin mining is legal in the country. However in 2021, after facing power shortages, the government proposed a draft bill to limit the power supply of new miners to 1 megawatt for each mine, and just 100 megawatts throughout the country’s fleet of miners.
  7. Malta has not conferred legal tender status to cryptocurrencies but recognizes them as ​​”a medium of exchange, a unit of account, or a store of value.”  
  8. Singapore is leading the charge for global crypto regulation. The country’s Payment Services Act began in January 2020, giving a proper framework for trading and using cryptocurrencies. After an application process, the Monetary Authority of Singapore is issuing digital payment token licenses to companies involved in crypto as well as virtual asset service providers. 
  9. Thailand is taking a harsher stance on cryptocurrencies. The Thailand Security and Exchange Commission (SEC) prevents cryptocurrencies from being used as a payment method. However, they maintain crypto’s position as a “digital asset,” allowing residents to exchange cryptocurrencies through governed and licensed crypto business operators.
  10. In Indonesia, regulators bar crypto from being used as a currency or for payments, however, cryptocurrencies are considered commodities, allowing the country’s citizens to trade and speculate with them. However, the government plans to impose greater restrictions on crypto exchanges there, requiring at least two-thirds of the exchange’s board of directors to be Indonesian citizens that live in the country.
  11. Japan has legalized cryptocurrencies in the country, and imposes no restrictions on owning or investing in them. The Payment Services Act in Japan requires crypto exchanges to register with the Financial Services Agency. 
  12. The UK has put regulations in place that allow its citizens to buy and sell crypto, however, crypto derivatives are not allowed in the country. Crypto exchanges in the UK must register with the Financial Conduct Authority (FCA).
  13. France characterizes crypto as “intangible moveable assets, “ and thus permits the ownership and trading of cryptocurrencies, as well as mining cryptocurrency.
  14. Italy considers cryptocurrencies “financial instruments.” Cryptocurrencies and foreign currencies are treated similarly in Italy, so they are thought of as a form of currency. Crypto profits from trading cryptocurrencies incur a flat 26% tax rate.
  15. Spain has no specific legislation in place for cryptocurrencies, other than the fact that they do not consider crypto to be legal tender. Citizens can buy, sell, and mine cryptocurrencies, and all people making earnings from crypto must disclose them to the Spanish Tax Agency.

Benefits of Cryptocurrency Regulations

Benefits of crypto regulation

Some people view all regulations as a hindrance to innovation, but measured regulation can benefit the cryptocurrency industry.

Regulating bodies can set network security standards and help enforce prudent fund management practices. They can also help mitigate volatility that’s associated with cryptocurrencies and reduce instances of market manipulation.

Market manipulation and other fraudulent activities are commonplace in unregulated markets, as there’s little recourse when cybercriminals steal money from investors. Regulated markets can provide more investor protections against fraud and increase overall confidence in the industry.

The liberalization and regulation of cannabis in many US states shows that measured regulation legitimizes industries and drives mainstream adoption. A similar regulatory posture may bring new users to crypto and positively influence the industry’s network effects.

Effects of Cryptocurrency Regulations

Governments face challenges when regulating cryptocurrency. Countries categorize digital assets inconsistently and none have created a definitive standard for regulating the industry yet.

Cryptocurrency regulations need to encourage the development of blockchain technology while protecting consumers from fraud and illicit activity.

Governments like China and India show that prohibition stifles innovation and encourages illegal marketplaces. At the same time, the United States, Australia, and Japan show how moderately regulated markets may look in the future.

Many governments are currently considering an array of regulations that will shape the future of cryptocurrency. The regulators may build consumer confidence in the industry with measured regulations, or they may slow innovation with heavy-handed policies.

Navigating the Future of Cryptocurrency Regulations

The crypto industry sits at an inflection point as governments develop regulatory frameworks. Ineffective regulation discourages development and may threaten the decentralized and anonymous tenets of blockchain technology.

On the other hand, effective regulation encourages innovation while protecting consumers.

To learn more about the ever-evolving cryptocurrency industry, check out the FTT DAO blog. Be sure to follow FTT DAO on Twitter and subscribe to the FTT DAO YouTube channel to keep up with the latest FTX news and crypto developments.

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