Five reasons why cryptocurrencies are raising alarm

Interest in cryptocurrencies has surged over the past year, and policymakers are scrambling to catch up. Investors have rushed into major digital currencies such as bitcoin and a growing industry of financial products tied to them, prompting regulators to lay out new rules for a rapidly growing world.

Financial regulators appointed by President Biden have recently pledged to crack down on any manipulation or abuse within the cryptocurrency industry, while advocates for the industry insist the government must lay out clear, consistent rules for all to follow.

Here are five reasons cryptocurrencies are spurring action from Washington:

Soaring and volatile prices

As stocks blasted to record highs through 2020, major cryptocurrencies exploded right beside them. The price of one bitcoin skyrocketed from roughly $7,300 at the start of 2020 to a peak of $63,503 in mid-April of this year. Other prominent cryptocurrencies such as ethereum and even coins created as jokes such as dogecoin saw similarly meteoric rises, which prompted a cycle of investor enthusiasm driven by soaring prices and prominent onetime supporters such as Elon Musk.

But the rally buckled in a major way this week not long after Musk disavowed bitcoin, knocking $30,000 off its price — two months of growth — and 40 percent off its value since last Friday.

“If you’re a crypto investor, you’ve probably had to deal with major drops in the past. But this time around felt especially painful,” wrote Lule Demmissie, president of Ally Invest, in a Friday research note.

“Bitcoin has looked like the classic case of a crowded trade that turned. Investors have jumped from Bitcoin to Ethereum to Dogecoin in search for the hottest trend in the crypto space. This week, crypto holders rushed to the exits, with all three coins down 30% or more from their peaks,” Demmissie added.

New technology

Major banks and investment firms that once refused to touch cryptocurrencies are now accepting digital tokens as an enduring part of the financial sector, helping legitimize the burgeoning technology.

After the Office of the Comptroller of the Currency (OCC) gave the banks it regulates the green light to hold cryptocurrency for clients, U.S. Bank, Bank of New York Mellon and Citibank took steps to offer crypto services. Goldman Sachs, one of the earliest investment banks to embrace cryptocurrency, announced this month its plan to offer bitcoin derivatives amid intense demand for crypto-linked bets, fueling concern among industry skeptics.

“My broader concern is that these initiatives were not done in full coordination with all stakeholders. Nor do they appear to have been part of a broader strategy related to the regulatory perimeter. I believe addressing both of these tasks should be a priority,” Acting Comptroller of the Currency Michael Hsu said during a House hearing this week.

Growing pains for platforms

While Wall Street power players have begun to dip their toes in the crypto world, the online trading platforms and applications that grew beside the digital currency boom have hit several technical and political speedbumps.

Coinbase, the biggest cryptocurrency exchange, and other firms experienced outages this week amid the crypto sell-off, and Binance — another exchange — limited all but a handful of cryptocurrency options trades amid the frenzy, drawing backlash from users.

The intense price swings and the technical issues they’ve spawned have prompted more skepticism among Democratic lawmakers about the legitimacy and safety of cryptocurrencies as investment products.

Sen. Sherrod Brown (D-Ohio), chairman of the Senate Banking Committee, urged the OCC this week to take a closer look at decisions made by his predecessors to allow some crypto trading and custody firms to offer some banking services nationally.

“A firm that cannot meet the rigorous requirements applicable to other banks should not be allowed to present itself to the public as a bank,” Brown said, calling cryptocurrencies “risky and unproven.”

But Peter Van Valkenburgh, research director at cryptocurrency think tank Coin Center, countered that the OCC’s supervision is more likely to protect preexisting customers of such firms than drawn in new ones.

“A bunch of people are already using this thing,” he said. “Do you want them to use it through a company that’s got heavy-duty federal regulation, or do you want them to go and find an international exchange that is licensed anywhere? Because they will.”

Security concerns

Some critics of cryptocurrencies dismiss them as little more than vehicles for money laundering and fraud. While those are far from the only current or potential uses, high-profile instances of crimes involving cryptocurrencies — including the $5 million in bitcoin ransom received by the alleged Colonial Pipeline hackers — have stoked concerns about regulatory gaps.

The cryptocurrency industry doesn’t fall neatly into the jurisdiction of any one state or federal regulator, making it difficult to set uniform standards or crack down on potential crime.

The Treasury Department is responsible for collecting taxes on cryptocurrency and ensuring compliance with anti-money laundering rules. The Securities and Exchange Commission has jurisdiction over certain investment offerings involving cryptocurrencies, while the Commodity Futures Trading Commission has jurisdiction over other products, partially because digital coins themselves blur the lines between securities and commodities.

And while federal bank regulators will monitor how the firms they supervise handle crypto, there is no one federal agency with the authority to regulate spot cryptocurrency exchanges, forcing many firms to get state-by-state certification from money transfer supervisors.

“While it’s novel, it’s incumbent on those regulators to understand it because this stuff is not going away,” said Ethan Silver, partner at law firm Lowenstein Sandler.

More money means more taxes

With more investors buying more cryptocurrencies for more money, the IRS has stepped up its efforts to make crypto owners aware of their tax burdens. The agency caused a stir in 2019 when outlining how crypto investors, some unsuspecting, would need to declare income from investments and potentially pay capital gains taxes.

But the IRS drew even more backlash Thursday after it announced that under President Biden’s plan to bolster tax compliance, individuals would have to report receiving cryptocurrency with a fair market value of more than $10,000, akin to how they currently report cash transactions.

Bitcoin fell sharply after the announcement, which evoked fears of steep tax bills or limited future price growth among investors.

“As long as we’re just providing equal treatment between cash and crypto, we’re providing needed clarity, and that’s almost always positive,” Van Valkenburgh said.