In 2022, how will U.S. regulatory policies affect the cryptocurrency market?

Source: Lawyer Sun Ming, Speech at the Zhibao Annual Meeting

整理: Youfei, Distributed Capital

The original title is: 《A Brief Analysis of the Current Status and Outlook of U.S. Regulatory Policies on Virtual Currency》

The Existing Regulatory Framework in the U.S. and the Functions of Various Departments

Overall, regarding the regulatory framework in the U.S., the lack of unified and one-stop legislation and regulatory departments leads to high regulatory and compliance costs. Practitioners find that they need to report to or apply for licenses from multiple departments when conducting business; failure to meet all requirements may result in penalties.

Treasury & IRS will formulate and enforce regulations related to crypto taxation.

SEC (Securities and Exchange Commission) has a relatively lenient approach to the regulation of governance tokens, typically not considering them as securities. Whether it is a domestic or foreign project, as long as one American buys the project's tokens, the SEC has jurisdiction over it. Therefore, U.S. projects generally design their tokens as governance tokens, which is currently the only loophole available.

CFTC (Commodity Futures Trading Commission) is a relatively friendly regulatory body towards the crypto industry, but its regulatory scope is limited to the derivatives sector, mainly crypto (commodity contracts). Compared to the CFTC, the SEC has a broader jurisdiction and greater power.

OCC (Office of the Comptroller of the Currency) is similar to China's Banking Regulatory Commission, and its jurisdiction covers many aspects of stablecoins. Whether it is USDT or USDC, stablecoins have bank deposits as reserve assets, which are intricately linked to banks. Currently, relevant legislation is still blank, and in the future, the OCC may introduce detailed rules on how banks can serve stablecoin issuers. If the relevant policies are relatively open, U.S. banks may provide reserve asset custody services for overseas stablecoin issuers. This will maintain the issuance of stablecoins while also sustaining the prosperity of the crypto industry.

CFPB (Consumer Financial Protection Bureau) will regulate project parties providing financial services to consumers (mainly stablecoins and DeFi) to protect consumer rights.

FinCEN (Financial Crimes Enforcement Network) is a regulatory agency focused on the payment sector, primarily overseeing anti-money laundering and anti-terrorism financing. U.S. exchanges and brokers are required to register for MSB licenses to facilitate FinCEN in establishing formal information channels. Exchanges and brokers must collect customer identity information and verify customer transactions to prevent clients from engaging in money laundering and terrorism financing. In the future, FinCEN will regulate the DeFi sector. Since the responsible parties in the DeFi industry are not clearly defined, regulation by FinCEN will be more complicated, possibly leading to accountability on a case-by-case basis.

Outlook on the Future Development of U.S. Regulatory Policies

Stablecoins: Stablecoins have a significant impact on the entire crypto industry and are a matter of great concern for government agencies. There is a loophole in U.S. regulation of stablecoins, which may be intentional by the government. In traditional finance, users must complete KYC before obtaining financial services; however, stablecoins have bypassed this iron rule in the U.S. financial industry, allowing anyone to access stablecoin financial services without KYC (unless the issuer redeems). This means that even criminals can obtain stablecoins. The U.S. government's subtle strategy may be to expand the credit of the dollar worldwide through stablecoins.

The U.S. government realizes that stablecoins may involve money laundering and terrorism financing. On one hand, KYC will need to be strengthened in the future, including that users holding stablecoins are not as anonymous as before. On the other hand, it concerns how banks will engage with stablecoin issuers like Circle. Stablecoin issuers similar to Circle will be required to hold a specific proportion of highly liquid reserve assets, such as government bonds or bank deposits. Of course, currently, the impact of stablecoins on the dollar is not yet significant.

Taxation: Currently, the U.S. government's taxation measures regarding virtual currencies involved in DeFi transactions are not clear enough. In the future, regulatory agencies will focus on issuing specific enforcement policies regarding taxation. Another point is the unrealized profits tax mentioned by Yellen, which applies to both stock listings and the crypto sector. Once this policy is implemented, it will be a significant negative for the capital market.

Securities Issuance: The question of whether the issuance of tokens by crypto industry projects constitutes a securities issuance is a long-standing issue. Many officials in U.S. securities departments have realized that using the old securities law framework to regulate virtual currency issuance is problematic. It could prevent some originally decentralized projects from issuing tokens; applying for securities registration under existing securities laws could hinder project progress.

SEC Commissioner Hester Peirce once proposed a safe harbor provision, which aims to give certain crypto projects a transition period (for example, three years). If a project reaches a sufficient level of decentralization, it will no longer need to meet the requirements for securities issuance, which is a significant breakthrough. It means creating a new category of asset issuance outside the securities law framework. Although this is just a proposal from an SEC commissioner, it is very meaningful and aligns well with industry conditions. Whether this proposal can become formal legislation may take a considerable amount of time to materialize. Furthermore, this requires congressional members to fully recognize the decentralized nature of this industry to promote the legislation. Currently, since the release of the safe harbor proposal, there has been no substantial advancement at the government level. The new SEC chair, Gary, also does not show particular interest in this proposal, instead focusing on cracking down on various token issuance projects.

Infrastructure Bill: The infrastructure bill, led by Biden, is a significant piece of legislation, with a notable relationship to the crypto industry concerning the definition of brokers. It may broadly encompass PoW miners like Ethereum or Bitcoin and DeFi project parties. This means they will bear many heavy reporting obligations, especially regarding user taxation. If a DeFi project party is classified as a broker, it will need to report users' transaction information to the government. However, this bill is not very practical because Ethereum miners, as verification nodes, cannot know who the specific parties are, making reporting impossible. Given the relatively vague definition of brokers, specific explanations from administrative departments are also needed.

DAO: DAOs, as a new form of organization, are no longer within the jurisdiction of regulatory bodies but fall under the legislative authority. The general legislative process requires a bill to be submitted by members of Congress and then approved by Congress. Since DAOs exist outside the current organizational structure (such as limited partnerships), there are no clear regulations regarding tax declarations and tax obligations. It is expected that there will be no legislation in this area for the next three years, as the scope of legislation is too broad. Additionally, current congressional members do not have corresponding recognition of DAOs, and introducing relevant legislation will take time.