Should the U.S. Government Impose More Stringent Regulations on Crypto Trading?

Despite the increasingly mainstream nature of an investment like Bitcoin (BTC -1.79%), the crypto market is still often referred to as the Wild West. Should crypto investing be more regulated than it is now? In this segment of Backstage Pass, recorded on Nov. 3, Fool contributors Trevor Jennewine, Brian Withers, and Rachel Warren dive into this complicated question and the broader implications of tighter crypto regulations. 

Trevor Jennewine: In late October, there was a new digital currency or a new cryptocurrency, Squid, that really caught the attention of investors. Not affiliated with Netflix in any way, but it certainly is a play on the popular show Squid Game. Anyway, this cryptocurrency skyrocketed 23,000,000% between Oct. 26 to Nov. 1 according to The Washington Post. I've seen different figures out there, but they're all above hundreds of thousands of percentage even into the millions of percentage points. In a few days, that's mind-blowing.

Earlier this week, the project crashed when the creators drained the liquidity of the cryptocurrency, taking about $3 million. The creator or creators, the website is now down, social media accounts are inactive or in the case of Twitter, it's been banned for suspicious or unusual activity and if in hindsight there were a lot of problems that maybe pointed to this being a scam. They were spelling errors in the white paper. There was a lock-up period, built into the protocol where after buying, you weren't allowed to sell for a period of time.

They named it something really catchy, even though it had nothing to do with the Netflix Show and this underscores something that the SEC Chairman Gary Gensler has been saying for a while. He recently compared cryptocurrency to a teenager and said that it wouldn't reach adulthood without federal oversight and then he pointed to issues specifically like money laundering and tax compliance.

But cryptocurrency itself was designed to eliminate the need for regulation from financial institutions like banks or payment processors. Blockchain technology replaces those institutions with miners, and the miners become responsible for solidifying transactions and in doing so they create new currency.

This question has two parts. First, how do you think the cryptocurrency community is going to respond to more stringent oversight from regulators like the SEC? Brian.

Brian Withers: Yeah, this is a tough one. I hear the story about the Squid digital currency and feel sorry for the folks who thought they were investing in a legitimate enterprise and the things that they're doing, and it's certainly unfortunate. I don't know that regulators [laughs] if there had been some regulations in place, what would that have stopped these squid guys from trying to scam people out of their money, I don't know.

Unfortunately, regulation always follows tech and it's hard, how do you regulate something that's this broad and just lots of significant number of people and entities are getting involved? I'm really not sure and I think any regulators rather than come down with a strong hammer are going to wade into this a little bit at a time. I don't know whether the cryptocurrency will even notice an impact for the foreseeable future. How about you Rachel?

Rachel Warren: Yeah. This is a sad story, I agree. I feel bad for individuals who thought they were investing in a legitimate crypto and then clearly had a very unwelcome surprise. I think one of the things that is interesting to note with some of these cryptos, especially the ones that seem to attract the quick online attention and go back down. I think it plays on some of those basest emotions that you struggle with as an investor of the fear versus greed tug of war.

There's this temptation because there's this idea that some of these cryptos could make you rich overnight, there are some people that have amassed huge amounts of wealth, although they are, I think in the minority from these cryptos. I think that's broad. I don't think the cryptocurrency community will respond particularly well to oversight, but I just think oversight is needed in a much broader capacity than it is now.

It is interesting, there is a new law that's being considered last I checked this is still true in the bipartisan infrastructure bill that would essentially require companies that facilitate crypto trades through tax information about those trades to the IRS and the idea that it would make it easier for investors to deal with that from a tax perspective but again, embodying what's happening with the crypto craze more into the current law. But you look at examples of other countries that have regulated cryptocurrency. One interesting one I found was Indonesia.

Initially, the country banned cryptocurrency and then they legalized it and now, any entity that deals in crypto assets, basically as commodity futures, have to comply with certain laws. They have to report to the Indonesian financial transaction reports and analysis center. There are similar regulations in place in countries like the United Kingdom, Singapore, and even Canada. The fact that we don't have a broader federal regulatory system in place for crypto, I understand the tech is always so far ahead, but I definitely think it needs to happen.

Jennewine: I think those are both great points. I don't think the crypto community will be happy about regulation, but I think regulation is important. I think the investors that lost their money on Squid, I think that's terrible. When I pointed out that in hindsight, it it's easy to see maybe some of the signs that it was a scam, it's much harder to see those things when you're actually going through it. What happened, it's terrible. However, long term, like Brian said, I'm not sure how much regulations will actually be able to impact the cryptocurrency market in general.

China has made cryptocurrency transactions illegal. They've prohibited citizens from working for crypto-related businesses and that initially caused a huge sell-off. Every time that news surfaces, the crypto market sells off. But it's since come back, it's hitting new highs.

I recently saw Bloomberg report that said maybe new crypto investors in China might be dissuaded from jumping into the market. But the ones that have already been there actually looked at it as a buying opportunity. They haven't really stopped trading. It's designed to work without government oversight. There are certain ways around the government's crackdown and that's exactly what's happening.