As the world of virtual currency edges ever further into the mainstream, banks and governments are becoming increasingly aware of the risks involved for investors and the need to apply formal regulations to the system to protect people from theft and scams. 

Understanding Cryptocurrency

Cryptocurrencies or crypto-assets are digital money forms that use encryption to protect and authenticate online payments. They are designed as a way to transact via a decentralised computer network using virtual ‘coins’ or ‘tokens’, removing the need for a central bank or government to oversee or maintain the process.

There are now thousands of different cryptocurrencies globally, such as Bitcoin and Ethereum. They can be bought and traded using distributed ledger technology such as Blockchain, whereby a database of ‘blocks’ securely record and link details of all cryptocurrency transactions. New cryptocurrencies entering the market via Blockchain as crypto miners, who validate transactions, are rewarded with newly generated tokens. 

Is investing in Crypto a good idea?

Like most things in life, investing in cryptocurrency has pros and cons. 

Those who are ‘pro-crypto’ will be the first to tell you that there are several advantages to transacting in this way, including faster payments, no risk of a single point of failure during the process and no transaction fees which banks would typically charge. Cryptocurrency can also offer some anonymity to users as there is no need to register with a third-party financial institution to complete payments. Many cryptocurrency supporters see it as a way to level the playing field for global payments as it removes the necessity for currency exchange in cross-border transactions. 

In addition, many investors have started buying cryptocurrency to generate a profit. Although there are no guarantees, Bitcoin prices have risen as much as 65% in one day, and the cryptocurrency market is now worth over $2.2 trillion compared to only $10 million in 2011. 

However, there are some significant disadvantages of cryptocurrencies too, including the fact that the market is highly volatile and can fluctuate unpredictably, meaning you could lose vast amounts of money as quickly as you could make it, with the market being seen to fall by 25% just a few days after a significant rise.

Not only does the value change constantly, but unlike credit cards or other traditional payment methods, crypto transactions come with no legal protection meaning that transactions are uninsured and usually irreversible. Governments also don’t support cryptocurrencies, so if you hold your investment in a digital wallet with a third party, you will not receive any assistance in getting your money back if the wallet was hacked or the holding company collapsed.

Another issue is illegal activity with criminals using crypto for tax avoidance, money laundering and illicit purchases, and hackers often favouring cryptocurrency payment in their ransomware demands. In addition to this, scammers frequently use cryptocurrency to either offer bogus investment opportunities where they claim to be able to grow your crypto investment by transferring it all to them, or they offer to reward you for investing with them before walking off with all of your digital cash.

Finally, and perhaps somewhat surprisingly, there is also an environmental downside to cryptocurrency, as its mining requires a massive amount of energy. This is expensive and detrimental to the environment as it creates a considerable carbon footprint.

What are the new regulations, and how will they affect the Crypto market?

When you consider the risks involved for organisations, individual investors, and the environment, it is easy to see why governments and financial institutions are looking to regulate the market as crypto grows in popularity.

So far, regulations are mainly still in the planning stage. However, the US Department of Justice did release its Cryptocurrency Enforcement Framework back in October 2020 and has successfully prosecuted several individuals for illegal activity involving crypto-assets.

Things are starting to move forward more quickly across the board now, driven in part by the need for the international community to ensure that, as the war continues in Ukraine, sanctions enforced on Russia can’t be sidestepped by dealing covertly in crypto.

It is reported that President Biden is about to sign a new CBDC (crypto and central bank digital currency) executive order in the next few days, which will explore national security, the economic impact of digital assets and the future of money as a whole, with a potential for the creation of a central bank digital currency which could be regulated and controlled by the government.

Meanwhile, the European Union will also be voting this week on their Markets in Crypto Assets (MiCA) framework, which includes a proposal for issuing licences to crypto companies to help ensure financial stability and investor protection throughout the continent.

The UK has indicated that they fully support the innovation and benefits of cryptocurrency but have also announced plans to legislate against misleading crypto advertising, ensuring that promotional literature is held to the same standard as other financial advertising and that it is ‘fair and clear’ to increase consumer protection.

It would appear that there is a global shift that will see the crypto space becoming more strictly monitored and regulated to protect investors and reduce illegal activity. However, these new rules are also likely to slow processes and raise costs for legitimate crypto companies, which could reduce the attraction of investing. With governments also considering the option of creating digital currency for their central banks, it could be that one day in the future, we all use cryptocurrency as our only legal tender.