There are no laws in the world of cryptocurrency. Though authorities around the world have expressed the need to bring cryptocurrency within the regulatory perimeter, fundamental challenges exist. Can something freewheeling, borderless, ever-evolving and unbeholden to any government or agency for its existence actually be regulated?

There is another and more fundamental challenge. Cryptocurrency is basically a collection of binary data. However, we have been conditioned to believe that money must be tangible, backed by something tangible or by the guarantee of a government or a Central bank. To accept an intangible computer code as money is a paradigm shift in our belief systems.

An encrypted, decentralised digital money, cryptocurrency is not legal tender – except in El Salvador. But it makes it possible to transfer funds around the world in a relatively anonymous way, through the use of a technology called blockchain, a “distributed database that is shared among the nodes of a computer network”.

As a consequence, enhanced regulatory and law enforcement frameworks in individual countries will not work unless complimented by such a global framework.

In India, the government planned to introduce the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, during the winter session of Parliament but did not do so before the session ended on December 22. The Reserve Bank of India, which had proposed to launch its own digital currency, has announced its postponement for six months.

Here are ten fundamental challenges in regulating cryptocurrency.

1. How to develop a regulatory framework for an intangible entity?

The common investment instruments in stock markets and banking systems are tangible products and some have a sovereign backing. But crypto-assets are not backed in the real world by assets or commodities. Till now, regulatory frameworks have not been crafted for anything purely intangible. As a consequence, no models exist for such a framework.

2. How does the market function?

No one seems to understand how exactly the crypto market operates. What are the forces behind it, apart from demand and supply for the cryptocurrency alone? For example, Bitcoin, the most popular type of cryptocurrency, is inherently volatile. Are shocks to speculators’ beliefs the only drivers for price volatility and the cause of excitement for investors? How can a regulatory framework be developed for a market whose working basis is foggy?

3. A market without governance

The structure of the Bitcoin market at present is decidedly concentrated, open to price manipulation and militates against investor protection. By definition, there cannot be any governance in such a decentralised, opaque market. Besides, on whom will the regulations be enforced?

Common investment instruments in stock markets and banking systems are tangible products and some have a sovereign backing. But crypto-assets are not backed in the real world by assets or commodities. | Francis Mascarenhas/Reuters

4. Regulating pure speculation

Bitcoin peaked above $67,000 in early November. By December 15, it was valued at roughly $48,324. Are Bitcoin and other cryptocurrencies actually speculative assets? How can such speculation be regulated?

5. Possibility of system breakdown and all data being lost forever

The cryptocurrency market is always vulnerable to attacks. The sudden breakdown of the market cannot be ruled out. If that happens and all the electronic records in the distributed blockchain ledger simply evaporate, recovery mechanisms may not work. Besides, who would implement them?

6. Lack of clarity on the basic nature of cryptocurrency

Is cryptocurrency an asset, a commodity, a security or a currency? Various jurisdictions define and classify these differently.

7. Who will regulate?

Given that cryptocurrency isn’t issued by a government or Central bank but is mined by individuals around the world, it isn’t clear who exactly would have the authority to regulate it.

8. Absence of risk management systems and governance of exchanges

Unlike securities markets that have a range of entities between buyer and seller, there are no intermediaries in the cryptocurrency market. The cryptocurrency exchanges function as trading platforms for order routing and trade matching. This potentially exposes investors to scams and frauds.

9. Difficulties in assessing tax liability

Globally assessing tax liability for cryptocurrencies is difficult. A sophisticated software for this is yet to be developed.

10. Prohibiting vs regulating vs banning

Will prohibiting cryptocurrency actually drive cryptocurrency underground, where it will operate without controls on money laundering or regulations to combat financial terrorism? Or is this reasoning just being used a pretext, to argue against a ban? If cryptocurrency really is unregulatable, why shouldn’t prohibition be complemented by an intense awareness campaign about the problems inherent in cryptocurrency?

Through history, there have been examples such as the Tulipomania, the South Sea Bubble or the Mississippi Mania, when millions of people became impressed with one delusion and chased after it. Is cryptocurrency such a phenomenon? For the moment there are believers and sceptics – the latter in greater numbers.

Pratip Kar was with the Securities and Exchange Board of India from its inception. He was the organisation’s Executive Director for 14 years from 1992.