Will Government Crack Down On Bitcoin And Other Cryptos?

Posted: Feb 10, 2021 9:03 AM
Will Government Crack Down On Bitcoin And Other Cryptos?

Source: AP Photo/Kin Cheung

This winter has been quite the rollercoaster ride for the ecosystem of exchange platforms specializing in cryptocurrencies. Bitcoin’s dramatic bull run of November through early January prompted surging demand for transactions across all tokens. The United States Commodity Futures Trading Commission (CFTC) indicted four senior members of BitMEX, subsequently arresting one of them. 

Outgoing Treasury Secretary Steven Mnuchin proposed new regulations that would require exchanges to maintain detailed records on people who transfer certain thresholds of coin value and to file currency transaction reports (CTRs) in many situations. Now the Biden administration has announced a freeze on Mnuchin’s proposal, much to the relief of the exchanges and traders alike.

And yet, demand for bitcoin, ethereum, and thousands of alt-coins remains high. A new study from bitFlyer found that nearly a third of Americans see cryptocurrencies as an attractive investment, making it twice as popular as gold in this regard. Some 15% of the survey’s respondents said that they currently own crypto assets.

If regulation is inevitable in the months ahead, will we see things start to trend the other way?  

The BitMEX situation in particular has thrown a spotlight on anti-money laundering (AML) regulations, know your customer (KYC) rules, and by extension the entire premise of these exchanges. Analysts who blithely insist that BitMEX is “too big to fail” are ignoring the wider implications of the indictments. 

At the heart of the Mnuchin proposal and the BitMEX prosecution lies the question of whether crypto exchanges can continue to stake a claim for anonymity and a relaxed approach to KYC. There are worries that governments will continue to tighten enforcement of regulations on crypto exchanges, which could trigger an exodus of funds that may bring many exchanges down. 

In extremis, some people fear that governments will step in and demand oversight over all crypto trades, which would soil the decentralized nature of crypto exchanges. 

Exchanges Are Feeling the Heat

Many exchanges are nervous that the BitMEX situation is just the beginning, and central bankers are eager to take on full oversight when it comes to coin exchanges.

Despite these concerns, other voices are broadly positive about the possibility of increased regulations and their impact on exchanges. They see the oversight trend as a maturation moment for crypto exchanges to improve their trading rules and attract more honest traders and amateur trade.

To be fair, there are over 500 crypto exchanges in operation, so it’s unlikely that all of them can survive in the long term, and many are already vulnerable. Even before the winter, 2020 had already rattled many exchanges. March 12 was the most volatile day ever for the crypto market, when many investors liquidated their funds and left for good. In March-April, BitMEX alone saw an exodus of about 91,000 bitcoins valued at more than $700 million.

The average daily volume of top derivatives exchanges, including Huobi, BitMEX and OkEx, dropped from nearly 60% to 30%. While none of them crashed, all the exchanges were reminded of their fragility, and the stampede for the exit prompted them to strengthen their infrastructure.

However, the subsequent drop in volatility led to fears in July that low trading volumes would bring down many exchanges, and it’s dropped even further since then to a 23-month low. Despite some predictions that another spike could be approaching, and even though instability in general usually boosts crypto, recent chaos hasn’t provoked increased volatility or spiked trades.

As noted in a recent analysis from Bybit, the popular crypto derivatives exchange, a heightened sense of bitcoin’s volatility has heralded fear, uncertainty, and doubt (aka FUD) in the crypto markets. With the ecosystem already looking shaky, would increased regulation harm or help the situation?

Regulations Are on the Horizon

“Registration requirements are a cornerstone of the regulatory framework that protects Americans and U.S. financial markets,” said James McDonald, division of enforcement director for the CFTC. “Effective anti-money laundering procedures are among the fundamental requirements of intermediaries in the derivatives markets, whether in traditional products or in the growing digital asset market.”

The BitMEX indictment referred solely to the issue of Americans illegally trading on the exchange. Legally, Americans cannot use international crypto exchanges, but US traders get around the blocks with a VPN, and BitMEX (and other crypto exchanges) have not been implementing solutions that prevent them from doing so. 

But there are also rumors that BitMex founders will also be charged for breaching sanctions against Iran and North Korea. Because they’ve turned a blind eye to KYC, they served as a jumping-off point for their regimes to trade internationally. If this is true, it will receive a far harsher response from the government.

The UK government is traveling in the same direction. The Financial Conduct Authority (FCA) announced a ban on the sale and promotion of crypto derivatives to amateur investors. It’s worth noting that this ban only applies to amateurs, not to professional investors, and it’s for protective rather than punitive reasons. Amateurs often don’t understand the market, which is highly volatile, difficult to value, and in a sector riddled with abuse and crime.

The ban isn’t expected to make a big difference to crypto exchanges worldwide, since the UK’s contribution to trade is small, but this could be the sign of wider change. Many people are wondering if crypto exchanges are about to discover that they can’t evade AML and KYC obligations forever. 

Will Regulations Kill Crypto Exchanges?

There’s an innate tension between KYC/AML, and the anonymous nature of crypto. Many digital asset enthusiasts are opposed to KYC on principle. They love crypto because it’s unregulated, they crave privacy, and they view KYC as removing their anonymity and ability to hide from the government. 

To these crypto enthusiasts, regulations could destroy exchanges. They would lose their decentralized essence and bring crypto under government purview. A rise in regulations could push off many traders who value decentralization, slashing trading volumes and heralding the failure of many exchanges.

But there’s also a wave of opinion that this development would be no bad thing. Angel investor and blockchain consultant Adam Cochran pointed out, “There is a difference between wanting sovereignty and privacy over your funds vs enabling criminal activity.”

While unregulated rogue coin exchanges may fall, that could leave a firmer future for exchanges that already agreed to abide by KYC and AML. Companies like Diginex, which listed on the Nasdaq; CME, which trades bitcoin futures for institutions; and the BC Group, which has been licensed by the Hong Kong Securities and Futures Commission to run a digital exchange for accredited investors, have already moved towards regulations because they wish to serve institutional investors.

The exodus from BitMEX after the indictment was far below the amount of funds the exchange lost during the volatile days of March. Some $476 million left in October, compared with $700 million in March-April, indicating that exchanges should fear an unstable market far more than government regulations that could stabilize it.

For many investors, news of increased KYC and AML regulations is a good thing, because it tilts the playing field away from shady dealers and in favor of law-abiding traders who seek an honest profit. In this sense, more exchange oversight in 2021 could be crypto’s maturity moment.

Crypto Is Resting at the Crossroads

The BitMEX indictments could be the thin end of the wedge for crypto trading platforms, which could see the end of a golden run of freedom to make and break the rules at will. But there’s no need to fear the arrival of stricter regulations.

Rogue crypto exchanges may fail, but for those willing to adapt, this could be the moment that helps settle the markets, increase investor confidence, and encourage trade, thus strengthening the positions of crypto exchanges in the long term.