Cryptocurrency and The Current Challenges Facing The Market

Cryptocurrency is digital money[1]. It uses cryptography, the process of converting information into code, as security to establish the authenticity of each transaction[2]. There are different cryptocurrencies in the market but they all possess four characteristics. Cryptocurrency is decentralised. Everyday currencies, such as the pound or the dollar, are controlled by governments or regulatory bodies. Their creation and valuation can be regulated by these entities[3]. Cryptocurrency is different. Its creation and transactions rely on a peer-to-peer network and are then confirmed in a public ledger, available to all users[4]. There is no single entity issuing, guarantying or affecting cryptocurrency. Therefore, it is the pure supply-demand relationship of the cryptocurrency that governs its valuation.

Cryptocurrency is transparent and anonymous. All transactions, from day one of the creation of the cryptocurrency, is stored in a public ledger[5]. For privacy reasons, the public record does not show any of the parties’ details but only their cryptographic signatures or hash. This permits identification while maintaining anonymity[6]. Cryptocurrency is hard to duplicate or counterfeit due to its being based on cryptography and protocols using advanced mathematics and computer engineering[7]. Cryptocurrency is a cheap alternative to using financial institutions[8]. It removes the need for a third party acting as intermediary since the transfers are made directly between parties, thereby avoiding fees for transactions.

Challenges

Cryptocurrency raises a number of challenges for regulators at a national and international level that are mainly due to its issuance and operation. It is a self-managed system emitting units of value independently while acting as both a method of payment and a means of custody[9]. This makes regulation extremely complex because each of these functions are currently performed by different entities in our society[10]. Effective regulation, therefore, requires large amount of time, personnel, infrastructure and international cooperation in order to be put into place[11]. The challenge of regulators is threefold.

First, cryptocurrencies differ from one another and are used differently. Ripple is a cross-border payment software aimed at the financial markets[12] while Bitcoin is used as an alternative to everyday currencies[13]. Meanwhile, Ethereum is a ledger technology that companies use to create new programs and smart contracts via its own currency[14]. It is more than just a currency unlike Bitcoin[15]. This variety in cryptocurrencies complicates the regulation of cryptocurrency as a whole.

Second, regulators face the challenge of lack of resources. In many countries the resources required for regulating cryptocurrency require a justification to taxpayers and there are currently more urgent problems to be resolved in society[16]. For instance, in September 2017, European Union customs officials raised concerns over the “lack sufficient resources” to monitor virtual currencies[17]. Consequently, this lack of resources leads to cryptocurrencies being dealt with on a cases-by-case basis rather than complete effective regulation[18].

Finally, the most complex aspects of regulating cryptocurrency are the multiple aspects of the currency itself. To avoid money laundering, regulators would need to focus on anonymity, while concerns about governance would require asking whether assets were potentially vulnerable to asymmetric information, theft or fraud. If it’s a ledger, the regulator would focus on reporting requirements or transparency.

Cryptocurrency’s associated risks and mitigation

As cryptocurrency can be converted into everyday money anonymously and cryptocurrency accounts cannot be seized or examined, it may be used for illegal purposes[19]. First, as virtual and decentralised money, cryptocurrency is hugely used in black markets, money laundering and other illegal activities. Bitcoin is used on the Dark Web to purchase and sell drugs, weapons and other illicit goods[20]. Cryptocurrency is also the means of choice for perpetrators of ransomware. For example, TalkTalk received a ransom demand for £80,000 in bitcoin in 2015[21]. Meanwhile in early 2016, the Dutch police arrested 10 people over bitcoin money-laundering allegations valued at 22 millions of dollars[22].

Second, cryptocurrency is an appealing option for tax evasion as it is not controlled by governments. Tax laws and regulations vary from one country to another and many do not yet have policies on cryptocurrency[23]. As such, salaries and sales paid in cryptocurrency could be used to avoid income tax liability as there is no agreement on whether these should be included in gross income or treated as capital gains[24].

Finally, there are concerns that cryptocurrency is or could be used for terror financing. In early 2017, the Indonesian government anti-terrorist entity alleged publicly that Bahrun Naim, a member of ISIS, sent Bitcoin to other members across Indonesia using Paypal[25]. According to The Royal United Services Institute, the threat of terrorist financing via cryptocurrencies is a risk that could grow in the future, but for the time being there are only limited available proof of terrorists’ use of cryptocurrencies[26].

References

[1] https://www.investopedia.com/terms/c/cryptocurrency.asp

[2] https://idsa.in/specialfeature/cryptocurrencies-and-the-regulators-dilemma_msharma_010817

[3] http://www.independent.co.uk/news/business/news/bitcoin-what-is-cryptocurrency-where-use-investment-dark-web-illegal-explained-value-exchange-rate-a8082491.html

[4] https://idsa.in/specialfeature/cryptocurrencies-and-the-regulators-dilemma_msharma_010817

[5] https://www.law.com/sites/almstaff/2017/11/07/new-wave-legal-challenges-for-bitcoin-and-other-cryptocurrencies/?slreturn=20180019072623

[6] https://idsa.in/specialfeature/cryptocurrencies-and-the-regulators-dilemma_msharma_010817

[7] https://www.express.co.uk/finance/city/905619/Cryptocurrency-what-is-bitcoin-ripple-ethereum-should-I-buy

[8] https://www.law.com/sites/almstaff/2017/11/07/new-wave-legal-challenges-for-bitcoin-and-other-cryptocurrencies/?slreturn=20180019072623

[9] https://www.uncitral.org/pdf/english/congress/Papers_for_Congress/29-DOLES_SILVA-Cryptocurrencies_and_International_Regulation.pdf

[10] https://www.bloomberg.com/news/articles/2017-10-11/global-regulators-play-bitcoin-whack-a-mole-as-demand-explodes