Developing Fit-for-Purpose Regulation
From the perspective of the nation state, cryptocurrencies present something of a paradox.
On one hand, they are a continuation of the familiar. It is easy to forget that currency itself is both a technology and a facilitator of commerce that has evolved alongside advancements in human civilisation, from cowry shells to silver coins to the printing of fiat. 1 Cryptocurrencies are simply the latest manifestation of money, purpose-built for the digital age.
On the other hand, the decentralised nature of the blockchain as originally conceived by Satoshi Nakamoto theoretically presents the most serious check on government power in history. Nothing less than the state monopoly on money supply – the most important pillar of centralised control alongside the monopoly on violence – is under threat.
The challenge for governments, then, is multi-faceted. First, how should they regulate cryptocurrencies and other digital assets issued and transferred using cryptography and distributed ledger technology? As securities, currencies, commodities or something else?
Any state attempt to ban digital assets outright is unlikely to succeed, as distributed ledger technologies are designed to be censorship resistant. Second, how quickly, and to what extent, should countries transition their fiat currencies to blockchain-backed digital currencies? Could it be as simple as reassigning each US dollar to a US digital dollar at parity?
Central Bank Digital Currencies
The creation of government digital currencies, which typically let people deposit funds directly with a central bank, will undoubtedly make global finance work better. Gov coins, also known as Central Bank Digital Currencies (CBDCs), will also shift power from individuals and retail banks to the state, alter geopolitics and change how capital is allocated. 2
Fifty monetary authorities, representing the bulk of global GDP, are exploring digital currencies. The Sand Dollar is already operational in the Bahamas, while China plans to showcase its new digital currency at next year’s Winter Olympics. 3 Given the advantages CBDCs enjoy over fiat, including low or no-cost transactions, more efficient payments and the secure settlement of cross-border transactions, their widespread adoption is inevitable.
Central Bank Digital Currencies will also allow governments to better support vulnerable citizens by facilitating more targeted and efficient fiscal stimulus. In a recession, funds can be deposited into the CBDC accounts of poorer households, cushioning their purchasing power from the effects of a downturn. 5 But adoption comes with an ironic twist – CBDCs are using the decentralised blockchain technology pioneered by Bitcoin to further centralise state power and control.
That said, the smooth transition from fiat to digital currency is far from certain, especially if governments retain the right – as is likely – to debase their CBDCs by issuing more as ‘needed’. As a result, Bitcoin will remain a call option on a global digital monetary system outside the purview of nation states, as well as a hedge against the short-termism of central banks everywhere. Bitcoin mining, in turn, is a convenient way for entrepreneurs and investors to gain direct exposure to this emerging monetary order.
Possible Regulatory Responses to Cryptocurrencies
So how might governments seek to undermine cryptocurrencies (and associated mining) given the threat they pose to centralised power? One reasonable assumption is that authoritarian regimes will regulate Bitcoin and its peers in a different manner to the West. Non-democratic powers are generally suspicious of any digital asset that facilitates capital flight, or that might serve as digital infrastructure for a decentralised financial future.
For example, Chinese officials have threatened to ban Bitcoin mining (in April 2019), and recently prohibited financial institutions from providing services related to cryptocurrencies. Investment bank H.C. Wainwright observes that stiffer crypto-directed enforcement and the ongoing decline in China-based mining activities, once home to as much as 70 percent of Bitcoin’s hash rate, is good news for North American miners.
Western governments are unlikely to try and marginalise Bitcoin to the same degree. But that doesn’t mean regulatory risk is non-existent. Hedge fund titan Ray Dalio claims that Bitcoin could become a victim of its own success. He thinks governments may attempt to crack down on Bitcoin if it becomes a genuine alternative to fiat, especially if bondholders sell their bonds in favour of Bitcoin as an inflationary hedge.8
In any future scenario, investors should expect most governments to more heavily regulate and tax cryptocurrencies to ‘protect’ citizens and raise revenues. This might involve imposing transaction reporting requirements, as well as corporate, income and potentially even transaction taxes (the majority of countries already apply capital gains tax to cryptocurrency profits). 9
Bitcoin as Legal Tender
Equally, it is almost impossible to imagine a future without cryptocurrencies generally and Bitcoin specifically. El Salvadorian President Nayib Bukele offered a sign of things to come when he announced that his country would partner with the Lightning Network payments platform Strike to reimagine its modern financial infrastructure using Bitcoin. 10 As a result, El Salvador has become the world’s first sovereign nation to adopt Bitcoin as legal tender.
