The blogpost is Part-3 of the Cryptocurrency Series taken up by the Centre. The present post is authored by Ms. Navya Bhandari & Mr. Pratham Pratap Mohanty, Third Year Law Students at National Law University, Jodhpur.
Cryptocurrencies have gained significant attention in the last decade. With lockdowns extending for months around the world, people discovered an investment market. The cryptocurrency market seems more lucrative for many such new investors, because of its short term profit possibilities, popularity in social media and easy market access.
However, governments have not always been supportive of the untraceable cryptocurrency markets. As discussed in the preceding post, India has been extremely critical of opening doors for such monetary tool, which might increase the nation’s already subsisting corruption and taxation issues. Similar stance has also been taken by countries in many other jurisdictions. Thus, it becomes important to understand the legal position of regulating cryptocurrencies in some major economics around the globe. The most contrasting positions are that of the United States of America and the People’s Republic of China. While one has given extreme relaxations to the cryptocurrency and has even started allowing companies to accept it as a legal tender, the other has significantly curtailed use and trade of global cryptocurrencies.
How the United States dealt with the problem of regulating cryptocurrency:
In the United States [“US”], the cryptocurrency trade channel is regulated by numerous federal and State laws and each state has its own unique norm. A crypto asset may act as a security, commodity or currency under the US federal laws, and therefore are governed accordingly. The Securities and Exchange Commission [“SEC”] regulates it if it fits to be a security,[i] the Commodity Futures Trading Commission [“CFTC”] has the power to regulate if it classifies as a commodity[ii] and the Treasury Department’s Financial Crimes Enforcement Network [“FinCEN”] regulates it if it is treated as a convertible virtual currency.[iii] Any crypto-asset could qualify as one or many of these, and hence be subject to the said regulations along with other state level norms, like those from taxation.[iv] Acting as a currency, the crypto asset will be a medium of exchange of value and the trade will be in accordance with the Bank Secrecy Act, 1970, like other currency is regulated. These regulations are the main anti-money laundering provisions of US law. The aforesaid act applies to financial institutions and other money service businesses in the US. Under this law, the crypto exchanges are treated as ‘money transmitters’, and therefore get themselves registered under the FinCEN, and comply with its requirements. However, it only has to be done if the entity is neither registered under the SEC or the CFTC.[v]
It is important to know that a cryptocurrency token which might be initially sold as a security in the first transactions, be sold as a currency or commodity in the subsequent transactions. Such is the flexibility of the US laws governing cryptocurrency. However, there are state specific laws also which govern the sector. It is notable that some states like Ohio, Arizona and Georgia are set to become the first states to accept taxes in cryptocurrency.[vi]
Anti–Money Laundering Regulations in the US
In order to regulate and prevent the threat of money laundering and terror funding brewing out of the anonymous nature of virtual currencies, virtual currency exchanges are required to conduct comprehensive risk assessment of their exposure to money laundering. FinCEN regulations require them to develop and implement a program which is designed to prevent such exchanges from being used as a front for facilitating money laundering and terror funding.
The Anti Money Laundering program must, “(a) incorporate policies, procedures and internal controls reasonably designed to assure ongoing compliance; (b) designate an individual responsible to assure day-to-day compliance with the program; (c) provide training for appropriate personnel, including training in the detection of suspicious transaction”[vii] In order to prevent transnational money laundering, US persons are prohibited from conducting business from nationals who are on Blocked Entities List of the Department of Treasury’s Office of Foreign Assets Control.[viii]
Following this model, the US has been able to let the cryptocurrency co–exist in its financial system along with fiat currency. It is imperative to see how other countries like Japan, Australia and Singapore are also dealing with the problem of regulations, and then formulate a model suitable for India. However, the question as to why these countries are willing to take that risk and allow cryptocurrencies still remains. Cryptocurrency in fact, has numerous benefits, which is the reason behind it’s growing adoption. These nations are trying to reap the maximum benefit out of it, and gain in the long run. Some of the benefits are: Decentralized nature of cryptocurrencies allows customers to send and receive money from around the globe. Through a peer-to-peer network of transactions, the dependence on a single payment service provider is reduced as users can now afford to have multiple options through different cryptocurrency platforms. With the advent of cryptocurrency, international trading has become easier and it has now become simpler to make cross border payments leading to an increase in the volume of trade. The fact that transactions can be conducted without regulatory mechanisms without the burden of compliances adds to the appeal to use such platforms.
- Cryptocurrency platforms are strongly secured due to the use of cryptographic encryption, which acts as a safeguard against traditional fraud and counterfeit currency. Such transactions do not require any disclosure of personal data effectively reducing the risk of information being stolen. Though no system is perfect in itself, cryptocurrency platforms are also susceptible to it, however, the chances of such hacks are relatively low.
