An Investigation into The Regulatory Challenges Faced by Crypto in Different Countries

An Investigation into The Regulatory Challenges Faced by Crypto in Different Countries
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Table of Contents 1.0. Introduction. 3 2.0. Background and Theoretical Foundations. 5 2.1. Systematic Risk. 5 2.2. Protecting the Investors. 6 2.3. Unethical Transactions. 6 2.4. Taxation. 7 2.5. Global Cooperation. 7 3.0. Countries with Different Regulatory Frameworks and Their Impact 8 3.1. Countries with Permissive Stance. 8 3.2. Skeptic Approach. 9 3.3. Countries with Complete Ban. 9 4.0. Insights Gained from Expert Analyses. 10 4.1. Decentralization. 10 4.2. Diversity in Crypto Market 11 4.3. Diversity across Jurisdictions. 12 4.4. Difficulties in Identity Verification. 12 5.0. Empirical Evidence. 13 5.1. Cryptocurrency, Corruption, and Money-Laundering. 13 5.2. Potential Cases. 16 6.0. Prospects for Further Research. 23 7.0. Research Design. 23 7.1. Data Collection. 23 7.1.1 Theoretical Foundations. 24 7.1.2 Professional Literature. 24 7.1.3 Empirical Evidence. 24 7.2. Inclusion Criteria for Empirical Research. 25 7.3. Exclusion Criteria for Empirical Research. 25 8.0. Conclusion. 25 References. 27  
1.0. Introduction
The concept of a decentralized currency introduced in 2008 manifested itself in the form of Bitcoin (the most popular cryptocurrency). Groundbreaking fluctuations in the value of Bitcoin between 2013 and 2017, with bullish trends dominating the long-term picture, drew the attention of investors and businesses around the world (Baker et al., 2023). As the ubiquity of Crypto grew, and it began to be seen as an alternative to traditional currency for a range of transactions, regulators worldwide began questioning its legal and ethical implications (Renda & Caneppele, 2023; Rysin & Rysin, 2020). Since then, a controversial debate surrounds Crypto, and countries differ in their treatment of this phenomenon (Brummer, 2019). Some countries consider Blockchain a welcome development and adopt a permissive approach, while others are skeptical, considering its prospective ramifications. Some countries have already imposed a ban on Crypto, while others are still deliberating over its validity.
The significance of the research on Crypto from a regulatory perspective lies in multiple factors. Crypto has gained massive popularity, and Blockchain technology is now widely adopted. An idea of the surging popularity of Blockchain can be gained by the fact that as of 2023 (by the time of writing this), more than 85 million Blockchain wallets have been registered. It significantly increased compared to only 11 million wallets registered by 2016 (Rowe, 2023). Similarly, Statista reveals that Blockchain has become widely adopted by organizations from a range of sectors worldwide, as shown below:
Figure SEQ Figure \* ARABIC 1: Blockchain technology use cases in organizations worldwide as of 2021
(Statista, 2021)
These findings indicate that the demand for Crypto is considerably growing. Amid such growing popularity, it is important to consider the controversies and their subsequent ripple effects resulting from the underlying regulatory framing of Crypto. Similarly, Crypto engages actors and stakeholders at a large scale, and it is important to understand how important stakeholders, such as investors, are affected by the impact of different regulatory perspectives on the Crypto market.
This paper begins with the theoretical underpinning and basic insights into the factors determining a permissive or restrictive regulatory stance on cryptocurrency. It is followed by scanning professional literature and understanding gleaned from the insights shared by industry experts and analysts. The next part delves into the empirical evidence gained through the scholarly literature, including potential cases from different countries synthesized with the theoretical foundations.
