Regulation in Higher Demand as the Cryptocurrency Industry Matures

14 August 2018 Publication

Investors and executives in the fast-moving world of cryptocurrency favor regulation – particularly when it comes to initial offerings, according to Foley’s 2018 Cryptocurrency Survey.

Favoring cryptocurrency regulation is really something when you consider that slightly more than a decade ago in 2008, the creator of Bitcoin proposed the system for electronic transactions as one that didn’t “rely on trust.” In other words, central banks and sovereigns were to be replaced by technology.

But the investors and executives responding to the Foley survey are now seeking more regulatory and legal certainty as the cryptocurrency industry matures. Based on what we’re seeing in Texas and around the country, that’s understandable.

Texas authorities have made headlines this year as they look into virtual currencies and seek to protect their citizens from deceptive and fraudulent activities in the cryptocurrency space. Thirty-two investigations over the course of four weeks found that no promoters were registered to sell securities in Texas (in violation of the Texas Securities Act). All but two of the promoters “were broadly using websites, social media and online advertising” to market in the state, and at least five promoters “all but ignored investing risks by guaranteeing returns.” Joe Rotunda, director of enforcement of the Texas State Securities Board, told the Dallas Morning News that unscrupulous promoters “are trying to get as much money as they can as quickly as they can” while the sector remains hot.

Not Just Texas

Texas is the second most populous state with a strong tech sector that makes it a hot spot for cryptocurrency – as well as unscrupulous activity of the kind noted by Rotunda. But regulators across the country have also been cracking down as the need for greater regulation is a national issue.

As mentioned above, the vast majority of respondents to Foley’s survey (84%) believe initial offerings of cryptocurrencies should be regulated by the federal government, states or both; 68% want regulation for ongoing purchases and sales of cryptocurrencies; and 55% say it’s needed when it comes to paying for goods and services.

This desire for increased oversight ties to another finding in the survey: 72% said the cryptocurrency industry does not have a well-grounded understanding of how existing regulation of financial markets and financial services applies to this immature technology. All of which is set against a backdrop of a lack of understanding among the general public of the underlying blockchain technology and how it works.

What Should Happen Next?

As federal regulators take steps to regulate various aspects of cryptocurrency activities and the industry seeks greater clarity, the next logical question is: What needs to happen to create certainty without unnecessarily limiting innovation?

First, it’s necessary to determine – preferably at a federal level, to avoid a patchwork of state regulations – what exactly a cryptocurrency is. Is it a security, a commodity or a currency? The answer to that question influences what part of the federal government will regulate it (the Internal Revenue Service, the Securities and Exchange Commission or the Commodity Futures Trading Commission).

Next, it’s a matter of determining the level of visibility to attach to cryptocurrency. As opposed to the “Wild West” attitude of the original cryptocurrency rebels, investors would like to see cryptocurrencies end up on exchanges that would provide some transparency. Reflecting on that point, respondents to Foley’s survey expressed strong interest in a retail investment product, with 72% saying that investors should be allowed to invest in exchange-traded funds holding cryptocurrencies. Indeed, Wall Street has warmed to Bitcoin in recent months, but there are concerns about whether now is the time to buy. The first analyst to cover Bitcoin urged caution last spring even though Bitcoin had rallied after falling from its heady days in late 2017. The caution turned out to be warranted, in the short term, at least.

Is All the Hype Warranted?

In the Foley survey – taken after cryptocurrencies’ value drop in early 2018 – 41% of respondents predicted a crash or bubble burst within 12 months and another 29% said it would happen in two to five years. Only about a quarter said it wouldn’t happen, and one wonders if those respondents thought it already had.

Moments like these are sometimes compared with the late 1990s before the internet bubble burst when tech stocks flew high even for companies that had very little real value. Another comparison, going further back in the history books, is the California gold rush in the 19th century. After an initial surge of fortune hunters, bad actors entered the fray – prompting calls for more rules and standards.

We are currently living through a major social change, and it’s anyone’s guess how blockchain will ultimately integrate into our daily lives. But cryptocurrency is one area that will likely have staying power when it comes to blockchain technology – even if some tightening and correction is on the horizon. Which means the moment is upon us to fully grasp the technology and regulate it properly and thoughtfully.

Peter Vogel is an attorney in Foley Gardere’s Dallas office, where he counsels clients both in trial and on transactional matters related to information technology, e-discovery, science and intellectual property. He has an M.S. in computer science and his clients include governments and administrative agencies, major corporations, banks, healthcare providers and emerging businesses.

Edward Block is an attorney in Foley Gardere’s Austin office and previously served as chief information security officer for the state of Texas. His practice focuses on the effects of new technology and emerging law on personal privacy at the state, federal and international levels.

For more information and to download Foley’s 2018 Cryptocurrency Survey report, please click here.

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