- The ever – increasing growth of cryptocurrencies has led to start-up companies adjusting their fundraising and investment strategies. Lately, the concept of Initial Coin Offering [“ICO”] has emerged wherein start-ups are raising funds by going public on a cryptocurrency platform and selling their own coins or tokens in place of selling equity in the company.[ix] Due to the volatile nature of cryptocurrencies investors may be wary of the risk involved but such investments provide a high risk and high reward scenario. Keeping in mind these significant aspects of cryptocurrencies, many governments around the globe have regulated or legalised the system. If India does not adopt this new technology, it will be left behind in its run for technological advancement.
The Chinese Model
The dilemma must be considered from the other side too, wherein the government bans it completely. Let’s take a look at China, where the government had banned the use of cryptocurrency initially. However, the ban was not successful in stopping people from the trade. People actually changed their Tether and VPN addresses to a different country where the trade was legal.[x] Essentially, if the government would have monitored or regulated the transactions like some states in the US have, they could have at least taxed the transactions, which would have added to the government’s revenue. Instead, people who wanted to trade still did, and the government could get no benefit out of it.
Central banks worldwide are testing Central Bank Digital Currency, to make use of blockchain technology. Given the bulk of transactions, taxing of crypto-trading opens up a new pool of income for governments. Wanting to capitalise on its advantages, on April 25, 2020 China launched its Blockchain Service Network.[xi] In continuation, the Chinese Central Bank is set to launch its own Digital Yuan, however, it would probably be delayed due to the COVID-19 pandemic.[xii] The Digital Yuan is expected to function in a similar fashion to paper currency as its value would be tied to Yuan. Once the digital yuan is launched, trade in all other cryptocurrency is expected to be illegal. The Central Bank will monitor the transactions through the platform; hence it would not have scope of anonymity.[xiii] The digital yuan however, would be different from the concept of cryptocurrency, but it will be a technological revelation which would address the concerns of money laundering and terror funding. The main difference between the digital Yuan and cryptocurrencies is that Yuan is a legal tender, centralised, and not anonymous. These features of the Yuan favour the Chinese government’s desire to have a strict regulation on the trade of the currency.
The rise of digital yuan would have a ripple effect on the world economy. There is a possibility that nations around the world would attempt to follow China’s footsteps and develop their own state-owned digital currency. Amongst these nations, India is a leading example, where state-owned digital currency is being considered.
[i] SEC Release No. 81207, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (Jul. 25, 2017).
[ii] See In the Matter of Coinflip, Inc., Order Instituting Proceedings, CFTC Docket No. 15-29 (Sept. 17, 2015).
[iii] Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies, FIN-2013-G001 (Mar. 18, 2013).
[iv] Virtual Currency Regulation Review, The Law Reviews, 2018 https://thelawreviews.co.uk/digital_assets/e61360db-b49e-4d17-83f0-eba976d0804c/The-Virtual-Currency-Regulation-Review—Edition-1.pdf?fbclid=IwAR2FmJE_wiR00icCX74ikohJaTBZBDF9n6x8GcHgKhZcz3nVXilSTTzpEUA
[v]Blockchain & Cryptocurrency Regulation, 2019, https://www.acc.com/sites/default/files/resources/vl/membersonly/Article/1489775_1.pdf.
[vi] Paul Vigna, Pay Taxes With Bitcoin? Ohio Says Sure, Wall Street Journal, (Nov. 26, 2018), https://www.wsj.com/articles/pay-taxes-with-bitcoin-ohio-says-sure-1543161720.
[vii] 31 U.S.C. § 5318(g)(1); 31 CFR. § 1022.320(a)(2). https://www.fincen.gov/sites/default/files/2019-05/FinCEN%20Guidance%20CVC%20FINAL%20508.pdf.
[viii] Specially Designated Nationals And Blocked Persons List (SDN) Human Readable Lists, US Department of the Treasury, https://www.treasury.gov/resource-center/sanctions/sdn-list/pages/default.aspx.
[ix] Sam Ameen, How Cryptocurrency is Changing the Game for Startup Investors, Forbes, (Dec. 6, 2017), https://www.forbes.com/sites/samameen/2017/12/06/how-cryptocurrency-is-changing-the-game-for-startup-investors/#2fb3a5992064.
[x] Despite Ban, China Keeps Trading Cryptocurrency Thanks to Tether and VPNs, Says Report, Cointelegraph, (Sept. 9, 2018), https://cointelegraph.com/news/despite-ban-china-keeps-trading-cryptocurrency-thanks-to-tether-and-vpns-says-report.
[xi] Mohammad Musharraf, China Launches Blockchain-Based Service Network for Global Commercial Use, Cointelegraph, (Apr. 27, 2020), https://cointelegraph.com/news/china-launches-blockchain-based-service-network-for-global-commercial-use.
[xii] How China’s New National Cryptocurrency Changes Everything, NPR, (Jan. 13, 2020), https://hackernoon.com/how-chinas-new-national-cryptocurrency-changes-everything-sc4032eq.
[xiii] Scott Horsley, China To Test Digital Currency. Could It End Up Challenging the Dollar Globally, NPR, https://www.npr.org/2020/01/13/795988512/china-to-test-digital-currency-could-it-end-up-challenging-the-dollar-globally.