2.0. Background and Theoretical Foundations
As discussed, Crypto's popularity and adoption significantly accelerated from 2013 to 2017 following the groundbreaking rise in value. As Bitcoin saw record-breaking adoption and appreciation, several other currencies, such as Binance Coin, Ethereum, and Ripple, to name only three, joined the Crypto market (Chen, 2021). There was a wide range of factors that forced the regulators to question the legal status of Crypto. It is important to note that each factor has a contentious debate. Therefore, the theoretical foundations that regulators and other think tanks use to support their arguments are discussed as follows:
2.1. Systematic Risk
The proponents of regulating the Crypto argue that it carries the systemic risk. As the argument goes, the growing popularity of Crypto can pose a risk to the stability of the entire financial market (Makrychoriti, 2016). Since the transactions are mostly unregulated and follow a complex mechanism for exchange, it is challenging to assess the impact of Crypto on the financial markets (Jalan & Matkovskyy, 2023). This argument is used to regulate or ban the Crypto. However, critics argue that no systemic risk is attached to Crypto as the market is relatively small and can act independently of the traditional financial market (Jalan & Matkovskyy, 2023). It is worth mentioning that China was among the countries that banned Crypto based on the alleged threats to the stability of the financial market (Branson, 2021).
2.2. Protecting the Investors
The regulators are keen to look at the transactions taking place in deregulated space from the consumers' perspective. The regulators show concerns about the speculative nature of Crypto's value and its ramifications for the investors. For example, the market can receive critical shocks due to sudden changes in sentiments, and such volatility carries a high risk for investors (Caruso, 2019). India is among the countries that consider Crypto a threat to consumers and use it as the base for their advocacy to ban the currency, even though it still goes unregulated and uninterrupted in India (Lohiya, 2022).
The critics of this proposition root their argument in the conventional wisdom of due diligence. The opponents place the responsibility on investors, emphasizing the need to exercise due diligence while carrying out the transaction at the investors' own risk (Bakos & Halaburda, 2019). This argument is also underpinned by the neoliberal philosophy of the free market, where equilibrium is determined by the free interplay between demand and supply, and any intervention is deemed counterproductive and a threat to efficiency (Trauth, 2018).
2.3. Unethical Transactions
The regulators have also shown concerns over the prospect of illegal financing, such as terrorist financing, through Crypto. These threats are associated with the element of anonymity inseparable from Crypto unless it is regulated and an intermediary is placed within the pathways of transactions (Corbet, 2021). The advocates of this perspective argue that Crypto serves as a haven for money launderers and those engaging in illicit trading (Corbet, 2021). It is important to note that the recent ban on Crypto in Pakistan is based on the threats of illegal financing and money laundering (Singh, 2023). It is further suggested that Crypto should be regulated by applying Anti-Money Laundering (AML) and Know Your Customer (KYC) requirements (Corbet, 2021).
On the other hand, critics express deep concerns over the possible application of AML and KYC regulations, arguing that such regulations can affect the participation of investors in the market who are primarily encouraged by the element of enhanced anonymity and privacy (Baker et al., 2023). Even though this argument does not address the concerns shown by regulators, it is used as a utilitarian wisdom to deter the ban or introduce any regulations that may affect consumers' privacy.
2.4. Taxation
Since transactions within the space of Blockchain remain off the regulatory radar, several regulators question its impact on tax revenue. The investors can use these spaces to evade the taxes (Baker et al., 2023). Based on this argument, the regulators advocate for making the Crypto transaction taxable, for which it is important to regulate the transactions (Baker et al., 2023). This argument is also countered using utilitarian wisdom, indicating that the burden of taxation can discourage participation and affect the value of the market (Baker et al., 2023). Therefore, it is also a matter of preference or striking a balance between the macroeconomic interest and the market's value.
2.5. Global Cooperation
Regulators in some countries, such as the United Kingdom, believe regulating the Crypto market can promote consistency and integrity at the global level, essential to smooth cooperation across different Crypto exchanges worldwide. Therefore, the Financial Conduct Authority in the UK regulates the integrity of the Crypto market and advocates for global standards for regulating the market to ensure global consistency (Tong, 2020). However, critics argue that not all countries or jurisdictions will likely impose similar standards while regulating Crypto. The variations across different regions can result in fragmented regulations that can rather damage than promote global cooperation (Baker et al., 2023).
The above discussion indicates that regulatory considerations of Crypto are a grey area. While the advocates of regulating or banning the market highlight the impact of unregulated markets on investors, the financial sector, the national economy, and integrity, the opponents are concerned about the impact of regulations on the participation rate and consumers' privacy. However, it is evident that the debates about the regulations critically impact the market, as the examples are provided where either Crypto is banned or made subject to certain regulations.
