The Path to Making the US the Crypto Capital of the Planet

The Evolution of Cryptocurrency Regulation in the US

The regulatory landscape for cryptocurrencies in the United States has been characterized by a complex interplay between encouraging responsible financial innovation and mitigating the risks associated with these digital assets. As the Biden administration works to develop a comprehensive regulatory framework, it finds itself caught between two extremes: unwilling to actively block cryptocurrency transactions for fear of restricting a growing industry, yet determined to police illegal cryptocurrency payments and their role in the cybercrime ecosystem.

In recent months, the U.S. government has taken steps to both support the development of cryptocurrencies and restrict their illegal uses. President Biden’s executive order pledged to promote “responsible financial innovation” while addressing the risks cryptocurrencies pose to consumers, investors, and the financial system’s stability and integrity. This order extended to all digital assets, including cryptocurrencies and non-fungible tokens (NFTs), with cryptocurrencies presenting the most significant security risks and potential economic benefits.

Recent Regulation

Over the past year, the U.S. government’s balance between encouraging entrepreneurial cryptocurrency ventures and discouraging criminal activities leveraging cryptocurrencies seems to have shifted. This shift is due to the volatility of virtual currencies and growing concerns about the types of crimes enabled by these currencies. The United States has shown an increased interest in developing domestic cryptocurrency policies that can have a global impact on overseas criminal enterprises, such as sanctioning cryptocurrency exchanges and individual wallets, and recovering cryptocurrency payments made to criminals.

While these measures are aimed at overseas criminal operations, making it more difficult for foreign actors to profit from international cybercrime, it remains to be seen whether they will be effective, enforceable, or scalable to address the full extent of the challenges posed by cryptocurrencies . However, they mark a significant step forward in the history of U.S. cryptocurrency regulation, demonstrating the government’s willingness to aggressively pursue criminal virtual currency enterprises and potentially enter the virtual currency space itself with a central bank digital currency (CBDC).

The Department of Justice

The Justice Department has also stepped up its efforts to combat cybercrime in court and seize virtual currencies allegedly obtained as part of criminal schemes. A notable success was the seizure of 63.7 bitcoins, roughly USD 2.30 million, of the USD 4.40 million ransom paid by Colonial Pipeline to hackers who penetrated the company’s system and crippled the fuel supply to the Eastern Seaboard. This seizure signaled the beginning of a period of more serious policing of cryptocurrency transactions, with the implication that similar seizures would occur in the future.

In February 2022, the Justice Department arrested Ilya Lichtenstein and Heather Morgan in New York for laundering roughly USD 4.50 billion in cryptocurrency stolen from the Bitfinex exchange in 2016, seizing more than USD 3.60 billion in stolen cryptocurrency. While the recovered sums likely remain a relatively small fraction of the overall pool of criminal cryptocurrency funds, the retrieval of the Bitfinex funds suggests that law enforcement may be successfully targeting some of the most significant or large-scale criminals with their investigations.

The Department of Treasury

The Treasury Department has also made efforts to make it harder for criminals to receive illicit profits by sanctioning virtual currency exchanges and blocking transactions with Russia-based exchanges like Suex, Chatex, and Garantex, as well as virtual currency mixer Blender.io. These sanctions aim to make it more difficult for online criminals to process transactions and receive payments from U.S. victims, but their effectiveness depends on the U.S. government’s ability to continually monitor which exchanges criminals rely on and update their blocklist. 

Alongside these more aggressive sanctions and policing efforts, the United States has called for the development of a central bank digital currency (CBDC). In the March 2022 executive order, President Biden emphasized the urgency of research and development efforts into the potential design and deployment options of a U.S. CBDC. However, the development of a U.S. CBDC is still at a relatively early stage, with the Federal Reserve encouraged to continue its ongoing research, experimentation, and evaluation.

Central Bank Digital Currencies (CBDC’s) 

CBDCs are intended to be centralized, issued, and, in some cases, directly managed by central banks rather than public, decentralized blockchains. They might compete more directly with stablecoins than other cryptocurrencies like Bitcoin that are not pegged to a reference asset. Ideally, CBDCs would offer some of the benefits of cryptocurrencies, such as fast transactions, innovation, and financial inclusion, while offsetting some of the risks, such as volatility, criminal activity, and energy-intensive mining.

However, the specifics of CBDC designs, such as their centralization, anonymity, traceability, and susceptibility to fraud, make it difficult to determine at this early stage who, if anyone, will want to use such state-backed virtual currencies and what benefits, if any, they will provide over existing forms of currency. There are also significant concerns around privacy and security linked to CBDCs, particularly the potential for central banks to implement CBDCs in a way that gives them insight into individuals’ spending decisions and payment history. 

As the rise of cryptocurrencies has demonstrated the difficulty of enforcing existing financial regulations in the context of new currencies and predicting how those currencies will be used and by whom, regulators would be wise to approach them cautiously and with an eye to the opportunities for abuse and illicit activity. It’s also a reason to be less confident about the types of benefits a CBDC will realistically be able to offer, especially since many of those could potentially be addressed through other, less radical changes to existing financial institutions and instruments.

Phases of Regulation

Ideally, cryptocurrency regulation would progress in two phases moving forward. The first phase would emphasize the importance of controlling the flow of cryptocurrencies to criminals by maintaining up-to-date lists of sanctioned intermediaries and providing U.S. individuals and companies with clear instructions for determining whether they are doing business with such foreign companies. Simultaneously, a large-scale analysis of whether these efforts are actually reducing illicit financial flows to criminal enterprises would be needed to understand the overall impact of these measures.

The measurement components of this first phase will inform the second phase. If these measurement efforts indicate that law enforcement has been successful in choking off illegal cryptocurrency flows, that will be a strong signal to the government to move forward with plans for a CBDC because the illegal uses of virtual currencies can be effectively controlled. However, if the first phase’s measurement efforts suggest little or no progress has been made toward stemming criminal uses of virtual currencies, that will be an indicator of how risky introducing new forms of those currencies could be. In that case, the U.S. government would be wise to focus on new avenues for enforcement before taking steps toward implementing a CBDC ahead of any understanding of how best to control theft, fraud, and extortion.