Washington faces steep cryptocurrency learning curve

Washington is grappling with how to govern cryptocurrencies, with many lawmakers facing a steep learning curve to understand how bitcoin and its brethren even work.

The virtual currencies are blurring decades-old lines that regulators use to police financial markets, posing new challenges for state and federal officials.

Investors are eager for more clarity, but fear a knee-jerk reaction from Congress that could derail the cryptocurrency industry in its early years. 

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“Until they decide to think radically differently about how to regulate financial services, I don’t know how this is going to get resolved so cleanly,” a financial technology lobbyist told The Hill.

Cryptocurrencies exploded in value and popularity in 2017 as investors caught on to the potentially disruptive power of tokens such as bitcoin and ethereum. Virtual currencies run on a digital public ledger that updates several times an hour, verifying transactions quickly and cheaply without involving banks.

As the value of cryptocurrencies exploded last year, traders began offering a slew of related futures and derivatives. Dozens of companies — some legitimate, others fronts for frauds — sought to raise capital by offering their own virtual coins through initial coin offerings (ICOs).

The proliferation of cryptocurrencies and the dizzying array of new investments has raised alarms with the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), which have both issued warnings to investors about their difficulties policing cryptocurrencies and related investments.

“A lot of our laws are fairly old. They’re fairly dated,” Brian Knight, director of the right-learning Mercatus Center’s financial regulation program, told The Hill. “The regulators have been sort of writing rules on top of the laws, some of which may make sense, some of which may be outdated themselves.”

The SEC and CFTC have penalized or started to probe dozens of companies that have offered cryptocurrency-related investments, financial advice and ICOs while potentially flouting trading laws.

Members of Congress in both parties have expressed concerns about amateur investors facing financial ruin due their lack of understanding of cryptocurrencies and few explicit protections.

“A lot of average people are using it and believing that it’s an investment tool,” said Rep. Carolyn Maloney (D-N.Y.) at House hearing this month on cryptocurrency investments.

“They’re pouring their life savings into cryptocurrencies and they stand to lose a lot of money when this bubble eventually bursts.”

Cryptocurrencies fit into several different categories of investments and financial products, some of which aren’t regulated on a federal level. The SEC and CFTC have asked Congress for more authority to police cryptocurrency exchanges, which are currently regulated by state money transfer licensing agencies.

But lawmakers have held back on writing new rules and standards as they try to learn more about the ways cryptocurrencies work.

“Congress needs a strong understanding of the technology and its application before we can understand how it fits into our existing regulations and the laws we have on the books may encourage or inhibit an efficient market,” said Rep. Randy Hultgren (R-Ill.) at the House hearing.

“There are a lot of questions in this.”

A virtual token could at the same time be considered as a security (akin to a stock or bond), a commodity (a scarce resource with inherent value), and a currency (a unit of transferring value.)

The lines drawn between securities, commodities and other financial products are based on a series of laws and court verdicts from the 1930s and ‘40s. One of the most challenging aspects of regulating cryptocurrencies is figuring out where they fit into these categories, if at all.

“It is not out of the question that a single transaction could be the transfer of money, the sale of a security, or offering of a commodity,” Knight said.

The lack of regulatory clarity has chilled action in the cryptocurrency investment space, as companies move away from previously planned exchanges, derivative listings and ICOs. Cryptocurrency prices have also fallen several thousand dollars from their 2017 highs.

“If policymakers get the line between commodity tokens and securities offerings wrong, or if it isn’t made clear by regulators, it will destroy the viability of these innovations and cede leadership in this technology to the rest of the world,” said Peter Van Valkenburg, director of research at CoinCenter, a cryptocurrency think tank.

Knight said he doesn’t think “it would be a good idea to take cryptocurrencies and put them all in one single bucket.”

But experts broadly agree that Congress should set some new guidelines for which agencies should regulate which kinds of cryptocurrency transactions, and whether deeper federal oversight is necessary.

“It’s a question of who’s going to regulate and are we going to have multiple parties with multiple rule sets regulating it,” Knight said. “That’s an area where Congress should at least consider stepping in.”