When it comes to trading stocks, to a certain extent, investors know what to expect. Stocks are heavily regulated, and these regulations protect investors from fraud and other risks. However, when it comes to cryptocurrencies, government regulations have yet to be put in place. This means the crypto markets carry less certainty with them, and hence, greater risk than the stock market.
For some investors, this has been a boon. Early crypto investors spent the previous decade profiting in the space despite, and perhaps because of, its unregulated nature. This was partially because these early investors seemed to find the lack of regulations a compelling reason to join in. In fact, many of these investors subscribed to the theory that cryptocurrencies could eventually change the very rules of global finance.
At their high in November 2021, cryptocurrencies combined reached a $2.9 trillion total market cap. Obviously, this is a drop in the bucket compared with the stock market’s $48 trillion value. But for an asset class that was little more than a decade old, it was significant.
However, since its 2021 peak, Bitcoin (BTC) has lost more than 70% of its total value. The crypto markets overall are now worth less than $1 trillion. Not to mention, it now looks like government regulations could be coming soon.
In March 2022, President Joe Biden signed an executive order to provide a “whole-of-government approach to addressing the risks and harnessing the potential benefits of digital assets and their underlying technology.” In addition, 10 countries have already launched a digital currency, and China intends to follow suit as early as 2023. In fact, more than 100 countries are exploring starting their own cryptocurrencies, and these countries combined account for 95% of global gross domestic product.
While some crypto investors are panicking, others are looking forward to what a regulated future could hold. Let’s dig into what regulations might mean for investors and the price of cryptocurrency assets.
— How regulations could affect investing in cryptocurrency.
— Who will be regulating cryptocurrencies?
— Cryptocurrency regulations and the price of cryptocurrencies.
How Regulations Could Affect Investing in Cryptocurrency
“Regulations are a positive aspect for the industry,” says Adam Reeds, founder and CEO of Ledn, a crypto-backed lending firm, because “many institutions and larger established groups are waiting on the sidelines.” In fact, he believes many of these institutions would like to invest in crypto, but a lack of regulations simply makes it infeasible for them.
In addition, regulations “should create a framework where there are disclosures,” says Katherine Dowling, general counsel and chief compliance officer for Bitwise Asset Management. These disclosures, Dowling goes on to say, will help create transparency for the overall investment class.
The importance of transparency for institutional investors cannot be understated. Due to the risk-management nature of institutions, there must be a risk profile for each investment. These kinds of risk profiles can only be built for transparent assets, which cryptocurrencies simply aren’t yet.
For example, the lack of transparency for the algorithmic stablecoin TerraUSD (UST) not only caused massive price drops for UST in May, but the collapse also affected its sister coin LUNA and BTC prices as well. A Chicago investor recently brought a securities fraud class-action suit against six crypto venture capital firms that backed Terra tokens in the months before the collapse.
This wasn’t the first time a cryptocurrency had caused severe financial hardships for investors. Ethereum’s DAO coin failed all the way back in 2016 due to a hack, which led to the theft of $60 million in Ethereum’s Ether (ETH) coin. Eventually, Ethereum’s underlying blockchain was forked and the stolen currency was returned, but the experience had profound effects. Not the least of which was the Ethereum community now having two different blockchains: Ethereum and Ethereum Classic.
More recently, a lack of transparency with Tether’s USDT coin has caused problems for the stablecoin. In fact, USDT’s issuer was fined $42 million by the Commodity Futures Trading Commission when the company was found to be in violation of the Commodity Exchange Act and other CFTC regulations. This was in addition to having already paid $18.5 million to the New York Attorney General’s office for a settlement back in February 2021. Much of the settlements and fines had to do with audit problems for USDT’s existing treasury. This is an example of a problem that could potentially be solved with greater crypto regulation.
In fact, until there are regulations governing the reporting and trading of cryptocurrency assets, it’s unlikely that any of these price drops will be the last, experts say. And for a large financial firm, this type of uncertainty is untenable. Due to their massive balance sheets, financial firms may avoid speculating in assets that could lose them massive amounts of capital due to underlying fiscal problems.
However, with the help of regulations and ensuing transparency, not only could large institutional investors stomach greater investments in crypto, those investments could help stabilize asset prices overall, says Vin Narayanan, chief strategy officer for KingsCrowd. In fact, Reeds adds, his company’s retail and high-net-worth clients simply want clarity when it comes to their investments. And until regulations exist, this type of clarity won’t be possible for cryptocurrencies.
