Regulation of Cryptocurrencies: Trends, Developments, and Challenges

Categories: Cryptocurrency

Section A Introduction

The evolution of money is traced back to as far as the barter exchange where goods were exchanged for another good and this brought about several inconveniences. These inconveniences led to the discovery of commodity money where metals such as gold and silver were used for trade, similarly commodity money brought about problems associated with uniformity of these metals and their sizes, weights as well as their purity. Fiat money was introduced hence the increased volume of transactions ultimately led to the need, discovery and use of virtual currencies, which are termed into ‘cryptocurrency’ today.

According to (Nakamoto, 2008) cryptocurrency is an internet-based medium of exchange which uses crypto graphical functions to conduct financial transactions.

Types of cryptocurrencies range from the Ether which is the token that powers the popular Ethereum blockchain, Lite coin also designed for smaller payments, Ripple and many more (Clements, 2018). Additionally cryptocurrencies use blockchain protocols which are a platform providing a mechanism for a distributed network consisted of computational nodes to periodically agree on a set of new transactions as well as the interest for the protocol signifying its attributes such as security, anonymity and data integrity (Yilmaz & Hazar, 2018)

The first cryptocurrency which is Bitcoin and being the most valuable digital coin as well as the first blockchain technology user was launched in 2009. Bitcoins are a purely peer-to-peer version of electronic cash which allows online payments to be sent directly from one party to another without going through a financial institution (Nakamoto, 2008).

Advantages realized by those who use cryptocurrencies vary in character and magnitude and are reliant on their uniqueness hence these benefits may change over time as their situation evolves (Jericho, 2019).

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Furthermore the author states that individuals and institutes use cryptocurrencies to store wealth, earn investment gains (or losses), transfer wealth, purchase goods or services and to pay debt.

Therefore the aim of the first section of this report is to provide a detailed literature on the current trends and developments within the cryptocurrency markets as well explaining the reasons behind the rise in interest in them. Lastly a conclusion will be drawn from the first part of the discussion.

Developments and Current Trends in the Trading of Cryptocurrencies

Supported by Yilmaz & Hazar (2018), the birth of Bitcoin as one of the digital coins not only led to a new digitalization movement in the payments sector, but also a new type of innovative technology based on decentralized digital currencies. After the launching of the Bitcoin’s in 2009, there was emergence and rise in alternative types of altcoins in the cryptocurrent markets. These section therefore discusses the major developments and current trends in the trading of these cryptocurrencies.

The rise in demand or interest in digital coins has led to States launching and accepting cryptocurrencies as a medium of exchange. These counties also have passed regulations affecting the use of these digital assets. For example In April 2017, Japan recognized cryptocurrencies as a legal method of payment while as in October 2017 and Australia passed a law which has been applicable from July 2018 to remove a double taxation problem for those accepting digital currencies (Srivastava, 2018). This means that in such countries digital assets are used to purchase goods and services as well as being used by investors to diversify their investment portfolios.

The rise in demand of digital coins has led to the halvening process which is aimed at stabilizing the supply of bitcoins as one of the digital coins (Kraken, 2020). This process was employed after evidence of the likelihood of saturation within the cryptocurrent markets and as a way to avoid the loss in value of crypto currencies. Ultimately halvening brought about the scarcity aspect of currencies as a way of regulating their supply and avoid too much digital currencies lying idle in the markets.

Improved or an increase in linkages between the financial market and economy to the virtual markets is also one of the current developments in the cryptocurrency market. These linkages can be fostered through developments such as future contracts that link to bitcoin prices and financial investment vehicles tracking crypto-assets to integrate it to both the traditional financial sector and the real economy. A report by (ECB Crypto-Assets Task Force, 2019) postulates that Futures contracts linked to bitcoin prices have been available in the US since December 2017 and are traded at low, but relatively stable volumes.

Similarly, one of the demand led developments within the cryptocurrency market is establishment of Auto Teller Machines (ATM) similar to those within the traditional banking sector allowing for withdrawal of cash convertible from digital coins for purposes of payments during trade. This development is evident in Botswana as there is a Bitcoin Machine in the Airport junction mall.

Price growth of crypto-assets has surpassed that of historical bubbles before the crash in early 2018 (ECB Crypto-Assets Task Force, 2019). The price of bitcoin increased by a factor of 19. 5 from the beginning of 2017 to the peak reached in January 2018. This implies that crypto-current assets still remain highly volatile depicting the market risk associated with virtual markets. To hedge against such risks, recent developments such as “stable coins” are used by traders to guard against price fluctuations.

