In the same way that the automobile was a big unknown in the days of horse-drawn carriages, cryptocurrencies are unknown in today's world of cash, gold, and credit cards. But it would be a grave mistake for government regulators to overreach and delay this innovation from reaching its potential.
Bitcoin BTCUSD, +5.12% prices tumbled last week after reports that South Korea would ban cryptocurrency trading - a threat that has since been calmed. But this trading scare underscores regulators' reasonable concerns about cryptocurrencies. How do you report and audit taxes? There is potential for outright fraud. Uninformed investors may unwisely invest their life savings into currencies that will become worthless. Security breaches in the exchanges could lead to massive thefts of wealth from investors. Perhaps most disturbingly, there is a legitimate concern that criminals and terrorist groups are using anonymized exchanges to move capital.
Lawmakers are justified in wanting to bring order to this madness to protect their citizens (and their tax base). The innovators in this space also want some clarifications from the regulatory community that will provide certainty and enable institutional investors to comfortably deploy their capital.
So there is a need for a baseline regulatory framework, as well as oversight, that legitimizes crypto-assets. This framework should outline principles for market participants to follow, and to begin to craft a strategy for tax treatment, but should avoid placing onerous filing or licensing burdens on the participants, thus allowing the market to evolve.
Read: Here's how the U.S. and the world regulate bitcoin and other cryptocurrencies
Also: Why bitcoin is worth exactly $0 (and blockchain might be very valuable)
Laws like those in New York, requiring a BitLicense for cryptocurrency activity with a large legal, compliance and filing cost, are a mistake and will only protect incumbents and drive innovation away. The Securities and Exchange Commission (SEC) ruling that the cryptocurrencies issued by Initial Coin Offerings are securities and need to be registered will drive these issuances overseas (probably to Japan and Singapore with their supportive regulatory regime) and the U.S. innovators and investors may not be able to participate.
Regulators would do well to get extensive feedback from sophisticated investors and innovators who understand crytocurrencies and their possible uses, as these sorts of developments are as unknown and incapable of being understood by policymakers today as the automobile was at the turn of the 20th Century. Specifically, we are attempting to regulate a decentralized network of trust that has never existed before, and must resist impulses to treat it like a centralized network, where if the intermediary (e.g. bank) is protected, the system remains safe. In this crypto-world, with no central intermediary, it will be only possible to understand how to properly regulate once the industry matures a bit and has found a purpose in the economy.
It would be an irrevocable mistake to wave a red flag in front of the next potential Google orFacebookThere are lessons from the rapid acceptance of the internet when considering legislating the cryptocurrencies. The permission-less innovation with respect to the internet was one of the keys to its success. Imagine how much progress would have been delayed - or crippled - if web developers had been forced to acquire a license to set up each new site. Security issues and other sinister uses of the web were not a deterrent to its use, but a business opportunity to encourage the market to develop products to protect privacy and tackle fraud.
In a short time, people have gone from reluctance to share credit-card information on the web to depositing checks with a smartphone. Anti-spam laws arrived well-after the spam filters had already been created. For cryptocurrencies to reach their full potential most rapidly, a permissive regulatory regime is advisable to allow the market itself to develop solutions to some of the technology's most pernicious elements. It would be an irrevocable mistake to wave a red flag in front of the next potential Google GOOGL, +0.00% or Facebook FB, -0.55% .
Atulya Sarin is a professor of finance at Santa Clara University. He has written on currencies in his book "Foundations of Multinational Financial Management" (sixth edition) and has worked extensively as a valuation expert.