Ahead of a Group of Twenty (G-20) summit of finance ministers and central bank governors overseeing the world’s strongest economies next month in Argentina, cryptocurrency regulation is becoming an urgent priority for officials worldwide.
Specifically, sovereign financial leaders are seeking guidance as to how they might police a transformative asset class, which can function as securities, commodities, so-called “utility tokens,” legal tender or property. It follows that existing legal frameworks are ill-suited for the regulation and taxation of decentralized ecosystems.
That regulators are paying so much attention to cryptocurrencies – already issuing warnings, guidance and regulations – reflects how relevant the asset class has become.
An Inevitable Response
The emerging G-20 agenda is an “inevitable” response to a roller-coaster year for decentralized ecosystems, where bitcoin’s value rose nearly 2,000 percent at the height of the 2017 bull market, and where broader cryptocurrency market capitalization soared past $500 billion.
Inflating the bubble was the proliferation of initial coin offerings (ICOs) – crowdfunding instruments that enable companies to raise public capital through the sale of digital tokens, and which captured roughly $4 billion from crypto investors last year.
But in the first quarter of 2018, regulatory jitters and governance concerns have sent crypto markets into free fall, with bitcoin losing 70 percent of its gains between its Dec. 16, 2017 peak and its Feb. 6, 2018 trough, where it sank below $6,000.
The slide in bitcoin, the veritable reserve token, sent shockwaves throughout correlated crypto assets, triggering an avalanche of volatility that erased half a trillion dollars in decentralized market value, within the same 48-day period.
Beyond unprecedented market risks, regulators globally have raised alarms about the lack of consumer protection, anti-money-laundering (AML), counter-terrorism-financing (CTF) and cybersecurity controls in decentralized ecosystems.
Now, government officials in over 20 countries and jurisdictions, ranging from the U.S. and China, to the British territory of Gibraltar and the African nation of Ghana, have issued guidance for monitoring and policing token markets.
In the West, some of the loudest voices for crypto regulation have been U.S. Treasury Secretary Steven Mnuchin, International Monetary Fund (IMF) Managing Director Christine Lagarde, and European Commission Vice President Valdis Dombrovskis.
Most recently, French and German Finance Ministers Bruno Le Maire and Peter Altmaier, respectively, and their central bank governor colleagues, Francois Villeroy and Jens Weidmann, called for a “trans-boundary” approach to regulating virtual currencies in a letter to the finance minister of Argentina, which currently holds the G-20 presidency.
While France, Germany and the European Commission, in general, appear to be more concerned with the impact of cryptocurrencies on financial stability and consumer protection, Mnuchin and Lagarde seem more focused on combating financial crime.
At a January 2018, CNBC-sponsored World Economic Forum panel discussion in Davos, Switzerland, the U.S. Treasury secretary’s and IMF chief’s comments were indistinguishable.
“My number-one focus on cryptocurrencies, and whether that be digital currencies, or bitcoin or other things, is we want to make sure they’re not used for illicit activities,” Mnuchin said.
The Treasury chief also noted that in the U.S., bitcoin wallets are subject to the “same regulations as a bank,” meaning that they must have compliant customer identification programs and AML controls, as specified by the Bank Secrecy Act.
Lagarde agreed with Mnuchin, saying, “The anonymity, the lack of transparency and the way in which it [cryptocurrencies] conceals and protects money laundering, financing of terrorism and all sorts of dark trades is just unacceptable.”
Despite a January 2018 Bitcoin Laundering study authored by British blockchain forensics firm Elliptic finding that only 0.61 percent of crypto transactions between 2013 and 2016 were dirty, these officials are most likely concerned with nation-state actors and terrorists exploiting distributed ledger technology (DLT).
Given the Treasury’s role in administering Office of Foreign Asset Control (OFAC) sanctions, Mnuchin is probably most perturbed by reports of blacklisted regimes such as Venezuela, North Korea and Russia using cryptocurrencies to evade economic bans.
Meanwhile, Lagarde’s crypto-terrorism-financing jitters may be overblown, as a July 2017 report published by the European Commission, the continent’s top financial watchdog, found a relatively low level of terrorism-financing risk in virtual currency transactions. That risk rating may vary across different jurisdictions, however.
Broadly speaking, regulatory attitudes toward crypto regulation can be grouped into one of three tiers: Permissive, Cautionary and Prohibitive.
For example, Gibraltar, the Isle of Man, Bermuda, Antigua, the Cayman Islands, Mauritius, Anguilla and Switzerland have all announced initiatives or introduced legislation to attract ICO entrepreneurs. In fact, the government of Gibraltar is the first to introduce comprehensive regulations for ICO fundraising. Also, Belarus is positioning itself as the most crypto-friendly regime in Eurasia.
One initiative advocated by several of these dovish regimes is the so-called “utility token” exemption, which would allow certain qualifying ICOs to avoid registering as a security and all of the regulatory compliance requirements that entails. For instance, it may not make sense to designate a token used to issue software licenses as a security.
Regardless of how a permissive jurisdiction may view an ICO, however, a utility token designation by the issuing country doesn’t mean that ICO will be granted the same status by other countries if it solicits foreign investors.
That said, regimes that could be best described as cautionary include: the U.S.; U.K.; European Union; Hong Kong; Canada; Singapore; Russia; UAE; and Japan.
The land of the rising sun might have the best developed framework for regulating cryptocurrency exchanges and businesses, and a model that Western governments should emulate, according to trade publication and education resource Bitcoin.com.
This is due to the Financial Services Agency (FSA), Japan’s top financial regulator, requiring crypto exchanges to maintain strict capital reserves, segregate customer funds from exchange accounts and implement robust Know Your Customer (KYC) procedures.
The most restrictive crypto regimes are China, South Korea, Vietnam and India. In fact, sweeping crypto bans enacted by the former two, are largely responsible for January’s massive decentralized market crash.
The People’s Bank of China, the top financial regulator in a country that accounted for over two-thirds of the world’s crypto-mining pool in 2017, announced in February that it was looking to “ban all crypto-related commercial business including banning and blocking both domestic and offshore cryptocurrency trading platform websites.”
Meanwhile, the South Korean Ministry of Strategy and Finance (MSoF) reversed course in January and said it intends to closely regulate crypto markets, as opposed to banning them.
Additionally, India’s Ministry of Finance announced in February: “The government does not recognize cryptocurrency as legal tender or coin and will take all measures to eliminate the use of these crypto assets in financing illegitimate activities or as part of the payments system.”
Regulation is a Value-Add
While speculators fret about what a regulatory crackdown could mean for their crypto holdings, legal standards will help promote confidence and security throughout the ecosystem.
For one, regulations will introduce proper disclosure and consumer protection mechanisms to filter out bad actors and scammers, who have gravitated toward the crypto frenzy and exploited its lack of transparency to defraud investors.
Secondly, as high-profile stories like the record $530 million hack of Japanese crypto exchange Coincheck and the estimated $400 million in funds looted from ICOs in 2017, according to accounting firm Ernst & Young, reveal, some legal framework is needed to promote effective cybersecurity controls.
Although it is unlikely that this upcoming G-20 meeting will result in global consensus for the regulation of crypto markets or overcome jurisdictional preferences for bank secrecy, among other things, the dialogue is needed to promote clarity and confidence in the economy of tomorrow.