Crypto Regulations: Apprehensions

Crypto regulation is antithesis to the idea of crypto. But, of course, as always anarchy has failed or is failing. The biggest problem with anarchy is that it magnifies the penetration and power of evil genius. In fact, till the time an evil genius is only attacking the poor masses, there is no call for his curtailment; however, the evil being evil loses his self-status and starts attacking the system itself, harming the reigning elites. Something similar has happened in cryptos. Of course, the elites would introduce regulation in the name of the protection of masses, but it is actually their own status that they want to protect; so, maintenance of status quo as much as possible is their motive behind crypto regulation. The haves rule over the have-nots by micromanaging their needs, including statuses. Cryptos were challenging their system. People were becoming millionaires just by creating and establishing new idea of money contrary to the old idea. Now that the new idea has occupied the imagination of people, esp youngsters, to such an extent that it is not possible to do away with it, the new idea has to be appropriated. Of course, crypto is not just about money, but the new idea of money is what has led to its acceptance. If seen with this perspective, the objective of crypto regulation would be to control the flow of money, including new money; to reorganize the accumulation to restore the identity of money, including new money, as a valuable resource aligned to the statuses of men; to ensure division of labor where the labor continues to work for wages, not self-interest as manifesting in crypto tokens; to appropriate extra wealth from the “undeserving” by calling it “theft”, “gambling”, “laundering”, “fraud”, or even “treason”; etc. Whether these attempts will fail or pass is for the time only to foretell. However, the apprehensions can definitely be expressed in less abstract terms, and that’s what I am trying to do below.

The first expected regulation is, of course, in the arena of crypto custody. The existing idea of crypto custody is the most straightforward, which is self-custody through hardware wallets. However, that’s what threatens the system the most. People in India and elsewhere have always been practising self-custody by storing physical gold, but self-custody of gold is obviously a threat to the person holding physical gold, as anything physical can’t be kept hidden for long. Digital money as represented in crypto tokens is, however, a natural candidate for self-custody. If you don’t divulge it yourself, nobody can know how much and what you own in your hardware wallet. Yes, nothing can be kept hidden to intelligence agencies for long, but I wonder if they have resources to peep into each single hardware wallet through blockchain data mining or otherwise. In nutshell, self-custody of wealth is the easiest form of self-determination, and that’s what has been attacked recently by the likes of FTXs. I haven’t researched it, but I wonder how much of assets kept in the custody of FTX were retail assets. It was actually the big guys, who can’t self-custody their assets as per the prevalent norms of the society, who were keeping the money in the custody of FTX. They were so self-assured that they didn’t even care to check if there was ever any actual custody or everything was being thrown into a common pool like rivers flowing into an ocean making their identification impossible thereafter. Oceans never die but FTXs do, and on their death, the money just flows in several directions available for appropriation to the best opportunists. Crypto regulation will definitely try to check this opportunism but I suspect they won’t stop at that. Their objective would rather be to appropriate all individual wealth in the name of secure custody. El Salvador is a precedent already where every citizen has a state controlled wallet holding his bitcoins. I apprehend such copycat regulations diffusing through out the world.

The second expected regulation is in the field of taxation. Taxation is always self-assessed. The tax authorities only interfere in suspected cases of tax evasion. There also, the tax evasion per se is not a crime. Of course, you can’t steal your own money. The state only makes a claim on your money in the name of providing security, welfare, order, etc. In my understanding, there is no fine line between tax evasion and tax planning. Tax planning doesn’t become ethical because of its legal status. Both are attempts to hide money reserved for the claimed betterment of the society. I am an anti-nationalist and don’t believe in the ability of the state to provide betterment if they subscribe to nationalism (which, btw, every present state does). But, I do believe in reservation of some portion of self-wealth for the betterment of society. There are certainly thoughts in the crypto world trying to provide better solutions for such reservation of wealth, but till the time they mature, the existing solutions are necessary evil. However, to stop them from becoming even more evil, it is necessary to limit their penetration. Cryptos do it pretty well by challenging national borders. Of course, the flow of money across national borders without paying taxes is called money laundering in the present realm (at least in India). But cryptos are changing such definitions. Nations don’t have a clue on how to tackle it. Their initial response is obviously expected to be utmost control by banning crypto transactions altogether like in China, Nepal, Morocco, etc. But, if utmost control is not possible, an approach as adopted in India can also be adopted where high taxes, including taxes deductible at source, have been imposed on crypto incomes, including transfer of money between people without any actual trading. Furthermore, losses arising from cryptos have been made non-deductible against gains from other sources as well as even against different crypto tokens (there is ambiguity on this and probably it will be challenged in the courts; however, the present advisory from the authorities is that losses from one crypto token can’t be adjusted against gains from another crypto token). Of course, the attempt of such tax regulations is to discourage crypto adoption, but an international phenomenon can’t be discouraged domestically. However, such copycat tax regulations in other nations can’t be ruled out, especially if any crypto income, whatsoever, starts getting linked to global money laundering to sponsor “terrorism”.

The third expected regulation is in the field of foreign exchange. As the present system exists, the national borders define the nature of money. Almost every nation has issued a fiat currency that it protects through regulations. It terms currency issued by other nations as foreign currency and limits its use, exchange and holding within national borders. Cryptos are a different breed altogether. They are not issued by any nation, not even by any identifiable legal entity in most cases. They are brought into use by the users of the crypto for mutual benefit. Whether they can even be termed as currency is debatable. Mostly, the stress by the authorities is to term them as either security or commodity. However, when cryptos were banned in India by RBI and the matter went to the Supreme Court, the Supreme Court of India had no hesitation in calling them currency. Since the challenge there was not on the question of foreign exchange regulation but on the question of fundamental right to carry out business, the challenge succeeded and cryptos were restored. However, there is no clarity on whether cryptos, especially bitcoin, can be considered as foreign currency and their use, exchange and holding be restricted. Though it is far-fetched and completely illogical, but the cryptos can also be termed as foreign currency and brought under foreign exchange regulations.

