Is it okay to regulate cryptocurrencies now?

At her confirmation hearing, Treasury Secretary Janet Yellen said many cryptocurrencies are used “mainly for illicit financing, and I think we really need to examine ways in which we can curtail their use.” Although her written testimony says the government also needs to “look closely at how to encourage their use for legitimate activities,” it seems clear: More regulation of cryptocurrencies is on
the way.
There are already proposed regulations, now possibly being reconsidered, to require much greater reporting and monitoring of transfers from private crypto “wallets.” If more comprehensive rules are in the works, what would they look like?
Many aspects of crypto are difficult to regulate. Governments cannot easily control the contents of blockchains, which are abstract ledgers. Furthermore, crypto markets are international and do not rely on the financial endorsement or facilities of the US; indeed, that is one reason for their existence.
Still, a relatively pro-regulation administration could do much more to try to control crypto. For one thing, it could use regulation to bring crypto exchanges into the banking system.
In September 2020, Kraken, one of the leading crypto exchanges, obtained a banking license from the state of Wyoming, thereby giving it access to the federal payments infrastructure. Part of the deal is that Kraken has to hold 100% reserves for its crypto assets, in essence treating them as a parking garage is supposed to manage cars. It is easy to imagine federal regulators forcing crypto exchanges into the banking system on a larger scale, and perhaps banks buying up or merging with crypto houses, again with stringent reserve requirements.
It is unclear what such regulation would accomplish. Crypto exchanges would become more bureaucratic and less innovative, as they would have a greater stake in the financial status quo. Non-
US-based crypto exchanges, and anonymised systems, could still be used to transfer funds secretly or
illegally. Still, banks are something the federal government has a lot
of experience regulating, and US regulators would achieve a certain illusion of control.
Other possible regulations could make it harder to create new transactional systems on top of current crypto assets, such as Ether. For
instance, the Ethereum platform underpins a growing series of
prediction markets, such as
Augur. These systems represent works in progress, but the ultimate goal is to have rapid, low-transaction-cost trades, executed through blockchains. Imagine, for instance,
a system for consummating
micropayments for products in
virtual reality.
Currently in the works is the construction of Ethereum 2.0, designed to lower transaction costs for such ventures. Attempts to regulate these platforms could impose stringent reporting requirements, create
capital requirements, cap their growth or force them to find a place within the structures of currently regulated mainstream entities, including banks. But those new
costs would probably stop their growth altogether, as these are hardly proven successes.
A more general principle is that the platforms easiest to regulate also tend to be the most legitimate and the least likely to engage in or encourage wrongdoing. Again, the net effect will be to make crypto, at the global level, harder to monitor and control. The better strategy would be to encourage the ascendancy of American-based crypto firms, and slowly allow them to evolve into a more traditional part of financial markets.
There is a plausible argument that, eventually, crypto exchanges should be regulated as financial clearinghouses. But the crypto platforms are currently small and are not sources of systemic macroeconomic risk. It remains to be seen how they ought to evolve or which functions they ought to serve, or indeed if they will succeed at all.
—Bloomberg