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Why Are Government Regulators Concerned about Cryptocurrency

Cryptocurrency is receiving much attention from government leaders and regulators. In this regard, perhaps the heads of state for the USA and China probably agree – cryptocurrency is proving a legal nightmare.

Compliance and function of blockchain are still not fully understood by those whose role it is to protect the public, which is causing problems for developers, investors, and regulators.

Easy Access and Difficult Withdrawal

With over 1600 cryptocurrencies and altcoins available, buying cryptocurrencies has become extremely popular and very manageable for users who have an internet connection and simple hardware; even mobile phones make it possible.

However, legal constraints make it difficult or even impossible in some countries to withdraw funds in fiat currency. Given that cryptos in themselves are traded between other users on a platform makes them quickly passed throughout their specific network. The very nature of these coins means that they are in effect a cyber currency, with no affiliation to fiat. Therefore, the danger to the user comes when there is no way to make a fiat currency withdrawal because the banks in countries are not associated with the coin or coins in the user wallet.

Untraceable Asset Value

Blockchain technology provides a system of asset trading without a banking intermediary or third party. The original and compelling selling point for Bitcoin to investors and the retail markets stressed the ease with which two people could exchange funds without interference by regulators or exchange fees. However, the illiquid and intangibility of cryptocoins makes this an untraceable bearer asset value, bringing with it a number of risks to the parties; they are unable to be fully insured against volatility within the market, and as with Bitcoin, their value is traded against the US Dollar, bringing their value into question when that fiat currency suffers devaluation.

In addition, there is no traceable liquidity of capital to the cryptocurrency company, making it impossible for regulators to ascertain any bankable accounting and therefore, users’ financial investment is without any form of security or insurance against fraud or theft.

No Underwritten worth

Last year, in 2018, hackers ripped off almost a billion dollars (USD); three and a half times that stolen in the previous year. This makes cryptocurrency curators sitting ducks when it comes to the sophisticated and very professional cyber hackers mainly through a complete lack of defence and risk evaluation related to crypto trading and underwriting security.

The vital need for insurance coverage in the industry that supports cryptocurrency assets can only become a successful part of this blockchain technology when regulators and fund managers come together to formulate an infrastructure that protects both users and custodians. Some of the more significant aspects involved are loss or theft of private keys, human errors, cyber-crime and lately, kidnap and ransom. In order for an underwriting executive to be successful, the insurers require fully audited accounts to ascertain cash liquidity, which has been extremely difficult to obtain due to the nature of the beast – any form of government or institutional financial involvement has been omitted through the blockchain protocol that forms the basis of Bitcoin and many altcoins.

Mark-to-Market [MTM] Accounting

Legislation under IRC Section 475 dealer classification: [a], a dealer, is someone who buys/sells securities as their fundamental business practice, [b] a person or business that interacts with customers trading in securities to enter into, assign, offset, assume or terminate positions as regular business or exchange.

The IRC defines a “security” as:

  • Partnership interest
  • Share of Corporation Stock
  • Interest rate
  • Currency
  • Equity notional [estimated] principal [primary] contract [agreement]
  • Note [commitment to pay], bond [fixed income investment], debenture [unsecured loan], or other acknowledgement of debt
  • Alternatively, a derivative of any of the above, and this includes a hedge position concerning any part of a “security.”
  • MTM [mark-to-market] ruling is that assets are valued at the end of the tax year, according to their Fair Market Value [FMV]. This means that the tax liability of cryptocurrencies, such as Bitcoin, could be far higher at the end of the year due to their increase in value.

    However, the downward price pressure arises when a crypto-investor wants to exchange his crypto-asset for fiat currency, usually the United States Dollar. The speculative trading of cryptocurrencies among users brings volatility to the market often over valuing the coin. However, the illiquidity in the ecosphere adds further devaluation when the user wishes to “cash out” in favour of fiat.

    The MTM rules regarding taxable income are almost secondary when it comes to cryptocurrencies because of their intangible nature and illiquidity, which puts them into a minority investor class and the problems arise for junior or short-term investors.

    Manipulation and Extortion

    There is nothing new about pump and dump practice in the equities market, but the regulatory authorities have been able to keep a handle on it. However, the practice of pump and dump cryptocurrency scams whereby investors, either singly or in a group, illegally promote a coin, which they hold to create a surge of interest to inflate the price in order to sell [dump] making massive profits when the price begins to fall, is proving to be harder to control. The end result is massive illegal profits for some and equally significant, devastating losses for the victims, who have been tricked into buying.

    In a 2018 Wall Street Journal report; over six months, $825 million worth of digital tokens were actively manipulated in 175 pump and dump schemes that affected 121 different cryptocurrencies. With trades lasting only a few minutes, the price of many of these somewhat obscure cryptocurrencies disappeared as soon as the trade was over.

    The coin price will be touted in all news media as being the best possible investment, and the scams are best suited to over the counter illiquid assets, such as cryptocurrencies. The group leading the pump and dump increase the demand, which is taken up by new investment traders and when the price has reached its zenith, the holders or issuers (ICO’s are sometimes the biggest scammers), begin the bear movement to make massive short-term gains.

    Regulatory Attention and Control

    The continued cloak and dagger attitude by both cryptocurrency developers and regulators is probably one of the most crippling syndromes, which has to be addressed by all parties if this form of technology is to become acceptable and safe to use on a global scale.

