Understanding three challenges that make cryptocurrency regulation difficult for nation states

The regulation of cryptocurrencies remains a headache for nations and there seems to be no easy way around this difficulty. Many say that innovation trumps regulation. While this is true, building a bridge between innovators and regulators is necessary for investor confidence. This article will look at three aspects that make crypto regulation difficult in Africa.

Decentralization

Decentralization is central to the nature of cryptocurrencies. This is the principle of blockchain technology, which provides security, freedom from censorship and privacy to crypto users. On the other hand, the technology also has some drawbacks, such as the inability for people to undo bad transactions and the permanent loss of funds if private keys are forgotten. As the advantages outweigh the disadvantages, decentralization of cryptocurrencies has been preferred, also to give people an alternative to centralized financial services.

Decentralization has existed in other ways before cryptocurrencies. Anticipating its impact on money, however, is new for regulators. Centralized authorities such as central banks are structured to monitor monetary policy and flows in a country. Cryptocurrencies, on the other hand, have no central authority, jurisdiction, or uniform policy. How can a single government monitor all decentralized cryptocurrencies?

Considering the costs of implementing regulatory requirements, it is easier to understand the potential costs of cryptocurrency regulation. This is how various countries end up banning the use of cryptocurrency. The bans are also the result of several scams that undermine investor confidence. Regulators try to act in the best interest of their citizens because protecting investors and capital is a key objective for them.

The rules today may not have existed decades ago; numerous collaborations have made it possible to set up functional frameworks for companies and regulators. That same collaborative effort is what will make crypto’s complexity easier for regulators to navigate.

Diversity of protocols and management

Different cryptocurrencies have different rules, protocols and governance systems. Bitcoin
BTC
, for example, has the Bitcoin Foundation, which consists of investors and developers who make decisions about the protocol. Some cryptocurrencies have no apparent formal leadership and their founders choose to remain anonymous. Others have fully trained companies, boards and staff. Based on principles such as “code is law”, some companies adopt flat structures, eliminating hierarchy altogether.

Contrast this with centralized structures where responsibility is clear. It is easier to meet established regulatory requirements such as compliance and reporting. How do crypto companies comply with financial reporting? Who is responsible for financial losses in a bear market? Who tracks suspicious or fraudulent activity? Where can they report these activities? The introduction of decentralized governance in the financial sector has therefore been complex considering some of these aspects.

Differences in protocols and governance mechanisms have fundamental principles about them. Appreciating these basics will be a good starting point to better understand crypto governance.

Jurisdictional diversity

Many crypto companies are moving to countries with favorable regulations. A ban in one country encourages a move to another so business can continue for companies willing to expand into the crypto industry. There is an ironic existence of the need to enable regulation, but cryptocurrencies were by design never intended to be formally regulated. Cryptocurrencies were designed for peer-to-peer use, ideally valued and used by individuals.

Perhaps if people individually understood the uses and risks of cryptocurrencies, it would reduce the need for regulation. However, many people have yet to understand how cryptography works. Others do not see the need to use it at all. The value of cryptocurrencies is very subjective at this point. These aspects are at the forefront of regulators’ minds. Why should they devote resources to something that barely a third of their citizens use on a daily basis?

The precedent set by El Salvador in 2021 and the Central African Republic in 2022 to accept Bitcoin as legal tender has yet to prove its significant value for other countries to follow suit. It is also still too early to tell what effect making bitcoin legal tender will have when it is designed as a peer-to-peer payment system. What needs to be appreciated is that people, companies and regulators are having ongoing discussions about the potential value and impact of crypto in their countries. It is perfectly acceptable for a country at this point not to have all the answers on how to regulate this dynamic industry. What would be worrying would be to sweep the problems under the proverbial rug.

Future prospects

One way to bridge the gap between crypto governance and regulation is to create forums for regulators to collaborate with crypto industry players. It will build on the strength of the relationship between regulators and industry players. Therefore, short courses, sandboxes and small wins are three points of progress for this complex area. A better understanding of the potential of these tools and of this dynamic ecosystem is essential. That it is currently difficult does not always mean that it will be impossible to regulate. Patience with the process will yield good results for years to come.

Disclosure: I have bitcoins and other cryptocurrencies.

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