The cryptocurrency market grew from a $1.5 billion market capitalization in early 2013 to over $795 billion in January 2018.' Bitcoin, an exemplar cryptocurrency, gained value from $0.08 before 2010 to over $17,000 per bitcoin in December 2017. (2) While cryptocurrencies have campaigned for revolutionizing financial transactions, the crypto-market is plagued by nefarious minds, fleecing investors in frauds and Ponzi schemes. (3) This crypto-mania therefore presents numerous legal and regulatory challenges that demand prompt and efficient responses. Nevertheless, the decentralized, anonymous nature of cryptocurrencies magnifies these challenges and has constantly outpaced the law's ability to respond. To understand the effects of different regulatory strategies, this Note compares regulatory landscapes on cryptocurrency between the U.S. and China.
In a nutshell, while China explicitly banned any exchange or financing activities between fiat money and "coin substitution" in 2017, the U.S. has placed cryptocurrencies within its existing legal labyrinth. What explains the difference and what is its result? Rather than reducing the regulatory variances simply to differences in political ideologies, (4) this Note attempts to explain the reasons behind the two countries' drastically different regulatory approaches by understanding the regulators' institutional capacities and objectives. This Note also identifies the interesting impacts of the two countries' regulatory approach. Namely, China has attempted to substitute the crypto-market with state-led projects and even potential crypto-fiats, while the U.S. regulatory framework has maintained its consistency, but left some areas lawless while others potentially over-regulated.
Part I of this Note introduces the background of cryptocurrency and its technological strengths and weaknesses. Part II surveys the existing regulatory landscapes of the U.S. and China. Part III explains the reasons why the two countries take drastically different approaches in regulating cryptocurrency. Part IV lists comparative strengths and weaknesses between the two regulatory frameworks. Part V concludes and cautiously makes policy recommendations.
BACKGROUND OF CRYPTOCURRENCY AND CRYPTO-MANIA
Emergence of Cryptocurrency
Cryptocurrency is a form of digital or virtual currency that uses cryptography to secure and verify transactions. (5) Created in 2008, bitcoin is the world's first decentralized cryptocurrency. (6) The term bitcoin encompasses both the bitcoin virtual currency and the payment system, the latter operating as a peer-to-peer transactional network that does not rely on any central government authority or established financial institution. (7)
One of the purposes of the bitcoin payment system is to overcome the trust-based model of conventional online transactions, which relies on financial institutions to process payments. (8) Satoshi Nakamoto, an alias of the unknown inventor of bitcoin, argues that the existing model requires a heightened yet unnecessary need of trust, but also tolerates a certain level of fraud. (9) Additionally, third parties are often unable to avoid disputes on finality in each payment, increasing transaction costs. (10) In light of these problems, Nakamoto proposes a more effective system, technologically making payment reversal impossible and eliminating the need for third parties. (11)
To eliminate such a need, the bitcoin payment system develops two processes: mining and blockchain. (12) Mining is the process by which transactions are verified and added to a public ledger. (13) This public ledger, also known as a blockchain, chronologically records every transaction in the system and serves as the foundation of the bitcoin verification system. (14) Each blockchain is encrypted and logs information into smaller datasets referred to as "blocks." (15) Each block contains information about certain transactions, a reference to a preceding block, as well as a verification process that employs mathematical puzzles, also known as proof of work, to validate the information stored with the block. (16) A new block of data will be added to the end of the blockchain only after computers in the same network reach a consensus, (17) but incompatible blocks will be rejected. (18) Since every transaction is encrypted and verified, blockchain technologically makes transaction reversal impossible and third-party verification unnecessary. (19)
The decentralized nature of bitcoin blockchain allows volunteers and engineers (often referred to as the blockchain ecosystem) to modify the blockchain network through "informal processes that depend on rough notions of consensus and that are subject to no fixed legal or organizational structure." (20)
