Cryptocurrencies are decentralized digital currencies secured by blockchain technology. Bitcoin, ethereum, and other cryptocurrencies have become almost as accessible as government-issued currency in recent years, but the government offers few consumer protections for them.
The Securities and Exchange Commission SEC — led by Gary Gensler, who taught a class on cryptocurrency at MIT — is trying to make the case that it can and will regulate whatever cryptocurrency investment schemes it decides fall under its purview. The relative newness and rapid expansion of the cryptocurrency industry have put it in a regulatory gray area. The SEC appears to have decided that an upcoming offering from Coinbase, the largest cryptocurrency exchange in the United States, meets its definition of a security.
Cryptocurrency exchanges allow people to buy and sell crypto. Coinbase is one of the biggest in the world and recently went public. In exchange, lenders would receive 4 percent interest on the loan — a far higher rate than traditional banks currently offer on their savings accounts. The SEC has not officially commented yet, though some people think this tweet qualifies as a response. What exactly are bonds and how do they work? As the New York Times recently explained , cryptocurrency is moving into the banking sector, offering services that are usually reserved for traditional banks, whose services are backed by government-issued currency the dollar, for example and have operated under consumer protection laws and regulations that go back decades.
For example, some crypto companies now offer interest-bearing crypto accounts, debit cards, and credit cards with cryptocurrency rewards. The SEC has previously shown an interest in cracking down on crypto. It launched a crypto regulation initiative in , which became a standalone office within the agency last December. But Coinbase is bigger and more high-profile than those companies. In a CBDC world, all transactions could in theory be monitored with the help of data analytics and AI in order to more quickly identify banks that are struggling or are engaging in questionable transactions.
At present, financial regulators must rely on the reports provided by banks, which means that remedial action comes late and often at a greater cost. In addition, in a CBDC world in which digital bank codes are visible to the clearing institution, it becomes much easier for the authorities to identify the parties to a transaction, which greatly simplifies the detection of criminal activity and eliminates the black markets characteristic of countries that deal largely in physical money.
The cost of fraud to U. The switch also simplifies the execution of monetary policy—the central bank can immediately change supply by issuing or canceling codes in its own accounts. And by paying interest on CBDC holdings, however, the central bank can directly transmit monetary policy to households, instead of influencing commercial deposit rates through the rates it offers banks on their reserve accounts with the central bank.
Today, with money held in commercial banks, the policymaker can only influence consumer and business behaviors indirectly. In the U. An unbanked Indian consumer with an Aadhar number and a smartphone could easily transact over a mobile app. This means that countries in the developed world will fairly easily be able to integrate people into the financial system who were traditionally outside of it.
These changes stand to take out many of the costs and risks implicit in the traditional system, which was built at a time when customers needed secure branches to deposit bags of cash. That has resulted in a trillion-dollar, 85, branch, operations and payments infrastructure in the US that employs 1. Beyond the unnecessary waste of the physical infrastructure, the system is slow and expensive: payments take an average of days to settle, and card processing fees eat up half of retailing profit margins.
With CBDC and central banks holding deposits, banks cannot overstretch customer deposits as they currently do, which will significantly de-risk the banking system. An even bigger impact could result from the lowering of default rates due to the precision of CBDC transaction data in monitoring the use of credit.
CBDC is not without its problems. One obvious risk is to privacy. A number of U. Other concerns revolve around the role of a central bank as a wholesale lender of first resort. State-controlled credit could potentially be susceptible to political pressure for sector-focused lending.
Would there be formal criteria for determining which banks would qualify for central bank funding? How easy would these be to manipulate in some way? Perhaps the biggest concern is with security, particularly cyber security. You can argue that the existing system, with multiple banks responsible for their own security, is exposed to more frequent but possibly more localized breaches of security. According to this logic, if the central bank gets hacked, then the whole system could be fatally compromised, although the risk of a breach actually occurring is perhaps reduced — given that a central bank would have the cyber expertise of its government at its disposal.
Essentially, the trade-off would be between recurring but manageable breaches and highly infrequent but catastrophic ones. A central bank would definitely be too big to fail. That said, the technology of the blockchain is highly secure and transactions are highly compartmentalized, which means that the central bank could potentially operate a highly distributed and compartmentalized system, thereby spreading the risk and consequences of any possible cyber-security breach more widely.
Indeed, the future use of blockchain for cybersecurity is expected to improve on the present situation. In my view, the move to low or no-cash economies based on CBDCs, whose sovereign monetary bodies compete on software-like features and costs, is inevitable. The new banking model will reach more people with better, faster services, and deliver credit to businesses on better terms, while preserving liquidity and efficiency in the capital markets.
Overall exposure to risk will likely be reduced and, while some degree of privacy may be lost, the benefits from protection against fraud and other crimes will more than compensate. You have 1 free article s left this month. You are reading your last free article for this month. Subscribe for unlimited access. Create an account to read 2 more. Economic systems. Read more on Economic systems or related topics Financial markets and Financial service sector.
