From Permissionless to Aggressive: Evolution of Crypto Regulation

Cryptocurrencies, or let’s say, Bitcoin (the first one ever), started as a quite small geeky niche in 2009. Very few people fully understood the concept, let alone guessed its potential back then. It wouldn’t be until May 22, 2010, that the first-ever real thing would be bought using BTC, and it was two pizzas. In a P2P transaction made between two American developers. So, we can say for sure that crypto wasn’t popular enough to be regulated by big-shot lawmakers.

That first purchase was like starting a snowball rolling downhill. People started to use Bitcoin as a global and permissionless payment method. Even for non-very-legal stuff, since it was a pseudonymous coin, difficult to track and block. That’s how the first BTC-focused marketplace was born: Silk Road, only available through the Tor browser, on the Darknet. That’s because it sold all kinds of illegal items —from drugs to weapons.

It wasn’t the best publicity for Bitcoin, sadly. This way, the first big ‘regulatory encounter’ the cryptocurrency had was against the US Federal Bureau of Investigation (FBI) in 2013 when they dismantled the site and arrested Ross Ulbricht, its founder. Bitcoin wasn’t designed to commit crimes, but it stayed in the general opinion (and in the lawmakers’ minds) that way for a while.

On the other hand, the terms “blockchain” and “distributed ledger technology” started to catch the attention of institutional players. Bitcoin’s underlying technology was becoming a promise to improve their own fields, so global regulators could be flexible about it.

First Steps + Sandboxes

Over the years, numerous companies and organizations started to test distributed ledgers in their own processes or directly created new services around this technology. To avoid stifling innovation, the general regulatory approach was “permissionless innovation:” developers in the crypto space should be generally free to experiment and explore new ways of using this technology without requiring explicit permission from regulatory authorities.

For instance, US Commodity Futures Trading Commission (CFTC) Commissioner J. Christopher Giancarlo delivered a speech about it in 2016. According to his words:

“«Do no harm» was unquestionably the right approach to development of the Internet. Similarly, “do no harm” is the right approach for DLT. Once again, the private sector must lead and regulators must avoid impeding innovation and investment and provide a predictable, consistent and straightforward legal environment (...) I believe that innovators and investors should not have to seek government’s permission, only its forbearance, to develop DLT so they can do the work necessary to address the increased operational complexity and capital consumption of modern financial market regulation.”

Regulatory sandboxes for crypto

Meanwhile, in the US and other parts of the world, regulatory sandboxes started to appear for crypto companies as a provisional solution. These are programs launched by regulatory authorities where a controlled and supervised environment is created to allow businesses to test new products, services, or models without immediately facing the full range of regulatory requirements. By considering the results of these tests, they could create proper rules for the future (in theory).

One of the first authorities to apply the sandbox method for crypto companies was the Canadian Securities Administrators (CSA), in 2016. In the same year, the UK Financial Conduct Authority (FCA) launched its own sandbox program with at least 24 crypto and fintech companies included. In the next few years, authorities from Japan, Panama, the Isle of Man, Spain, the European Union, and more regions would join this trend. But that would be just the starting point for crypto regulations worldwide.

Exponential growth and more incidents

We can’t say sandboxes just died out because they’re still around globally. However, authorities were always skeptical of cryptocurrencies more than their underlying technology, and that didn’t exactly change too much. For 2021, the global cryptocurrency market capitalization reached peaks of $2.7 trillion [CMC], and at least 103 countries (52%) were applying Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) laws and taxes for crypto-related activities [US Library of Congress Report].

In a market of this size, some incidents and crimes were bound to increase. According to the 2022 Crypto Crime Report by Chainalysis, “Cryptocurrency-based crime hit a new all-time high in 2021, with illicit addresses receiving $14 billion over the course of the year, up from $7.8 billion in 2020.” Stolen funds and crypto scams were the leading crimes that year.

Meanwhile, a huge regulatory step was taken inEl Salvador by June 2021: Bitcoin officially became a legal tender. A fact that increased not only that coin use but maybe the whole crypto market cap. And the concerns of global organizations, starting with the International Monetary Fund (IMF). They expressed how this kind of adoption could cause a series of financial and legal issues for the American country and beyond.

But 2022 would be the year of global lawmakers becoming really alert against the crypto world, due to several unfortunate and high-profile incidents.

Terra, 3AC, and FTX

It’s even difficult to believe that all of this happened in the same year. However, we can say it was like big dominoes falling. The first market crash involved Terra (LUNA) and its stablecoin, Terra USD (UST). UST lost its $1 peg on May 8, 2022, leading to panic selling and causing UST's value to plummet to $0.1. This collapse, alongside the failure to restore UST's peg, resulted in a staggering $40 billion collapse of the Terra protocol.