Meanwhile, bitcoin also functions as a virtual currency, serving as a "medium of exchange existing entirely in intangible form that is not legal tender, but which can substitute for legal tender." (21) It is an "internet-based virtual currency in which the ownership of a particular unit of value is validated using cryptography." (22) Mining functions both as a transaction system and the means through which bitcoin is released. (23) The process essentially involves resolving complex mathematical puzzles and intense coding, which create additional blocks in the blockchain to facilitate further transaction. (24) Bitcoin's value as a virtual currency derives precisely from the creation of this alternative yet useful form of money. (25) Upon the initial "release" of bitcoin, "miners" were incentivized to solve the mathematical puzzles by rewarding them a certain amount of bitcoins. (26) The cap was set at 21 million bitcoins. (27)
Inspired by the bitcoin-blockchain technology, over 1,900 other cryptocurrencies or crypto-based tokens have emerged with different functions. (28) For instance, Efhereum issued its cryptocurrency, ether, to operate a decentralized software platform and offer developers smart contracts to issue their own tokens. (29) Ripple issued XRP to facilitate exchanges among cryptocurrencies and fiat money. (30) However, unlike bitcoin or Ethereum, the Ripple network is not decentralized. Rather than open the network to the public, it runs a permissioned blockchain network that predetermines its transaction validators. (31)
Crypto-based tokens, in contrast, usually represent ownership of an asset, and by employing existing blockchain technology and smart contracts (often powered by the ERC standardized smart contract based on the Ethereum network), (32) a company might forgo a traditional initial public offering ("IPO"), and instead issue shares and voting rights over the blockchain through initial coin offerings ("ICOs"). (33) Rather than providing ownership interest, other ICO projects issue the so-called utility tokens or app coins, providing users with future access to the blockchain product or service, usually at a fraction of the finished product's sticker price. (34) As the crypto-mania has spread worldwide, capital raised through ICOs increased from approximately $95 million in 2016 to over $3.8 billion in 2017, and continued to escalate to over $18 billion until September 2018. (35)
Technological Strengths and Weaknesses of Cryptocurrency
As a Payment Platform
Because no intermediary is involved, cryptocurrency transactions are theoretically cheaper and faster than traditional payment networks. At least theoretically, the elimination of third-party intermediaries allows small businesses to gain access to capital, protect individuals against capital control and censorship, and encourage innovation. (36) For instance, cryptocurrency can eliminate a variety of authorization fees, transactions, and customer service fees that have burdened small businesses under the current credit card system. (37) Cryptocurrency also facilitates cross-border transactions. (38) In 2014, immigrants in developed countries sent at least $427 billion in remittances back to relatives living in developing countries. (39) While the global average fee for sending remittances was 7.37%, bitcoin payment system charges only 0.005 bitcoin or 1% of the transaction. (40)
On the other hand, the decentralized nature of the cryptocurrency payment system presents opportunities for crime and fraud. (41) The pseudonymous nature of cryptocurrency can be abused for money laundering and transactions of illicit goods and services. (42) Although substantive evidence is lacking, the anonymity of cryptocurrency transactions "allows" criminals to discreetly move ill-gotten money. (43) Additionally, online black markets such as the infamous Deep Web and Silk Road have already taken advantage of the pseudonymous nature of bitcoin, where buyers can use bitcoin to purchase illicit drugs online in the same way that cash has been traditionally used for illicit purchases in person. (44)
In China, the explosion of cryptocurrency trading was accompanied by fraud, theft, and scams. (45) Around the same time as the police shutdown of Silk Road, Global Bond Limited, a Chinese bitcoin trading platform, suddenly closed its transaction platform, vanishing with about $5 million worth of bitcoin. (46) Due to the decentralized nature of the transaction platform, Chinese law enforcement was often confused about what exactly was "stolen." (47)
As a Virtual Currency
As a virtual currency, cryptocurrency offers a functional alternative to state-issued fiat money. (48) Cryptocurrencies, especially bitcoin, can allegedly provide the most value to failing monetary regimes where residents are losing confidence in the value of their central bank. (49) Unlike state issued currencies, cryptocurrency appears to have "no political master to serve." (50) Transactional cryptocurrency allows citizens to have an option of exchange in countries where domestic currency only derives its value from its redeemability at a fixed rate for U.S. dollars. (51) For...