The Cryptocurrency Markets Face Major Regulatory Headwinds
August 12th, 2021 | Posted in Investing
Cryptocurrencies have emerged in recent years as an alternative, high-risk asset class often characterized by a lot of hype, complex technological innovations few understand, and the occasional pop culture reference. They are also notorious for very high, unpredictable bouts of volatility. We do not invest in them here at Zacks Advantage.
Cryptocurrencies have been in the spotlight more recently for a different, far less investor-friendly reason: regulatory crackdowns.
In late May, a string of bad news rattled the crypto market and sent the most popular coins into a downward spiral. In an about-face, Tesla reversed a decision to accept bitcoin as a form of payment, citing concerns over carbon emissions generated from producing bitcoin (as if this was breaking news).1
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The selling pressure intensified when China’s government pledged in a statement to “crack down on bitcoin mining and trading behavior,” to safeguard against growing financial risk. Since most bitcoin is mined in China, investors grew increasingly worried about regulatory headwinds building in the country, which could compromise bitcoin’s future.
At around the same time, the SEC Chairman, Gary Gensler – who taught a cryptocurrency class at MIT – urged lawmakers to pass a law regulating crypto exchanges. He has since kept up the pressure, more recently referring to the crypto markets as full of “fraud, scams, and abuse” and pledging to use all of the SEC’s authority to regulate markets as much as possible.
Mr. Gensler made clear his goals of regulating digital assets like bitcoin just as the agency regulates stocks, bonds, and commodity-related trading instruments. His statements have been echoed by other developed nations like Japan, and follow a crackdown already taking place in China.
But like all legislation and regulation efforts, it’s complicated. The federal government currently classifies bitcoin as a commodity, which limits the SEC’s ability to regulate how it is bought and sold. The SEC has therefore been increasingly pressing to classify digital currencies as securities, which would give the SEC authority to police trading and by extension, exchanges. The SEC has brought several suits and had much success to date, but as ever, the ability to regulate moves exponentially slower than the pace of technological innovation – certainly the case for the crypto markets.
Cryptocurrencies are also a hot topic in Congress at the moment. The bipartisan ~$1 trillion infrastructure bill contains new rules about cryptocurrency reporting, which could fundamentally change the way it is traded. As of now, cryptocurrency exchanges like Coinbase have no legal requirement to report gains and losses from crypto trading each year to the IRS, as is required from securities brokers like Charles Schwab and Fidelity. Coinbase simply tells investors to self-report gains and losses, which means very low levels of compliance. Tax evasion is rife in the crypto space, with billions in uncollected capital gains taxes each year. An amendment to the infrastructure bill seeks to change that.
As it were, the Treasury already has the legal authority to require crypto brokers like Coinbase to report trading activity and gain/loss information to the IRS, and they were already planning to issue new guidance in the coming years to require reporting. The infrastructure bill may accelerate this process.
The regulatory push is also happening on a global scale. A few weeks ago, the Basel Committee for Banking Supervision – which is a group of global central bankers including the Federal Reserve – proposed a strict rule requiring banks to apply a 1,250% risk weight to bitcoin. In short, a bank would need to set aside at least $100 in cash for every $100 in bitcoin, essentially deeming the cryptocurrency a worthless asset.
Bottom Line for Investors
Regulatory efforts against cryptocurrency are in very early stages, but the direction seems abundantly clear. Policymakers are losing patience, and the feeling that something needs to be done is increasingly bipartisan. Again, however, this is not breaking news by any measure—regulatory pressures on cryptocurrency have been growing and will continue to grow in the future, shrouding the market in uncertainty for years to come.
In our view, cryptocurrency is too volatile, unpredictable, and lacks intrinsic value – there are no earnings, just arbitrary predictions about what the price should be. Our work here at Zacks Advantage is focused on fundamental analysis and research-based decision-making, which at this stage, we think cryptocurrency lacks.
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1 Wall Street Journal. August 5, 2021. https://www.wsj.com/articles/cryptocurrency-compromise-emerges-for-infrastructure-bill-11628185806
2 Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.
3 Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.
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