While cryptocurrencies are becoming a more practical alternative means of transacting and storing value, regulators remain perplexed over how to align its trade to global best practice.
Regulating cryptocurrency: Bit by Bit
Under the pseudonym Satoshi Nakomoto, the originator(s) of cryptocurrency conceptualised the block chain to facilitate the movement and ownership of assets away from centralised financial structures. The point was decentralisation with the clearing and controlling of transactions happening in many different places at the same time (Box 1: The Blockchain). This makes it almost impossible for legislators to exercise direct control over the system. So far, central banks have managed to apply regulation to cryptocurrency exchanges so trading is regulated, but the transactional world remains unfettered.
A Bit of change
Cryptocurrency, specifically the flagship currency Bitcoin, has grown in popularity over the past decade and has received special attention this year with the price of one Bitcoin jumping from $952 to over $10 000 at the end of November. Seasoned financial professionals and first-time investors have been equally excited, and identically confused over the rise of Bitcoin. While transacting has not picked up meaningfully over the last decade, the currency’s investability and profile as a store of value has substantially increased. Specialist exchanges have popped up in almost every major city in the world and even passive product houses are getting involved with several exchange-traded notes (ETNs) and exchange-traded funds (ETFs) available for purchase.
Cryptocurrencies are decentralised and virtual, and were developed for anonymous payments made entirely independent of governments and banks. It is different to traditional ‘fiat’ currencies in that it has been specifically created as a reward for maintaining a specific ecosystem. In the case of Bitcoin, it rewards the maintenance of the blockchain*. The method of payment for maintaining the blockchain is called ‘mining’. The blockchain is a decentralised payment system.
Box 1: What is the blockchain?
The Bitcoin blockchain is an immutable, public, distributed ledger:
• Immutable: Once a record has been in the blockchain for a couple hours, changing or erasing it of it by then.
• Public: Anyone, not just a bank employee, can look at the blockchain.
• Distributed: Synchronized copies of the blockchain are held by computers all over the world. There is no undisputed master copy; all copies are created equal.
• Ledger: The blockchain is a list of transactions.
Source: Tess Rinearson for Medium
Some of the benefits of cryptocurrencies are improved protection from transaction fraud, lower chances of identity theft, lower fees, unrestricted use and the easy, instantaneous accessibility of funds, and a large degree of anonymity. But there are serious risks attached to cryptocurrencies as well.
A Bit of conflict
Central banks and regulators basically have contention with the very core of what cryptocurrencies are because their positive attributes indirectly enable the adverse use of the very same technology. Some of the risks of a continued unregulated cryptocurrency generation include:
• Funding of terrorism initiatives;
• Illegal soliciting of money through ransomware;
• Funding of unlawful schemes, businesses and institutions;
• Money laundering; and
• Fraudulent transactions untraceable to individual “real” identities.
Despite the noteworthy attributes, one cannot ignore the pressing reality of opportunistic and ill-intentioned individuals using cryptocurrencies in illegal activity. Consequently, a degree of regulation seems fitting.
A Bit of control
Technically, cryptocurrency technology is regulated. It is a self-regulated system where miners are incentivised to assume the primary functions of a central bank. The argument for further regulation, therefore, lies herein: cryptocurrency, as it now exists, has no statutory liability against which a claim can be made or a trial can be held within any given country. One may argue that the judicial regulation of cryptocurrency is necessary for security reasons – both nationally and globally.
However, since cryptocurrency is not issued by any central bank, none can claim the role of regulator. Central banks can only push for legislations, bills and laws which regulate domicile companies, platforms and other entities that operate within the cryptocurrency ecosystem.
For example, on amendment of the Bank Act and the Payment Services Act in Japan, local regulators have announced an intention to fully monitor, to the extent of physically inspecting, the security practices of virtual currency exchanges within the region. In the United States, New York is the only state with an official ruling on Bitcoin and other DVCs by implication. All domiciled legal entities are subject to compliance with BitLicense standards, a virtual currency business license applicable to all local transactions. Moreover, the Mexican government is well into developing a framework for the regulation of digital currency participants under the FinTech law. In Australia, regulators seek to encourage technological advancement and the Australian Securities and Investments Commission (ASIC) only provides regulatory guidance for the initial public offering (ICO) issuers and operators. An ICO is a form of capital raise like an initial public offering (IPO) in the equity market. Other countries establishing or at least making explicit intent to regulate virtual currency exchanges include the United Kingdom, Europe, India, and countries in Southeast Asia.
Although various countries have promoted and for now still permit the use of Bitcoin, other regions (Bangladesh, Bolivia, Ecuador and Kyrgyzstan) have declared an outright ban of the currencies and the exchange platforms thereof. In November 2013, the People’s Bank of China proclaimed that Bitcoin would never be endorsed as legitimate currency in China. A position that would later, in 2017, be backed by a shutdown of cryptocurrency exchanges and ICOs in the country.
From our perspective, this is backwards. Effective legislation is possible and include regulation that:
• Establishes a clear operational framework, rules and bounds within which users and developers can thrive;
• Recognises and facilitates the development of innovative technology and systems;
• Mitigates broad-based risks; and
• Provides clear specific regulatory guidance.
Regulation can facilitate essential collaboration between decentralised systems and state institutions where it allows for growth and a healthy competitive environment. This is an important juncture given a move by certain central banks to develop state-owned virtual digital currencies, by employing blockchain technology.
A Bit of closure
New technologies, innovative business models and changing consumer needs are all part of the moving current of digital innovation, across all sectors of the global economy. The banking industry finds no exemption here. The tide of innovation will continue to churn out new and better ways for institutions to operate, for businesses to grow and for people to live. The onus is upon every economic agent to either initiate the disruption or adapt thereto, or else be left behind.
Ultimately, the technology that is cryptography itself is an undoable insurgence. Thus, the implementation of efficient regulation whether for or against cryptocurrency is essential. Of this one needs be cautious: too much regulation can have the inverse effect of stifling the full potential of an otherwise effectual innovation. Therefore, central banks and regulators need to determine the correct balance of incorporation and/or regulation of this technology as the world moves further toward a more digitised existence, anyway.