The Pros and Cons of Crypto and Blockchain-related Regulation

TL: DR

- Regulation as a concept in cryptocurrency is when digital assets are made accountable and transparent to a governing body, usually the government.
- When digital assets are regulated, certain procedures and requirements are introduced to ensure that they are safe and viable for investments.
- Although there are advantages and disadvantages to the introduction of regulations on crypto, it is much more advisable for it to be done in the short term.
- The present regulations are not tailored to crypto. However, they can be amended to suit it.

Keywords: Regulation, crypto, digital assets, accreditation, procedures.


Crypto Regulation

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When regulations are mentioned in cryptocurrency, they are often used in the concept of three categories:

- Know Your Customer (KYC)
- Anti Money Laundering (AML) regulations,
- Securities regulations, issuance, and trading restrictions.


AML and KYC regulations aim to verify customers' identities and assess the possibility of using business relationships to facilitate money laundering.

As late as 2018, most crypto exchanges and companies made minimal efforts to verify their customers' real-world identities. However, things have changed as crypto companies have realized they must follow KYC and AML practices to avoid regulatory crackdowns.

In a KYC process, the user provides basic personal information, such as their name, address, social security number, etc. AML regulations then check this information against lists of known criminals or those at high risk of money laundering. Monitoring a client's transactional behavior is also necessary to identify possible money laundering activity.


The Role of the SEC in Regulating Cryptocurrencies

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As with the 1920s capital markets, today's digital asset markets are characterized by rampant speculation, market manipulation, deception, and outright theft. As a result, many digital assets are bought solely with the expectation of reselling them for a profit, and when those bubbles burst, unwitting investors lose all their wealth.

With the fear of not having a repeat of the Great Depression, Congress enacted the Securities and Exchange Commission (SEC) to regulate the nation's capital markets and securities industry. This enactment gives the SEC jurisdiction over securities issues - including bonds, stocks, investment contracts, notes, and derivatives derived from securities, brokers, dealers, and securities exchanges.

For a financial asset to be declared a security, the SEC takes it through two tests - the Howey test and the Reves test.

Howey's test determines whether an asset represents security by examining three criteria:
- whether it is an investment of money,
- whether it is part of a common enterprise, and
- whether the transaction expects a profit.

According to the Reves test, a promissory note is presumed to be a security. Still, that presumption can be rebutted by demonstrating a "family resemblance" to an asset that is not a security. The major factors are:
- The purpose of the transaction, e.g., to make a profit.
- How the assets will be distributed?
- What do investors expect from the asset?
- Other factors that can reduce the risk of the asset.

Apart from accessing assets, the SEC also regulates cryptocurrencies by:
- Ensuring the assets have environmentally safe mining processes for their blockchain
- Protecting investors from risks and abuse by ensuring that crypto exchanges have rules to ensure their safety.
- Ensuring crypto and crypto exchanges are transparent, accountable, and ready to clamp down on any sniffs of criminal activity, money laundering, etc.

With this background information clearly stated, here are the pros and cons of having crypto and blockchain-related regulation:


The Pros of Crypto Regulations

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The protection of Investors
There are benefits to regulating security token issuances or any issuance at all. One of these benefits is protecting investors. By restricting who can invest in unregistered securities offerings, the potential investor pool is significantly reduced, which poses serious problems for legitimate projects. Nevertheless, it makes raising money more difficult and less attractive for bad or outright fraudulent companies.

The ICO craze that marked 2017 underscored the importance of investor protection. Investors could throw money at any project with a decent whitepaper or a catchy pitch outside of securities laws. Unfortunately, many companies were just pitches with no product or plan. These "investments" are often worthless, leaving their investors with no recourse after defrauding them. The potential reward of ICOs would have been less, and the penalties would have been more obvious if they were subject to greater regulatory scrutiny.

A high level of legitimacy throughout the industry
The crypto industry is far riskier than traditional capital markets, despite the industry's wild west image. As a result, the market has moved more quickly, creating a more accessible environment for investors and entrepreneurs alike. Still, the risks have made the largest players - institutional investors - reluctant to enter.

There is a common belief among crypto investors that as institutional investors become more comfortable with cryptocurrency, prices will rise, and demand will skyrocket. Crypto assets will be legitimized, and institutional investors will send a message that the asset class is here to stay due to their entry into the market.

Although the crypto community views regulators warily, institutions view increased regulation as a necessary and positive step before investing in crypto.

An increase in the quality of issuances
By increasing regulation, token issuances will be of higher quality. Securities laws increase the barrier to entry into the token fundraising market and increase the scrutiny of token issuances. With a more difficult and scrutinized process for token issuance, fraud or poorly thought-out projects will be discouraged from holding an ICO, resulting in high-quality security token issuances.


The Cons of Crypto Regulations

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Valuable projects are excluded
A high barrier to entry indeed increases the quality of the projects within the crypto space. Still, it also screens out high potential projects because managing a compliant issuance places a heavy financial and regulatory strain on smaller, capital-starved companies.

A major reason cryptocurrency and ICOs gained popularity quickly was that they offered investors the opportunity to invest in projects much earlier than possible with existing securities laws. On the flip side, early-stage companies can gain access to capital quickly and easily through the ICO model to help finance the development of their products. In addition, raising funding for companies with great products and ideas would be easy without determining how to structure an offering and comply with regulations.

Investor Exclusivity
For issuers seeking Regulation D or Regulation S exemptions, the classification of tokens as private securities drastically reduces the potential investor pool by limiting the eligibility for investment based on accreditation. In addition, while the SEC allows issuers to sell to non-accredited investors outside the US, issuers must comply with their respective local regulations, including their accreditation requirements.

As a result of the accreditation standard, less financially savvy individuals may not be able to invest in private ventures with a limited amount of information.

The reason for this development may be respectable as it seeks to protect the people who are less sophisticated from being exploited. However, accreditation standards are sometimes poorly executed. Using investors' net worth and income can be inaccurate measures of their sophistication.

Poor User Experience
User experience refers to the experience users have when purchasing or trading tokens. Despite not being as important as the other factors that impact the entire fundraising ecosystem for private companies, it does affect investment ease.

Investing in tokens early on was relatively easy. Users only had to create an account using their email addresses. However, over the past few years, exchanges and ICO issuances have gradually increased their requirements for customer identification documents and information to enable entry. In addition, there has been the introduction of the AML/KYC procedure. These procedures identify customers as part of anti-money laundering and counterterrorism programs. Although these procedures are meant for the bigger picture, i.e., to reduce criminal activity, they can also be a lot of an inconvenience in some cases.


Conclusion

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Despite the fears in the crypto world about more regulation, there is no contention about the fact that, in the short term, it will benefit the crypto community. By limiting crypto to limited categories within current securities regulations, crypto preserves the status quo, slowly eroding its disruptive potential. That process was probably expected as introducing a new asset class would not immediately prompt regulators to modify regulations. However, regulations rarely change immediately, and while current rules aren't tailored to crypto, the application of these regulations will not be a death sentence for blockchain development.

If stricter regulations are applied, it can lead to valuable projects freezing out, thus excluding relatively less wealthy investors from investing in the early stages using accreditation requirements.

Regulation will help protect investors from fraud and attract institutional investors, resulting in a healthier crypto economy in the short term. With time, we hope regulations will be rewritten to better fit crypto and the token model.







Author: Gate.io Observer: M. Olatunji
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* This article represents only the views of the observers and does not constitute any investment suggestions.
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