Rhode Island Chronicle

Cryptocurrency is currently at the frontier of financial development. It provides both opportunities and risks in financial markets and has attracted significant attention in recent years. Accordingly, the number of market players involved in the cryptocurrency business has risen. The new business model provided by cryptocurrency, along with the exponential increases in cryptocurrency prices, may have enticed investors toward cryptocurrency, with many utilizing cryptocurrencies as a speculative asset to take advantage of the early gains. However, the subsequent price crash was a wake-up call to speculators dealing with cryptocurrency. Additionally, risks related to price manipulation in cryptocurrency markets are not unheard of.

Although many central banks issue warnings about the use of cryptocurrency and have explicitly denied its status as a currency, only a few have banned its use as a financial asset. Policymakers are concerned about the low liquidity, the use of leverage, market risks from volatility, and the operational risks of cryptocurrency. Many central banks emphasize that cryptocurrency is not legal tender and that users face the risk of unenforceability of cryptocurrency transactions. The Global Research Center compiled regulations on cryptocurrency. Its report shows that it can be legally traded in countries where cryptocurrency is allowed as long as it follows existing rules or laws related to financial instruments. Regardless of the regulatory stance, policymakers are wary that cryptocurrency would be used for illegal activities, such as money laundering, trade-in illicit or controlled substances, or terrorism finance. Policymakers are also aware of the potential lack of consumer and investor protection. Deposit insurance for cryptocurrency holders is limited and not supplied by domestic monetary authorities. The combination of its potential benefits and macroeconomic risks begs the question of what determines policy openness or aversion to cryptocurrency.

Cryptocurrency and its Policy Environment

Cryptocurrency is an electronic token that originates from the need for direct peer-to-peer online payments. The most widely used and known cryptocurrency is bitcoin, introduced by an unknown developer or a group of developers with the pseudonym Satoshi Nakamura. It uses a decentralized public ledger to record ownership and transfers of value. The innovation behind cryptocurrency is that transactions are verified by several “miners,” who solve a complicated cryptographic problem to verify the ownership of the cryptocurrency and the subsequent transfer. The miner who solves the cryptographic problem first and validates the transaction receives cryptocurrency as remuneration. The mining process is an open-source program that the public can access. The peer-to-peer verification system bypasses typical trusted third parties such as a bank or a credit card company. Various innovations in the cryptocurrency have emerged since bitcoin rose to popularity, thereby broadening the definition of cryptocurrency. While some central banks are mulling over establishing their cryptocurrency, the industry is mainly market-driven.

Cryptocurrency in its current state is not considered a substitute for money. One of the most significant points of contention regarding its value is that any sovereign authority does not issue it; thus, its intrinsic value is questionable. Money has three essential features — a unit of account, a generally accepted medium of exchange, and a stable store of value. Cryptocurrency cannot take the role of a team of reports and a store of value because cryptocurrency’s market valuation is characterized by significant volatility in prices. Bitcoin, the largest cryptocurrency in terms of market capitalization, saw its value rise in 2017 before losing 30% of its value in December 2018. The unenforceable nature of cryptocurrency transactions in many countries also prevents them from becoming a common means of payment.

In its beginnings, cryptocurrency was used as a payment instrument. Since cryptocurrencies use distributed ledger systems that bypass intermediaries, they can potentially reduce the cost of international transfers, including remittances. Lower transaction costs can ultimately contribute to financial development and increased financial access. Thus, while the considerable uncertainty over the value of cryptocurrency currently prevents it from being recognized as a currency that functions as a unit of account or a store of value, it is primarily used for payment that promises anonymity and the elimination of intermediation costs. As the cryptocurrency gained more recognition in the financial sector, market players began to use it as a speculative investment asset.

Like other financial instruments, the cryptocurrency began to be traded in cryptocurrency exchanges. Hypothetical trading is conducted in businesses where consumers can buy, sell, and exchange cryptocurrencies using dollars, euros, yen, or other cryptocurrencies. Currently, over 200 enterprises support cryptocurrency trading all over the world. The major exchanges are located in countries such as the US, the Republic of Korea, and Samoa.

Despite the recognition of policymakers of the risks of cryptocurrency, the policy stance on cryptocurrency among countries remains heterogeneous, with some countries being open to its use, silent in terms of regulation, or explicit in its prohibition. The Global Legal Research Center provides a comprehensive report on cryptocurrency’s legal and policy landscape. While some countries ban cryptocurrency outright, most governments neither regulate nor promote it. Among other countries, Italy, Australia, and Japan require the registration and licensing of cryptocurrency operations. Meanwhile, the report shows that the Isle of Man and Mexico allow cryptocurrency as a means of payment.

Uncertainty over security, the legality of its transactions, and the extent of consumer and investor protection has kept policymakers wary about its operations. Because of this, many central banks around the world try to inform the public about the difference between legal tender, which is backed by their central bank, and cryptocurrency, which is neither supported by the domestic nor other foreign monetary authorities. Furthermore, the combination of the speculative nature of cryptocurrency and its lack of supervision poses a threat to both investors and consumers. Although the cryptocurrency market itself is not large enough to pose a global risk at this time, it may still pose risks to consumers and investors in smaller countries where cryptocurrencies are being used.

