Cryptocurrency regulation: decoupling major economies

While the US and China share cryptocurrency concerns, differing regulatory policies could remove the shine of digital assets for investors.

Few investment sectors are as controversial as cryptocurrencies. In recent years, the asset class has grown to mark a noticeable footprint across the investable universe, with the global crypto market totalling around $2 trillion in value, depending on where the pendulum of sentiment swings. Bitcoin, the most famous, accounts for approximately half of the sector’s full size. 

Because cryptocurrencies are predominately held by digital enthusiasts, many dismiss that their volatile pricing could spill over and significantly impact traditional investment asset classes such as equities or fixed income. The topic sparks ongoing debate between those who view cryptocurrencies as the future, versus those that consider crypto as a conduit for underground criminal activity.

However, these viewpoints seem to be narrowing. Already entangled in an ongoing political tirade, the US and China are both embarking on constructing institutional frameworks that could not only set a precedent for investors within their respective markets, but perhaps could influence how other countries handle digital assets in the future.

In prepared remarks before the Aspen Security Forum in early August, new chair of the US Securities and Exchange Commission (SEC) Gary Gensler highlighted that, “no single crypto asset fulfills all the functions of money,” echoing literature from a mid-July People’s Bank of China (PBOC) white paper that stated cryptocurrencies “can hardly serve as currencies used in daily economic activities.”

The geopolitical rivals have also flagged that cryptocurrency’s lack of intrinsic value – the nature of the asset means that it is not necessarily linked to any tangible collateral - could lead to speculative risk and could provoke capital misallocation, helping to facilitate illegal activity such as money laundering. Both worry that this could pose a threat to financial and social stability, while endangering public interest.

Opposing Responses

Despite shared concerns, the US and China are taking precautionary measures independent from each other. Gensler’s comments gravitate towards congressional action that explicitly prevents cryptocurrencies from falling between regulatory cracks. 

“We stand ready to work closely with Congress, the Administration, our fellow regulators, and our partners around the world to close some of these gaps” reads Gensler’s transcript, suggesting that cryptocurrencies should be regulated like a security, while stablecoins - digital assets tied to fiat currencies or exchange-traded commodities - should be traded as securities or investment companies. 

The regulatory approach of the US differs from China’s response, which prefers a blanket ban on anything associated with cryptocurrency. Beijing’s oversight impacts other established sectors like banks and payment platforms, condemning businesses that allow cryptocurrency trading.

The different approaches stem from where each believes directive will have the most meaningful impact: the US looks to regulate demand, while China seeks to control supply.

These separate focuses create an inherent mismatch between efforts to assimilate digital assets into a broader investment class, and rules aimed to protect investors.  Since neither the US nor China may fully achieve their desired intention, falling short of their goals could mean that policymakers risk extending ineffective measures that sour the appeal of investing in digital assets.

Broader, aligned regulation of digital assets could help to cultivate greater acceptance for cryptocurrencies as an investable asset, and it could promote blockchain technology as an aid to fostering financial inclusion, such as the lowering of cross-border remittance costs. Creating a well-defined regulatory framework would allow governments to begin taxing cryptocurrency business-like transactions, helping them raise taxes to replenish funds depleted from the coronavirus pandemic.  

The Digital Barrier

But any technology that stops at China’s borders limits global adaptation. Not only would China’s blanket ban on cryptocurrency mitigate the innovative benefits that crypto enthusiasts tout, but it would also extend the regulatory arbitrage that threatens financial and social stability – something that both the US and China seek to avoid.

An area that could have tremendous impact on the development of digital asset classes is the adoption of electronic money. As the exploration of digital currencies by major central banks sits at various stages of development, China’s e-CNY has already been tested across major cities, with a nationwide roll-out expected prior to the 2022 Winter Olympics.

Beijing’s push for a digital currency coincides with a regulatory clampdown elsewhere in the tech space. In the context of anti-trust fines and the elevation of user data concerns to national security status, promoting a transparent and regulated digital currency on a network overseen by the central bank would be the antithesis to concept of cryptocurrency, which is founded on the notion of a decentralised finance (DeFi) network. A move to block the DeFi network would simultaneously prohibit capital outflow by way of stablecoins, which can currently be used to circumvent China’s closed capital accounts. This would reinforce Beijing’s strategy to manage supply-side regulation and solely promote innovation that aligns with national interest.

Some analysts consider the two regions’ approaches to be no different to investors holding fiat currencies backed by different sovereign policies. Asen Kostadinov, head of strategy at Copper Co., a digital asset trading platform based in the UK, explained to FinanceAsia that, because neither the US nor China wants their competitor to thrive, this has led them to extend their “policy decoupling”, which has come to be more evident over the past few years. He noted that as a result, investors are likely to end up owning two very different types of digital asset that run on very discrete networks. 

The response to the development of cryptocurrency investment by the US and China is a litmus test for future digital investments. Choosing to focus on either the demand or supply side of regulation may set a precedent for how other countries adapt to controversial assets going forward. But the US and China example also represents a lost opportunity to achieve a coordinated response to the current landscape, suggesting that universal adoption for any digital asset will not come easy.

¬ Haymarket Media Limited. All rights reserved.
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