The issue of taxing cryptocurrencies held-up for a few days the unprecedented trillion-dollar infrastructure bill, which otherwise had bipartisan support in the US. The bill was finally passed on 10 August and will go to the US Congress for further deliberations.
How something that’s a fringe new-age technology to some, an embodiment of liberty from institutional control to others, and a gimmick to yet others, came to overshadow political discussions around one of the boldest legislations in recent times is telling. And it portends broad and sweeping regulations coming to the world of cryptocurrencies, much to the dismay of the retail aficionados, recent converts and ‘maximalists’ in the case of Bitcoin as they prefer to call themselves.
While in the past three weeks, Bitcoin and Ethereum have rallied in terms of price vis-à-vis fiat currencies, purists might say that to look at cryptocurrencies and their potential from that lens is only scratching the surface. While there are more than 11,000 tokens or crypto coins in circulation today, including some that were designed as jokes or ‘memes’, Bitcoin represents the real coming of age of cryptocurrencies, with a market capitalisation of $850 billion (or nearly half the overall crypto pie).
A rush to regulate, and contrasting views
Despite sceptics calling for reform to the Bitcoin base layer for years, that would allow more transactions, loyalists have guarded against any such move as they truly believe such a move will erode the most fundamental tenet of Bitcoin – its decentralised nature. Maximalists argue that the finite supply of 21 million Bitcoins ever to be mined is the best bet against monetary inflation, and mainstream institutional investors seem to have been sold on the narrative, with most having either direct exposure to Bitcoin or indirectly to equities of publicly traded exchanges like Coinbase that do.
Ethereum, on the other hand, the de facto platform for decentralised finance applications today, underwent an upgrade recently. Dubbed EIP-1559, the software upgrade fundamentally changes the way transactions are processed on Ethereum by providing clear pricing on transaction fees in ether paid to miners to validate transactions and ‘burning’ a small amount of those tokens. The burned tokens will be permanently taken out of circulation. By reducing the number of tokens, the currency that remains in circulation become rarer and more valuable. The Ethereum protocol may turn out to be more valuable than the token in the long run given the applications in smart contracts made possible.
Gary Gensler, chairman of the Securities and Exchange Commission, said recently that investors need more protection in the cryptocurrency market, which he called “rife with fraud, scams and abuse” and like the “Wild West”. The inherent volatility in cryptocurrencies that loyalists refer to as “a feature and not a bug” seemed to have caused this strong comment.
We may still be far from a world where crypto transactions are as ubiquitous as cash, but more countries like El Salvador, that rely heavily on international remittances, may look to embrace cryptocurrencies as a viable hedge against macro headwinds from monetary policies relating to dominant currencies and trade imbalances.
And yet, this view is so far removed from what Cathy Wood, the famed CEO of Ark Invest, a progressive investment management company had to say recently. Ms Wood referred to cryptocurrencies as “MoIP” or “money over internet protocol” much like the “VoIP” technology that has replaced most of traditional voice telephony and associated billions in revenue for mobile carriers in less than five years since it became mainstream. She argued that because the development of the internet did not build a payment rail as one of the foundational blocks, blockchain-based tokens are the coming in of a layer that was missing in the world wide web, in a way that will enable the internet to truly drive financial inclusion.
CEO of Square and Twitter, Jack Dorsey, who is another Bitcoin evangelist, agrees in that Bitcoin is the most natural fit as the “monetary layer native to the internet itself”.
How will the two tangential world views manifest for the future of Bitcoin and for cryptocurrencies more broadly? The lobbying efforts by the industry at Capitol Hill aside, it will call for a collective effort at educating policymakers, central banks and bringing the issues to the public discourse.
Emily Choi, President and COO of Coinbase, argues that cryptocurrencies be treated at par with other financial instruments, especially around KYC (know your customer) disclosures. She argues that as a $10 ACH bank transfer does not entail the disclosure of a recipient’s tax details, if regulation mandated something on those lines for cryptocurrencies, it will end blockchain innovation in the US and the ecosystem will migrate elsewhere, just as mining operations had to recently move out of China after a recent regulatory clampdown there.
Charles Hoskinson, who founded the Cardano platform and serves as the CEO of the blockchain research and engineering company IOHK, recently spoke to Bloomberg and offered “Zero-knowledge cryptography” as a solution to energy-intensive mining as also of increasing transaction volumes on blockchains. Simply put, if someone sends you a Bitcoin, you need to be able to have the whole blockchain know that it is real and hasn’t been double-spent. If you have zero-knowledge proofs or mechanisms to validate the transaction in kilobytes, for blockchains that run in exabytes, that translates to an energy-efficient way to transact while safeguarding the decentralised and privacy-focused nature of blockchains.
Another mechanism to make cryptocurrencies more portable and fail-proof perhaps is the application of oracle networks like Chainlink. Every independent node or oracle in the decentralised oracle network independently retrieves data from an off-chain source and brings it on-chain. Stablecoins like Tether and USDC are inherently backed 1:1 to a fiat in principle and therefore to sovereign monetary policy. Arguably, a blockchain not backed by a fiat asset can also be linked to an off-chain set of regulations and governance frameworks via an oracle network so that crypto transactions are compliant while still being decentralised.
Cryptocurrencies are more entwined with conventional finance too, according to The Economist. Goldman Sachs plans to launch a crypto exchange-traded fund; Visa now offers a debit card that pays customer rewards in Bitcoin. Binance, a leading exchange recently, in a bid to self-regulate, announced they will stop derivative trading in certain markets to control speculative short trading in cryptocurrencies. Regulation to protect investors, therefore, needs to be considered in terms of ramifications to the broader financial ecosystem.
Despite sceptics calling for reform to the Bitcoin base layer for years, that would allow more transactions, loyalists have guarded against any such move as they truly believe such a move will erode the most fundamental tenet of Bitcoin – its decentralised nature.
We may still be far from a world where crypto transactions are as ubiquitous as cash, but more countries like El Salvador, that rely heavily on international remittances, may look to embrace cryptocurrencies as a viable hedge against macro headwinds from monetary policies relating to dominant currencies and trade imbalances. The utopian promise of real inclusion and empowerment offered by maximalists, however, seems far-fetched when only a few million people have access to this instrument in a world where hundreds of millions have fallen back into poverty amidst the pandemic. Some projects in places like Ethiopia to link national identities with smart contracts have shown real promise and need to be scaled up.
Regulation must be welcomed but regulations must be founded on trust and transparency and arrived at with a framework developed by multi-stakeholder consensus. If that doesn’t happen, crypto regulation may end up serving as a self-fulfilling prophecy for a community that believes cryptocurrencies were conceived as a hedge against unilateral thinking around sovereign money.
The views expressed in this article are entirely personal and are not representative of the author’s employer or those of any other entity.