Investigation Into Regulatory Challenges Faced by Bitcoin in Comparison with the US Dollar

Investigation Into Regulatory Challenges Faced by Bitcoin In Comparison with the US Dollar
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1.0. Introduction
Since its adoption peaked, the crypto market has become a breeding ground for controversy. The regulators are concerned about the unique nature of anonymous transactions within this newly-found alternative to traditional finance (Chen, 2021). Notably, the number of cryptocurrency users worldwide has crossed 420 million as of 2023, with 90% trading in Bitcoin (making it the most frequently adopted cryptocurrency) (LinkedIn, 2023). Therefore, it is no surprise that Bitcoin often remains hotly debated from its regulatory perspective (Motsi-Omoijiade, 2022). While the opponents of peer-to-peer trading are critical of the non-application of Anti-Money Laundering (AML) and Know-your-Customer (KNY) related provisions on Bitcoin's trading and demand a transparent system that simulates the regulatory coverage for traditional institutions, the proponents of unregulated crypto market argue otherwise (Corbet, 2021). The supporters of the permissive approach believe that the regulatory restrictions are likely to affect the unique nature of transactions, deter innovation, and affect the participation rate (Motsi-Omoijiade, 2022). These controversies and polarization around them also reflect on the global scale as a few countries, such as China, have already blocked Bitcoin, and some want to regulate it. In contrast, others (mainly Western countries) have begun to regard Bitcoins as Crypto-assets with minimal focus on changing their regulatory status (Motsi-Omoijiade, 2022).
On the other hand, the USD is an adequately regulated currency and is supposed to comply with traditional regulatory obligations. The institutions, such as Banks and trading platforms, facilitating the exchange of USD are also under the conventional regulatory framework (Baur et al., 2018; Oniha & Sanchez, 2020). The comparison between USD and Bitcoin is based on the realization that USD is a competitive conventional market alternative to Bitcoin with widespread adoption, easy accessibility of data, and high visibility.
The paper starts from a broader perspective as the initial part deals with the historical overview of Bitcoin, focusing on key controversies that drew regulatory attention. It is followed by the main part of the discussion, which is the comparison between Bitcoin and USD, focusing on different regulatory aspects, with each aspect treated as a separate theme and discussed under an exclusive heading.
2.0. Historical Background
The peer-to-peer electronic trading system termed Bitcoin commenced in 2008 through a White-Paper, and the mining started with a book traded using Blockchain technology in 2009. From 2009 to 2013, its adoption grew exponentially, but the regulators remained skeptical and unsure about different regulatory options proposed for the Crypto market. There was a lack of seriousness at the regulatory level because the administrative cost of regulations may outweigh any benefits as the adoption was not as ubiquitous as to merit an active intervention (Motsi-Omoijiade, 2022).
A major incident occurred in 2014 when Mt. Gox, one of the largest Bitcoin exchanges, became a victim of hacking, compromising several accounts and significantly stealing Bitcoins. As Mt. Gox announced bankruptcy, regulators worldwide took it as an opportunity to learn and work out the measures to stop similar adverse events (Mishra, 2023). After considerable deliberation, Bitcoin received a massive shock in 2018 when China banned Crypto. It resulted in a critical freefall of Bitcoin's value as China had the largest user base of Bitcoin traders then (Jennings, 2021).
By 2020, several other countries had joined China by imposing a complete ban on Crypto. However, this restrictive stance met a counter-narrative in 2022 with the rise of Decentralized financing platforms collectively termed DeFi. The advocates of DeFi built a strong argument in favor of decentralized financing, which promotes anonymous and borderless transactions, while questioning the regulatory restrictions imposed on conventional financing (Aquilina et al., 2023). It is important to note that the extent to which different countries or schools of thought welcome DeFi involves high variation.
3.0. Bitcoin versus US Dollar (USD)
This section is devoted to professional and scholarly debates regarding the similarities and differences in regulatory aspects associated with USD and Bitcoin. A few highly debated and debatable issues are considered to constitute the themes upon which this section is based. The themes unfold as follows:
3.1. Regulatory Bodies at the National and International Levels
The USD is a highly governed currency due to its international scope and influence on the global financial markets. Its trade is highly regulated at National and International Levels. At the national level, the US State Department of Treasury primarily oversees the transactions and other activities involving USD within national banks. The department has regulatory oversight over savings status and the factors considered for issuing coins (Motsi-Omoijiade, 2022).
