Lack of Legal and Regulatory Clarity

Note: Data in this section last updated September 12th, 2022

In most of the world, the crypto space still exists in a legal “grey area”. The technology is still relatively new, and many governments haven’t had time to catch up.

And while the space has its fans in the administration, it also has its share of detractors. For instance, SEC Chief Gary Gensler labeled the space as the “wild west” and Elizabeth Warren called DeFi “one of the shadiest parts of the crypto world”.

Elizabeth Warren Doesn’t Like DeFi

Source: Twitter

Although some things are definite – like the fact that profits gained from cryptocurrency trading is taxable in the US – there are still several open issues. While going through the entire gamut of these outstanding legal questions is well beyond the scope of this article, here are a few recurring themes:

• Cryptocurrencies: Although the US has deemed that Bitcoin is not a security, it has not passed the same judgement on every project (in fact Ripple, once one of the largest projects, is currently battling the SEC on that issue). In addition, many nations are struggling to deal with the tax implications of novel concepts such as airdrops

• DeFi: With the $40 billion collapse of the Terra stablecoin, DeFi is coming into sharp regulatory focus. Some of the questions regulators are trying to address are the legal treatment of decentralized exchanges, the enforcement and validity of smart contracts and potential regulations around stablecoins

• NFTs: Given the fact that the NFT market is only a few years old, it has been largely ignored by regulators. That said, there are several outstanding questions when it comes to the legal standing of non-fungible tokens, including: are they securities, what intellectual property rights are transferred in a sale and how do KYC and AML laws apply?

• DAOs: Given that DAOs have no physical location and don't register as corporations, they often exist in a legal state of limbo. This creates several potential risks – it’s not clear whether DAO members have the same personal protection they would have in an LLC, there’s no clear guidance on how a DAO pays taxes and it’s not clear how DAOs can do business with traditional corporations

Unfortunately, these uncertainties haven’t always stopped authorities from pursuing action against alleged offenders. While some of these cases are definitely warranted, such as the prosecution of an OpenSea employee for the insider trading of NFTs, others have been met with fierce resistance from the crypto community.

Perhaps the biggest example of this is the Netherlands’ arrest of blockchain developer Alexey Pertsev, the creator of Tornado Cash. Tornado Cash is a “mixing” protocol designed to protect a user’s privacy. Consumers can deposit cryptocurrencies in the platform, get an “IOU”, and then redeem this IOU for a fresh set of tokens with different identification numbers.

While there are a dozen valid reasons for wanting privacy, Tornado Cash was unfortunately often used heavily by criminals and rogue regimes such as North Korea.

Despite this fact, most people in the crypto space agree that it’s unfair to punish someone for creating a an open-source piece of code – that would be like jailing Tim Cook because drug dealers tend to use iPhones.

Given the unclear state of regulation in crypto, the Biden administration issued an executive order in March calling on regulators to explore the risks and benefits of the technology. Researchers will focus on potential measures to protect consumers and the financial system, mitigate illicit activity, advance US leadership in the technology and promote safe and equitable access.

While the results of this report could greatly impact centralized systems such as Coinbase or Tether, it’s not clear how regulation would work for the broader ecosystem or if it’s even possible in the long-run.

After all, blockchains are decentralized systems -- that is, they’re run by thousands to tens of thousands of computers across the world – so there’s generally no central point authorities can use to enforce rules or shut them down.