The potential for cryptocurrencies to increase speed and lower the cost of doing business is threatened by theft, poor security and criminal activity.
The accelerating growth of cryptocurrency markets presents a dire need for regulatory controls around crypto assets. Many people assume that protecting blockchain technology, the almost tamper-proof distributed ledger that underlies cryptocurrencies, ensures the security of cryptocurrencies. But crypto exchanges are regularly hacked — the largest so far on January 2018 when Coincheck lost US$530m. Meanwhile, the flood of initial coin offerings (ICOs) invites abuse, and the anonymity of cryptocurrencies facilitates illegal dealing in everything from weapons to drugs to human trafficking. While the underlying technology might be secure, cryptocurrencies are not — and, even if they were, their ease of use supports criminal activity.
Asserting regulatory controls will not be easy. Many argue that dramatic value fluctuations make cryptocurrencies more like commodities than currencies, leaving regulators perplexed.
Balancing security, transparency and innovation
Despite concerns about regulation stifling potential innovation in crypto assets, there are exciting developments; for example. Kenyan startup BitPesa — a bitcoin-based remittance service that integrates with Kenya’s mobile money system M-Pesa to reduce friction and transaction fees. In trade finance, the DLT that underpins cryptocurrencies may allow supporting documentation to be attached to financial transactions, reducing risk of human error or exploitation.
But the risks of cryptocurrencies must be addressed before they can live up to their potential. Many risks relate to crypto’s anonymity. Although the path of a cryptocurrency token on the blockchain’s open, decentralized distributed network is transparent, the token ownership and what it was used for is not.
This anonymity is not compatible with current laws and global regulatory trends demanding more transparency to guard against money laundering, tax avoidance and other criminal activities. If governments cannot see a transaction, they cannot identify evaded taxes. Even Switzerland has had to relax privacy laws to transfer money in and out of the country.
Anonymity also puts large financial institutions in a bind. New laws that tighten liability rules for large companies, such as banks and accounting firms, could impact financial institutions’ willingness to accept or transfer cryptocurrencies. The EU and UK’s anti-money-laundering directives and Criminal Finances Act compel financial institutions not to deal with any transaction related to criminal activities. Even “not confirming” that taxes have been paid on the cryptocurrency being transferred into a bank could be considered facilitating criminal activity. Similarly, if the owner of a crypto asset is anonymous, financial institutions may struggle to identify illegal movements of sanctioned assets or activities of people and organizations subject to economic sanctions.
Diverse regulatory perspectives
With these risks in mind, it is easy to see how poorly regulated cryptocurrencies could have disastrous consequences, leaving consumers open to fraud risk, reducing government coffers and funding terrorism, human trafficking and other criminal activity.
Regulation has emerged on a country-by-country basis, without international coordination. Interestingly, the less democratic countries see crypto as a more immediate threat — specifically to their own central authority over the money supply — and have been quicker to address the absence of regulation. While China was once home to the world’s most active cryptocurrency exchanges, authorities banned these last year and have since blocked access to platforms that offer exchange-like services. Chinese regulators have been at the forefront of a global push to rein cryptocurrencies amid concerns over excessive speculation, money laundering, tax evasion and fraud.
The tougher stance is beginning to catch on. In the US, the Securities and Exchange Commission (SEC) has launched multiple probes, saying many coin issuers, their lawyers and advisors may have breached its rules. SEC Chair Jay Clayton said he believes most digital tokens are effectively securities and should be regulated as such. However, Clayton also acknowledges that definitions in the industry are evolving, DLT has incredible promise for the financial industry and regulators must be flexible. In Europe, the European Securities and Markets Authority (ESMA) stresses that ICOs are extremely risky, highly speculative investments that may fall outside the regulated sector.
Meanwhile, in February, the European Supervisory Authorities (ESAs) for securities, banking, insurance and pensions jointly announced concerns about an increasing number of people buying highly risky virtual currencies without being aware of the risks. Since virtual currencies and exchanges used to trade them are not regulated under EU law, regulators warned that cryptocurrency investors are not protected from a cyber attack or if an exchange goes out of business. Mark Carney, Governor of the Bank of England, emphasizes that crypto assets behave differently from other currencies but also argues that their regulation is vital.
In Spain, the tax authority has requested names and trading information on cryptocurrency buyers in 60 companies as part of an investigation into crypto-enabled tax evasion and money laundering. South Korea has introduced measures to tackle speculation in the sector, banning the use of anonymous bank accounts in cryptocurrency trading. And India’s government has announced measures to “eliminate” the use of cryptocurrencies in “illegitimate activities or as part of the payment system.”