Strategy & Operations » Financial Reporting » Will regulation threaten the growth of Bitcoin and cryptocurrencies?

Christian Kourtis of Gowling WLG explores how regulation and taxation could damage the popularity of existing digital currencies

It is safe to say that 2017 will be the biggest yet for Bitcoin and cryptocurrencies. The attention generated by Bitcoin’s sharp increase to above the $1,000 (£800) threshold earlier in the year has led to a renewed focus on Bitcoin and cryptocurrencies in general.

While the price of Bitcoin is interesting, it would be unwise to attach unwarranted significance to it. A currency in its infancy is likely to be volatile. However, when considered in the wider context, its price has consistently increased since 2014-2015 as its volume and market size has grown.

The draw to cryptocurrencies

In the face of wavering fiat currencies, cryptocurrencies have seen a surge in popularity – particularly in response to actions taken by governments that threaten the established, “normal” financial system. Taking the raid on Cypriot private bank accounts by the authorities as an example, Cypriots flocked to Bitcoin in response. A similar situation occurred in Spain in anticipation of comparable actions by their national government.

More recently, India’s decision to demonetise aspects of its currency caused a surge in the reliance on Bitcoin and other cryptocurrencies from across India.

The role Bitcoin and other cryptocurrencies have played during these recent examples of disorder in the traditional financial system provides a compelling narrative for their ongoing future role. However, that is not the whole story, and with greater adoption comes the spectre of regulation and taxation, which could impact their desirability.

Regulation and taxation

The rise of cryptocurrencies has not gone unnoticed by national governments and regulators with many actively looking at their regulations and taxation structures. While Bitcoin may be the test case, any other currency with hopes of being adopted as part of the mainstream, for example Ripple or Litecoin, should take note.

It appears that regulation of cryptocurrencies will start with the exchanges, as governments put up barriers to exchanging national currencies to either deter users or to make the cost onerous.

As an example, earlier in February, the price of Bitcoin and other cryptocurrencies dropped sharply following the announcement from China that two of its major exchanges had suspended Bitcoin and Litecoin withdrawals for one month. The claim made by the exchanges was that the suspension is to enhance security procedures in respect of their anti-money laundering capabilities and other legal risks.

Taxation is another aspect to consider. The Israeli authorities have considered applying capital gains tax to Bitcoin sales; treating them as intangible property rather than foreign currency. The same questions are being asked in each jurisdiction. At present, the UK Exchequer and the New York State Department of Taxation have opted not to make cryptocurrencies subject to sales tax. In contrast, Australia has considered applying such a tax to all digital currency purchases. This will be an important area to monitor as interest grows.

A final thought…

Attempts by national governments to constrict Bitcoin and other mainstream cryptocurrency growth must be approached with caution. Over regulation or taxation of the mainstream cryptocurrencies may see the benefits of these digital currencies stripped away, risking their abandonment by users in favour of newer cryptocurrencies that are truer to the original concept. In this way, cutting the head of this hydra may create more rather than fewer problems.

Christian Kourtis is an associate at the international law firm Gowling WLG.