Cryptocurrency: The regulatory struggle of new age financial technology

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Justin Diamond looks at rise and fall and rise of Bitcoin, and what is needed to ensure future viability of cryptocurrencies that are by nature, decentralised and untraceable.

Consider the impracticality of using Bitcoin to purchase a coffee. From the time you leave home in the morning to the time you arrive at the coffee shop, Bitcoin’s value may drop by 20%, making the transaction unpredictable and undermining consumer confidence.

2017 vs. 2018

2017 – the year cryptocurrency made a global name for itself. The year Bitcoin climbed from below $1,000 USD to almost $20,000 USD, where the cryptocurrency market cap soared from $18bn USD to over $800bn USD and where ICO funding exceeded traditional VC funding.

Source: Coindesk

This beckons the question: How will 2018 be remembered?

At a glance, we are due for a ‘bubble pop’ – the year where the financial world comes to their senses and realises the fleeting nature of cryptocurrency

Although 2018 has already seen Bitcoin plunge to $9,000 USD, a market crash does not appear to be on the horizon. Rather, the significant price fluctuation is indicative of a market correction; a healthy adjustment following a barrage of regulatory announcements.

While regulation may lead to short-term speculation, this may be a necessary sacrifice for long-term vitality.

The year of regulation: legitimising cryptocurrency

The problem – An unregulated landscape  

The decentralised, untraceable nature of cryptocurrency poses obvious threats to regulatory authorities.

Enabling individuals to evade the scope of regulators undermines Basel III and other risk management measures which protect the integrity of the financial system. By providing anonymity to users, cryptography impedes detection of money laundering and other forms of digital crime.

The cases of Mt. Gox, (where billions of dollars of Bitcoins where stolen), and Silk Road, (exposing the extent to which the dark web utilised Bitcoin to fund illicit transactions), have compelled regulators to grapple with consumer protection and the role of cryptocurrency in digital crime.[1]

Regulation – Undermining the idea of a decentralised market?

If cryptocurrency is premised on a free market notion and derives value from its immunity to third-party regulators, is regulation counterintuitive?

Whilst financial disintermediation and circumvention of third party institutions are powerful assets, more is needed to support the sustainable adoption of a currency.

To thrive, currencies require State legitimacy and endorsement.

Currency is dependent upon the meaning society places on its value, and its utility in the context of social interactions and transactions as a medium of exchange. Cryptocurrencies typically fall short in this respect – their volatility inhibits their use for daily transactions.

Consider the coffee example above.

Consumer confidence drives the mainstreaming of currency. Given the significant role of government institutions in protecting and instilling consumer confidence, currencies ought to have a much higher chance of adoption if they do not circumvent the state but are legitimised by it. Volatility has thus kept institutional investors at bay, who typically play a significant role in market price stability.

As articulated here by Commodity Futures Trading Commissioner Brian Quintenz, “regulation can add to credibility… and I think the participants in this market want a credible marketplace”.

Nevertheless, according to technologists Isaac Pflaum and Emmeline Hateley “it is essential that a coherent regulatory approach be developed”,[2] with a focus on embracing the utility of cryptocurrency, rather than enacting onerous regulatory requirements to suffocate it.

Finding a solution

Regulators globally are confronted with a common question: How can the benefits of cryptocurrency be harnessed, whilst protecting consumers and preventing cryptocurrency-enabled crime?

Answering this question requires an assessment of the existing regulatory landscape. While China has adopted a stringent scheme, banning all ICO’s and internet access to all things cryptocurrency related, countries such as Australia, South Korea and the US have taken less severe approaches.

South Korea: South Korea is currently preparing a regulatory plan for ICO’s, by working with the tax authority to implement a robust framework and promote blockchain technologies. Nevertheless, authorities have cracked down on illegitimate exchanges, and implemented a rule disallowing anonymous accounts from trading.

Australia: Since 3 April 2018, Australian based cryptocurrency exchanges have been required to abide by Anti-Money Laundering (‘AML’) regulation, enforced by AUSTRAC. Obligations include registering with AUSTRAC, identifying and verifying customers, reporting suspicious matters and adopting an AML program to identify, mitigate and manage laundering and terrorism financing risks. 

Additionally, in addressing the 2017 Australian Payment Summit, RBA Governor Phillip Lowe suggested the eventual endorsement of an official digital currency – ‘the eAUD’; using distributed ledger technology (upon which Bitcoin is based). While Lowe indicated the potential efficiencies of an eAUD, he conceded that there are a range of complex operational and policy questions which first need to be considered, and that there are no immediate plans of issuance.

Nonetheless, Lowe’s consideration in addition to the recent regulatory changes signify a trend toward the legitimisation of cryptocurrencies as an asset, instilling confidence in the market.

United States: The Securities and Exchange Commission (‘SEC’) have not rejected nor endorsed cryptocurrencies as an asset class. However, the SEC have expressed an intention to apply securities laws to exchanges in the near future. Additionally, the SEC have indicated their disapproval for the manner in which ICO’s are conducted, cracking down on fraudulent ICO’s, such as ‘Centra’.

A multilateral approach is needed

An analysis of the different regulatory systems reveals a “patchwork of inconsistent and incomplete attempts”.[3] According to Pflaum, “so long as commitments to international cooperation … are informal, non-binding and carry no penalties, regulatory arbitrage will drive users of the currency towards operating in states with the lowest regulatory burdens”.[4]

The international landscape

International bodies including the United Nations Office on Drugs and Crime, the Financial Action Task Force (FATF) and the G20 have played a significant role in researching cryptocurrency-related crime, developing regulatory frameworks and facilitating international collaboration, respectively.

G20 financial policymakers have agreed to carefully monitor cryptocurrencies, urging international standard-setting bodies to continue working toward a multilateral response. The regulatory guidelines developed by FATF have been welcomed, with members setting a July deadline for concrete recommendations on global implementation of FATF standards.

Aligned with the G20 sentiment, political scientist Malcolm Campbell-Verduyn posits that the FATF framework provides an “effective balance in mitigating potential risks and actual opportunities”.[5]

How will 2018 be remembered?

A multilateral, consistent set of standards needs to be adopted by the international community. The FATF guidelines appear to be the most robust, co-ordinated and appropriate approach yet. Accordingly, if the G20 recommendations in July are adopted by the international community, cryptocurrency regulation should begin to look more apt for its purpose – promoting confidence in the market whilst effectively combating nefarious activity.

[1] H. Deng, R., 2017. Handbook of Blockchain, Digital Finance, and Inclusion (Volume 1) Cryptocurrency, FinTech, InsurTech, and Regulation. 1st ed.

[2] Pflaum, I., & Hateley, E, 2014. A bit of a problem: national and extraterritorial regulation of virtual currency in the age of financial disintermediation. Georgetown Journal of International Law, 45, 1169–1215.

[3] Pflaum, I., & Hateley, E, 2014. A bit of a problem: national and extraterritorial regulation of virtual currency in the age of financial disintermediation. Georgetown Journal of International Law, 45, 1169–1215.

[4] Pflaum, I., & Hateley, E, 2014. A bit of a problem: national and extraterritorial regulation of virtual currency in the age of financial disintermediation. Georgetown Journal of International Law, 45, 1169–1215.

[5] Campbell-Verduyn, 2018. Bitcoin, crypto-coins, and global anti-money laundering governance. Springer - Crime, Law and Social Change, 283-305.

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About the author

Justin Diamond

Justin is in his final year of a Bachelor of Commerce and Law at UNSW. He is a keen problem solver, with a passion for technology and cryptocurrency. Justin is pursuing a career in management consulting at Oliver Wyman once he completes his studies.

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