Do We Need More Crypto Regulation? Two Sides of the Story

Is cryptocurrency regulation the bogeyman many make it out to be?

Lawmakers in Washington have been grappling with the thorny topic of crypto regulation for some time. The sprawling cryptocurrency industry is currently worth over $2 trillion -- and senior figures, from Treasury Secretary Janet Yellen to SEC Chair Gary Gensler, all believe more oversight is necessary.

At the same time, long-standing crypto enthusiasts fear regulation will suffocate this burgeoning industry. Here's a summary of both sides of the debate.

Pro regulation

Those in favor of regulation believe it will help the industry to thrive. Here's how.

It will increase investor protection

There's a reason Gensler described crypto as the Wild West. It is rife with scams and there are few rules in place to prevent market manipulation or insider trading.

Plus, there are hidden risks that many investors don't consider. For example, if you put your savings into an interest-earning crypto platform, how sure are you that your cash is protected? What if the platform goes bankrupt or gets hacked? These are things regulation could eventually address.

It could prevent money laundering and tax evasion

Many argue that criminals use the anonymous nature of crypto trading to launder their ill-gotten gains, making regulation essential. There's a fear that cryptocurrency cash is being used to finance terrorism or funnel money from illegal activities.

As a result, most major cryptocurrency exchanges have know-your-customer (KYC) procedures. Users have to submit personal information, such as their name and photo ID, before they can open an account or deposit money. However, there are still plenty of KYC-free exchanges where people can trade anonymously.

Cryptocurrency -- especially stablecoins -- could impact the wider economy

Stablecoins are cryptos that peg their value to other commodities like gold or U.S. dollars. There are different types of stablecoins, but one model already has authorities worried: fiat-backed stablecoins.

Fiat-backed stablecoins are pegged to traditional currencies like the dollar. In theory, they should be backed 1:1 by assets held in reserve. That way, if everybody tried to withdraw their tokens at the same time, they could.

But right now, that's not the case. For example, Tether (USDT), the biggest stablecoin by market cap, supports about half its tokens through a type of short-term debt called commercial paper. If there is a run on Tether, investors may find they can't access their money. And global credit agency Fitch Ratings has warned that it could also affect the stability of the whole short-term credit market.

The crypto industry can't reach its full potential without more regulation

Mainstream adoption has grown considerably in the last few years, but there's still a long way to go. At the moment only about 14% of Americans own crypto, according to a report from Gemini. Regulation that protects retail investors might encourage more people to dip their toes into the crypto waters.

It would also likely build confidence for institutional investors who have to follow strict compliance and risk management rules. For example, if an institution was found to have dealt in cryptocurrency assets that were later connected to illegal activities, it could find itself embroiled in a criminal investigation.

Without clear guidelines, it's very difficult for cryptocurrency investors and users to be sure they're in safe waters, which is a big impediment to future growth.

Anti regulation

Here are some common anti-regulation arguments.

It goes against the spirit of cryptocurrency

The ethos of decentralization -- cutting intermediaries like big banks and governments out of financial transactions -- is central to the culture of crypto. It empowers individuals to manage their money without anyone watching over their shoulders, and it takes power away from big banks and corporations. Put simply, regulation flies in the face of this idea.

It will damage innovation

The cryptocurrency industry has thrived in recent years, in part because blockchain technology promises to disrupt various industries, particularly finance. The decentralized nature of these businesses often means start-up costs are much lower because there's no need to build centralized networks and infrastructure.

But the other reason the industry is doing well is because of the flexible fundraising models. Cryptocurrency companies have been able to raise money quickly without having to follow complex security laws. And retail investors have been able to put money into projects they otherwise would not have been able to access.

It will push the crypto industry into other countries

The global nature of the cryptocurrency industry means there's a fear that stricter U.S. regulation would simply push the industry into more crypto-friendly jurisdictions. There would be two major consequences to this:

• The U.S. might miss out on the economic benefits of this new industry. Places like Miami and California are already actively trying to attract the cash and jobs that could come with being crypto hubs.
• If the industry moves outside U.S. borders, it would be harder to ensure any kind of investor protection. It's often better to keep people inside the tent.

It will drive down crypto prices

It does not look likely that the U.S. will try to follow China and ban cryptocurrencies completely. However, stricter regulation would almost certainly hit prices in the short term -- partly because so many people are scared of it. The very idea of regulation has become somewhat of a bogeyman in cryptocurrency circles. As a result, crypto prices tumble even on rumors of large-scale regulatory moves.

It's worth pointing out that some experts argue regulation would have a positive impact on prices in the long term. For example, in time, the short-term loss of any illicit funds could be more than offset by cash from big institutional investors. And regulation that builds trust and adds a level of investor protection would help the industry to grow even further.

Ultimately, what matters is the nature of any new cryptocurrency regulation. Heavy-handed regulation that massively hampers the activities of legitimate projects could be damaging. But sensible regulation that weeds out bad players could create an environment where genuine projects could thrive.