For countries where cryptocurrency transactions occur, policymakers also need to consider other policy or legal issues. In particular, the anonymous nature of cryptocurrency leads to concerns about using it to finance illegal activities such as trade in illicit substances, tax evasion, and financing of terrorism. Thus, particular regulations are put in place on top of existing laws on commercial activities. The Global Legal Research Center reports that the Republic of Korea, for instance, prohibits the use of anonymous bank accounts in cryptocurrency trading. The government of the Republic of Korea also requires banks to report activities deemed suspicious under regulations in its thrust to prevent money laundering. In addition, the report shows another example of cryptocurrency regulation with the licensing requirement of Israel’s Supervision of Financial Services for financial asset service providers, which includes virtual currency. While cryptocurrency operations have started to face registration and licensing requirements, they have remained outside most supervisory reach. Thus they maintain that users of cryptocurrency do so at their own risk.

As opportunities and threats connected with cryptocurrencies become more apparent as news about cryptocurrency operations unfolds, policymakers adopt their attitudes and policy stance toward cryptocurrency. For instance, the Global Legal Research Center reports that Japan revised its regulations on cryptocurrency to respond to the increasing speculation in the market. In 2017, Japan changed the Payment Services Act to define cryptocurrency explicitly and require the registration of dealers who exchange cryptocurrency with legal tender such as yen. In 2018, Japanese regulators issued business improvement orders to cryptocurrency exchanges in response to the incident when Coincheck, one of the biggest cryptocurrency exchanges in Japan, lost about $400 million in cryptocurrency. From this episode, we see that regulators can quickly respond to the threats that unfold from new financial technology.

In contrast, some policymakers decide not to regulate cryptocurrency specifically and allow existing laws on commodities or financial instruments to govern the use of cryptocurrency. The regulations compiled by the Global Legal Research Center present several examples. Austria considers cryptocurrency a business asset, classified under other intangible commodities. The Czech Republic similarly considers cryptocurrency a thing, which explains their “liberal approach” to cryptocurrency, essentially neither promoting nor hindering its development as they would in another commodity trading. Australia sees cryptocurrency as assets for capital gains tax. Anguilla treats cryptocurrency that functions as securities to be regulated under the existing securities framework. Meanwhile, some other countries, such as Bermuda and the Bahamas, currently do not have specific regulations on cryptocurrency and are in the process of exploring their regulatory or legislative options.

The risks of cryptocurrency are undisputed, but its policies vary widely. With its increasing presence in financial markets, cryptocurrency cannot be ignored, particularly by policymakers. Policymakers have been vocal about giving warnings, but not all have been active in banning or regulating it. Even the policy choice of no regulation is a policy decision in itself. Policymakers are not prohibiting but essentially allowing people or firms to engage in cryptocurrency transactions at their own risk. In the next section, we discuss how some policy choices or legal frameworks affect policymakers’ attitudes in permitting or regulating cryptocurrency.

The reason why cryptocurrency needs to be regulated 

From the standpoint of investors, cryptocurrency regulation is quite essential. With the right kind of regulations, the government can make the cryptocurrency market a safer environment for investors.

1. Allow select cryptocurrencies

Thousands of cryptocurrencies exist around the world. Most investors, however, are only familiar with a few of those, such as Bitcoin, Ether, Ripple, and Dogecoin, among others. They hardly have any knowledge about the thousands of other virtual assets. So, to protect customers, a regulatory authority clearing cryptocurrency is required, which can disclose all information about the digital assets’ performance, risks, and potential.

2. Prevent market manipulation and protect investors

Market manipulation and price volatility are joint in cryptocurrencies. Take, for example, Bitcoin, the world’s oldest and most popular cryptocurrency, which rose to all-time highs since the beginning of 2021 before plummeting and losing a considerable amount of its value. So, the lack of authorized information on these digital assets and their technological complexities make it imperative to put regulations in place to safeguard investors.

3. Online fraud and cyber security risks

Investing in cryptocurrencies comes with another risk — online fraud. Hacking is a major threat worldwide, and cyber-attacks have become common. One cyber-attack could result in losses for investors who have put their savings in cryptocurrencies. The authorities can implement measures to help cryptocurrency investors protect their assets through regulations. Also, investors can address concerns or reclaim their investments if they lose them.

4. Money laundering

Any unregulated system can fund criminal acts. As a result, a client due diligence process akin to a bank is required. This can help keep track of investors’ real identities and verify their locations when they are buying or selling cryptocurrencies. Any infringement of such norms should be met with severe sanctions.

5. Understanding risks associated with technology

Technology is advancing at a breakneck pace. This carries a significant danger, as such changes can render technology, including blockchain, outdated in the future. Given the rapid technological change, information infrastructure and professional financial advisors skilled in cryptocurrency are required. That way, investors can understand the technical risks of cryptocurrencies and make informed decisions.

Conclusion 

Cryptocurrencies and the underlying blockchain technology are becoming a pervasive force in the global economy, affecting everything from cross-border retail payments to interbank transfers. The growing adoption and decentralized nature of cryptocurrencies pose unique and unprecedented challenges for financial authorities, capital markets regulators, consumer protection and privacy bureaus, and tax authorities worldwide. However, cryptocurrencies also bring opportunities to leverage the internet to provide new digital pathways for individuals and micro-, small and medium-sized enterprises into the global financial system. Further, cryptocurrencies and underlying blockchains contribute a new paradigm for secure data and value transmission, storage, and access. As such, the technological and economic particularities of cryptocurrencies require prudent regulation that accommodates cryptocurrency’s characteristics and use cases.

About the Author

Darren Olayan is a blockchain advocate deeply experienced in the development, promotion, and services. Through both positive and negative experiences, Olayan has become proficient in the vague constantly shifting regulation side of blockchain and spent years advising companies on licensing procedures. Darren is adamant that the NFT technology will change the world of technology and has the potential to level the playing field worldwide.

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