Mookerjee is also a senior fintech adviser to Warburg Pincus, a global growth investment firm.
Although Bitcoin is widely recognized as pioneering, it is not without limitations. For example, it can only process seven transactions a second. By contrast, Visa handles thousands of transactions per second. The time it takes to confirm transactions has also risen. Not only is Bitcoin slower than some of its alternatives, but its functionality is also limited.
Other currencies like Bitcoin include Litecoin , Zcash and Dash , which claim to provide greater anonymity. Ether and currencies based on the Ethereum blockchain have become increasingly popular. However, issues with Ethereum technology have since caused declines in value.
Ethereum has seen its share of volatility. Put simply, smart contracts are computer programs that can automatically execute the terms of a contract. With traditional operations, numerous contracts would be involved just to manufacture a single console, with each party retaining their own paper copies. However, combined with blockchain, smart contracts provide automated accountability. Smart contracts can be leveraged in a few ways: When a truck picks up the manufactured consoles from the factory, the shipping company scans the boxes.
Beyond payments, a given worker in production could scan their ID card, which is then verified by third-party sources to ensure that they do not violate labor policies. As mentioned previously, cryptocurrency has no intrinsic value—so why all the fuss? People invest in cryptocurrencies for a couple primary reasons.
Apart from pure speculation, many invest in cryptocurrencies as a geopolitical hedge. During times of political uncertainty, the price of Bitcoin tends to increase. Bitcoin is not the only cryptocurrency with limits on issuance.
The supply of Litecoin will be capped at 84 million units. The purpose of the limit is to provide increased transparency in the money supply, in contrast to government-backed currencies. With the major currencies being created on open source codes, any given individual can determine the supply of the currency and make a judgment about its value accordingly. Applications of the Cryptocurrency. Cryptocurrencies require a use case to have any value. The same dynamic applies to cryptocurrencies.
Bitcoin has value as a means of exchange; alternate cryptocurrencies can either improve on the Bitcoin model, or have another usage that creates value, such as Ether. As uses for cryptocurrencies increase, corresponding demand and value also increase. Regulatory Changes. Because the regulation of cryptocurrencies has yet to be determined, value is strongly influenced by expectations of future regulation.
In an extreme case, for example, the United States government could prohibit citizens from holding cryptocurrencies, much as the ownership of gold in the US was outlawed in the s. Technology Changes. Unlike physical commodities, changes in technology affect cryptocurrency prices.
July and August saw the price of Bitcoin negatively impacted by controversy about altering the underlying technology to improve transaction times. Conversely, news reports of hacking often lead to price decreases. Still, given the volatility of this emerging phenomenon, there is a risk of a crash. Many experts have noted that in the event of a cryptocurrency market collapse, that retail investors would suffer the most.
Initial coin offerings ICOs are the hot new phenomenon in the cryptocurrency investing space. ICOs help firms raise cash for the development of new blockchain and cryptocurrency technologies. Startups are able to raise money without diluting from private investors or venture capitalists. Bankers are increasingly abandoning their lucrative positions for their slice of the ICO pie. Not convinced of the craze? With cryptocurrencies still in the early innings, there are many issues surrounding its development.
According to this theory, members of society implicitly agree to cede some of their freedoms to the government in exchange for order, stability, and the protection of their other rights. By creating a decentralized form of wealth, cryptocurrencies are governed by code alone. The following section will discuss these tangible aspects of cryptocurrency development. Under current accounting guidelines, cryptocurrencies are most likely not cash or cash equivalents since they lack the liquidity of cash and the stable value of cash equivalents.
In the US, IRS Revenue Ruling stated that holders of cryptocurrencies should account for them as personal property, with gains or losses on purchases or sales. The value of cryptocurrency holdings on balance sheets would be at cost or fair market value at the time of receipt. The ruling left many questions unanswered. These rules exclude certain investment assets, but do not explicitly exclude cryptocurrencies, so their applicability is unclear.
Outside the US, accounting treatment of cryptocurrencies varies. In the EU, a decision of the European Court of Justice rules that cryptocurrencies should be treated like government-backed currencies, and that holders should not be taxed on purchases or sales. Regulatory treatment of cryptocurrencies continues to evolve, but because the technology transcends global boundaries, the influence of national regulators is limited. Japan has not only legally recognized Bitcoin, but also created a regulatory framework to help the industry flourish.
This is considered a major step forward for legitimizing cryptocurrencies. The media has generally praised the new regulatory scheme, though the Japanese Bitcoin community has criticized the system as hampering innovation. The move follows the major fraud and investor losses from the Mt. Gox Bitcoin exchange scandal. The retail investor— Mrs. She wants something regulated and trustworthy.
On the other hand, US regulators have been less than keen about the rise of virtual currencies. US regulators are starting to crack down on previously unregulated cryptocurrency activities. Take initial coin offerings ICOs for example. Despite their popularity, many ICOs are for new cryptocurrencies with speculative business models, and have been widely criticized as scams.
