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Protocol | Fintech

Washington is rushing to regulate crypto. It’s a mess.

The SEC, CFTC, IRS, FinCEN and Congress all want a piece of crypto oversight. The confusion has some in the industry calling for clearer regulations.

SEC headquarters in Washington

The SEC is just one of the agencies considering new cryptocurrency regulations.

Photo: Saul Loeb/AFP/Getty Images

The wild swings in crypto prices this year have enthralled and disheartened investors, alarmed Wall Street and focused the attention of regulators and lawmakers who already had cryptocurrency in their sights.

With shares of Coinbase, a prize of Silicon Valley investors who placed early bets on cryptocurrency markets, swinging along with the price of Bitcoin, tech is worried too.

The soundness and stability of cryptocurrencies has gone from a fascination of early, enthusiastic adopters to a mainstream concern. One particular worry is the ability of vague tweets from a single person — Tesla CEO Elon Musk, who has mixed his personal ardor for cryptocurrencies with the electric-vehicle company's business — to send crypto prices gyrating.

Subscribe to Protocol | Fintech for even more on crypto — and the latest news, analysis and research on fintech.

Washington once seemed befuddled by cryptocurrency, handing out confusing rulings. But the SEC is now chaired by Gary Gensler, who taught a course on blockchain at MIT. He made it clear at a recent House committee hearing that the crypto industry could come under greater regulation. "If one trades bitcoin in America today, there's not an investor protection regime," he said.

The early crypto scene was dominated by libertarian types seeking to evade or defeat regulation. But now, a substantial number of players in the crypto industry have been seeking more regulatory clarity. There are a number of areas where the industry interacts with regulators, from banking to securities to taxes.

That's part of the problem: Tokens that act like securities could fall under the Securities and Exchange Commission. The Commodity Futures Trading Commission is eager to keep its oversight of currency markets. And the Internal Revenue Service wants to make sure transactions that result in gains are properly taxed.

Read more: Crypto regulation is coming. Even regulators aren't sure how.

While it's unclear if or when Congress might pass legislation on the crypto industry, these agencies could have a major impact on how the industry operates. Yet key agencies still lack permanent heads, and future appointments could shift regulatory strategies considerably.

Here's a rundown of where regulatory efforts stand.

Crypto exchanges

One big question is who is responsible for regulating crypto exchanges. The SEC's Gensler in his recent remarks said he was concerned about manipulation and is reviewing how to regulate crypto exchanges.

Currently, crypto exchanges have no overarching regulation, as equity markets do. Coinbase, for example, is registered in most states with a money transmitter license, but not as an exchange. The Office of the Comptroller of Currency has granted national trust charters to a handful of exchanges, but the agency's new chief has called for a review of crypto rules.

Read more: Bitcoin is crashing. Coinbase is looking beyond trading.

Those patchwork frameworks are designed to keep customers' money secured and guard against money laundering, but they're not meant to prevent price manipulation in the way regulations of securities exchanges and commodities futures do.

The House of Representatives passed a bill in April to create a digital asset working group with the SEC and CFTC. The group, which would include industry companies, would produce a report within a year on regulatory framework for digital assets. The fate of that bill in the Senate is unclear.

Also, the SEC and CFTC already have a cross-agency working group on crypto. "It's not clear to me what a committee like that is going to do," said Jerry Brito, executive director of the Coin Center, a D.C. industry policy group, referring to the new proposal.

Last year, then-Rep. Mike Conaway proposed the Digital Commodity Exchange Act, which would create new regulation of "digital commodity exchanges" under which crypto exchanges could opt in to regulation by the CFTC. The CFTC currently oversees foreign currency exchange markets and commodities futures markets. But rules for swapping heads of cattle don't translate well to dogecoin and NFTs, and the commission currently has limited oversight of crypto trading exchanges.

That bill also would allow token sales to proceed as regulated securities under the SEC's purview and then, if they pass a certain test, become commodities overseen by the CFTC. That could resolve lingering questions about the exact point in time that a project that raises capital for a future planned token as a security offering — a SAFT — later becomes a commodity that can be freely traded, Brito said.

However, the bill did not pass and Conaway has retired; the bill would need to be reintroduced in this Congress.

The SEC has an ongoing case against Ripple, the issuer of the XRP token and creator of the Ripple network, and two of its executives. The question of whether XRP is a security has been hotly debated in the industry for years. The legal action could prove to be a landmark for the industry.

Some in the industry believe the SEC should more clearly state what is a security — which requires a slew of regulations and investor protections — and what isn't. But the SEC seems to be fine with what it has laid out so far and what enforcement actions it has taken, Brito said.

