Regulation – Cryptocurrencies’ Biggest Issue

Are regulations here to make our life safer, or is it just to prevent cryptos from becoming too mainstream before they know how to control it?
Are regulations here to make our life safer, or is it just to prevent cryptos from becoming too mainstream before they know how to control it?

The roller-coaster of cryptocurrency pricing is on the downward slope again. Bitcoin has fallen by a quarter in the past month, with various other large currencies such as Ethereum and Ripple down more than 40%. This will crate regulation issues.

Sceptics point to the multitude of regulatory issues and avenues for fraud and outright theft. Advocates continue to insist that these are the “future of finance”.

One of the major reasons for the recent sell-off is that investors are selling their crypto to pay off the capital gains tax they are required to pay on their gains. It has been estimated that around US$25 billion is owed in the US alone.

But there is a more fundamental issue at play of investors hurrying to convert their profits from initial coin offerings (or ICOs) into fiat currency like dollars. This is where a new crypto token is created in exchange for existing cryptocurrencies like bitcoin.

The lack of regulation to safeguard the profits made from ICOs reflects the wider issue facing the future of crypto. If cryptocurrencies are to become a more mainstream asset, they will need regulation – but this will be unpopular with much of its existing fan base which is inherently libertarian.

ICO trouble

The transfer of crypto gains from an ICO to fiat currency can produce quite the scrummage as cryptocurrency investors attempt to exit the market with the greatest amount of value possible. In early 2018, it was reported that almost 46% of 2017 ICOs had already failed.

The pressure to exit in a timely manner has been exacerbated by the massive number of ICO scams that have taken place. Crypto analysis site Diar estimates that, since 2017, nearly US$100m had been lost to ICO exit scams where organizers have little or no intention of creating a financial product that will perform to the standard that is advertised to investors.

The cryptocurrency world is heavily unregulated and so ripe territory for scammers to operate. Fraud in cryptocurrency markets has to date taken multiple forms. As well as ICO issues, there has been fraud at exchange level, the most famous example of which was the collapse of the Mt. Gox exchange which once handled 80% of global bitcoin trading.

The substantial number of issues and vast sums of money involved has resulted in the US Securities and Exchange Commission casting its supervisory gaze on the crypto world.

Serious questions

A growing body of academic research has raised serious questions over the true underlying integrity of cryptocurrency markets. It highlights the various areas where regulation is needed if bitcoin and others are to have a viable future.

Declines in liquidity have also been found to contribute to the risk of a crash in Bitcoin. This is problematic given that, even under normal trading conditions, Bitcoin is found to be more volatile, less liquid and costlier to transact than other assets.

My own research has suggested that cryptocurrencies are only very lightly linked to other financial or economic assets, and that the majority are unaffected by the main market announcements. All of this goes to show that cryptocurrencies can be manipulated and do not reflect normal market activity.

The underlying economic value of cryptos has also been evaluated, with some suggesting that a crypto’s value is determined solely by the willingness of its holders to hoard. Others have found that crypto values are mainly a function of their network depth and not their intrinsic usefulness – again leaving it open to manipulation. Still others point to the economic limits to bitcoin arising from its mining cost.

To be merited as a somewhat viable and trustworthy financial market product, cryptocurrencies must in some way adhere to a common standard of international regulation. Until this occurs, we will continue to observe situations involving substantial theft from international exchanges, continued disquiet as fraudulent ICOs are uncovered with investor funds channelled around the world, and most interestingly, a market that has become so sensitive to minute details that even the smallest hint of strife can generate substantial price volatility. The challenge for proponents of cryptocurrencies is how to continue to promote their decentralized, anonymous, libertarian nature as their issuance and trading become more and more regulated.