Since ICOs can be sold across national borders, it remains to be seen whether ICO issuers will choose to comply or simply move transactions outside of the US. Due to the pseudonymous nature of ICO transactions, it may be difficult for national governments to significantly limit cryptocurrency sales or trading.
Regulation is also expanding beyond ICOs. This move is a result of concern that cryptocurrency investors believe they are receiving the protections and benefits of a registered exchange when they, in fact, are not. To date, compared to securities brokers, cryptocurrency exchanges have had no capital rules and have been largely unregulated other than for anti-money laundering—something that seems to be subject to change. Exchanges registered with the SEC will be subject to inspections, required to police their markets, and mandated to follow rules aimed at ensuring fair trading.
New York State created the BitLicense system , which imposes new requirements on companies looking to conduct business with New York residents. As of mid, only three BitLicenses have been issued, and a far greater number withdrawn or denied. In contrast, Vermont and Arizona have embraced the new technology. Both states passed laws providing legal standing to facts or records tied to a Blockchain, including smart contracts.
Arizona also passed a second law prohibiting blockchain technology from being used to track the location or control of a firearm. Computer hacking and theft continue to be impediments to widespread acceptance. These issues have continued to rise in tandem with the popularity of cryptocurrencies. In July , one of the five largest Bitcoin and Ethereum exchanges Bithumb was hacked, resulting in the theft of user information as well as hundreds of millions of Korean Won.
The pseudonymous nature of blockchain and Bitcoin transactions also raises other concerns. In a typical centralized transaction, if the good or service is defective, the transaction can be cancelled and the funds returned to the buyer. Despite advancements since their inception, cryptocurrencies rouse both ire and admiration from the public. The challenge proponents must solve for is advancing the technology to its full potential while building the public confidence necessary for mainstream adoption.
After all, critics are not entirely wrong. Bitcoin and its investors could end up like brick and mortar stores, eclipsed by the next big thing. New cryptocurrency advancements are often accompanied by a slew of risks: theft of cryptocurrency wallets is on the rise, and fraud continues to cast an ominous shadow on the industry.
Still, cryptocurrencies and blockchain could be truly transformative. The only limit is your imagination. Cryptocurrencies are primarily used to buy and sell goods and services, though some newer cryptocurrencies also function to provide a set of rules or obligations for its holders. During mining, two things occur: Cryptocurrency transactions are verified and new units are created. Effective mining requires powerful hardware and software.
Miners often join pools to increase collective computing power, splitting profits between participants. Groups of miners compete to verify transactions. Cryptocurrency wallets help users send and receive digital currency and monitor their balance.
A decentralized network of computers competes to solve complex math puzzles in order to mine the cryptocurrency. The more computing power a miner has, the higher their chances of being rewarded in new bitcoin. That has raised alarm bells for policymakers around the world, with China even banning crypto mining completely last year.
That move led to an exodus of crypto miners from the country to the U. Part of the language in the White House announcement focuses on giving the U. This is especially significant now that China has effectively banned cryptocurrencies. Biden has tasked the Department of Commerce with "establishing a framework to drive U. Several crypto industry figures have called for such action, including the bosses of Coinbase , Kraken and the Winklevoss twins' Gemini exchange.
The Blockchain Association, an organization that represents multiple well-known crypto companies, said Wednesday that Biden "has the opportunity to ensure America remains the global leader for technological innovation for years to come. It comes as China has led the charge toward central bank digital currencies, or CBDCs, with more and more people using smartphones to make payments and handle their finances.
Biden isn't saying whether the U. Rather, he's calling on the government to place "urgency" on research and development of a potential CBDC. The Federal Reserve last year began work on exploring the potential issuance of a digital dollar. The central bank released a long-awaited report detailing the pros and cons of such virtual money, but didn't take a position yet on whether it thinks the U.
While CBDCs could rapidly speed up the settlement of payments, policymakers are evaluating a number of issues around financial stability and privacy. Delivery of the new policy agenda removes a key source of uncertainty for an industry that has already been rocked by numerous regulatory hiccups and scandals.
Securities and Exchange Commission over allegations it violated securities laws with its retail lending product. Coinbase has similarly run into trouble with the watchdog, though it managed to avoid punishment. The SEC threatened Coinbase with legal action over a product similar to BlockFi's which offered users interest payments on their crypto holdings. The company subsequently dropped plans for the service.
Crypto investors appeared to agree. Clarification: This story has been updated to clarify that the move by President Biden was an executive action. Skip Navigation. Investing Club. Key Points. The measures focus on six key areas: consumer protection, financial stability, illicit activity, U. The Biden administration also wants to explore a digital version of the dollar.
VIDEO White House economic advisor Brian Deese breaks down new executive order on crypto. Squawk on the Street.
The Deputy Governor said crypto-technology is underpinned by a philosophy to evade government controls. "Cryptocurrencies have specifically been. The establishment of a government-backed cryptocurrency is a threat to the freedom of commerce and would give Washington the ability to. When currencies evolved to paper-based systems, backed by gold or silver and managed by private or government banks, this built-in protection against monetary.