One major trend within the digital markets is market capitalization of cryptocurrencies (ECB Crypto-Assets Task Force, 2019) which experienced a decline in 2018 prior to an all-time high increase since its establishment. Additionally the report furthermore postulates that market capitalization of digital coins has moved in tandem with asset prices with reference to bitcoins.

Lastly the demand in cryptocurrency has led to cyber security fraud such as exchange hacks, social media identity hacking, taxation fraud and many others. These discrepancies have led to the need to regulate this markets hence the increase in crypto friendly regulations as one of the trends within the digital markets globally.

The Rise in Interest of Cryptocurrencies

Despite the unprecedented growth from 2009, cryptocurrencies for the first time experienced a drop in interest in 2018 (Dourado, 2014). The initial rise in interest in cryptocurrencies was driven by several other factors which are outlined below:

2008 global instability

In 2008, the developed world banking system almost collapsed and had to be rescued by sovereign governments via takeovers of bad banks with bad loans, and the printing of money to loan to major banks, whether rescued or surviving (https://en. wikipedia. org/wiki/Financial_crisis_of_2007). During this period of recession that prolonged from 2008 to 2014, alternative measures by governments to support their economies and stimulate economic growth were proposed. Amongst the suggested solutions: limited stimulus via infrastructure spending, such as the American Reinvestment and Recovery Act of 2009; support for ICT enabled services, often environmentally sustainable industries to create new ‘virtual’ growth in the digital economy were proposed (https://medium. com/@noogin/the-financial-crisis-and-history-of-bitcoin-27ebdb932b99).

Distrust of the traditional banking systems

Traditional banking systems regulated by Central banks and financial intermediaries such as banks avail funds in terms of loans to investors and households for consumption and investment purposes. The banking systems stagnancy because of its obsolete infrastructure and taking days or weeks to send money around the world as well as external factors such as inflation, recession and other financial crisis do not hold for cryptocurrent markets. This is because Blockchains which are a distributed, decentralized ledgers, allow individuals to anonymously transact and maintain records without an intermediary. According to (Clements R. , 2018) decentralization allows digital markets to be immune to both inflation and deflation. Ultimately some investors viewed digital coins to be a hedge against volatile local currencies and geopolitical risk hence the distrust of the traditional banking sector led to the rise in interest over the past years.

Various forms of social media particularly Facebook and others played a major role in in the publicity and familiarity of cryptocurrencies. This was through the network effect which allows for a new technology to be simple to use because more people use it hence the elevated increase in the demand for cryptocurrencies. For example not so long ago Coinbase, which is one of the largest Bitcoin exchange in the United States added over 100,000 customers in one day after the Chicago Mercantile Exchange announced it would launch Bitcoin futures. (Clements R. , 2018)

The improved access to information also led to the rise in interest of cryptocurrencies. Information on how to mine digital coins in some Universities are learning modules for students. Such information is equally relayed through the internet. For example The Khan academy you-tubers also have free tutorial videos on you tube that provide an in-depth knowledge on cryptocurrent markets one learns at their comfort zone. Lastly experts in the digital coin market have been holding seminars across the globe to impart knowledge to various communities on the mining of cryptocurrencies especially bitcoins.

Another factor that led to the rise in interest and demand of bitcoins was the initial coin offering (“ICO”) market which was red hot in 2017 (Clements R. , 2018). The initial coin offering market allowed companies to issue out digital coins that made it accessible to a service called a “utility” or “app” token which represented an investment opportunity. These ICOs according to (Clements R. , 2018) generated in excess of $1. 2 billion of start-up capital in 2017, and were seen as a workaround traditional venture capital. Consequently participation in these ICOs required the use of cryptocurrencies such as Bitcoin and Ether. As an economic principle of complementary goods, an increase in the demand of ICO relatively required an increase in the demand of cryptocurrencies particularly Bitcoin and Ether.

Conclusion

The main objective of the first part of the report was to describe the developments and current trends in the virtual markets as well as the major reasons that explain the rise in interest in them. Virtual markets experienced radical growth before a decline in 2018 due to several factors such the global financial crisis which called for the American Reinvestment and Recovery Act of 2009 proposing for the use of ICT to develop virtual markets as a way of stimulating economic growth. Additionally distrust of the traditional banking systems, influencial forces from various social media forums and improved accessibility to information on cryptocurrent markets fueled the rise in digital coins. Lastly the rise in interest of cryptocurrencies was due to the demand of initial coin offering markets which act as complementary good to bitcoins and other digital coins. As one of the developments, some countries formally launched the use of bitcoins as a medium of exchange of goods and services and this furthermore led to establishment of ATMs. The decentralized nature of the market and factors such as its secureness, digital aspect and the network effect led to the rise in interest in virtual currencies amongst others. Improved linkages that try connect virtual markets to the real economy and financial systems, market capitalization of these cryptocurrency coins as well as crypto friendly regulations are some of the current trends and developments within virtual markets.

