How Would You Like to Pay? Cash, Credit, or Crypto?

Over the last year, cryptocurrency has gained a growing cache. With a total market value in excess of $2 trillion, 14% of the U.S. population, 21.2 million people, now own some form of cryptocurrency. Lauded for its security, lower transaction fees, and greater confidentiality due to blockchain’s decentralization, crypto’s growth shows no sign of diminishing. Rather, data indicates that 56.7 million U.S. adults are likely to buy cryptocurrency within the next year.Currently, approximately 2300 U.S. businesses and 15,000 worldwide accept bitcoin, the most widely-held coin among cryptocurrencies. Moreover, within the last month, there has been a spate of announcements driving cryptocurrency acceptance by and in the market. Among them, PayPal now allows its users to purchase $100k of bitcoin per week on its platform; AMC will soon allow moviegoers to buy tickets or concession items online using bitcoins, and JP Morgan recently launched an in-house bitcoin fund available to its Private Bank clients.

With momentum and growing adoption comes greater scrutiny. Described by Securities Exchange Commission ( SEC) Chairman Gary Gensler as the “Wild West,” the cryptocurrency market is unregulated, highly volatile, and a magnet for fraudulent conduct. According to Crypto Head, a cryptocurrency “knowledge source,” there were 82,135 cryptocurrency-related crimes reported last year, a 295% increase from 2019.

The most prevalent types of fraud included:

1. Initial coin offering scams involving fabricated cryptocurrency;

2. Pump and Dump schemes and;

3. Cryptocurrency theft involving hacked accounts and stolen coins, the most recent of which was the hacking of Poly Network, a decentralized finance (DeFi) platform that allows users to engage in peer-to-peer transactions, in which $610 million was stolen though subsequently returned by the hacker who indicated that he hacked the system “for fun.”

Regulation Is On The Way

As a result of the increasing demand and inherent fraud in cryptocurrency, the crypto market is beginning to face pressure. In her letter to the SEC, Senator Elizabeth Warren (D-MA) questioned the lack of regulation surrounding cryptocurrency exchanges as well as the general lack of investor protection. In responding to Senator Warren, SEC Chairman Gensler made his position clear, “Right now, I believe investors using these platforms are not adequately protected.” Gensler is absolutely unequivocal that to the extent certain tokens are traded as securities, they are subject to SEC regulation and oversight. Acknowledging that cryptocurrency’s current ecosystem lacks sufficient controls, Gensler stated, “We need additional Congressional authorities to prevent transactions, products, and platforms from falling between regulatory cracks,” and indicated that legislative priorities should focus on trading, lending, and decentralized platforms (DeFi).

On the legislative front, Representative Patrick McHenry (R-NC) and Representative Stephen F. Lynch (D-MA) recently introduced the Eliminate Barriers to Innovation Act of 2021, which calls for the SEC and Commodity Futures Trading Commission (CFTC) to establish a working group to analyze the legal and regulatory framework of digital assets in the U.S. as well as set forth recommendations for best practices to reduce fraud, manipulation, and improve investor protections.

The issue of cryptocurrency also arose in connection with the recent bipartisan $1 trillion infrastructure package passed by the U.S. Senate. Included in the Infrastructure Investment and Jobs Act (“the Act”) is a tax reporting provision for cryptocurrency brokers, which is expected to raise over $28 billion over 10 years to fund a portion of the proposed infrastructure improvements. Within the crypto community, the provision has caused an outcry. At issue is the definition of a “broker.” The Act defines a broker as “any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” Under this definition, entities such as miners, who verify blockchain transactions, and similar third-party validators as well as software developers and other network providers would be subject to tax reporting.

Key points to remember if you’re considering the cryptocurrency market:

1. Education is key: Cryptocurrency is complex, unregulated, and not for the risk averse. Like any asset class, it requires research. This is non-negotiable, particularly given that according to Gemini’s 2021 State of U.S. Crypto Report, 60% of the crypto-curious indicated that they are “not very” or “not at all” knowledgeable about cryptocurrency today. For purposes of the Report, the crypto-curious, comprising 63% of U.S. adults, are defined as “those who do not currently own cryptocurrency but indicate either wanting to learn more or planning to buy soon.”

2. Cryptocurrency is here to stay: Gemini’s research indicates that 40% of surveyed U.S. adults would consider receiving part of their salary in cryptocurrency and 65% would consider a credit card with crypto rewards.

3. Regulation is on the horizon: Recently, the SEC announced the investigation of Coinbase over its proposed lending program, which would allow users to earn interest on its platform. This is consistent with SEC Chairman Gensler’s remarks before the U.S. Senate Banking Committee in which he identified the crypto-assets market as one of the SEC’s regulatory priorities, specifically noting the need for more robust oversight and investor protection. When and how guard rails will be erected around cryptocurrency’s ecosystem remains an open question, but know that the “Wild West” will be tamed.