Macro threat or golden opportunity? : Governments are divided over crypto regulation
This week, EU lawmakers pushed the bloc’s major regulatory package on crypto, dubbed Markets in Crypto Assets (MiCA), to the next stage, where it will be subject to trilogue negotiations by the EU council, parliament, and commission. Pro-crypto lawmakers may have disarmed MiCA’s most controversial provision – a restriction of proof-of-stake cryptocurrencies like Bitcoin – but the legislation still contains many requirements that could transform today’s largely unregulated crypto markets. The toughest conditions target stablecoins - cryptocurrencies designed to match the value of real-world fiat currencies. These are divided, through definitions, into two categories: Asset-referenced tokens (ARTs), which maintain a stable peg through a basket of multiple assets (presumably, for example, MakerDAO’s DAI), and e-money tokens (EMTs) which include centralized stablecoins like Circle’s USDC or Tether’s USDT. For both groups, issuers will be forbidden from rewarding holders with interest, and, if their market cap exceeds €5 million (relatively small by stablecoin standards), they will have to register with regulators and meet strict reserve requirements. While many supporters of crypto welcome regulation as a prerequisite to reduced volatility and institutional adoption (such as by pension funds), some have expressed concern that such stringent conditions could pose a cost and compliance barrier to new and innovative projects.
Contrary to the tough line drawn by EU institutions, some EU members have sought to capitalize on a burgeoning tech sector that attracts talented developers and wealthy investors alike. Earlier in May, Germany announced in its first tax guide for crypto that individuals could sell Bitcoin (BTC) or Ethereum (ETH) tax free if they held it for at least a year prior. Portugal, meanwhile, has secured a top spot alongside Miami, the UAE, and the Bahamas as a crypto ‘haven’, by exempting cryptocurrency from capital gains tax. While its finance minister has recently called this policy into question, any U-turn has so far been rejected.
The divergence in tone and approach between EU bodies and member states may owe to a fundamental difference in priorities. While individual members manoeuvre for early advantage in what could be a technological revolution comparable to the advent of the internet in the 1990s and 2000s, the EU is taking a wider view of the threats crypto could pose to the bloc’s macroeconomy and monetary sovereignty in the form of its currency, the Euro. The immediate context is the collapse of Terra Labs’ algorithmic stablecoin UST and its sister coin, Luna, which wiped out $60 billion in wealth in a few days starting on 7 May. While crypto is highly volatile and crashes are not unheard of, what set this incident apart is that many individuals lost what they thought was a relatively safe investment in a stablecoin, as they bought UST to benefit from a ‘guaranteed’ 20 percent annual interest paid by a savings protocol called Anchor.
The crash once again raised consumer protection to the top of the crypto regulatory agenda, with a recent ECB report on ‘financial stability risks in crypto-asset markets’ warning of a ‘spillover to the wider economy’. In the US, meanwhile, the Luna crash was mentioned by Treasury Secretary Janet Yellen as justification for rapid regulation during a Senate committee meeting, and President Joe Biden has signed an executive order commissioning a report from federal agencies on digital assets by September 2022. The impetus to regulate and potentially harness crypto in the US stems in part from a growing technological rivalry with China. The latter banned crypto trading and mining in 2021, probably to eliminate competition for its digital yuan, the Central Bank Digital Currency (CBDC) it launched later that year. If the US and EU overlook reservations about privacy and centralization, they may choose to boost their own CBDCs with similar restrictions on traditional cryptocurrencies.
Finally, some developing countries have opted for an opposite approach by embracing cryptocurrency completely. Since making Bitcoin legal tender in September 2021, El Salvador’s president Nayib Bukele has routinely taken to Twitter during market downturns to proclaim that his country had ‘bought the dip’. In April, the Central African Republic became the second country to adopt bitcoin as official currency, in this case alongside the French-backed CFA franc. Last week, El Salvador hosted the representatives of 44 countries at a conference on financial inclusion and the digital economy, promoting greater adoption of Bitcoin by governments. The attraction of crypto in such countries is twofold. On an individual level, by virtue of its increasing scarcity, crypto is seen as an accessible hedge against often rampant local fiat inflation and devalued currencies as governments struggle to repay foreign debts. On a national level, a decentralised store of value with a transparent, coded-in monetary policy levels out the playing field, as smaller countries are wary of being subject to the latest whims of the US federal reserve or China’s central bank, or, worse, suffer foreign reserve seizures like those currently threatened against Russia as a follow-up to sanctions.
As crypto regulation is still in its infancy, who is driving decisions is often more significant than the exact wording of bills that are often defeated or amended. For example, Sam Bankman-Fried, the founder of crypto exchange FTX, has expressed his intention to donate as much as $1 billion to the 2024 US presidential campaign. As the technology continues to attract mainstream adoption, crypto regulation is likely to become a key policy issue in future political contests.