The event has profound implications, both for El Salvador and the future of finance. El Salvador relies on remittances for 20 percent of its GDP and incumbent service providers often charge an exorbitant 10 percent or more in fees for international transfers that can take days to arrive. 11 The new system will slash those fees to close to zero and allow for instantaneous transactions.
The case study is a reminder that truly disruptive technology is almost impossible to regulate out of existence. Savvy governments also understand that technological innovation is one of the best tools they have for underwriting long-term productivity growth, and less regulation can lead to better results. As the Chinese saying goes, “when the winds of change blow, some people build walls and others build windmills.”
Megatrend summary: Regulation of Digital Assets
- Governments are grappling with the regulatory challenge posed by digital assets, which will make global finance work better, but threaten the state monopoly on money supply.
- Central Bank Digital Currencies (CBDCs) provide many of the benefits of Bitcoin, but in an ironic twist, will further centralise state control.
- Authoritarian powers will regulate Bitcoin and its peers with a heavier hand than democracies (although more regulation should be expected everywhere).
- Ultimately, though, cryptocurrencies are too beneficial to be regulated out of existence. Bitcoin remains a call option on a global digital monetary system outside the purview of nation states, and a hedge against the short-termism of central banks.
 Sammartino, Steve, Time for Gov Coins and Crypto Stability, Eureka Report, 18 May 2021 https://www.eurekareport.com.au/investment-news/time-for-gov-coins-and-crypto-stability/149828
 Bordo, Michael and Levin, Andrew, Central Bank Digital Currency and the Future of Monetary Policy , Vox EU, 23 September 2017 https://voxeu.org/article/benefits-central-bank-digital-currency
 ARK Invest, Bitcoin Mining The Evolution of a Multibillion Dollar Industry, 9 March 2020, https://research.ark-invest.com/bitcoin-mining-white-paper
 The Economist, The Rise of E-Money – The Digital Currencies that Matter, 8 May 2021, https://www.economist.com/leaders/2021/05/08/the-digital-currencies-that-matter
 The Lex Column, Crypto’s Libertarian Warriors Face Fiat Currency Fightback, AFR, 24 May 2021 http://www.afr.com/markets/currencies/crypto-s-libertarian-warriors-face-fiat-money-fightback-20210524-p57ukc?btis
 Brock, Jared A., Bitcoin and Ethereum are Dead (And Their Honest Investors Know It), Medium, 20 May 2021 https://medium.com/surviving-tomorrow/bitcoin-and-ethereum-are-dead-and-their-honest-investors-know-it-a36ee97df89d
 Hankin, Aaron, China Threatens to Ban Bitcoin Mining, Market Watch, 9 April 2019,New York Times, https://www.marketwatch.com/story/china-threatens-to-ban-bitcoin-mining-2019-04-09
 Dede, Kevin, With Crypto Now Institutionalized and Ingrained, Many North American Miners are Ready to Pounce, H.C. Wainwright, email sent 1 June 2021
 Lewitinn, Lawrence, Ray Dalio: ‘I Have Some Bitcoin’, Coindesk, 24 May 2021 https://www.coindesk.com/consensus-ray-dalio-i-have-some-bitcoin
 Sigalos, MacKenzie, El Salvador Looks to Become the World’s First Country to Adopt Bitcoin as Legal Tender, CNBC, 5 June 2021, https://www.cnbc.com/2021/06/05/el-salvador-becomes-the-first-country-to-adopt-bitcoin-as-legal-tender-.html