Since the creation of the Mesopotamian shekel, the first known currency minted 5,000 years ago, some medium for exchanging goods and services has existed. People like money so much that our world revolves around its creation and exchange.
In 2008, a new currency entered the financial lexicon. This innovation in monetary exchange was based on a paper written by the infamous and enigmatic Satoshi Nakamoto entitled Bitcoin: A Peer-to-Peer Electronic Cash System.
Since then, over 2,000 cryptocurrencies have entered the financial marketplace. The value of these decentralized currencies topped $3 trillion in 2021, although it has fallen recently to $1.3 trillion and remains volatile. As well as being an unstable currency, some people have described the cryptocurrency security landscape as ‘the wild west.’
There are regulatory rails in place to secure and manage the threats to centralized finance; but the question is, can cryptocurrency be regulated using the same (or similar) rules?
Why have decentralized currencies?
Cryptocurrency was designed to remove key challenges of trust during electronic payments. The system proposed in the Nakamoto paper is designed around ‘cryptographic proof’ that eliminates the need for centralized financial institutions. This decentralized system allows the individual to act, in effect, as their own ‘bank’. As Nakamoto concludes, “We have proposed a system for electronic transactions without relying on trust.”
Sounds great. But since then, cybercriminals have hijacked bitcoin and other cryptocurrencies. A Europol study into nefarious uses of cryptocurrencies points to the growing use of crypto for fraud and cybercrime.
The report says, “Recent years have seen cryptocurrency increasingly used as part of criminal activities, to launder criminal proceeds and avoid sanctions. Criminals have also become more sophisticated in their use of cryptocurrencies. In addition to using cryptocurrencies to obfuscate money flows as part of increasingly complex money laundering schemes, cryptocurrencies are increasingly used by criminals as a means of payment or as an investment fraud currency.”
Cryptocurrency is a perfect medium for a variety of scams. For example, the recent OneCoin Ponzi scheme saw investors defrauded, collectively losing over $4 billion.
A lack of regulation controlling cryptocurrency allows scams such as OneCoin to proliferate. However, the tide is turning, and regulators are beginning to address cryptocurrencies and the decentralized crypto exchanges (DeFi) platforms used to manage crypto transactions.
Controlling the uncontrolled
The current regulatory controls on cryptocurrency are nascent at best and non-existent at worst. However, a recent Executive Order signed by President Biden earlier this year on “Ensuring Responsible Development of Digital Assets,” may set the regulatory wheels in motion in the USA. The driver for this appears to be the explosive market cap for cryptocurrencies of $3 trillion in 2021, with over 40 million North American investors leading the way.
The Executive Order on cryptocurrencies attempts to direct the Securities and Exchange Commission (SEC), FinCEN5, the Federal Reserve Board, and the Commodity Futures Trading Commission (CFTC) to regulate cryptocurrencies and exchanges. Each has issued guidance; for example, the SEC announced in April 2022 that it is working on initiatives covering platforms, stablecoins, and crypto tokens. In addition, the SEC expects to register and regulate crypto exchanges and focus on asset custody to minimize investor risk.
Regulations that control cryptocurrencies are beginning to form in other parts of the world too.
Brazil has over 10 million crypto-investors and is building a ‘regulatory sandbox.’ Regulators are taxing the crypto platforms, declaring that bitcoin is an asset to control transactions and achieve visibility and governance insights. The Brazilian Securities and Exchange Commission (CVM) has the power to approve crypto exchange platforms.
In addition, Brazil intends to extend existing AML (Anti-Money Laundering) laws to virtual currencies. A new bill to regulate cryptocurrencies will be put in front of Brazilian lawmakers and regulators.
The UK’s Financial Conduct Authority (FCA), H.M. Treasury, and the Bank of England formed a Crypto-assets Taskforce in 2018. The UK is already developing a regulatory framework around cryptocurrencies, with the FCA covering KYC, AML, and CFT (Know Your Customer, Anti-Money Laundering, Countering Financing of Terrorism) designed explicitly for crypto assets. Also, crypto exchanges must register with the FCA unless they have an e-money license.
In the UEA, transaction values in cryptocurrencies are around $26 billion each year, with the Middle East now one of the fastest growing crypto-markets in the world. The Dubai Financial Services Authority (DFSA) has added a crypto regulatory framework to its roadmap. A DFSA consultation paper seeks advice from the financial sector and the wider investment community on the type of regulatory framework needed for crypto tokens relevant to the market.
The challenges of regulating cryptocurrencies
The World Economic Forum (WEF) Digital Currency Governance Consortium has over 80 organizations working on developing global standards and regulations in the crypto space. Regulation targets are a vital area of the work carried out by the consortium.
Also, 91 countries, to date, are exploring or have issued a Central Bank Digital Currency (CBDC). These are a cryptocurrency backed by a central, state-sponsored bank. Plans to legitimize crypto by creating CBDCs are likely to see these currencies come under the same controls and regulations as centralized currencies.
However, applying rules, such as AML/CFT checks, across the multitude of crypto-exchanges will require regulation at the interface level, e.g., the crypto-exchange, and to capture transactions and cross-jurisdiction controls governance.
Still, the nature of crypto-currency is to have complete autonomy from the broader financial landscape. This makes regulation complex and potentially circumventable. A paper from the U.S. Attorney General’s Cyber Digital Task Force says this on the matter:
“Even properly registered exchanges can serve as a haven for criminal activity by operating under lax rules or by flouting AML protocols. In the normal course, registered exchanges that comply with AML standards and “know your customer” (“KYC”) requirements are likely to possess relevant transactional information. However, exchanges that avoid compliance with such requirements provide criminals and terrorists with opportunities to hide their illicit financial activity from regulators and investigators.”
The paper states that international cooperation on the regulation and registration of crypto exchanges is needed if the world is to have any control over the use of these exchanges for nefarious deeds.
A united effort
Cryptocurrency is unlikely to disappear from the currency map. However, the regulation of cryptocurrencies and exchanges is not likely to be straightforward simply because of the decentralized nature of its design. Work is taking place worldwide to achieve control, with regulators developing frameworks.
The technology to perform AML/CFT on crypto exchanges is available. However, for regulations to bite, a global coming together of authorities and appetite for regulation is needed. Only by a collective effort can the world ensure that crypto does not become a domain only for the cybercriminal.