Crypto regulation is coming. Which tokens may be affected?

Several crypto projects may be subject to enforcement under recently proposed regulatory guidelines.

The US is moving towards crypto regulation

The US government is tackling regulation of digital assets.

In recent months, comments from key members of the Biden administration, enforcement by regulators and several reports have shed light on how the US government intends to regulate cryptocurrencies. Treasury Secretary Janet Yellen has been particularly vocal in calling for digital asset regulation, particularly regarding dollar-pegged assets. Following the collapse of the TerraUSD stablecoin in May, Yellen and several members of Congress committed to drafting a comprehensive stablecoin regulatory framework to protect US investors. A draft of a new bill regulating stablecoins released last week includes a two-year moratorium on “endogenously secured stable coins” and would potentially require all non-bank stablecoin issuers to register with the Federal Reserve.

The Securities and Exchange Commission and the Commodities and Futures Trading Commission have also recently stepped up their crypto enforcement efforts. In July, the SEC accused crypto exchange Coinbase of listing “at least nine” tokens that it believes should be classified as securities. The regulator has also revealed that it is conducting investigations into all US-based crypto exchanges after chairman Gary Gensler indicated he believed several platforms violated securities laws by trading against their own clients. The CFTC, usually seen as more lenient on crypto regulation than the SEC, has also sparked concern among crypto users in recent days after it filed an initial case against the decentralized autonomous organization Ooki DAO for allegedly operating an illegal derivatives trading platform.

However, the bulk of information about possible crypto enforcement came from the White House’s first crypto regulatory framework released earlier this month. The document described how several government agencies would seek to monitor the growth of digital assets and focus on goals ranging from promoting access to financial services to combating financial crime.

With so much documentation being prepared and released, it is becoming increasingly difficult to understand how it will all interact with the current crypto landscape. Crypto Briefing takes a look at three cryptocurrencies that could be subject to regulation under recently released legislation.

Tornado Cash (TORN)

After the Ministry of Finance sanctioned Tornado Cash, the privacy protocol‘s TORN token may be the most obvious crypto asset to face regulatory scrutiny in the future.

August 8, Treasury’s Office of Foreign Assets Control announced that it had sanctioned protocol because it had “failed to implement effective controls” to prevent cybercrime-related money laundering.

Tornado Cash allows users to deposit ETH or USDC from one Ethereum address and withdraw it to another, breaking the line of traceability typically found on open ledger blockchains. While many crypto-natives have used the protocol for legitimate purposes such as maintaining financial privacy, it has also become a popular avenue for cybercriminals looking to launder stolen digital assets.

The Biden administration’s crypto regulatory framework has made it clear that it intends to combat all forms of crypto-related crime. The report points to the use of digital assets by the likes of the Lazarus Group – a North Korean state-backed syndicate responsible for several major crypto hacks in the past year. With such a harsh response against criminal groups, any protocol that helps them launder their ill-gotten gains will be a prime target for further enforcement.

Although the US has sanctioned Tornado Cash’s code, criminalizing any interaction with the protocol in the US, there is little the authorities can do for now to enforce the ban. Nevertheless, many other DeFi protocols looking to serve US users have proactively complied with the sanctions, blocking addresses that have interacted with Tornado Cash from using their services.

In response to the enforcement action against Tornado Cash, TORN lost significant value, falling from a local high of $30.43 to $5.70 today. Since the developers of the protocol have shown little interest in modifying Tornado Cash to help it comply with anti-money laundering regulations, it is unlikely that future US crypto regulations will do anything but harm it and its token going forward.

MakerDAO (MKR and DAI)

Although the Maker protocol and its over-collateralized DAI stablecoin have not yet been involved in any US crypto regulation, users expect it to happen in the not-too-distant future.

MakerDAO co-founder Rune Christensen recently posted an “Endgame Plan” to the DAO’s board forum, outlining how the protocol can position itself to cope with future crypto-regulation. In his proposal, Christensen suggested lending DAI against real-world assets and using the interest to buy ETH on the open market. The degree to which MakerDAO succeeds in accumulating ETH over the next three years will determine whether it should consider allowing DAI to drift from its dollar peg to become a free-floating asset.

