Understanding Three Challenges That Make Cryptocurrency Regulation Difficult for Nation-States

The regulation of cryptocurrencies remains a headache for countries and there seems to be no easy way around this difficulty. Many say that innovation is more important than regulation. While this is true, building a bridge between innovators and regulators is necessary for investor confidence. This article looks at three aspects that make crypto regulation difficult in Africa.

Decentralization

Decentralization is central to the nature of cryptocurrencies. This is the principle of blockchain technology, which provides crypto users with security, freedom from censorship and privacy. On the other hand, the technology also has some drawbacks, such as the inability for people to undo bad transactions and the permanent loss of money if private keys are forgotten. Since the advantages outweigh the disadvantages, decentralization of cryptocurrencies is preferred, also to provide people with an alternative to centralized financial services.

Decentralization existed before cryptocurrencies in other ways. Anticipating its impact on money, however, is new to regulators. Centralized authorities such as central banks are structured to oversee monetary policy and money flows in a country. Cryptocurrencies, on the other hand, have no central authority, jurisdiction or uniform policy. How can a single government oversee all decentralized cryptocurrencies?

Given the cost of implementing regulatory requirements, it is easier to appreciate the potential costs of cryptocurrency regulation. This is how several countries end up banning the use of cryptocurrency. The bans are also the result of numerous scams that undermine investor confidence. Regulators try to act in the best interests of their citizens because protecting investors and capital are important objectives for them.

Today’s rules may not have existed decades ago; numerous collaborations have made it possible to set up functional frameworks for companies and regulators. The same concerted effort will make the complexity of crypto easier for regulators to navigate.

Diversity of protocols and governance

Different cryptocurrencies have different rules, protocols and governance systems. Bitcoin
BTC
for example, has the Bitcoin Foundation, which is made up of investors and developers who make decisions about the protocol. Some cryptocurrencies have no clear formal leadership, with their founders choosing to be anonymous. Others have fully trained companies, boards and staff. Based on principles such as “code is law”, some companies adopt flat structures, eliminating hierarchy altogether.

Compare this to centralized structures, where responsibilities are clear. It is easier to comply with established legal requirements, such as compliance and reporting. How do crypto companies comply with financial reporting? Who is responsible for financial losses in a bear market? Who detects suspicious or fraudulent activities? Where can they report these activities? The introduction of decentralized governance in the financial sector has therefore been complex due to some of these aspects.

Differences in protocols and governance mechanisms have basic principles. Appreciating these basics is a good starting point to better understand crypto governance.

Legal diversity

Many crypto companies are moving to countries with favorable regulations. A ban in one country incentivizes moving to another, so businesses can pass as those looking to expand into the crypto industry. There is an ironic existence of the need to enable regulation, but cryptocurrencies were never intended to be formally regulated by design. Cryptocurrencies are designed for peer-to-peer use, ideally valued and used by individuals.

If people individually understood the uses and risks of cryptocurrencies, perhaps that would reduce the need for regulation. However, many people have yet to understand how cryptography works. Others don’t find it necessary to use it at all. The value of cryptocurrencies is very subjective at the moment. These aspects are paramount for regulators. Why spend resources on something that barely a third of their citizens use every day?

The precedent set by El Salvador in 2021 and the Central African Republic in 2022 to accept Bitcoin as legal tender has yet to prove its significant value for other countries to follow suit. It’s also too early to tell the impact of making bitcoin legal tender when designed as a peer-to-peer payment system. What should be appreciated is that people, companies and regulators have ongoing discussions about the potential value and impact of crypto in their country. It is perfectly acceptable that a country at this point does not have all the answers on how to regulate this dynamic industry. It would be worrying to sweep the problems under the proverbial rug.

Future perspectives

One way to bridge the gap between crypto governance and regulation is to create forums for regulators to collaborate with players in the crypto industry. It will build on the strength of the relationship between regulators and industry players. Therefore, short courses, sandboxes and small wins are three points of progress for this complex area. A better understanding of the potential of these tools and of this dynamic ecosystem is essential. Just because it’s difficult now doesn’t always mean it’s impossible to regulate. Patience with the process will yield good results in the coming years.

Disclosure: I own bitcoins and other cryptocurrencies.

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