3.0. Countries with Different Regulatory Frameworks and Their Impact
It is important to note that Crypto faces mild to critical challenges due to the debates from regulatory perspectives. The countries are divided in their treatment of Crypto. The countries are divided into the following three categories as of 2023:
3.1. Countries with Permissive Stance
It is important to note that several countries allow restriction-free trading of cryptocurrency. For example, the US, Canada, and Australia adopt a permissive approach that involves treating cryptocurrencies as an alternative to the traditional currency with no discriminative legal status needed (Arslanian, 2022). However, it is important to mention that despite these countries adopting a permissive approach, Crypto has not maintained its original status of freedom. For example, the US, Canada, and other identical jurisdictions have obligated all exchanges to register with the central commission or exchange and report suspicious activity or transactions (Arslanian, 2022). Hence, it is evident that traders must be careful while using Crypto for buying and selling, as illicit transactions can appear on the regulatory radar and affect the traders. Therefore, despite the anonymity, it is not a haven for illicit businesses as the exchanges must report suspicious activities. As understood, these regulatory requirements will likely affect the participation rate. This obligation might have affected the temptation of investors who have previously used the currency for illicit exchanges and reduced their participation (with low-risk tolerant illicit traders deciding to stay away from the market).
3.2. Skeptic Approach
Besides, there are countries and regions where Crypto is not banned, but they keep warning the public about the ramifications of dealing in Bitcoin and similar currencies. For example, the European Union allows restriction-free trading of Crypto. However, the EU also highlights that the illicit use of Crypto and its ramifications for consumers are beyond its control (Avgouleas & Marjosola, 2021). In other words, the EU adopts an overall negative and skeptical view of Crypto, unlike the US, Canada, and Australia, treating it as an extension of traditional currency. It is important to note that sentiments are among the key drivers of crypto markets. Investors' speculations play a vital role in determining the boom-and-bust cycles for Crypto (Sackheim & Howell, 2020). Therefore, it is understandable that the negative institutional portrayal can affect the participation rate and acceptance of Blockchain in the respective countries and regions. India is also among the countries where Crypto is not banned, but the debate about the impact of Crypto on consumers' interests nurtures negative sentiments. The concerned authorities keep warning the public about the risks of cryptocurrency. The sentiments in India are also affected by the repeated emphasis by the Reserve Bank on banning the currency. The threats of a possible ban in the future also surround uncertainty, which is likely to have impacted the adoption of Crypto in India (Reuters, 2023).
3.3. Countries with Complete Ban
Before dividing deep into the debate, it is important to mention that the regulatory challenges of Crypto have also resulted in a complete ban on the currency in several regions. For example, China, Saudi Arabia, Pakistan, Egypt, Bangladesh, Afghanistan, and several other countries (mostly from the developing world) have already banned trading in virtual currency, considering the threats discussed earlier (Orji, 2022). These bans have also affected the overall sentiments of crypto traders with subsequent impact on participation and demand. For example, it was one of the biggest shocks for Bitcoin to experience a decline of up to $34000 within the three months following China's directive to its banks and other financial institutions to stop accepting cryptocurrency transactions in 2021 (BBC News, 2021).
4.0. Insights Gained from Expert Analyses
There are a number of regulatory challenges covered in the debates around cryptocurrency. This section is devoted to looking at those challenges through experts' lens by delving into the key debates in the professional literature.