The US Department of Treasury regulates taxation, public debt, and currency management (USAGov, 2023). Within this capacity, it keeps issuing notifications intermittently, aiming at interventions to strengthen or restore the balance within the areas of currency management on its radar (USAGov, 2023). Therefore, the department will likely determine the trade of USD, the levels reserved by the banks, and the issuing of new currency.
While the department does not cover Bitcoins, considering the permissive approach prevalent throughout the country, it keeps issuing critical warnings. For example, in a recent note, the department warned the US government regarding the adverse implications of unrestrained adoption of Bitcoin (Goforth, 2018). The department has warned that crypto trading (including Bitcoins) remains a critical threat to the financial stability of the US. On the same note, the government and policymakers are advised to strengthen the regulatory framework for crypto assets. The department has also emphasized the need for proper implementation of existing regulations (Goforth, 2018). Hence, the US Treasury Department remains critical of Crypto while not regulating it. The warning is largely rooted in the department's focus on the stability of the USD, considering that the unrestrained bitcoin trading may hurt the market factors interacting with the USD, which is evident from its emphasis on financial market stability.
However, the US Treasury's recent warning also has its geopolitical context. For example, Flitter Yaffe-Bellany (2022) has noted that the US Treasury Department has played an active role in regulating and monitoring sanctions against Russia in the wake of its Ukrainian invasion. In several warnings, the department has considered using Geolocation tools to restrict customers from trading in crypto-assets within the sanctioned region. The department has also expressed concerns over Russia's prospect of relying on Bitcoin and other crypto assets to evade the sanctions (Flitter & Yaffe-Bellany, 2022). Hence, a convincing case exists that despite the US generally adopting a permissive approach to Bitcoin's unregulated status, the department's reservations are largely rooted in the geopolitical conflict with Russia.
However, Cox (2023) points out that Russia's unscrupulous use of Bitcoin is only one of a few major factors motivating the Treasury Department to be critical of crypto trading. The reports from the financial sector show that despite having a negligible share in overall financial transactions, Crypto is popular among criminals who continue to manipulate it to their advantage. This factor has alarmed the US Treasury Department and compelled it to create a case for revisiting the unregulated status of Crypto (Cox, 2023). Hence, the Treasury has rooted its criticism against Crypto assets in some of the major controversies associated with Crypto discussed earlier.
Two important regulatory bodies to be discussed in this context are the Securities and Exchange Commission (SEC) and the Commodity Future Trading Commission (CFTC). SEC is mandated to regulate the securities. Over the past few years, on various occasions, the SEC has intervened in the trading of crypto assets. For example, on one occasion, it sued an individual for not registering his sales of retail crypto products (Goforth, 2018; Goforth, 2021). On another occasion, it penalized the former Coinbase executive on the allegations of insider trading (Goforth, 2021). Hence, the SEC keeps asserting its influence and entitlement to treat Crypto as a security.
However, it is important to note that the SEC treats Bitcoin as an exception and regards it as a commodity, arguing that it fails to pass Howey's test (Duggan, 2023). When drawing the line between the USD and Bitcoin, it is critical to note. For instance, the trading of USD in the foreign exchange market or Forex is treated as commodity trading and comes under the purview of CFTC (Goforth, 2021). Therefore, there are no critical complications associated with the regulatory status of USD as it is seen through the regulatory lens of CFTC (Goforth, 2021).
However, the lack of clarity surrounding the status of Bitcoin triggers a controversial debate. For example, a recent professional article by Stevens (2023) highlights that ambiguity associated with Crypto trading gives a highly complicated view of the scenario. For example, if Bitcoin is declared a commodity, it would come under the jurisdiction of the CFTC. In the future, the US Government is looking to authorize the CFTC to regulate spot and futures trading. If this is true, CFTC will treat bitcoin similarly to other commodities. The distinction between CTFC and SEC will bring intricacies to the regulatory status of Crypto, where other cryptocurrencies are treated as a security and only Bitcoin a commodity.