The aforementioned regulations are clearly en route. The questions many crypto investors are now asking is: What will these regulations look like, and who will be enforcing them?
Who Will Be Regulating Cryptocurrencies?
Sen. Cynthia Lummis, R-Wyo., and Sen. Kirsten Gillibrand, D-N.Y., recently proposed the bipartisan Responsible Financial Innovation Act, which has now been referred to the Senate Committee on Finance.
One interesting aspect of this bill that’s incredibly important, Dowling says, is that it proposes having the CFTC be the primary regulator of cryptocurrencies. Interestingly enough, Dowling goes on to point out, “Gillibrand serves on the Agricultural Committee, which has oversight over the CFTC.”
Dowling points out that one of the biggest problems the discussion around cryptocurrency regulation has had is defining what “bucket” the asset class falls into. Are they securities? Are they commodities? Or are they another type of vehicle entirely?
Dowling says that despite how many investors think of them, “it’s not a foregone conclusion that these digital assets are all securities. In fact, many are not.” This means that the Securities and Exchange Commission may not be the best authority to handle crypto regulations.
SEC Chair Gary Gensler seemed to echo this sentiment when he recently pointed out that with regard to Bitcoin, at least, he considers the cryptocurrency to be a commodity. Of course, this falls in line with many crypto investors’ beliefs that Bitcoin is “digital gold.”
This is also a far cry from when Gensler agreed with former SEC Chair Jay Clayton, who said he believed “every ICO I have seen is a security.” An ICO is an initial coin offering, which is how many cryptocurrencies enter the marketplace. Chairman Clayton went on to say, then, that with regard to cryptocurrencies, the SEC has “jurisdiction, and our federal securities laws apply.”
This would not be the case, however, if cryptocurrencies were defined as commodities. There would be different definitions of the asset class, leading to different regulations. Gillibrand and Lummis should have a good take on these different regulatory classes: Not only does Gillibrand serve on the committee overseeing the CFTC, but Lummis serves on the Senate Committee on Banking, Housing and Urban Affairs, which oversees the SEC.
As Dowling points out, certain cryptocurrencies with certain attributes might still be considered securities, and these will most likely fall under the purview of the SEC. Dowling goes on to say that “creating these definitions and making sure they are correct” is extremely important. If you define cryptocurrencies incorrectly, she says, “you may be treating them in ways that aren’t appropriate for them.”
This could wind up being the most important role of Lummis and Gillibrand’s Responsible Financial Innovation Act: determining how the government defines cryptocurrencies and hence whose jurisdiction the individual currencies fall under.
With regard to the question, then, of who will be regulating cryptocurrencies: Right now, the verdict is still out, but two distinct possibilities are the CFTC and the SEC.
Cryptocurrency Regulations and the Price of Cryptocurrencies
Regardless of how cryptocurrency regulation unfolds, many experts in the field believe that coming oversight and regulation will ultimately help stabilize digital assets’ prices.
Cryptocurrency prices have been in freefall since the fourth quarter of 2021. For many retail investors, it appears a bottom may never be hit. Even the Chinese government is now forecasting that Bitcoin will go to zero. Of course, this kind of statement could be enough to keep many retail investors out of the asset class entirely, accelerating its losses.
Narayanan believes, however, that eventually regulations should help stabilize crypto prices. He says this is because regulations could allow for more institutional investment, with retail investors injecting more capital into digital assets. Massive inflows of capital could cause the prices of regulated cryptos to stabilize, attracting retail investors who haven’t taken the asset class seriously yet. This would further drive value and stability.
For investors who fear cryptocurrency regulations, Reeds says crypto price concerns today have very little to do with any pending regulation. He goes on to say that the current drop in cryptocurrency prices has more to do with global macro factors.
And that’s why Reeds’ organization is “having a lot of conversations, especially with Canadian regulators, and really looking forward to protecting our clients and making sure all information about these products is disclosed.” He says a nation will eventually house “the new SWIFT banking system for digital assets.” In order for a government stablecoin to become the global reserve for digital assets, that coin will have to be regulated and transparent, he explains.
Cryptocurrency may be falling in price right now, but the genie is out of the bottle. Even if Bitcoin does “go to zero,” it may be hard to imagine a future world where cryptocurrency doesn’t exist. And if regulation really is an answer to stabilizing crypto prices, competition on that field could allow new crypto leaders to emerge.
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How Will Cryptocurrency Regulation Affect Crypto Prices? originally appeared on usnews.com
Update 06/29/22: This story was published at an earlier date and has been updated with new information.