4.1. Decentralization
Decentralization has been a matter of deep concern for regulators around the world. For example, Wanjiru (2022), an expert analyst specializing in cryptocurrency, highlights the dilemma associated with decentralization. On the upside, it provides the participants a space where they can privately and anonymously make transactions. Hence, it is a positive sign when seen from the perspective of how it empowers the consumers. However, since no central authority regulates the transaction, it is impossible to determine each transaction's authenticity and integrity. Then, the author refers to the cost of implementing the control mechanism for a decentralized currency market. Hence, the bans in several countries are based on the assumption that the cost of regulating the currency in a decentralized form outweighs the cost associated with banning the currency. Allen (2023) agrees with these concerns shown by Wanjiru and sees the positive framing of decentralization by the advocates of Bitcoin as an illusion. The author quotes the example of FTX, a renowned crypto exchange that suffered a critical liquidity shortage in November 2022. As the market declined, the investors in huge numbers decided to withdraw their funds. Soon, the exchange was overwhelmed, and it denied a huge number of withdrawals, creating serious concerns for the investors. All these happenings were later disclosed by research. Allen argues that crypto exchanges can use decentralization to their advantage to affect the consumers. Therefore, the case for banning Crypto is based on logical assumption as regulating a decentralized market is a highly costly consideration.
Similarly, an article recently published on NASDAQ highlights how decentralization remains Crypto's "greatest weakness" while also being its "greatest strength." Among the issues highlighted in the article, a critical issue is the pressure from the centralized organizations that generally negatively portray all decentralized organizations or activities. This negative view makes the crypto market vulnerable to regulatory concerns and subsequent restrictions or bans (NSDAQ, 2022). This discussion indicates a critical dilemma. For example, if the currency faces regulations and becomes centrally regulated in a region, it will likely compromise one of the greatest appeals for investors. Similarly, if it goes decentralized, it will continue to be subject to regulatory barriers.
4.2. Diversity in Crypto Market
Another genuine and one of the most critical issues, as also highlighted by Wanjiru (2022), is the diversity across the organizations controlling different cryptocurrencies. For example, some of these organizations have maintained high transparency, with their leadership visible and clear on their rules and regulations. On the contrary, entities operate without clarity on the teams behind them. Similarly, some organizations have flat structures, while others follow traditional hierarchies. Wanjiru argues that this diversity makes it hard for the regulators to introduce generally applicable rules and regulations. Since the companies differ in their structures and policies, it is also likely to affect their ability to comply with the regulations. It will result in a fragmented response from the market, which is challenging to tackle and respond to. This regulatory challenge also tempts the regulators to impose a straightforward ban instead of regulating the market.
4.3. Diversity across Jurisdictions
On the regulatory front, cryptocurrency is also faced with challenges due to the diversity of jurisdictions. Understandably, this problem is pronounced in countries with more decentralized governance systems where each state, county, or regional segment is supposed to have its own independent regulatory framework (Corbet, 2021). Since jurisdictions may vary in their approach to regulating cryptocurrencies, it poses the risk of fragmented regulations (Corbet, 2021). This difficulty presents challenges for regulators as discrepancies across regions may affect the implementation, resulting in the wastage of resources directed toward regulating the crypto markets (Baker et al., 2023). This can be seen as a potential reason for either leaving Crypto unregulated or imposing a complete ban, as a midway approach (regulating) is surrounded by ambiguity and uncertainty.
4.4. Difficulties in Identity Verification
As mentioned before, several countries have a critical concern regarding the passage that crypto markets afford for customers for money laundering and identity fraud. However, a critical trade-off exists between implementing the relevant controls and maintaining anonymity (Corbet, 2021). It is important to understand that cryptocurrency is based on the philosophy of peer-to-peer anonymous exchange. It is in clash with the regulators in the countries following restrictive regimes requiring the markets to implement KYC and AML protocols. It will require the exchanges to verify the customers like traditional banks, such as using government-issued documents for verification. If the crypto market players use this process, it will blur the line between traditional banking and Crypto, likely affecting investors' participation (Finance Magnates, 2023). This trade-off and how implementing KYC and AML threatens the Crypto's recognition explains the dilemma faced by the crypto markets. For example, it prefers getting banned to maintain its anonymity-oriented identity.