Christensen believes MakerDAO is likely to draw attention from US regulators because it is issuing a dollar-pegged stablecoin. When this happens, the Maker Protocol would not be able to comply with anti-money laundering sanctions similar to those issued against Tornado Cash even if it wanted to. In Christensen’s eyes, a better long-term option would be to allow DAI to drift from its dollar peg and become a free-floating asset, reducing the regulatory burden placed on the protocol.

For now, it seems unlikely that MakerDAO will need to implement such plans. A recently released draft of a House Stablecoin Bill produced under Yellen’s leadership suggests a more conservative approach to stablecoin regulation. In the proposed draft, only Terra-like stablecoins that are exclusively secured by tokens from the same issuer will face enforcement. However, the draft also requires all non-bank stablecoin issuers to register with the Federal Reserve to continue serving US users. Since the details of such legislation have yet to be defined, it is unclear whether this requirement will mean that MakerDAO is unable to comply.

If MakerDAO is unable to register as a non-bank stablecoin issuer in the US, it will likely affect the value of the protocol’s MKR governance token. DAI could potentially become a restricted asset in the states, and OFAC could even sanction Maker Protocol smart contracts like it did with Tornado Cash. While this situation currently seems unlikely, MakerDAO’s regulatory risk is still worth noting.

Monero (XMR)

Last on our list is not an Ethereum protocol like Tornado Cash or Maker, but an entire blockchain – Monero.

Launched way back in 2014, Monero is arguably the most successful privacy-focused blockchain seeing active use and development today. Unlike Bitcoin or Ethereum, which broadcast all transactions and wallet balances on a public ledger, Monero’s transactions are completely private. The network uses several privacy-preserving features such as call signatures, zero-knowledge proofs, stealth addresses, and methods to hide IP addresses to ensure privacy and anonymity for all users.

Like Tornado Cash, Monero’s ability to obscure the ownership and origin of coins has drawn the ire of regulators in the United States. In 2020, the Internal Revenue Service began offering a cash reward of $625,000 to anyone who could crack Monero’s privacy and reveal its users’ transactions. However, that bounty has never been claimed, demonstrating the strength of Monero’s privacy technology.

Still, Monero’s resilience is a double-edged sword. While that may make using the network more attractive to those who want to preserve their financial privacy, it also makes it a potential target for further regulation and enforcement. Like Tornado Cash, cybercriminals use Monero for a variety of illegal activities. For example, cybersecurity firm Avast has previously identified malware that uses a victim’s computer to mine Monero and send the profits back to the virus’s creator.

While Monero is a prime candidate for enforcement even under current regulations, no action has been taken against it. Authorities have likely focused their efforts on protocols that facilitate a higher volume of illegal transactions (such as Tornado Cash) instead. But if the crypto space—and Monero—continues to grow, it’s likely only a matter of time before OFAC declines additional sanctions against privacy protocols.

As has been the case with Tornado Cash and TORN, any kind of enforcement against Monero will almost certainly affect XMR. All US-based crypto exchanges already refuse to accept Monero deposits or open spot markets for XMR, as they cannot confirm whether the tokens have been acquired through illegal activities. Further regulation, both from the US and abroad, would likely limit access to the blockchain or make it illegal to send transactions through it – and that would be bad news for XMR.

The Future of US Crypto Regulation

While Tornado Cash, MakerDAO and Monero are among the crypto projects most likely to be implicated by future regulations, many other tokens could also be affected. At least in the United States, it is likely that any protocol that facilitates the trading of valuable cryptoassets will have to comply with some form of anti-money laundering regulation in the future.

In addition, those issuing their own dollar-pegged stablecoins will likely face additional regulation, both due to the perceived safety of the dollar as a national currency and the growing pile of failed stablecoin projects that have cost US investors billions of dollars. Whether such regulation will harm crypto adoption or facilitate its adoption by the mainstream remains to be seen. While some recent cases from the SEC and CFTC seem to take a hardline approach against crypto, others like the House Stablecoin Bill are relatively lenient.

Whether those in the room like it or not, crypto regulation is coming. And those who are aware of and understand the possible effects will be better positioned for the changes than those who stick their heads in the sand.

Disclosure: At the time of writing this piece, the author owned ETH, BTC and several other cryptocurrencies.