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The challenge of regulating the unregulatable

simple complexity

To the dismay of speculative traders the world over, the U.S. Securities and Exchange Commission (SEC) recently opted to reject a proposed exchange-traded fund that would have indexed the so-called cryptocurrency Bitcoin.

Bitcoin was the first of now many cryptocurrencies that operate off of a “blockchain.” This is a revolutionary system proposed by an anonymous individual (in this legendary whitepaper) that can achieve consensus through decentralized transparency and properly aligned incentives. Essentially, people who don’t trust each other can trust the system of ledgers that keeps a publicly available account of who did what.

The way that Bitcoins enter the world is through “mining.” At its most basic level, this involves people with powerful computers verifying transactions and receiving rewards for their efforts. Bitcoin and other coins can also be acquired by individuals or firms through exchanges.

The infamous Winklevoss twins had filed a proposal to start an exchange-traded fund that would track the price of Bitcoin, allowing easier and more institutionalized access to the asset for investors. The SEC rejected it, noting the ambiguities surrounding the platform, immense volatility, and lack of protection for stakeholders.

In their decision, the SEC made a few interesting remarks that leave the future of regulation and listing of digital currencies in a strange limbo. This digital currency was rejected in part because “the significant markets for Bitcoin are unregulated,” which could raise “concerns about the potential for fraudulent or manipulative acts and practices in this market.” In a glimmer of hope, however, the SEC did note that “Bitcoin is still in the relatively early stages of its development and that, over time, regulated Bitcoin-related markets of significant size may develop.”

Bitcoin isn’t the only thing at state here. Hundreds of other cryptocurrencies have emerged that are changing the ways people are able to match with unique goods and services over the internet. One such crypto, Ethereum, allows users to create “smart contracts” in which parties that do not trust each other can agree to some sort of exchange, executed by code.

Another token called Golem creates a market for idle computer power. Other big coins that employ the power of the blockchain include Dash, Ripple, Monero, Litecoin, NEM and, of course, the comically named Dogecoin.

The SEC and other regulators ought to figure out where cryptocurrencies stand. Are they property or currency? Are such transactions taxed like any other? Are earnings on trades taxed as capital gains or something else? And perhaps most importantly, how can we simultaneously recognize anonymous platforms as enablers of illegal transactions and legitimate financial instruments?

These are not easy questions.

However, I hold the opinion that regulators ought to clarify these questions sooner rather than later, while cryptocurrencies are still (somewhat) in their infancy. This technology is advancing quickly and is here to stay—regulated or not. Should regulators want any say over this decentralized system, they must work to understand the platform and respect the fundamentals of the system. They should make their expectations for compliance clear and reasonable, without distorting the markets so much as to discourage individuals and exchanges from cooperating.

This will require intense inquiry, including observations from areas of study including (but certainly not limited to) economics, ethics, public policy, political science, sociology, psychology, political economy, and philosophy. Considerations of this sort could offer a holistic picture of the interactions between people, value and the internet.

Additionally, consideration of how these currencies presently are used can only take us so far. Since their adoption rate is very low, the current use is likely not representative of how currencies would be used once they become mainstream.

Serious attention must be paid to the fact that cryptocurrencies, as they stand, often are utilized to more easily conduct illicit trades (especially drug trade). This is not a strikedown argument against their integration into mainstream use because keeping them in the limbo between legitimate and illegitimate will not end that class of usage. However, regulators ought to consider these realities when crafting the institutions, bearing in mind that we should strive not to disincentivize legitimate use through unbearable regulation.

If cryptocurrencies are anything, they are unpredictable; the only thing that seems clear to me is that smart cryptos will be a powerful force in the future. But for now, Bitcoin remains a non-mainstream but mainstream enigma, one that will keep regulators scratching their heads and traders kicking themselves for not buying or selling at the right price. And so long as these coins are not allowed at the “big kids” table, they will be limited in their adoption and progress will be stalled. It is time for serious consideration of how we as a society want to use this new technology, and how we want our governments to regulate them.

Columnist’s note: No part of this article should be taken as investment advice. This was adapted from a piece I wrote for Duke Political Review.

David Wohlever Sánchez is a Trinity sophomore. His column, “simple complexity” runs on alternate Wednesdays.


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