The CFTC doesn't have a permanent head yet, but Chris Brummer has reportedly been a lead candidate. He has a deep background in crypto and is well-liked in the industry.

Cross-border questions

The Financial Action Task Force, a group of 200 countries and jurisdictions that sets international standards related to money laundering and terrorist financing released a draft of new guidance on regulating digital assets in March.

Some in the crypto industry aren't happy. Coin Center argued that the guidelines are overly broad in requiring companies that aren't acting as custodians of cryptocurrencies to register and conduct anti-money laundering activities. Currently FinCEN requires only those controlling the assets be regulated as money transmitters. The draft guidelines also seem to suggest prohibiting peer-to-peer cryptocurrencies and privacy coins, Coin Center said.

The guidelines would also add counter-party identification, similar to what FinCEN recently proposed in a rule that was hotly contested by Coinbase and others. FinCEN hasn't made a decision on that proposed rule yet.

Read more: Andreessen Horowitz calls crypto proposal 'an ill-advised regulation'

Then there's China. What happens in that country often has an outsized effect on the crypto market, due to China's role as a hotspot for crypto mining and a highly-active community of crypto traders on social apps like Weibo.

China's regulators this week effectively banned financial institutions and payment companies from most uses of cryptocurrencies. Chinese citizens can still trade crypto, but often need to do it through offshore exchanges. Yet the country remains interested in digital currencies, including the creation of a digital yuan.

Taxing matters

The IRS has been less vocal on cryptocurrency, though on Thursday, the Treasury said the tax agency would require disclosure of cryptocurrency transfers worth more than $10,000.

Beyond beefing up reporting requirements, there are two categories of issues. First, what constitutes income and basis, a matter that gets complicated as the tax authorities have to figure out what to make of technical aspects of cryptocurrencies like hard forks and airdrops.

Bitcoin had a hard fork in 2017, which resulted in holders of bitcoin receiving bitcoin cash tokens. Some reported the bitcoin cash they received as income; some reported only the sale of bitcoin cash as income; and others treated it like a stock split. "There's never been a clear ruling," Brito said.

Rep. Tom Emmer reintroduced a bill this week to require the IRS to create a safe harbor until it clarifies that issue.

The second issue is whether cryptocurrency should qualify for a de minimis exemption. Some in the crypto industry believe there should be an exemption for crypto similar to a law for foreign currency. (The scenario envisioned is a U.S. tourist who bought euros for a trip to pay for meals and incidentals, and finds herself with a paper gain as the currency swings.) A bill has been proposed that would make gains from cryptocurrency equal or less than $200 not taxable.

This could apply not just to buying coffee with crypto that's appreciated in value, but also for other uses of crypto that are not for buying goods, such as identity verification. For example, Microsoft has launched a decentralized identity authentication technology that uses Bitcoin. However, such technologies could require tiny transactions that currently could be taxable events, Brito said.

Bitcoin ETFs

Exchange-traded funds exist for gold and foreign currencies, giving investors the ability to bet on or hedge risk related to those commodity prices. But the SEC has yet to approve a bitcoin ETF, after years of efforts.

The SEC seems to believe that the real problem is that the underlying markets where they're trading are not safe, said Brito.

"Whenever the SEC has rejected a bitcoin ETF, the reason is consistently about: They're not confident in the integrity of the underlying markets," Brito said.

The DCEA bill would resolve that concern because the ETFs could trade on a CFTC-supervised market, Brito said. Or the industry itself could decide to self-regulate and gain the SEC's confidence that way. But unless either of those things happen, Brito doesn't expect bitcoin ETFs to be approved anytime soon.

Stablecoins

You won't hear about stablecoins on "Saturday Night Live" because they lack the potential for price appreciation (or big crashes) that define cryptocurrency in the popular imagination. But stablecoins have become a large part of the crypto trading market precisely because they address volatility in crypto prices. They also hold potential for other uses such as payments.

There hasn't been much change to how stablecoins are regulated. But a recent move by Facebook-backed Diem to move back to the U.S. from Switzerland could cause Congress to act.

The OCC released an order last July clarifying that federally-chartered banks can custody cryptocurrency, which was seen as a positive step in mainstreaming the industry.

The OCC, however, still doesn't have a permanent leader. Michael Barr, a former Treasury department official and former Ripple adviser, was slated to be nominated but was reportedly dropped due to opposition from liberal Democrats.

In the meantime, Michael Hsu, who has been acting comptroller since May 10, said Wednesday that the OCC, the Federal Reserve and FDIC are in talks for an "interagency sprint team" on crypto regulatory issues.

This story was updated Thursday at 10:28 a.m. Pacific to include the Treasury's new rules for reporting cryptocurrency transactions.

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