Mayday For The Cryptocurrency Market
Authors: Aayush Jain and Devansh Parekh
Fifth-year students at Government Law College, Mumbai
The past couple of months have been eventful for the cryptocurrency market and its enthusiasts. From what was once seen as a revolution in the currency domain, it only took minute regulations and tweets to result in the downfall of cryptocurrencies. In this article, the authors discuss the social media impact as well as international regulations that affected the volatility of the market and caught the world by surprise.
II. Is Elon Musk Manipulating the Market?
From Harshad Mehta manipulating the stock market to Elon Musk accused of practicing the same in the cryptocurrency market, investors and traders at the respective exchanges have suffered millions of losses. Pursuant to the Harshad Mehta scam, India granted statutory recognition to the Securities and Exchange Board of India (“SEBI”) in 1992 to regulate the capital market for listed companies and securities in India and to protect the investors from such horrendous scams. In contrast, the crypto exchanges are not backed by any fundamentals or regulated by a statutory body.
Recently, Elon Musk and his tweets have been increasing the volatility of the crypto market by huge margins. While this behaviour would make him liable under Section 12-A of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (“PFUTP Regulations”) in India and under Section 9(a)(2) of the Securities Exchange Act of 1934 in the United States of America for manipulating the stock market, no regulations are governing the cryptocurrency market. Elon Musk has been regularly tweeting for and against Bitcoin (“BTC”). As recent as May 2021, Elon Musk, whose company, Tesla, itself has $1.5 million in BTC, tweeted his concerns about the impact of “mining bitcoins and the harmful impact on the environment.” This, along with other important events as discussed below, led to a major crash in the crypto market and several investors/traders suffered heavy losses.
III. A Race for Regulations?
With the highly volatile and speculative nature of cryptocurrencies, oversight of this asset class and trading platforms is critical and necessary. Investors are rushing to the hot new asset class, while regulators are struggling to rein in the market. Blockchain and decentralized finance are gaining a lot of momentum worldwide and are expected to be implemented for more practical purposes as the technology becomes more familiar and developed further.
Like other countries, China is coming down hard on the crypto market. China has been putting pressure on the crypto space by reiterating its commitment to support regulation first introduced in 2017. The National Internet Finance Association, the China Banking Association, and the Payment and Clearing Association of China issued a statement saying that digital currencies should not be used as currencies for payment, and have banned financial institutions from dealing in cryptocurrencies and providing crypto-related services. This is not the first action taken by China against cryptocurrencies. In 2017, it shut down several cryptocurrency exchanges and banned initial coin offerings. Presently China has vowed to reduce energy consumption as well as shut down all active cryptocurrency mining projects which have also been a major reason for the bloodbath.
IV. Regulated Trading Platforms
Germany has been actively regulating exchanges. It is one of the first countries in the world to offer legal certainty to financial institutions. The German Banking Act (Kreditwesengesetz – “KWG”) allows financial institutions to take custody of crypto assets as a new type of ‘financial service.’ Their regulations stipulate that any form of transaction in crypto assets may be done through a BaFin-licenced exchange, custodian, or Bitcoin ATM for German native citizens and legal entities. Additionally, Germany follows stringent Risk-Based Approach policies such as Enhanced Due Diligence and Know Your Customer requirements.
On the other hand, Canada has decided to take strict actions. The Canadian regulating body, Ontario Securities Commission (“OSC”), decided to clamp down on Poloniex, a Seychelles-based crypto exchange once owned by Goldman Sachs-backed start-up called Circle. The OSC has decided to not spare the rod and charged the crypto exchange for flouting securities regulations by trading securities without registration, not complying with prospectus disclosure requirements, and engaging in activity “contrary to the public interest.”
Further, following the exponential growth and fall of cryptocurrencies, USA agencies have also been aiming at aligning their policies on BTC and cryptocurrency-related issues. To propagate their policy of raising taxes and prevent tax evasion, the Biden administration proposed the American Families Plan. This will enact a new rule for businesses and crypto exchanges, requiring them to report any cryptocurrency transactions with a fair market value of $10,000 or more to the Internal Revenue Service (“IRS”). However, recently Tezos Users sued the IRS for the refund of taxes against the same plan that the Biden administration proposed. The case would have important implications of how proof-of-stake rewards are taxed.
