The Regulation of Cryptocurrencies

Governments walk a fine line when they regulate new technologies: at the same time as wanting to foster growth, they have a responsibility to ensure public safety. This is a key point to consider in the current Cryptocurrency mania.

The recent plunder of more than $534 million worth of Bitcoin from the Japanese cryptocurrency exchange Coincheck last week has highlighted the potential risks and vulnerabilities associated with cryptocurrency trading. South Korea, a major hub for cryptocurrency trading, announced that it too had uncovered almost $600 million worth of foreign exchange crimes largely executed through the use of cryptocurrencies. Given these recent developments, it is unsurprising that governments are becoming more vocal about regulation.

Cryptocurrency trading is characterised by over 753 varieties of cryptocurrencies with a market capitalisation of roughly $114 billion, 68% of which is comprised of Bitcoin and Ethereum. Since cryptocurrencies are decentralised (i.e. they are not issued by a central bank) they fall outside the purview of regulators and have been accused of facilitating online criminal activity such as scams and ransomware attacks. The very nature of cryptocurrencies – namely their anonymity – makes fraud prevention particularly challenging as there is no means to revert transactions or retrieve stolen funds.

Despite its shortcomings, it is said that cryptocurrencies are likely to play in instrumental role in the global economy by revolutionising traditional banking and payment systems. Promoters of cryptocurrencies suggest that cryptocurrencies make transactions easier than under traditional banking systems. Since there is no central authority, consumers are free to make their own transactions without the use of intermediaries or third party fees; thereby serving as an efficient tool in global commerce. Some also argue that cryptocurrencies provide users with greater control and security over transactions. Since payments made through cryptocurrencies are anonymous, this reduces the threat of identity theft. While some might argue that this anonymity protects online criminals, Blockchain technology ensures that all transactions made through Bitcoin and other cryptocurrencies are made available for others to see. This gives law enforcement the ability to track transactions and perhaps make it easier to trace the owner than it otherwise would be.

Given this information, it appears that governments are faced with a tough choice: either allow cryptocurrencies to proliferate and manage the consequences later, or ban its use entirely to circumvent illegal online activity. The latter would certainly prevent governments from benefitting from the untapped potential Blockchain technology offers. Perhaps instead, it would be wiser for governments to find ways to regulate cryptocurrencies without stifling innovation. This may be achieved by establishing laws which require all cryptocurrency transactions to run through a regulated exchange. Regulating exchanges makes it easier for governments to combat illicit behavior and ensure that taxes are paid. Similarly, governments should create stricter frameworks for ICOs (Initial Coin Offerings). Although the Financial Conduct Authority defines an ICO as a “deposit taking, e-money issuance, contract for difference or a collective investment scheme,” there is no supporting regulation to ensure that ICOs meet a minimum standard. An effective policy to safeguard investor’s wealth would be for ICOs to provide evidence that they can hold large stakes of customer’s money and have adequate refund mechanisms should they fail to deliver.

Although cryptocurrencies may facilitate illegal activity, countries such as Japan and South Korea have been leveraging cryptocurrencies as a means to bolster economic growth. However, in order to achieve these benefits, regulators should strive to put in place safeguards which limit the illegal use of cryptocurrencies without stymieing beneficial technological change.