How Governments Impact Cryptocurrencies
VYSYN Ventures Weekly Insights #59 - Inconsistency in regulatory frameworks exacerbate market conditions
Aggressive actions from major governments have contributed to some of the downside movements recently observed in the cryptocurrency market. Across the globe, governments are taking wildly varying dispositions towards cryptocurrency assets. For some nations, Bitcoin and cryptocurrencies have been strongly supported and even been adopted as a legal tender. Others outright outlaw the growing industry.
The varying responses are undoubtedly taking their toll on cryptocurrency market movements. For instance, the recent clampdown in China played a significant role in shaping the negative sentiment which saw Bitcoin decline over 50% from high-to-low.
In the latest VYSYN Release, we detail some of the varying responses from major governments around the world. We also analyze how these responses have impacted the cryptocurrency market and industry.
Why do governments vary in their response to cryptocurrencies?
Cryptocurrencies remain a nascent asset class and how governments treat this category of assets is still evolving. Governments have been taking various approaches to regulating the asset class and are finding different levels of success in the process.
In many asset classes, such as commodities and equities, there are homogenous or widely shared rules governing how the asset class is treated. Shared ideologies among regulatory bodies such as the Fed, the European Union, and the Bank of England serve to shape such shared rules. Moreover, transnational bodies such as the IMF, The World Bank, and OPEC further serve to align these rulesets.
However, when it comes to cryptocurrencies, we are still a long way from transnational bodies providing input on how the asset class should be treated. Moreover, the censorship resistant and permissionless nature of blockchain-native assets makes the assets more agnostic to the input of such bodies.
Given the above, we remain in a state of evolution with various governments taking different approaches to governing the asset class. For the remainder of the article, we consider the approaches of three major governments and how their regulatory actions have helped or hindered them.
El Salvador enters new territory by setting Bitcoin as legal tender
Salvadoran President Nayib Bukele has enthusiastically touted the country as a destination for cryptocurrency entrepreneurs. (Jose Cabezas/Reuters)
In June, El Salvador set the record of becoming the first-ever country to make Bitcoin a legal tender. After an original proposal by the country’s President Nayib Bukele, the nation’s Legislative Assembly passed it into law.
According to reports, adopting Bitcoin in this way is aimed at boosting the economy of El Salvador which has a considerable remittance level as a result of many of its citizens living abroad and often sending money home to their families. With most of the country’s population not having bank accounts, Bitcoin is expected to encourage financial inclusion as the nation aims to grow its economy.
Although this legislation has been passed by El Salvador, it has not come without its fair share of criticism. The World Bank has cited environmental and transparency issues as reasons why it will not help El Salvador in the implementation of the new system. Whether Bitcoin will be suitable for carrying out everyday payments is another challenge spotted by critics of this development.
Despite the criticism from the World Bank, President Bukele’s government has gone ahead to issue $30 each in cryptocurrency to citizens of El Salvador. This will serve as a motivation for them to sign up for the digital wallet. Bukele insists that the law, which will take full effect from September 2021, will help to attract investment into the country. He also notes that it will help in boosting consumption and cutting the cost of sending remittances.
India imposes opaque cryptocurrency guidelines
While El Salvador is taking an extremely supportive stance, India has been going in the opposite direction. A leading financial services institution in the country, ICCI Bank, recently warned customers against using their remittance service for crypto-related transactions. This recent move by ICCI sets the tone for an uncertain regulatory environment in India. In 2020, the Indian Supreme Court lifted a ban that restricted banks from servicing cryptocurrency firms.
Until the time of writing, this judgment has not been reversed, neither has there been any contrary judgment. As a result, many crypto users in the country are simply taking advantage of the inconsistency in the regulatory framework to carry on with their activities.
This unclear direction from Indian authorities is making major practitioners reluctant in settling in the region. For instance, the exodus of miners could have been an opportunity for India to become a major mining hub, but the uncertainty in terms of regulatory policies has seen many of the miners pass on the opportunity of settling in India.
China clampdown stifles vibrant economy
China has recently imposed heavy restrictions on its once dominant cryptocurrency industry. China previously held the greatest share of both Bitcoin-to-fiat trading volume and Bitcoin mining activity but has lost both as a result of its heavy-handed regulatory approach.
The Chinese government claims that the clampdown is in an attempt to sanitize its financial industry, ensure financial stability and get rid of bad actors that are capitalizing on the pseudo-anonymity of Bitcoin and other cryptocurrencies. However, many crypto users think otherwise. The dominant assumption is that China is trying to eliminate every possible competition for its soon-to-be-launched digital currency.
The recent crackdown by China catalyzed a mass exodus of Bitcoin miners from China in their droves. The latest data released by Cambridge Center for Alternative Finance (CCAF) estimates that China’s share of global hashrate declined from over 75% in September 2019 to 46% in April 2021. With the clampdown exacerbating since then, these figures are expected to be even lower in recent months.
Governments have major impact on cryptocurrency market and domestic industries
The approach that governments take to regulating their cryptocurrency industry can certainly have an impact on market conditions. There is evidence that the trend predominantly shapes market movements among cryptocurrencies, see here and here, but commentary and action from governmental authorities certainly play a role. The Chinese crackdown on Bitcoin mining and trading activities helped shape the negative sentiment surrounding market conditions.
The everyday cryptocurrency investor can do little to address this as such developments often come suddenly and unexpectedly. Sophisticated investors can ensure that they employ sufficient risk management to alleviate the impact of such developments. Hedging tools, diversification, and managing asset exposure are all techniques that can be considered to minimize the impact of unexpected developments on your overall portfolio.