When we hear the word cryptocurrencies, three fixations tend to pop up: price volatility, anonymity and, perhaps most of all, its enduring association with the darker corners of the internet.
These concerns have been widely popularized. With over 1,500 unique coins and tokens out there (amounting to £309bn total capitalization), it’s not hard to see why the regulators are looking to shine a brighter light on this market.
This article looks at the bodies seeking to regulate cryptocurrency, including the proposed methods and market sentiment.
The stand-out arguments for regulatory intervention are greater consumer protection and more effective financial crime prevention. With Bitcoin’s meteoric rise in price last year and subsequent monumental crash, consumer protection is more relevant than ever.
Banks and card issuers such as Lloyds, Bank America, and JPMorgan have banned the purchase of cryptocurrencies on their credit cards, ostensibly to protect their customers from volatility and risk.
If private enterprise is acting as the lead advocate for protecting the consumer, does this hint at a laggard approach from the UK regulators? Or are they – like everybody else – simply limited by knowledge asymmetry?
In the UK, Parliament recently-launched a digital currencies inquiry, therefore providing an education as well as a sense of regulatory direction.
Equally important is the potential for far more efficient financial crime prevention. Bitcoin and cryptocurrency in general, has long been tarred with the brush of facilitating financial crime; despite a litany of benign uses, this reputation is not undeserved.
Indeed, a recent European Commission report affirms that decentralized virtual currencies are a potential new criminal tool for terrorist financiers and money launderers to move and store criminal funds for the following reasons:
- A lack of EU regulation and monitoring in the area
- An inability to report suspicious activities to financial intelligence units
- The ‘dark pool’ effect
- The inherent features of anonymity and cross-border reach, as well as structural complexities.
Who could regulate
In the UK, the Financial Conduct Authority (FCA) is the regulatory body for firms providing financial services and seems the best fit to regulate cryptocurrencies.
Although the FCA does not regulate cryptocurrencies at present, it has published consumer warnings branding both cryptocurrency contracts for difference (CFDs) and Initial Coin Offerings (ICOs) as high-risk, speculative investments.
Despite this general malaise. however, the FCA does not appear to be beating the drum for greater regulation. Indeed, chief executive Andrew Bailey, rejects Bitcoin’s description as a currency but calls it a “very volatile commodity”. As a commodity, it would not come under the purview of the FCA.
“Chief executive Andrew Bailey, rejects Bitcoin’s description as a currency but calls it a ‘very volatile commodity‘”.
However, HM Revenue and Customs (HMRC) takes the inverse view and treats cryptocurrencies as if they are a foreign currency, thereby exempting it from value-added tax, and designates it as an intangible asset for capital gains purposes.
Fortunately, the EU’s proposed amendments to 4MLD may provide the regulatory direction needed to resolve this dilemma. Referred to as the ‘Fifth Anti-Money Laundering Directive’, this draft proposal sets out a clearer legal definition of virtual currencies which all member states must implement and expands the category of obliged entities to include providers of exchange services between virtual currencies and fiat currencies, as well as custodian wallet providers.
If the UK remains obligated to enforce EU directives during the Brexit implementation period, then cryptocurrency exchanges would be considered relevant firms under the MLRs 2017, and would be obliged to carry out the same checks as financial institutions and other relevant firms. However, one could speculate that these changes will most likely take place even in the case of a ‘hard Brexit’.
Even if the world’s regulators came to the agreement that cryptocurrency should become a regulated commodity, there hasn’t been a unilateral agreement on how this might be done. Some jurisdictions may ban it outright, while others may move to regulate exchanges by retrofitting existing AML frameworks.
A third option may be to class cryptocurrencies as a defined asset class, thereby bringing it under the scope of regulation. Another option is the creation of a state-backed cryptocurrency, like Russia’s oft-touted ‘cryptorouble’.
Should a regulator choose one of the above or opt for an entirely different approach, their desired approach should be carefully balanced to ensure its program of oversight does not end up stifling innovation.
The market sentiment
With supranational bodies looming, market sentiment seems to have shifted towards embracing regulation and self-regulation, as a necessary step towards widespread adoption. Some UK firms are already taking steps to collectively promote a sound benchmark in terms of best practice for the crypto market.
CryptoUK was officially announced as the first self-regulatory trade association for the UK cryptocurrency industry. Comprising of seven UK-based companies, including Coinbase and CoinShares, the body intends to promote best practice by having its members subscribe to a ‘Code of Conduct’. This includes best practice guidelines on due diligence, segregation of customer funds and the promotion of formal engagement with regulatory and legal bodies, including law enforcement.
The subject of cryptocurrency is a complex and evolving one, presenting an ever-changing risk exposure to those firms who are brave enough to get involved. Some firms deem cryptocurrency far too extreme and refuse to deal with it in any capacity, while others attempt to mitigate this by retrofitting existing policies and practices and/or by using analytical tools like Chainalysis or Elliptic.
The long-term efficacy of the latter remains unclear, hence why the implementation of a regulatory framework should not be understated.
2018 is already shaping up to be a breakthrough year vis-a-vis cryptocurrency regulation. It featured high on the agenda at last month’s World Economic Forum, and is due to be discussed at this year’s G20 summit.
As governor of the Bank of England, Mark Carney, put it: “The time has come to hold the crypto-asset ecosystem to the same standards as the rest of the financial system. Being part of the financial system brings enormous privileges but with them great responsibilities.”