Section B Introduction

One of the major roles of financial intermediaries such as Central Banks in financial systems is to regulate the monetary markets and ensure stability, accountability as well as protecting both the commercial banks and its customers through rules and regulations. Often times command and control instruments which basically are direct regulation measures are used in financial systems. Accordingly, the direct regulation of cryptocurrencies would involve regulating the code or protocol, developers, the design features of the blockchain itself, wallet providers, node operators, miners and users or engaging in legislation and rule making that govern white papers (Hossein, 2019).

In contrast, indirect regulation measures constitutes of market discipline-inspired regulatory regulations of exchanges where cryptocurrencies are exchanged for fiat money, custodians and other services (Hossein, 2019). Cryptocurrency itself cannot be regulated but rather its service providers are obliged to comply with applicable regulations in order to adequately protect consumers to have confidence in their service providers (Raymarkers, 2014).

Therefore the second part of this report discusses the potential regulatory challenges within the virtual markets, as well as how to deal with such problems and lastly a conclusion based on the literature will be drawn.

Regulatory Challenges and Solutions That May Arise from Trading of Cryptocurrencies

Cryptocurrency payments can be made without personal information linked to the transaction. This offers strong protection against identity theft and almost full anonymity of the buyer (Vejačka, 2014). Despite these advantages, the pseudonymous, anonymity and decentralized nature of cryptocurrencies makes it harder or impossible to regulate the digital markets. For example, digital currencies can be used to finance nefarious activities such as terrorism or purchasing of drugs. Consequently its ability to be reconverted into cash without any traces becomes a challenge. This problem can be addressed through setting up a regulatory market point where digital coins are exchanged for real money. Alternatively (Raymarkers, 2014) proposes that since public keys cannot screen sanctions because of inability to figure out any sanction lists and inability to link them to individuals, block chains could be adopted since they record public transactions that provide a greater pool for regulation scrutiny.

Digital markets such as bitcoin markets if unregulated and not backed up by any Government can be a threat to the economic stability of foreign exchange markets. Alternatively conflicts between digital markets and foreign exchange markets lead to global economic destabilization. Moreover, if virtual markets are leniently regulated than fiat currencies this leads to an unequal playing field within the market payment services. In order to deal with this problem, cryptocurrency could be declared a legal tender and follow monetary regulations just like any other legal tenders (The Law Library of Congress, 2018)

Another measure of addressing regulatory challenges encountered through financing of goods and services within the black markets is implementing regulatory strategies aimed at reducing leverage in the cryptocurrencies ecosystem. This can be achieved by imposing leverage restrictions on credit or payment institutions that engage in lending (both in fiat and cryptocurrency) to the market participants in the cryptocurrency ecosystem (Hossein, 2019). This measure of a decentralized implementation strategy enforces rules that are initially applied to the banking and payment sector hence we have an invisible hand regulating cryptocurrencies.

Conclusion

Despite the several advantages of cryptocurrent markets to economies and individuals, their decentralized nature and anonymity makes it is not possible to regulate cryptocurrency itself. Regulatory challenges within virtual markets arise due to several problems brought by crypto current markets such as anti-money laundering, counter-terrorism financing, riskiness of virtual markets and taxation problems to mention a few. Alternatively its service providers are obliged to comply with applicable regulations in order to adequately protect consumers to have confidence in their service providers. Moreover these regulations do not hold for all economies globally but rather are country specific. Potential regulatory challenges even though not completely eliminated can be mainly addressed through implementing decentralized regulatory strategies aimed at reducing leverage in the cryptocurrencies ecosystem. Lastly reaching a consensus by all countries as to declare crypto currency as a legal tender or monetary measure could alleviate all the regulatory challenges because then it would be regulated by a the central bank rules and regulations of any asset considered as ‘money’.

Updated: Jan 25, 2024
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Regulation of Cryptocurrencies: Trends, Developments, and Challenges. (2024, Jan 25). Retrieved from https://studymoose.com/regulation-of-cryptocurrencies-trends-developments-and-challenges-essay

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