Financial sector regulators are grappling with the difficult question on how to rein in cryptocurrencies and initial coin offerings (ICOs).
Cryptocurrencies are decentralised, location-less, privately issued or mined on a computer network for peer-to-peer transaction purposes. These features make the prospects of regulating cryptocurrencies extremely challenging.
The growing public interest in cryptocurrency and ICOs have led to concerns relating to consumer protection, money laundering, and financing of criminal activities. The anonymous feature of some cryptocurrencies raises fear of being conduits for money laundering and terror financing. These consumer protection, in particular, retail consumer protection concerns stem from the volatile nature of cryptocurrencies. The Bank of England (BOE) Governor Mark Carney called the huge price moves and volatility of cryptocurrencies “speculative mania.” Draghi pointed out that the value of Bitcoin had oscillated much more wildly than that of the euro and that cryptocurrencies were not backed by any public institution.
The consensus at the recent SEACEN Policy Summit on Cryptocurrency Regulation and Central Banking was that any regulation would have to be carried out at the interface between the crypto world and the real world, i.e., at the exchanges where a cryptocurrency is exchanged for national fiat currencies. Such exchanges should be required to follow AML/CTF (Anti Money Laundering/Counter-Terrorism Financing) recommendations issued by the Financial Action Task Force (FATF).
While exchanges appear to be a useful nexus for regulation, policymakers should not be too rigid with the regulatory framework. They should be careful with how they attempt to assimilate cryptocurrency into existing regulatory framework. Banning cryptocurrency or a rigid approach to regulation at this stage might not be the best approach. Such an approach could eliminate financial incentives required to further research and develop the blockchain and distributed ledger technology.
Blockchain and the distributed ledger technology have the potential to improve accuracy, efficiency and security across payments, clearing and settlement. Several central banks including the European Central Bank, the Bank of Canada, and the Bank of Japan are conducting research into using blockchain for financial market infrastructure.
If cryptocurrencies are banned or heavily regulated, this could also adversely affect any potential spill-over benefits of the technology in other fields including healthcare, finance, governance and so on.
A measured and well-reasoned approach is required at this critical junction. Policymakers should continuously assess and monitor the environment to enhance their understanding of the ecosystem as well as existing and emerging risks. They need to be agile. The cryptocurrency ecosystem comprises of many important actors, such as exchanges, wallets, payments companies, and mining just to name a few. The lines of demarcation between actors are not necessarily clear. It is not uncommon to find entities providing a platform with products and services being offered across multiple industry sectors, and others operating in multiple industry segments using assorted brands. Universal cryptocurrency platforms which provide a diverse range of products and services to the public are emerging. In some instances, wallets are progressively being integrated with exchange services. The wallet interface is used as a mean to load the wallet and provide storage for newly acquired cryptocurrency within their platform. Similarly, payment companies are also increasingly offering fully-fledged money transfer platforms that enable the storage and transfer of cryptocurrencies. Very often this also includes an integrated currency exchange service.
While the time has come to hold the crypto-asset ecosystem to the same standards as the rest of the financial system, the nexus for regulation of cryptocurrencies is not straightforward. Even when regulation is approached from the point of the exchanges it is still challenging. Let us start with the simple model that all entities operating as exchanges must be legally incorporated and registered. This approach will address the issue of location and jurisdiction. Given the borderless nature of cryptocurrencies, to be effective this requirement would need to be global. This will require global cooperation and coordination to be effective. In case of cross-border payments, the determination of location has important implications. Cryptocurrencies have the potential to quick transfers of substantial amounts of money across borders, regardless of the location of the payer and the payee. Even in cases where the location of the exchanges has been determined, it will still be possible for an individual to transfers coins from his or her private wallet in Country A, to buy goods in Country B through an exchange located in Country C. Even though the actual value is being transferred between Country A and Country B, the virtual currency transaction is taking place across Country A and Country C and from Country C to Country B. Given that regulation is been approached a country-by-country basis rather than on a globally coordinated approach differences regulatory approach are emerging.
While regulation on a country-by-country basis might drive positive competition among jurisdiction for talent, technology and start-ups, it could also be detrimental. If there are significant differences in regulatory approaches, this could create opportunities for regulatory arbitrage, whereby actors from countries with strict regulations engage in cross-border activities in countries with weaker regulations, and consequently heightening system risk concerns.
There may be differences from country to country in the threshold of permissible cross-border transaction amounts. Some countries may even have restrictions on inflows and outflows of funds. There may also be taxation-related issues.
Despite the challenges, it is imperative that policymakers and regulators remain vigilant to existing and emerging risks associated with cryptocurrencies. Policymakers should continue to focus on AML/CFT requirements, consumer protection and market integrity. They should continuously monitor and assess the environment to better understand the implications of cryptocurrencies and the potential benefits of blockchain and distributed ledger technology.
The author, Mark McKinzie, is a Senior Financial Sector Specialist at The SEACEN Centre.
The South East Asian Central Banks (SEACEN) Research and Training Centre was first established as a legal entity in 1982 with eight member central banks/monetary authorities which has since grown to twenty members in 2014.