The fourth expected regulation is in the field of the issuance of cryptos. As I already stated, cryptos are not issued by any identifiable entity. Till now, the only precedent (I can think of) where crypto token has been held security is LBRY’s token LBC. The US district court for New Hampshire held it as security. The precedent is very weak as coming from a subordinate court and is not in the category of legal precedent at all, persuasive or binding. Anyways, in this case, LBRY Inc didn’t challenge the SEC’s contention that it offered and sold LBC in interstate commerce. Thus investment in a common enterprise was established; the only issue was whether those investing in LBRY Inc were doing so with profit motive from the efforts of the promoters or third party. Such an issue may not arise in the case of majority of crypto tokens because nobody would be fool enough to admit itself as an enterprise collecting money for issuance of tokens. The issuance of tokens in crypto world is determined by the use cases of the token essentially involving the blockchain. By its very definition, there is no single entity that single-handedly manages the blockchain, so nobody gains from the efforts of the promoter or third party. The working of proof of work blockchains is straightforward, but even proof of stake blockchains are also nothing more than community efforts. Stakers who double up as nodes are just representatives of the community like chosen political leaders. The fact is that blockchain can’t be categorized as a profit generating enterprise at all. It is at best a co-operative society which shares the fruits of the co-operative efforts amongst its members, using a kind of lottery system. Even if there is no existing mechanism or organs to regulate issuance of crypto tokens, new mechanisms and organs can be set up. The idea is simple. The state has interest in controlling all activities within its boundaries. Till now cryptos are not illegal because they don’t fall under some existing category of legislation, but once a category has been created for them, of course, the legalities and the illegalities will be also created by default.

The fifth expected regulation is in the field of trading of cryptos. Trading of cryptos can be regulated either as securities or as commodities. As already stated above, cryptos as securities is a weak case. Can cryptos qualify as digital commodities is questionable. Just because some people start calling bitcoin digital gold, it doesn’t make bitcoin a commodity. Furthermore, bitcoin is traded both in the spot market and the derivative market. Trading of commodities in spot market, in India at least, happens at different levels at different price levels: farmers/producers to wholesalers, wholesalers to retailers, retailers to end-consumers. bitcoin can’t be consumed like gold. It has a use case in the blockchain Bitcoin, but it is not consumed like gold by converting it into jewelry, etc. The fact is this that cryptos are a different category altogether. They don’t fit into any existing category. Another fact is that they can indeed be traded, on both centralized and decentralized exchanges. On decentralized exchanges, their trading is governed by self-executing smart contracts or by the blockchain/distributed ledger code itself, but on centralized exchanges, the trading is more or less in the nature of security or commodity trading in other centralized exchanges. Can there be regulations for centralized exchanges. Yes, I think there can be. The idea of cryptos is decentralization and trustlessness. However, till the time it is achieved, centralized exchanges and the corresponding regulations are also necessary evil — centralized exchanges do enter into nefarious activities. Anyways, centralized exchanges are private enterprises gaining from crypto boom, irrespective of whatever exchange tokens they may issue. There is no reason why they shouldn’t be regulated. Strictly speaking, they are actually not part of the crypto world; so, their regulation doesn’t harm the idea of crypto. However, the fear is that once they are regulated, the decentralized exchanges will also be attempted to be regulated. Decentralized exchanges are by their very nature not amenable to regulations. If regulated, they will cease to be part of the crypto world. The first regulation that comes to mind when one thinks of regulation of decentralized exchanges, is tweaking of smart contracts or blockchain/distributed ledger code to make the transactions KYC complaint. Next could be incorporation of tax deductible at source. Then could be banning of “illegal/black money transaction” as per the categorization done elsewhere or in the smart contract or blockchain/distributed ledger code itself. There could also be ceiling on transactions. The possibilities are limitless and highly intrusive. This is actually the most fearsome apprehension. The clubbing of centralized and decentralized exchanges together can kill the idea of cryptos.                   

There are many other possible fields of regulations but one more I am discussing is in the field of competition law. I have heard people like Gavin Wood say regulations can be good for industry as they can ensure decentralization. I don’t know what he exactly meant when he said that, but I am attributing good intentions to him and interpreting it to mean that the competition law tweaked to cryptos would ensure that the no single staker or a closed group of stakers can control too many cryptos by becoming a high percentage staker in all of them or that no single staker or a closed group of stakers can stake more than a certain percentage in a crypto project. I am not sure if we need any regulation for that. But, anyway, if demands will originate from the industry itself, expect such regulations to be made too, which can very well directly attack the idea of cryptos or even lead to nationalization of crypto projects. If that happens, it would be the end. To be frank, the idea of Polkadot is also based on the concept of federation of states with centralized security a la the USA. I don’t know what is more dangerous: centralized security a la nations or centralized capital a la global corporate. However, I know for sure what Gavin Wood was suggesting is like opening a pandora box with limitless possibilities of control by the state. Scary!

Note: I am a lawyer and know exactly how and for what purpose law is used.        

About the Author

Ankur Mutreja
Ankur Mutreja is an advocate-cum-writer, and his blogs are amongst his modes of expression. He has also authored number of books, which can be downloaded from the links on the top menu.

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