The second ‘incident’ involved the venture fund Three Arrows Capital (3AC), which managed up to $10 billion in assets and investments, including significant holdings in Terra (LUNA) tokens. Following Terra's collapse, 3AC faced financial troubles, ultimately owing $3.5 billion to global creditors. Their bankruptcy filing in June 2022 had a ripple effect, impacting institutional creditors and causing losses for crypto protocols like Genesis Trading, Voyager, and Celsius, as well as affecting retail investors.

The last case centered on FTX, the third-largest global cryptocurrency exchange at the time. FTX faced a liquidity crisis in November 2022 due to severe funds mismanagement. Binance's decision to sell its FTT holdings (FTX native token) led to a surge in customer withdrawals that FTX couldn't meet. FTX filed for bankruptcy, and its founder, Sam Bankman-Fried, was arrested in December 2022.

The collapse of FTX raised concerns about investor protection and regulatory oversight, causing massive losses (over $3 billion) for institutional and retail investors. This, along with Terra and 3AC in the same year, would of course bring visible consequences for the whole industry in terms of regulations.

The current outlook

We must note that regulatory crypto-friendliness varies from region to region, but we’re likely in the “aggressive” mode in many countries these days. This approach isn’t exactly new, though. New York, in the United States, has been applying a tight BitLicense for crypto businesses since 2015, while China and other countries have completely banned this industry.

Right now, other regions are becoming stricter against crypto as well. In the US, for instance, the Securities and Exchange Commission (SEC) has been suing over 150 crypto projects and brands since 2013. In 2023, some big names entered their targets: the global crypto exchanges Coinbase, Kraken, and Binance.

As a consequence, Changpeng Zhao (ex-CEO of Binance) pleaded guilty to charges of violations of AML laws in the US. The exchange is expected to pay over $4 billion in penalties, while Zhao will be judged in the country. At least, Binance's products are still working normally, and the company has a new CEO —so no more big crashes in 2023.

In the European Union, the first cross-border comprehensive regulatory framework for cryptocurrencies is set to take full force in June 2024. The new Markets in Crypto Assets (MiCA) is expected to regulate all cryptocurrency providers, including stablecoin issuers, for the EU 27 member states.

According to a study by CoinGecko, cryptocurrencies are legal in 119 countries, illegal in 22, neutral in 25, and regulated in 62. The majority of crypto bans are applied in Africa and Asia. On the other hand, as indicated by PwC, at least 42 different countries worldwide have been developing new crypto regulations since 2023. They include rules for stablecoin regulation, travel rule compliance, licensing and listing guidance, and crypto framework development.

Crypto regulation for the future

We can’t know for sure what’s next, but we can take some educated guesses. After the Terra and FTX incidents, stablecoins and crypto exchanges have become top priority for regulators. The European Union already put its limits with MiCA, and other regions will likely follow suit sooner rather than later. In the US, a stablecoin-specific bill is being considered. The UK, Hong Kong, Singapore, Australia, and South Africa are on the same path.

Meanwhile, according to the Atlantic Council, “130 countries, representing 98 percent of global GDP, are exploring a CBDC (Central Bank Digital Currencies).” These countries will likely adapt their own cryptocurrency regulations around their CBDCs, adopting them as legal tender. They pose some control and privacy concerns, though.

Beyond this, some mostly unexplored territory by regulators in the crypto world includes Decentralized Finance (DeFi) tools like bridges, Non-Fungible Tokens (NFTs), smart contracts, ID solutions, and memecoins. Could this be touched by government laws in the future? At least we know about some cases already.

For example, the EU passed a bill mandating the inclusion of a "kill switch" in smart contracts. This measure would require these apps to have an accessible and reversible mechanism to terminate their execution in specific circumstances, like a scam attempt. Likewise, the International Organization of Securities Commissions (IOSCO) published a report about potential regulations for DeFi activities.

The future seems regulated for a lot of aspects of the crypto industry, especially the ones somehow related to fiat currencies. However, we can still use tools without middlemen like Obyte, and do our best to support P2P operations. Remember that “freedom software” is being developed to trade freely, too.

The absence of a single central authority or control point in most crypto ecosystems makes it challenging for regulators to shut down or control the entire network. The absence of any powerful centers (like block producers) in DAG-based crypto ecosystems like Obyte makes them entirely regulation-resistant. In general, peer-to-peer (P2P) transactions eliminate the need for intermediaries, making it difficult for regulatory bodies to monitor and control transactions.

Additionally, the privacy features of some cryptocurrencies, including Obyte, pose challenges for regulators in tracing and monitoring individual transactions. The immutable nature of distributed ledgers ensures that once a transaction is recorded, it cannot be altered or tampered with, further enhancing resistance to regulatory interference. If you want to protect your data and funds, and have to choose between a centralized service and a decentralized one, always go decentralized!

Featured Vector Image by storyset / Freepik