VI. Crypto’s “Green” Future
A mining operation commands a large amount of energy consumption and has become the center of a heated debate around the “green” future of crypto assets. Crypto miners use powerful, specially designed computer equipment to verify virtual coin transactions in a process known as mining. With cheap energy available, certain provinces such as Inner Mongolia, Sichuan, and Xinjing have become hotspots for Bitcoin mining. Since this energy is primarily fueled by coal, it is the reason behind Beijing's ban on crypto mining in the country. In March, the province of Inner Mongolia announced a ban on the activity of mining as part of the country’s mission to achieve carbon neutrality by 2060. Iran also banned bitcoin mining for 4 months to avoid summer blackouts. Mirroring this reasoning as well as taking into account the tweets of Elon Musk, New York is likely to ban mining of cryptocurrency for 3 years to protect as well as study the environmental impact.
VII. Precautionary Approach
As a move to caution investors, the United Kingdom Advertising Standards Authority banned the advertising campaign launched by Luno as the campaign omitted the risks associated with investing in cryptocurrency.
In India, the Reserve Bank of India (“RBI”), vide its notification, and the Supreme Court, vide its judgment, has clarified that currently there are no restrictions for any businesses to provide services in cryptocurrencies subject to caution and proper due diligence. However, the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 is still pending before the Lok Sabha as of today.
Ambiguity over regulations by the Indian Government is hurting the crypto industry. The major concern is that such an ambiguous stance comes at a time when the crypto industry has been witnessing a significant increase in new users and volume of transactions.
Along with the tweets, several strict regulations, and bans, this inevitable downfall has led to a serious loss of almost $1 trillion worldwide in the month of May. While this crash may not be as bad as the “crypto bubble” in 2018 that lasted for a long time, it has led to negative sentiment in the market. Nevertheless, with the increase in investors/traders daily as well as scams such as the Turkish Vebitcoin scam, every government, and their regulators should actively protect the investors and prevent further environmental damage.
VIII. Potential to be the Future
With decentralization becoming a critical concern for regulators and government institutions, a new variant of cryptocurrency, known as Central Bank Digital Currencies (“CBDCs”) has been seen gaining traction from prominent governments across the globe. A report by the Economist Intelligence Unit recently suggested that the coronavirus pandemic has greatly accelerated the adoption of digital currencies across the world.
Though the essence of cryptocurrencies lies in decentralization, governments across the globe are experimenting with a centralized variant, known as the CBDCs. Simply put, a CBDC is a digital version of a fiat currency that uses a ‘private’ blockchain system. These private blockchains are controlled by one organization - central banks. With the help of CBDCs, central banks can issue and track the whole lifecycle of a country’s currency digitally, right from its creation.
The European Central Bank (“ECB”) published a report on the issuance of a digital Euro in October last year. The ECB noted that the digital euro would be accessible to all citizens and firms, making daily settlements fast, easy and secure. The main purpose is to complement cash, and not replace it altogether.
India is not behind either. RBI has been considering creating India’s own CBDC since as early as 2017. The RBI-issued digital currency is expected to reduce the job of intermediaries when it comes to settling payments and give the central bank tighter control over the country’s growing concern around bank frauds.
In pursuance of the environmental concerns that cryptocurrencies potentially cause, Canada’s Central Bank is planning to introduce Canada’s new cryptocurrency which promises a lower environmental impact than Bitcoin. It would be interesting to see what form of blockchain technology Canada will use for its cryptocurrency and whether it will set an example for other countries to adopt a similar method in their CBDCs.
These few months have been very eventful for all participants in the crypto space worldwide. Despite the recent harsh regulations and bans, crypto’s growing success and increasing use since its launch has attracted tremendous attention across the world. However, the future is still uncertain with institutions and governments across the world having various outlooks on the subject. There is much debate about this evolving technology, and it would be fascinating to see which path it takes in the future.