The brutal war in the Ukraine is at the top of everyone’s mind these days. From concerns about the expansion of the war to further disruption of a supply chain already in disarray due to the COVID pandemic, the conflict significantly impacts people’s daily lives.
However, given the dire humanitarian issues in the conflict, it is somewhat surprising that cryptocurrency has become a major issue during the war. More than $100 million in cryptocurrency donations have made their way to Ukrainian forces. But Western governments are concerned that Russia may be using cryptocurrency to evade the severe financial sanctions the world has imposed.
Extensive cryptocurrency use by both sides of the conflict has again highlighted the general lack of cryptocurrency regulation. But with it becoming ever more apparent that cryptocurrency is here to stay and will be a significant player in financial markets, world governments are racing to put regulations in place.
Why is there only limited cryptocurrency regulation?
Contrary to popular belief, cryptocurrency regulations do exist. Many countries have put regulations, restrictions, or flat-out trading bans in place. But like those countries, the regulations are all over the map.
There are a few reasons that cryptocurrencies have achieved sky-high valuations (the total crypto market is worth just shy of $2 trillion) without substantial and consistent government intervention. First, one goal of crypto is to avoid central controls such as government regulation. Crypto has become the symbol of financial freedom for the masses, with governance placed in the hands of crypto owners.
Another roadblock to regulation is that governments aren’t yet sure how to categorize cryptocurrency. Is it a currency? Absolutely if you ask El Salvador, who made Bitcoin legal tender in late 2021. Is it security? China seemed to think so, calling it a speculative asset before banning crypto transactions and payments. Is it something else? Doesn’t matter what it is, the IRS wants to tax it but hasn’t quite yet figured out how. Without a widely accepted designation for cryptocurrency, it is unclear who can or should regulate it.
Governments also appear to be somewhat confused about what cryptocurrency issue they want to address first: consumer protection or environmental aspects. Bitcoin’s use of a proof-of-work (PoW) consensus mechanism for entering transactions on the blockchain is a notorious energy consumer. Currently, most consumers rely on any of the secure crypto wallets available for the storage and security of their Bitcoin and cryptocurrencies.
Although the actual effect of Bitcoin mining remains a point of debate, especially when compared to other technologies with substantial climate impacts, some governments and organizations have moved to restrict or limit bitcoin mining.
In early 2022, the European Union indicated it would ban PoW-based cryptos because of their harmful climate effects. However, after consideration, the EU Parliament rejected a ban and transitioned their attention to consumer protection.
Other governments are also flip-flopping their positions on cryptocurrency. For example, Singapore, which at one point was very friendly to cryptocurrency, recently issued guidelines intended to limit or prevent cryptocurrency trading. According to the Monetary Authority, cryptocurrency is “not suitable for the general public.”
In addition, many countries (more than 100 at last count) are launching their own central bank digital currencies (CBDCs) to displace cryptocurrency. The list grows every day: the United States, China, Russia, the UK, Mexico, Sweden, Nigeria, and many more are in the planning stages for issuing digital currencies in the next few years.
With so many different attitudes about cryptocurrency and its benefits or threats, it is not surprising that there is no coherent regulatory framework for cryptocurrency.
Why is cryptocurrency regulation needed?
The war highlights one primary concern governments have about cryptocurrency: the ability to launder money or enact transactions that evade authorities. Western governments, in particular, view cryptocurrency as a way Russia can sidestep sanctions that the West hoped would end the war.
Because cryptocurrency values user anonymity and wallets are identified by cryptographic keys, the lack of transparency facilitates questionable or even criminal activity. And criminals are taking advantage, as reports suggest that money laundering via crypto increased 30% in 2021.
But money laundering is far from the only criminal issue facing cryptocurrency. It is straightforward for almost anyone to launch a cryptocurrency (according to CoinMarketCap there are now nearly 19,000 different cryptos), and many are vulnerable to hacking.
Even the most well-established cryptocurrencies have fallen prey to cyberattacks that have cost owners hundreds of millions of dollars. Most recently, the highly popular Axie Infinity gaming metaverse platform suffered an attack that bled more than $600 million dollars from the platform. The hacker immediately began laundering the stolen coins to prevent recovery, leading to renewed calls for consumer protections for cryptocurrency users.
The ease of launching currencies and the lack of controls also have led to thousands of scams targeting unsophisticated crypto users looking to become the next crypto whale (users with more than $1 million in cryptocurrency). Although the amounts are smaller than the most notorious hacks, scammers still defrauded consumers of $14 billion in 2021.
One more concern for consumers is cryptocurrency’s high volatility, which is why some governments consider crypto “unsuitable” for public investment. Bitcoin has experienced several rapid runs followed by equally massive crashes. In just the last year, Bitcoin reached several all-time highs only to plummet more than 50% within months. Similarly, new currencies frequently have a significant initial price spike only to quickly become essentially worthless. Volatility makes crypto attractive for diligent investors, but for average investors, it can be a recipe for disaster.
So what are governments doing about crypto in the war?
Russia has made no bones that it will take full advantage of cryptocurrency. The Russian government has endorsed cryptocurrency as a currency, and recently suggested it may start accepting Bitcoin for gas and oil purchases. So governments enforcing sanctions are adding controls to ensure sanctions have their intended effect.
The European Union has increasingly addressed cryptocurrency as it added new sanctions. In the most recent round, the EU tightened controls on prior cryptocurrency restrictions for Russia, issuing a blanket prohibition on providing Russia with resources via cryptocurrency.
Similarly, in the U.S., both the Department of Justice and the Department of the Treasury are taking a closer look at cryptocurrency flows to Russia. The DOJ has a task force focused on investigating cryptocurrency flows related to sanctions. And Treasury indicated that compliance with sanctions is currency agnostic - fiat and crypto alike must comply.
Above all, governments are now using the renewed focus on crypto concerns in the war to launch broader efforts at regulation. The Biden administration, for example, recently issued its “Executive Order on Ensuring Responsible Development of Digital Assets” with the goal of creating a comprehensive regulatory framework for crypto. Many other countries are in similar investigatory stages.
Conclusion
There is no question that widespread cryptocurrency regulation is coming. The war has only hastened its arrival. The form it will take remains an open question. And while much of the crypto community is supportive of reasonable regulation, there remains a strong tension between regulation and the goals of cryptocurrency. How that tension will be resolved will be a storyline to watch.