The complex issue of cryptocurrency regulation

(Zach Copley, CC BY-SA)

Along with the development of the cryptocurrency market there is a growing interest in this area among legislators and regulators, but the adopted approach varies between individual countries.

The internet technology that enables the use of virtual currencies as means of payment is a network with a peer-to-peer architecture, that is a fully distributed network, without a central unit controlling it. Such currency competes with traditional banks, which are also looking for a way to use it for their own needs.

Many global supervisory and regulatory institutions have a rather skeptical view of digital currencies. Public entities, including central banks and financial supervisory authorities, are issuing warnings against cryptocurrencies, emphasizing, among others, their speculative nature, and the possibility that they may be functioning in a manner similar to pyramid schemes (e.g. the Reserve Bank of India, the Bank of Russia, and in Poland both central bank NBP and the Polish Financial Supervision Authority). Many central banks are also conducting research on cryptocurrencies – these include the Bank of England, the Bank of the Netherlands, the People’s Bank of China, and the Bank of Japan.

It can be expected that in the near future trade in virtual currencies will become somewhat formalized and supervised. Such a direction has been adopted, among others, by China, Japan, the United States, as well as the EU.

The regulation of cryptocurrencies primarily involves combating their possible use for the purposes of criminal activity, which is why they are being covered by regulations relating to money laundering and financing of terrorism. Regulations concerning digital currencies will also seek ensuring a greater degree of protection for the consumers and investors active on this market, for example, through the imposition of disclosure obligations on the companies operating in this industry.

In September 2017, the Chinese authorities surprised the financial markets by introducing significant restrictions on cryptocurrencies. This resulted in a temporary crash in the prices of bitcoin and other digital currencies. Just a few months before that, in May 2017, the People’s Bank of China and other Chinese regulatory authorities claimed in a joint statement that initial coin offerings were seen as related to criminal activity, such as the illegal issuing of securities, financial fraud and pyramid schemes.

Nevertheless, China still remains a center of innovation in the field of financial technologies, and the issuance of the statement, as well as the introduction of the restrictions on digital currencies, were interpreted by the market as only a temporary speed bump in the development of this sector.

During the same period, the Japanese adopted a completely different approach with respect to virtual currencies – Japanese regulators approved 11 cryptocurrency exchanges as part of a program aimed at building Japan’s position as the most cryptocurrency-friendly country (the cryptocurrency exchanges enable their clients to convert bitcoins and other cryptocurrencies into standard currencies and vice versa). Additionally, in May 2017 virtual currency legislation was passed in Japan, which was interpreted as a sign of confidence in the growing cryptocurrency sector. Several days later, the Japanese company Bic Camera announced that it would launch a pilot program involving accepting bitcoin payments in several of its stores. The legislation also introduced the requirement for cryptocurrency exchange operators to register at the Japanese Financial Services Agency.

According to representatives of the digital currencies market, regulatory activities should take into account the strong innovation potential of both cryptocurrencies and blockchain technologies, as well as the fact that this market is still in the early stage of development. These regulatory activities should also be coordinated with measures aimed at supporting innovation, including financial innovation.

Enthusiasts of digital currencies warn against regulations that could restrict legal business activities and inhibit the development of innovation. After all, one of the factors underlying the existence of cryptocurrencies was the desire to create decentralized monetary structures.

Due to the fact that the determinants of functioning of the electronic money sector may change rapidly – as exemplified by the division of the bitcoin currency into two branches, bitcoin and bitcoin cash, which occurred in August 2017 – any effective regulatory systems have to quickly and efficiently respond to the changing market conditions. Some of the cryptocurrencies offer their users greater anonymity than bitcoin, which increases the risk of illegal transactions. One good example is the collapse of the Tokyo-based Mt. Gox bitcoin exchange, which lost bitcoins worth USD473m in circumstances that are yet to be explained (only part of bitcoins were later recovered).

The quickly changing market conditions and the rapid development and increasingly common use of virtual currencies mean that proper regulation of this sector requires regulators’ cooperation with the representatives of the industry, maintaining a dialogue with the regulatory authorities in other countries, as well as clear strategies of passing the information concerning potential threats to the general public.

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