5.0. Empirical Evidence
This section engages in the debates within the scholarly literature, focusing on empirical evidence about the regulatory challenges of cryptocurrency in different countries. Through a systematic mapping, Silva & Mira da Silva (2022) have identified key regulatory obstacles cryptocurrencies face. The study highlights several key themes. One of the most critical challenges is fragmented governance, as also highlighted by Wanjiru (2022) and Allen (2023), which makes it hard to ensure across-the-board compliance. Similarly, the research shows that cybersecurity threats associated with the Blockchain and the lack of a proper mechanism to ensure consumers’ safety remains a potential challenge (Silva & Mirda da Silva (2022). Similarly, Cumming et al. (2019) have studied various cases of how cryptocurrencies have navigated regulatory challenges and discussed them in synthesis with the theoretical underpinning. Cumming et al. agree with the above findings about the diversity of governance and the subjective nature of the trading. However, the researcher does not blame the market but emphasizes the need for an upgraded and holistic framework and ecosystem to regulate 'crypto assets.' Based on the findings, it is argued that crypto markets have emerged as a new reality, and the old frameworks are not positioned to cover their sophisticated dimensions. It is also inferred that the solution lies in a collaborative framework where market leaders partner with the governments to establish a comprehensive ecosystem to ensure and balance the interests of all stakeholders, including government, markets, and customers.
5.1. Cryptocurrency, Corruption, and Money-Laundering
There is also considerable debate focusing on the money laundering threats associated with the popularity and ubiquity of cryptocurrencies. For example, Campbell-Verduyn (2018) has studied the money laundering threats, key underlying arguments, and the regulatory measures to overcome the threats. The article concludes with two major arguments. Firstly, the researchers find that the vulnerabilities associated with Blockchain technology are more associated with money-laundering risk than Crypto as digital currency itself. In other words, technological improvement can address many of the problems currently faced by regulators. Secondly, the actions taken by the Financial Action Task Force (FATF), irrespective of their outcomes, are essential to balance the interest between the markets and regulators. In other words, the researchers create a case for a midway approach between a restrictive and permissive paradigm, which involves monitoring the currency and its ethical implications unless a robust framework is in place, which may take time given that the market is still in its premature phase and is likely to evolve with time.
Rysin & Rysin (2020) have also given coverage to the regulatory challenges facing Crypto due to money laundering threats. The researchers have gone to the depth of the analysis and identified the loopholes within the transaction process that present or enhance the risk of money laundering. Two potential threats include money mixers and shadow money services businesses (MSBs). The researchers argue that money mixers who pool the money deposited by users to enhance privacy and obfuscate the source of money make the crypto market a temptation for money laundering. Similarly, several shadow MSBs in disguise of licensed MSBs continue operating and present regulatory challenges. These issues have repeatedly been outlined by regulators worldwide and need an appropriate response from the market to ensure compliance with the AML protocols. However, the current vulnerabilities within the crypto market in the form of money mixers and shadow MSBs make it difficult for Crypto to allay the regulators' concerns. Rysin & Rysin conclude by emphasizing the need to improve the technological aspects of Crypto to remove the identified vulnerabilities and improve transparency and accountability.
Both Campbell-Verduyn and Rysi & Rysin hold the technological vulnerabilities accountable for the loopholes, making Crypto a breeding ground for money launderers. It means that cryptocurrencies do not intrinsically pose a threat, and there is the possibility that future technological improvements fix the current regulatory issues. Renda & Caneppele (2023) have also made a significant contribution to the empirical literature by conducting interviews with experts specializing in the fields of AML compliance in Switzerland. The interviewees dismissed the idea that the regulators' initiatives were being taken with industry consultation as a misperception. The findings suggest that through consultation with industry experts, the regulators decided to tackle the money laundering threats through a consortium and follow the technology-neutral approach. The participants also highlighted that the current measures were inadequate to deter money laundering through crypto exchanges. However, efforts are in the process to improve the protocols. The inferences about the inadequacy of current protocols in Switzerland resonate with Cumming et al.'s (2019) argument about the need for a digitalized and robust system specially designed for Crypto. In other words, the difficulties faced by the technology-neutral framework in Switzerland are likely to be rooted in the fact that it is old and a general framework with no specific provisions to give holistic coverage to the complexity of crypto-market dynamics. Therefore, Cumming et al.'s advice for technological evolution appears relevant to Switzerland's case.
Kankanam Pathiranage et al. (2020), in their review of the implications of cryptocurrency for developing countries, pursue the same line of argument as a...