Cryptocurrencies’ rising regulatory challenge

Virtual currencies continue to gain interest as regulators and central banks explore issues and potential adoption of the technology.

The total combined market capitalization for cryptocurrencies at the time of writing was at $267bn according to CoinMarketCap. But while there may be appetite for the virtual currencies, price volatility and cryptocurrency scams continue to be of concern, and are driving increasing regulatory interest in the sector.

Over £27m has been reported lost to crypto and forex scams for 2018/19, according to a report by the UK’s Financial Conduct Authority (FCA). The number of scams reported to the regulator tripled from the same time the year before to over 1,800.

On May 28, the board of the International Organization of Securities Commissions (Iosco) published a consultation report and requested public feedback on identified issues, risks, and key considerations relating to crypto asset trading platforms (CTPs), and in particular the level of plans in place in the case of loss.

“There may be concerns about what procedures the CTP has in place in the event of a loss of participant assets, including a loss due to theft, bankruptcy or insolvency of the CTP,” the report said. “Iosco believes that fostering innovation should be balanced with the appropriate level of regulatory oversight.”

Compliance considerations

Regulators continue to seek a way forward to ensure the safety of both the markets and market participants.

A study conducted by the European Parliament on cryptocurrencies in July 2018 found that anonymity was the key issue that needed to be addressed within the cryptocurrency market particularly with consideration to anti-money laundering and tax evasion. Additionally, the report acknowledged the cross-border nature of cryptocurrencies were also not being addressed by the existing European legal framework.

On March 12, 2018 the Bank of England’s Financial Policy Committee stated that “existing crypto assets did not pose a material risk to UK financial stability.” But the Committee said they would be monitoring the situation and in the “event that one or more crypto assets were likely to become widely used for payments, or as an asset intended to store value, the FPRC would require current financial stability standards to be applied to relevant payments and exchanges.”

In June the FCA published a regulation perimeter report in which it stated that “the boundary between providing mostly unregulated technical infrastructure to deliver financial services and providing regulated activities is increasingly narrowing. This also raises questions around whether financial regulators have the necessary tools and techniques to effectively oversee those organizations.”

It also stated that the Treasury would consult later this year on the crypto assets that currently fall outside the regulator’s supervision perimeter.

Part of the challenge is the difficulty in transposing existing regulation to cryptocurrency, and the cross-border nature of the technology which brings into question jurisdictional oversight.

On May 29, the World Economic Forum launched six Global Fourth Industrial Revolution Councils, to “work together to develop policy guidance and address ‘governance gaps’ or the absence of well-defined rules for emerging technology.”

In Europe, the fifth Anti-Money Laundering Directive (5AMLD), which was published in the Official European Journal in June 2018, will come into force on the 10 January 2020. The regulation has created new reporting regulatory requirements on the crypto asset exchanges and custodian wallet providers. Both entities will have to perform identity checks for clients and beneficial owners, as well as notifying regulators of suspicious activity. But since the time of publishing the regulation, proposals for a sixth version have already been distributed.

In April, HM Treasury published a consultation on 5AMLD. “The government has worked closely with the FCA and Bank of England through the Crypto Assets Taskforce to develop a comprehensive policy and regulatory approach to crypto assets and distributed ledger technology,” the report stated.

Facebook’s Libra

On June 18, Facebook announced the company’s plans to launch its cryptocurrency Libra, and the development of its digital wallet Calibra by 2020.

“For many people around the world, even basic financial services are still out of reach: almost half of the adults in the world don’t have an active bank account and those numbers are worse in developing countries and even worse for women. The cost of that exclusion is high — approximately 70% of small businesses in developing countries lack access to credit and $25bn is lost by migrants every year through remittance fees,” read the statement.

Facebook’s Libra is collectively governed by its network participants, but it’s transaction ledger will be open source software allowing anyone to build wallets and other applications to operate on the network.

On July 2, the US House Committee on Financial Services sent a letter to Facebook asking for the social media site to halt development of Libra, saying that the products raised “serious privacy, trading, national security, and monetary policy concerns for not only Facebook’s over 2 billion users, but also for investors, consumers, and the broader global economy.”

On July 30 the US Senate Committee on Banking, Housing, and Urban affairs had a hearing on regulatory frameworks for digital currencies and blockchain.

“It seems to me that digital technology innovations are inevitable, could be beneficial, and I believe that the US should lead in developing these innovations and what the rules of the road should be,” said Senator Mike Crapo, chairman of the US Senate Committee on Banking, Housing and Urban Affairs.

“The digital currency and blockchain ecosystem is diverse, and care must be taken in determining what gaps may be present in the existing framework and developing a more comprehensive approach,” said Crapo.

On July 29 Ripple’s chief executive officer and executive chairman wrote an open letter to the US congress asking policy makers not to “paint [them] with a broad brush” as “digital currencies have the opportunity to complement existing currencies like the US dollar – not replace them.”

Despite concerns, it is a key technology receiving increasing attention from global central banks.

In January the Bank of International Settlement (BIS) published a survey on central banks’ thoughts on digital currency. 85% of central banks surveyed said they would be either somewhat unlikely or very unlikely to issue any type of central bank digital currency (CBDC) in the next three years.

“Motivations for issuing a CBDC are largely idiosyncratic (e.g. falling availability of cash in a jurisdiction). This has meant that only a limited number of central banks are proceeding to the pilot stage with CBDCs, and even fewer see issuance of a CBDC as likely in the short or medium term,” the survey stated.

However, on June 30, the head of the BIS told the FT the need for digital currencies may come earlier than expected.

“Many banks are working on it; we are working on it, supporting them,” said Augstín Carstens. “And it might be that it is sooner than we think that there is a market and we need to be able to provide central bank digital currencies.”

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