Lolaeva et al. (2021), in their research about the legal coverage of Crypto, highlighted the same concerns as discussed above. The researchers have found that recognizing their status is an important precondition to regulating crypto assets. It involves identifying them with existing objects, such as securities or commodities, or as a novel or unique object. In either case, the legal complications are unavoidable. The scenario will be more complicated if Crypto is treated as a separate object requiring new regulations and interventions. Stevens (2023), in the above article, also agrees with Lolaeva et al. (2021). However, Stevens also indicates complications associated with having a divided recognition of Crypto, with Bitcoin treated as an exception. Hence, both authors indicate the ambiguities associated with the regulatory status of Crypto. It is unclear if the SEC or CFTC should be held responsible for Bitcoin. This distinction is material due to the differences in regulatory stance and strictness shown by each body.
Another notable institution controlling currency trading and exchange is the Financial Crimes Enforcement Network (FinCEN). Established in 1996, the department deals in a wide range of regulations, primarily aiming to deter money laundering and exploitation of customers. For this purpose, two widely adopted regulations are Anti-Money Laundering (AML) and Know-Your-Customer (KYC) (The US Gov Official, 2023).
FinCEN has taken several initiatives to deter AML by ensuring that the origin of money cannot be hidden or that individuals or businesses trying to unscrupulously conceal the origin to manipulate the money trail could be penalized. For example, the department legally binds the funds' transmitter to disclose the transfer of funds beyond a specified limit from the US to another destination (The US Gov Official, 2023). As understood, it is easy to implement this regulation to transmit funds in USD, as the remittance and other forms of transfers are performed by recognized banks, money exchanges, or other financial institutions (The US Gov Official, 2023). Therefore, spotting suspicious activity is smooth as the reports from the concerned bank or exchange can help the authorities reach the suspects.
It is important to note that FinCEN is among the most active regulatory authorities in bringing virtual currencies, including Bitcoin, on the regulatory radar. For example, in 2013, FinCEN declared that it recognizes virtual currency exchanges and administrators as Money Service Businesses (MSBs) per its definitions (The US Gov Official, 2023). Since then, FinCEN has obligated all the exchanges dealing in Bitcoin or other virtual currencies to register with it and abide by all the terms and conditions associated with AML and KYC (The US Gov Official, 2023).
Besides, FinCEN has kept reiterating that virtual currency mixer service providers remain under the umbrella of MSBs and must comply with the protocols to protect the customers and avoid money laundering in line with treasury regulations (The US Gov Official, 2023). Notably, FinCEN has practically expressed its authority and engaged in multiple cases of bans and penalties imposed on mixers or exchanges engaged in transactions that do not qualify as legitimate under AML or KNY protocols (The US Gov Official, 2023). In a recent note, FinCEN has warned the Treasury and the concerned regulatory authorities regarding the potential threat associated with the currency mixers. The warning came out in the wake of the recent indication of terrorist funding to Hamas and other militant groups allegedly channeled through Crypto Mixers. In a detailed regulatory proposal, FinCEN emphasizes that the US Treasury officially recognizes Crypto Mixers as a threat to deter their intermediation in money transactions to discourage terrorist funding and other acts of AML (Hamilton, 2023).
The scholarly literature also aligns with FinCEN's stance on the potential threat held by Crypto exchanges unless regulated and the virtual currency mixers. For example, Crawford and Guan (2020) have based their study on the synthesis between existing statistics about the illegal activities around Bitcoin and interviews conducted with the users about its potential. The findings suggest that the worth of illegal activities per year for Bitcoin accounts for approx. $72 billion. The findings also indicate that money mixer services are highly risky for customers and the economy due to their interaction with AML and KYC. For instance, it is found that several virtual currency mixing services have disappeared considerably despite their name. The scams have largely affected the users' trust in these services, while the users' awareness about the privacy and loopholes associated with these services remains low. See (2023) elaborates on these findings by arguing that Bitcoin mixers adopt a complicated multistage process, making it difficult for the legal authorities to cover all aspects and detect illegal activities. The research indicates a major gap in the legal coverage of the process where decentralized mixers use off-chain communications to engage in tainted money transactions. These findings re-echo FinCEN's recent advice to the Treasury to recognize the mixing services as a threat (Hamilton, 2023) and strengthen the prospects of mixers' involvement in terrorist funding.
