Like it or not, the future of cryptocurrency will be determined by bureaucrats

Denizens of the cryptocurrency world ought to get used to rubbing shoulders with regulators. The dark underbelly of the bonanza in  initial coin offerings, rising concerns about the security of cryptocurrency exchanges, and a rush of “Main Street” investors to the scene have helped convince bureaucrats across the globe that cryptocurrency markets deserve a lot more attention. As a US Senate hearing illustrated this week, however, the question of how best to apply that attention is head-achingly complicated.

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Why you should care: The stakes are high, and not just because billions of real dollars are on the line. Many think the blockchain technology underlying cryptocurrencies can be as disruptive as the foundation of the internet. Decisions by policymakers will influence whether and how the promise unfolds.

Crackdowns have commenced:

• China has banned ICOs and cryptocurrency trading, and may clamp down on mining.
• South Korea has banned ICOs and anonymous trading.
• Japan has introduced a licensing regime for cryptocurrency exchanges.

 Gaps: Regulators are still wrestling with how to define cryptocurrency, which is partly why there are still big holes in oversight.

In the US, for instance, cryptocurrencies are classified as commodities, which makes them the purview of the Commodity Futures Trading Commission. But the agency lacks the authority to directly oversee cryptocurrency exchanges, J. Christopher Giancarlo, CFTC’s chair, told the Senate committee (pdf) at this week’s hearing. It can’t make them do things like register with the government, report transactions, or comply with cybersecurity checks—in fact, under current law no federal agency has such authority, Giancarlo said.

Last line of defense: With the feds’ hands tied, state-level regulators are left picking up the slack—even though they traditionally spend their time policing things like check-cashing and other so-called money transmission services. This isn’t working, for at least two reasons. First, cryptocurrency exchanges “provide a networked good that inherently crosses state lines,” argues Peter Van Valkenburgh, director of research at Coin Center, a blockchain policy think tank. Second, the definition of “money transmission” varies by state. The morass of confusion and uncertainty, combined with stiff penalties for running afoul of the law, is discouraging technologists and entrepreneurs, according to Van Valkenburgh.

The ICO conundrum: Initial coin offerings, in which—poof!—a new digital currency pops into existence, are especially concerning to securities regulators. Simply calling something a “currency” doesn’t keep it outside of the jurisdiction of the US Securities and Exchange Commission, SEC chair Jay Clayton told the Senate committee (pdf). Many ICO tokens look like securities, he said, since they are “promoted as investment opportunities that rely on the efforts of others, with their utility as an efficient medium for commercial exchange being a distinct and secondary characteristic.” That horse has left the barn, though: ICOs have raised more than $4 billion, and according to Clayton none have yet registered with SEC.

The bottom line: Regulating cryptocurrency markets is a high-stakes, complicated, fast-moving work in progress. Stay tuned for new developments, including:

• More from the SEC: Expect the commission to keep ramping up enforcement against dubious ICOs.
• Congress’s response: Clayton and Giancarlo agreed that a new regulatory framework is needed, which may require new legislation. Good luck with that.
• Action in the states: Regulators from seven US states recently agreed to join forces in regulating exchanges.
• A push for global rules: France and Germany will propose international regulations at the G20 summit in March.