    There is little doubt that governmental agencies around the world have realised the very urgent need to get a better grip on blockchain technology to bring fiscal governance in place for their citizenry, whether they are providers or users. However, the fear behind the suspension or outright banning of cryptocurrencies in some countries is not merely based on a lack of understanding, but more on the scurrilous nature of the people behind the scams and in this regard, it behoves all honest players to leave their avarice at the door and join the crusade for innovation.

    Cyber Risks and Insecurity

    Investment speculators have made millions of dollars with cryptocurrency in the last few years, and cybercrime has been contributing to the volatility in the retail price of digital currencies like BTC, ETH, and others.

    The transactions for drugs and ransomware attack payoffs along-side money laundering and terrorism have also become part of the criminal enterprises related to cryptocurrencies around the world.

    There are five significant attack methods used by cyber criminals:

    Taking advantage of lax exchange security

    Cybercriminals attack currency exchanges – in 2011, and 2014 Mt Gox was robbed through a security breach of almost $460 million and in 2015 BitStamp, also announced significant $5 million loss to operational funds from its “hot wallet.”

    Enslaving devices to mine crypto-currency

    Online criminals with an interest crypto-currency mining have reproduced the same hardware and software infrastructure: PCs, routers, phones, browsers have been attacked with the use of malware that “enslaves” a device and through encryptions; the thieves can retrieve crypto tokens in their attack.

    Breaching Security of Insecure Wallets

    Otherwise referred to as “virtual pickpocketing”: Consumers store their crypto currency in wallets that require security keys not only to sign in but also to verify transactions. These so-called “hot wallets” become the target of cybercriminals who place malware into the currency transaction system to breach security. The best security practice of using a “cold wallet” [off-line storage of security keys] is often not taken by consumers.

    Tax Evasion and Money Laundering

    The scale of this type of criminal activity has been difficult to ascertain given the levels of anonymity and the ability of users to exchange cryptocurrencies into fiat currencies. However, in 2017, various government agencies were confident that the funds being used in this manner were small and limited to only a few cryptocurrencies. Yet, government agencies continue to place limitations on the use of some cryptos, and Japan Financial Services Agency has called for pressure on cryptos such as Dash, Zcash, and Monero because they are believed to be used by criminals because of their privacy protections.

    In January 2018, the evidence became known by the Department of Homeland Security in the United States that illegal activity by narcotics trafficking and money laundering cartels were exploiting peer-to-peer crypto exchanges.

    Targeting the Blockchain Technology Infrastructure

    The criminal activity aimed at DLT (distributed ledger technology) or blockchain protocols used by miners and crypo-currencies to provide proof of work or record transactions has been on the increase. In 2016 the Ethereum DAO [Decentralized Autonomous Organization); the venture capital fund based on a smart contract by the Ethereum developers, was attacked and $70 million of the funds stolen before the developers were able to instigate a “hard fork” to stop the attack. Undaunted, the thieves used a “distributed denial-of-service” attack against ETH to slow down transaction processing time.

    Unsafe Investment Havens – Fake ICOs

    Potential investors are almost desperate to get into the cryptocurrency market, and this is due in part to the massive press coverage given to the Bitcoin millionaires. Often the need to invest coupled with what looks like high value profit making from ICOs is what leads to downfall.

    Although the cryptocurrency landscape has been around for many years, it is still difficult for consumers to tell fake from legit as with this Howeycoins, launched by SEC as an educational tool to show how hard it is to spot the fraudsters.

    Technology Risks and Energy Consumption

    There is no denying that Bitcoin Mining is an expensive business and a recent study by Cambridge University in the United Kingdom, found BTC mining energy levels to be the same as those of Switzerland. In the grand scheme of things, this probably equates to a minute amount of the worldwide energy usage, however, for consumers, it is this high-energy cost that puts mining BTC out of reach for anyone other than those with a large bankroll.

    The technology risks come into play when there is a problem maintaining the hardware, or if energy supply is cut-off or reduced.

    Mining and Hard Fork Wars

    Crypto forks and the term “hard fork civil war” is commonplace with much hype surrounding them in the cryptocurrency ecosphere.

    What is a fork?

    The short answer is; a fork is an event that divides existing blockchain from a single software protocol into two co-operating versions.

    When forks occur accidentally: two miners simultaneously discover the same block; some nodes from the blockchain DLT create will create a second parallel chain with different information. The consensus protocols on the original chain will identify this fork, and the problem is quickly resolved without causing a destabilising effect on the network.

    However, when developers purposely instigate forks to repair vulnerabilities, alter the basic protocols of the network or modify the source code to include new features the forked code is legitimate and requires users to upgrade the software to incorporate the latest fork. These purpose built forks create a new digital asset or community of users or a new protocol to work within the blockchain platform.

    Conversely, forks sometimes come with hackers attached as with the Ethereum DAO, which caused a massive theft of $180 million ETH during the month of May 2016 and in June of 2016, hackers spotted a exploited a serious flaw in the DAO code allowing them to pilfer more than $50 million ETH from user wallets.


    Regulation and compliance notwithstanding, the introduction of fully compliant and trustworthy software that is reliable and follows moral and ethical standards will do much to bring universal [democratic] blockchain application for global users.