3.2. Regulatory Challenges for Crypto in Economic and Social Context
The existing literature has given multidimensional coverage to the economic risks and challenges arising from the complicated regulatory landscape surrounding the Crypto market and its threats to the US dollar. For example, a range of studies regards the rise of Bitcoin and its unregulated trading as a threat to the ecosystem within the financial market (Manaa et al., 2019; Dumas et al., 2021). For example, Manaa et al. (2019), through recent research relying on the market and economic data, outline that the interaction between Crypto and the traditional financial market is on the rise, and it is shaping new patterns of payment and changes to existing financial infrastructure with far-reaching implications for the monetary policies. The researchers have argued that the current regulatory complications associated with Crypto pose serious threats to the economy through their manipulation of financial infrastructure. There is the indication that if timely measures are not taken to recognize the Crypto assets and integrate them into the traditional financial structure, ambiguity, and unregulated transactions pose the risk of financial instability. Dumas et al. (2021), in research focusing on the Indian context, also highlight the same risk. Based on the insights gleaned from the findings of their research, Dumas et al. (2021) conclude that technological vulnerabilities potentially affect the price stability of Crypto, and growing reliance on Crypto can potentially affect the financial markets due to the risk of high volatility attached to Crypto due to technological vulnerabilities. Even though the researchers do not articulate the regulatory aspect of technological vulnerabilities, its implications for regulators cannot be ruled out.
These studies reinforce the idea that regulatory ambiguity and inadequacy of regulatory frameworks introduced to cover Crypto may have dire macroeconomic consequences. Manaa et al. (2019) highlight the risks of regulatory ambiguity and inefficacy amid Crypto's unrestrained infiltration into the existing financial market infrastructure. Technological vulnerabilities draw attention to the complexities associated with regulating Bitcoin. These findings converge that Bitcoin significantly diverges from USD and other traditional counterparts due to the complexities associated with its technological, procedural, and methodological aspects. Therefore, the increase in the involvement of Bitcoin in traditional financial markets arguably poses a threat to the stability of these markets.
Despite the above concerns being widespread and justifiable, the existing literature also indicates silver linings in emerging contexts. For example, Poong (2023) studied different types of Crypto-assets, including Bitcoin, concerning their corresponding regulations. The focus of the study is the same as in the above studies: to assess the implications of regulatory inadequacy for Crypto for the financial market. The researcher has also agreed with the above studies that regulatory complications remain risky for the financial market. However, on the upside, evidence suggests that after a comprehensive set of well-directed regulations is formulated, Crypto can serve as a better and easier-to-access alternative for the Start-up seeking financing services, thereby revolutionizing the traditional banking system. In other words, the banking system will likely reduce reliance on traditional currency as the appropriate regulatory considerations enable financial institutions (including banks) to deal in Crypto assets.
Even though Poong has made strong optimistic indications, these indications are based on the assumption of an ideal scenario. It is agreeable to a considerable extent that digital currencies can boost the accessibility of financial services and help financial institutions better streamline their activities. However, regulatory complexities associated with Crypto assets make it unlikely that the regulators will reach a solution anytime soon. Therefore, the immediate and mid-term threats arising from Bitcoin's gradual displacement of USD in the traditional financial market cannot be ruled out.
An important extension of Bitcoin's function is its adoption by nonprofit organizations. To this end, Howson (2020) has considered the case of Crypto-giving, which refers to donations through Crypto platforms. The research shows a considerable willingness among nonprofit organizations to receive donations in Crypto alongside traditional currency, enabling them to innovate and maximize the scope for philanthropic considerations. However, the regulatory challenges also call into question the validity and reliability of Crypto-giving, as it is yet uncertain how the payments received in digital currency are used to benefit the intended beneficiary. Similar concerns have also been shown by Shin et al. (2020), who, in their study, found that nonprofit organizations can leverage the potential of crypto-assets by integrating them into their financial manage...