Don’t Fear Crypto Dip; Fear Regulations that Will Harm America’s Cryptocurrency Lead

After a massive runup for the past few months, the cryptocurrency market experienced a slight dip over the past week and a half. This dip may be ending as Bitcoin surged back above $50,000 yesterday and is above $55,000 as of this writing, while other cryptos are also climbing back. Long-term trends for the market still look strong as more and more well-known financial firms are starting to purchase cryptocurrency for their portfolios, and more retailers are starting to accept cryptocurrency payments.

But while the overall crypto market remains strong, recent regulatory actions from both the Securities and Exchange Commission (SEC) and the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) threaten the United States’ preeminence in this industry and the ability of ordinary investors to buy and sell cryptocurrency.

Almost nothing demonstrates this preeminence better than the U.S.-based cryptocurrency exchange Coinbase. As it went public earlier this month through a direct listing, Coinbase had already cemented the U.S footprint on the development of cryptocurrency and blockchain. The origins of cryptocurrency are shrouded in mystery, as no one has definitively identified Bitcoin’s pseudonymous inventor Satoshi Nakamoto or where he lives. But Coinbase—backed with seed capital by American venture capitalists such as Marc Andreessen and the respected financial firm USAA that serves members and veterans of the U.S. military—is among the most to stabilize the sector to enable all types of people to invest in and utilize cryptocurrency.

When the company was founded in 2012, after cofounders Brian Armstrong (the current CEO) and Fred Ehrsam met on a Reddit thread, cryptocurrency had just started to get off the ground but was already facing headwinds from the theft and hacking at the Mt. Gox exchange in Japan. Coinbase helped build the cryptocurrency sector by providing secure custody of digital assets for ordinary investors lacking expertise in digital wallets and lengthy passwords.

In past posts about companies going public, I lamented that middle-class investors could not grow wealthy with companies through early-stage investment, because mandates in laws like Sarbanes-Oxley and Dodd-Frank have made it prohibitively costly to go public until the firms have grown substantially in size. That’s still my lament, as Coinbase’s market cap just after it went public was $99.6 billion, whereas most companies in the decade before Sarbanes-Oxley was enacted in 2002 went public with capital raises of less than $50 million, and Home Depot famously went public in 1981 with just four stores under its wing. The ability of middle-class investors to take risks, but also to ride the wave of a growing company like Home Depot at its early stages, was gone.

But even if regulation prevented middle-class investors from joining wealthy “accredited investors” in prospering by buying early-stage stock of the company, the cryptocurrency bought and sold by Coinbase customers was relatively free of red tape. And by simplifying for ordinary people the complex issues of custody and passwords, Coinbase helped middle-class investors build the same kind of wealth with cryptocurrency that they used to be able to build with early-stage stock listings like that of Home Depot. Coinbase customers who began buying Bitcoin when a single unit was selling at less than $600 are now sitting on more than $50,000 per coin.

But now, middle-class access to wealth-building through crypto is facing dark clouds as federal regulators are pushing edicts that would have the effect of putting new types of cryptocurrency off limits to ordinary investors just as Sarbanes-Oxley and Dodd-Frank put stock in early-stage companies out of their reach. As CEI adjunct fellow Paul Jossey points out, the SEC’s deeming of all types of new cryptocurrencies as “securities”—despite a lack of authorization from Congress or even formal rulemaking—“discourages those creating the future economy from starting U.S. blockchain companies or allowing its citizens full access.” In particular, Jossey notes that the prosecution of video platform LBRY for creating digital tokens for its network, “creates roadblocks for … new projects” and “squelches competition.”

Across the Potomac from the SEC’s D.C.’s office, the Vienna, Virginia-based FinCEN has proposed regulations that my CEI colleague Ryan Nabil and I note in comments to the agency could “significantly hamper America’s lead in FinTech and other industries.” In the comments we filed with FinCEN on its proposal to expand “know your customer” regulations from the Bank Secrecy Act to transfers of cryptocurrency to individual wallets, we make the case that “the costs of the proposed regulations—in terms of compromised privacy and data security for lawful users of cryptocurrency as well as barriers to entry for new MSBs [money service businesses] and developers of digital assets—vastly exceed any potential benefits.”

We explain that the regulations that would essentially require reporting and/or retention of all transactions in a crypto wallet if just one of those transactions equaled $10,000 or, in some cases, $3000, the regulation would drive cryptocurrency developers and investors offshore, both because of the tremendous compliance costs and the harms to individual privacy and data security.

We also note that the rules raise “strong Fourth Amendment concerns by allowing the U.S. government to obtain a record of all transactions associated with a covered private wallet, as well as those of its transacting counterparties, without obtaining a warrant.”

As Ryan Nabil also notes in the National Interest, data indicate that only a tiny minority of cryptocurrency transactions involve illicit purposes such as money laundering and tax evasion. Indeed, if cryptocurrency were really seen as a tax haven, we would expect to see a jump, rather than a dip, in crypto prices after word leaked out last week about the Biden administration’s plans for massive tax increases on capital gains. But cryptocurrency prices fell along with stocks when details of this disincentive to investing were reported.

Increasingly, as I have also noted, experts see cryptocurrency financing as important to blockchain-based projects from land titling to medicine. But overregulation and punitive taxation could curtail this valuable pipeline to continuing American progress. As we conclude in our comments to FinCEN:

If that becomes the case, many businesses relying on smart contracts and other blockchain-based technologies might ultimately move to alternative jurisdictions with friendlier rules. Such a development would significantly hamper America’s lead in FinTech and other industries that will benefit from these technological breakthroughs.