Congratulations to our Fall 2021 Undergraduate Essay Contest runner up, Ieva Varanauskaite!
IEVA VERANAYSKAITE – FEBRUARY 22nd, 2022
Cryptocurrencies have quickly become a newly emerging asset class (Corbet et al.,2018) and a part of financial markets (Gajardo et al., 2018), with growth in quantity mined and value. For investors cryptocurrency offers portfolio diversification and expected high returns, with cheap transaction fees due to a lack of a ‘middleman’ from its decentralised nature. Investors can exchange cryptocurrencies into fiat currency, purchase and sell, and speculate on the price of cryptocurrencies with futures amongst other options (Hong 2017). This variety underscores the attractiveness to a multitude of investors and firms.
Despite the appealing characteristics of cryptocurrencies, potential shortcomings are laced into its operation. Transaction fees are approximately $0.40 cents/transaction, but as Brito, Shadab, and Castillo (2014) note, the system lacks consumer protection measures, such as
KYC (know-your-customer) and anti-money laundering policies. The detriment is exemplified by the information asymmetry that exists in the markets due to the lack of understanding of the underlying technology, with platforms deficient in transparency. This exacerbates concerns over cash reserve availability to satisfy claims if all withdraw assets simultaneously, as platforms rarely disclose how much of their consumers assets they’re holding.
Furthermore, monetary policy has potential to become ineffective at regulating the economy as, if widely popular, cryptocurrencies can disrupt payment systems and avoid regulatory schemes as there is no unanimous interest rate (Claeys et al., 2018). A further issue is tax evasion- government policy currently tackling the financial intermediaries through which tax evaders operate (such as the FATCA being established and requiring FFI’s to identify their US account holders) and not jurisdiction (Marian 2013 p.38). There’s a crack in policy as cryptocurrencies have the characteristics of tax havens. Sophistication is improving as tax exempt third parties are signing Bitcoin-equity swap contracts and buying commodities and securities.
In establishing regulation, there’s debate over whether cryptocurrency is a currency, a payment system, a property or a hybrid of all (Middlebrook and Hughes, 2014). Especially considering how certain cryptocurrencies have different design feature protocol, such as Ethereum allowing users to program ‘smart contracts’ that mimic physical ones, and are stored on a decentralised blockchain database, as contrasted with Ripple’s ‘closed’ blockchain where users control the transactions verified on the network. The DCEA defines a digital commodity as a personal property that is tangible, freely exchangeable and can be freely transferred and held (Dig. Commodity Exch. Act of 2020), which is different from FinCEN’s previous implication of cryptocurrency as a money transmission. This provides a means for Congress to provide explicit guidance via legislation to create more stability in the cryptocurrency market (Bagby et al., 2019) by establishing conditions on specific types of cryptocurrencies that companies can follow to curb illicit activity. The DCEA amends the Commodity Exchange Act to create defined limits between the CFTC and the SEC by establishing a regulatory outline that protects consumers and protects market integrity.
Notably, regulation attached to a cryptocurrency has just as much impact on its success in the market regardless of the cryptocurrencies characteristics. FinCEN ruling that any firm that transfers funds from one person to another requires a money licence, which applies to cryptocurrencies, and as of March 2013, the Bank Secrecy Act applies to cryptocurrency markets as exchangers and operators are required to register as a Money Service Business, meaning complying with anti-money laundering regulations. Despite the range of approaches, Congress has not taken explicit action and has left federal agencies responsible for regulation.
Currently registering with the CFTC, which enforces jurisdiction and provides the public information on cryptocurrency, as a digital commodity is voluntary. A tighter coordination of the CFTC and DCEA, with clear guidance from Congress that focuses on consumer protection would foster growth of digital commodities by building on consumer trust (Meredith and Tu, 2015). Improvements could be made on the DCEA language, as noted by Makonnen (2018), which would provide guidance on jurisdiction that would aid in companies’ clarity, preventing fears of regulatory overreach and establishing a comfortable position between absolute anonymity and complete openness. This would furthermore reduce the information failure investors experience with the complex and new technology of digital commodities, allowing for more informed and less risky decisions.
Overall, improper regulation limits the ability for companies to operate and develop, driving firms away from the US. A cryptocurrencies’ success depends equally on its ability to flourish in a regulated system either from self-regulation (private regulatory bodies such as the Bitcoin foundation) or state intervention, and its economic viability in the long run.
Disclaimer: The views published in this journal are those of the individual authors or speakers and do not necessarily reflect the position or policy of Berkeley Economic Review staff, the Undergraduate Economics Association, the UC Berkeley Economics Department and faculty, or the University of California, Berkeley in general.
