Regulation of both cryptocurrencies and the blockchain space is coming. In April 2018, the European Commission stated: “Twenty-three European countries have signed a declaration on the establishment of a European Blockchain Partnership. The Partnership will be a vehicle for cooperation amongst Member States to exchange experience and expertise in technical and regulatory fields and prepare for the launch of EU-wide blockchain applications across the Digital Single Market for the benefit of the public and private sectors. This should ensure that Europe continues to play a leading role in the development and roll-out of blockchain technologies.”
While government legislation and regulation may strike concern for investors in older blockchain networks, there is a clear opportunity for newer networks to take advantage of the impending change. According to Forbes: “2018 is poised to be a year of regulatory clarity for cryptocurrencies—but in what capacity? Legislatively or via regulatory action? Under state or federal law? Or will it be some combination of all the above? And, even if government action can catch up, how long can that parity last before the crypto-space speeds ahead? Governments inherently, and usually appropriately, move slowly and with deliberation, and investors may hesitate as they wait for government action. In that case, the market may need to step in to police itself. Cryptocurrency managers should anticipate and get ahead of these coming changes by identifying their own risk areas, developing mitigation controls or even a formal market-wide due diligence process.”
The sentiment is shared by The Next Web company, which provides a list of 15 countries where regulation is being discussed. Among them are the US, Canada, Japan, Korea, China, Singapore, Australia and the EU: “If 2017 was the year of the ICO, it seems as if 2018 is destined to become the year of regulatory reckoning. Things have already begun to heat up as countries around the world grapple with cryptocurrencies and try to determine how they are going to treat them. Some are welcoming, others are cautious. And some countries are downright antagonistic.”
What Will Regulators Require?
Until specific regulations of the blockchain/cryptocurrency market are announced, the details remain uncertain. However, KYC/AML and taxation will likely be first on the list.
Know Your Customer (KYC)
Capital gains made on token trading will be something that many governments will require reports on in order to inform tax bills. To do so requires knowledge of the transacting parties and that means KYC regulations on blockchains and exchanges—the ability during onboarding to identify users as individuals or corporations with registered signatories. A successful blockchain must have compliance preassured across numerous jurisdictional boundaries.
Under the current SEC approach, tokens are only being sold to accredited investors. To our knowledge, no blockchain tokens have been offered in a fully SEC-registered public offering. The SEC and other market regulators have been aggressively pursuing scams and other violations.
Anti-money laundering (AML)
To prevent blockchains and cryptocurrencies from becoming havens for money launderers, organized crime and drug or weapons trafficking, each transacting party must be accountable for incoming and outgoing transactions. We predict that regulation will demand full provenance and traceability of all circulating tokens and the undoubtable identification of who is behind them.
On one hand, blockchain users require fully private transactions. On the other, regulatory agencies with court orders in hand must retain the power to revoke that privacy if needed. A successful blockchain must provide both—full transaction privacy and a trustworthy system for privacy revocation, mindful of jurisdiction.
For a network to deliver on all of these requirements is difficult, and for many existing blockchains will be impossible. Regardless of what Bitcoin, Ethereum, Stellar, Monero, Dash or Zcash do in the future, they will find it exceedingly difficult to untangle the identities or provenance of past transactions, their willingness to bend to regulatory pressure notwithstanding. The technology structures of many of these prominent blockchains simply cannot be modified to allow it, Bitcoin and Ethereum included. Any blockchain capable of supporting regulatory requirements gains an opportunity for traction over older, non-compliant networks.