September 5, 2017    8 minute read

Regulating Cryptocurrencies: The Neccessity of Cooperation

Ensuring Stability    September 5, 2017    8 minute read

Regulating Cryptocurrencies: The Neccessity of Cooperation

Cryptocurrency companies and providers sprung out of a rebellion started by Bitcoin to have a decentralised and digital currency, free from any state or central authority interference. Applying the old adage, you catch more flies with honey than with vinegar; the best approach to regulating these currencies is cooperation. Pushing for hard regulations on entities that do not want to be governed will drive the practice underground, a loose example being the prominent rise of moonshiners in Prohibition America.

Increasing Scrutiny

The rise of unregulated ICOs in recent times and the general decentralised nature of cryptocurrency can lend such currencies to nefarious individuals with evil intent, from fraud and misrepresentation to Ponzi schemes and money laundering. The most poignant example is the Silk Road, which was a notorious online black market, renowned as a platform for selling drugs. The site used a combination of technologies, including Bitcoin, to protect the identity of high-value sellers, whereas buyers had to provide a physical shipping address for the services or product.

This meant that should law enforcement officials have infiltrated the site, there was very little chance of identifying sellers. Combined with scandals surrounding OneCoin and the high fraud potential of ICOs, regulators will want to prevent criminals from taking advantage of cryptocurrencies as such currencies gain popularity and become more mainstream.

Highlights: Russia

Recently, the Moscow Exchange announced a commitment to regulating virtual currencies, analysing current markets to help protect investors whilst the Russian Finance Ministry says Bitcoin resembles a pyramid scheme. Deputy Finance Minister Aleksey Moiseev stated that:

‘There is a point of view that cryptocurrencies like Bitcoin are a financial pyramid. It’s hard to argue with this point of view. The investments are very risky.’

However, as previously noted, there appears to be a contradiction between prevailing viewpoints in Russia. On the one hand, voices like the Deputy Finance ministers are calling for stronger regulation of cryptos, with potential investors needing to be qualified (have at least six million rubles on an account, make at least 40 transactions a year with a turnover of six million rubles, or work for at least two years in a financial institution that trades securities) before they can invest.

Yet, on the other, news coming from companies utilising power plants plan to lease excess power to bitcoin miners. Such agreements have the potential to open larger Bitcoin farms, as almost 30% of the cost goes to energy expenses. Following this thread, more reports have revealed that the founder of Ethereum, Vitalik Buterin, is working with Russian-owned development bank Vnesheconombank (VEB) on a new venture titled Ethereum Russia (ER). ER will work with VEB to provide education, events and architecture reviews for VEB, whilst simultaneously supporting the development of a new blockchain research centre at the National University of Science and Technology (MISIS). The creation of this new entity is to ensure the independence of the Ethereum Foundation, allowing the first body to remain ‘pure’ whilst other vehicles cooperate in new ventures.

By working closely with a cryptocurrency, the VEB will be able to learn, develop and implement blockchain, leading to better services for the public and private clients. Whilst Blockchain is relatively a new concept, Russia is ensuring it stays ahead of the game and is throwing weight behind research and development. By openly cooperating with cryptocurrency founders, companies and blockchain users, Russia is defining its place in the cryptosphere. Other partnerships in the private sector include Big Four Deloitte CIS and Russian blockchain solutions firm Waves partnering up to provide ‘comprehensive ICO services.’ Waves is keen to exploit this strategic partnership to shape the crypto-regulatory world. This serves to show that there is potential for cryptocurrency icons to reshape the legislative environment in their image.

Rather than outright banning or levying heavy sanctions against cryptos, Russia is using honey to regulate the market; by encouraging mutual development, cryptocurrencies and companies using such currencies will want to self-regulate and mature, as lucrative business deals can arise on the platform. Self-policing, structuring the currency so that it is harder for criminals to use and developing security strategies all help with legitimacy and securing strong partnerships with state and private institutions who are threatened by the renowned shadow of digital currency. This is not to say that strong legislation is not needed where black market activities are concerned, but tarring all users as criminals is the wrong approach, especially since the market is worth over $160 billion.

SEC and Securities Law

As previously submitted, ICOs pose a threat to investors where a company issues tokens with the promise of delivering a service that is never completed or served. To sell securities, many requirements need to be satisfied before one acquires a licence. With ICOs, the lack of these requirements could open them up to abuse and blockchain could facilitate nefarious intentions. What’s more, the lack of any legal mechanisms leaves companies out in the cold and open to ‘project risks and challenges.’

Primarily, a difficulty with regulation is classification – from a legal view, the contentious point is whether the issuance of tokens is akin to the creation of a new security. If they create a security, they will be regulated as such. A saving grace could be the fact that unlike shares, they do not confer ownership and can, in some instances, still be used as currency. In this way, a backer is purchasing a specific set of tokens, which can then be used on that particular chain to conduct other transactions.

Shares are locked into the company that offered them. Shares do not have utility in this sense, whereas tokens have value outside of comprising an expression of value: that is, they can be exchanged on the chain for other things. However, changing the terminology does not change how the law will interpret it – if the process is similar to an IPO, and the token looks, walks and talks like a share, the regulatory body will regulate ICOs like IPOs, along with all the aspects that are typically included, such as prospectuses, listing requirements, governance objectives and so on.

Rumours have surfaced, as published by The Daily Caller, that Members of Congress are working on legislation that would provide protections to currencies should they satisfy minimum requirements, such as instigating measures on the currency that prevents use by terrorists, drug traffickers, and others engaged in unlawful business practices. Requiring compliance with anti-money laundering policy is not ‘hard’ regulation, but the chance for legitimacy in return will surely persuade cryptocurrency founders to search for stronger and more secure trading.

The Impacts of Stringent Regulation

However, it is not merely cryptocurrencies that are affected by these developments. The underlying technologies, the proposed ideas and the startups seeking funding all perish if harsh or inadequate regulation is levied against the market. To take blockchain as an example, an outright ban would cause prices to drop due to a lack of utility, leading to a loss of funding for projects aimed at harnessing this technology. Moreover, start-ups and companies alike will avoid those jurisdictions as a result of not feeling welcome. This has ramifications for developing the technology, which has implications for Fintech, the legal industry and medicine, to name a few.

Regulation is important to protect all parties involved- not just the investor, but the entrepreneurs too. The Ethereum ecosystem, which has sprouted several other projects- including Golem- could be under threat from tough regulation, should it interfere with ‘business as usual’. Criminals would move from currency to currency to finance their operations, but the slower and more sluggish start-ups, relying on expertise and funding in the ecosystem’ would suffer more. Stunting innovation, slowing growth in technology and causing regression in applications for such technology are all possible effects of poor regulation.

Conclusion

Our traditional understanding of securities, investments, assets and currency must not weigh too heavily on regulators, else they risk destroying some elements of progress. Bitcoin, Blockchain and the rise of digital currency, with borderless, jurisdiction-less transactions have challenged our thinking. Striking a balance is necessary.

It is suggested that regulators seek to work with experts in the crypto-field to provide legal environments to grow and protect advancements in technology, whilst also protecting investors from the potential harms of fraudulent activities. Mounting an attack against black market activities requires a better understanding by law enforcement of digital currencies, as well as cooperation from founders and miners as to how to root out these individuals. Offering security and legitimacy to founders in return for complying with anti-money laundering policies is a good start.

 

 

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