Regulation Steps Up
February has seen material developments in cryptocurrency regulation. Most regulatory questions are currently concerned with the classification of cryptocurrencies (i.e as security or a commodity), their tax treatment, and anti-money laundering regulation.
In December, Australia introduced new laws regulating exchange services. Exchange services now need to be registered with the Australian Transactions Reports and Analysis Centre (AUSTRAC) and comply with anti-money laundering requirements. This follows similar regulation in the EU, US and Canada that puts cryptocurrencies on a more equal playing field with fiat currencies. On a practical level, it means more stringent ID requirements for individuals buying cryptocurrency and mandatory reporting to AUSTRAC of any suspicious activity on the exchange. We believe this will reduce the risk of cryptocurrency use in digital fraud, and view the regulation as a positive step in the regulatory landscape.
The United States has not yet classified cryptocurrencies in a clear way, especially over whether certain tokens qualify as securities. However, if the token derives its value from an external, tradable asset, it will likely be classified as a security token and therefore become subject to federal security regulations. Importantly, there are nuances to this regulation such that even a utility token can be deemed a security if it were marketed to perform like a security. In Hong Kong, on February 9, the Securities and Futures Commission stated that exchanges 'should not trade cryptocurrencies which are securities'. Most exchanges responded by either confirming they did not provide services for security tokens, or removed them from their platforms. An important part of our investment process is to determine if a crypto asset falls in the category of a security.
On February 6, the US Senate Committee on Banking, Housing and Urban Affairs addressed the question of how lawmakers should consider cryptocurrency regulation. Here the heads of Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) testified on a range of topics including market oversight, price volatility and ICOs. The take-away from this hearing was that lawmakers took blockchain technology seriously, agreed it is here to stay, and showed a willingness to make durable regulation.
Bitcoin was designated as a commodity by the CFTC earlier this month. The IRS similarly ruled that bitcoin should be viewed as property, not as a currency, for tax purposes.
Chinese regulation is less clear: there was speculation in late January that their ban of ICOs may end in 2018. However, the Chinese newspaper Xinhua hinted that the government may be planning to prevent all cryptocurrency trading, including on foreign websites, by blocking websites. China has already become a much smaller market for crypto trading and as such the importance of its regulatory environment has decreased. Chinese mining remains significant but even if this were banned we would likely see increased decentralisation as mining moves overseas, which in our opinion is a positive development.
Crypto is a nascent asset class. Regulatory clarity will come. In the meantime, we are closely tracking developments as there exist both risks and opportunities associated with the current regulatory state.
James Simpson @jronsim - Analyst, Apollo Capital