Crypto Regulation Needs to Strike a Balance

India has become the latest country to clamp down on the trading of increasingly popular cryptocurrencies amid mounting international concern over their exploitation by criminals and potential impact on monetary policy. But while the misuse of these digital assets needs to be curbed, there’s concern that excessive regulation could undermine the sector’s decentralised appeal and curb innovation.

India indicated this month that it plans to ban most cryptocurrencies, apparently making way for an official digital currency. In September,  China’s central bank outlawed all virtual coin transactions. Other countries, such as Turkey, Algeria, Indonesia and Vietnam, have also imposed bans and restrictions, while the European Union and the US are moving towards tighter regulation of the sector, whose global value is estimated to be over 2 trillion dollars. The need for greater checks and balances was recently underlined by the chair of America’s financial regulator, the Securities and Exchange Commission, who likened the cryptocurrency market to the ‘Wild West’.

Cryptocurrency use has soared in recent years.  Essentially digital currencies independent of banks and largely free of regulatory oversight, they can be traded and used to purchase and invest, with low transaction costs. Transactions are recorded anonymously on secure, publicly accessible digital databases called blockchains, obviating the need for intermediaries. There are now around 4,000  different virtual coins in circulation – Bitcoin, created in 2009, the oldest and best-known.

They have been billed by their proponents as the future of finance. Over a hundred million people globally are now believed to be employ them, offering clear advantages for the ‘unbanked’, those who don’t use, or are unable to use, conventional financial services. Indeed, there are signs of rising demand in some developing countries, especially regions of conflict, where banking provision can be limited and local currencies weak and prone to plunge in value. Earlier this year, El Salvador became the first country in the world to adopt Bitcoin as legal tender. And a number of other states have either launched digital currencies or are currently piloting them.

But the decentralised appeal of cryptocurrencies is being increasingly exploited by criminals and countries subject to sanctions because they can carry out transactions anonymously, making them difficult to track. The scale of illicit use was brought into sharp relief this month when America’s Internal Revenue Service revealed that in the last financial year 93 per cent of the assets it seized were cryptocurrencies, with a value of $3.5 billion. The haul was linked to a range of crimes, including tax and wire fraud, money laundering and illegal drugs distribution.

In a further alarming development, cybercriminals are demanding payment in digital coins in surging ransomware attacks, the availability of the former actually fueling the latter, some experts suggest. And there is mounting evidence that internationally-isolated Iran and North Korea employ cryptocurrencies to evade sanctions – Pyongyang accused by the UN of stealing more than $300 million dollars’ worth of virtual coins in recent years.

At the same time, countries are concerned that should cryptocurrency use continue to grow at pace and vie with real money, central banks may struggle to determine and enforce monetary policy. In China, for instance, citizens have employed digital assets to circumvent the country’s strict capital controls. Central banks are particularly concerned about cryptocurrencies called stablecoins whose value is fixed to national currencies or commodities. Widely used, in part because they don’t suffer from the price volatility of many of their rivals, stablecoins may in future be subject to ‘runs’ if users lose confidence in them, potentially destabilising financial systems. Another worry is that the galloping value of unbacked cryptocurrencies has all the hallmarks of a speculative bubble that could eventually burst with serious economic consequences.

While even digital asset enthusiasts would be hard pressed to argue against the need for a degree of regulatory reform of a sector whose integrity is being called into question and placed under scrutiny, there is clearly a risk of throwing the baby out with the bathwater. Some regulation, perhaps aimed at combating financial crime and promoting consumer protection, would help address negative perceptions and risks around virtual coins and, in so doing, ease public scepticism and encourage widespread adoption. Too much intervention, though, could lessen their appeal, especially if further jurisdictions choose to ban them.

Governments around the world will need to strike a regulatory balance. As keen as some officials are to exert control over the market, they must guard against overzealousness as this will threaten cryptocurrencies’ selling point as a decentralised, borderless means of payment and investment. Heavy-handedness might also put a squeeze on innovation in the sector, as the latitude it has so far enjoyed has helped to encourage enterprise and provide the scope to disrupt the financial industry, creating new jobs and fostering financial inclusion. Worse still, tough regulation could simply prompt industry players to shift their operations to regulation-lite jurisdictions.

Authorities around the world are weighing these considerations as they decide how to address the challenges thrown up by the cryptocurrency boom. With the sector seemingly having just as many pros as cons, reaching agreement over courses of action will not be easy.



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