Crypto-assets pervade modern society, but interest from the public has been matched with concerns over their interplay with the global financial market and their sustainability, thus prompting repeated calls for regulatory scrutiny [1]. A 2020 study by the UK’s Financial Conduct Authority (FCA) showed that 78% of respondents had heard of Bitcoin, while one in 20 Britons have at some point owned digital coins. The continued rise and increased availability of crypto-assets have widened the debate on how to regulate them, with some jurisdictions opting for an outright ban.
Without advocating for any specific regulatory approach, this article makes a case for regulating crypto-assets in a more balanced way and explains how that can be achieved.
The problem with prohibition
Many nations have enacted tough legislation to prevent trading, buying, or owning cryptocurrencies. In April 2021 the Central Bank of Turkey announced a ban on cryptocurrency payments, claiming that they were 'neither subject to any regulation and supervision mechanisms nor a central regulatory authority’. Similar rules have also been proposed in India, where a ban on private cryptocurrencies is due to be considered by politicians in the coming months.
A comparable picture can be seen across Egypt, Nigeria, Bolivia, Ecuador, Algeria, and Nepal, but it is not clear whether these restrictions can stand up to the test of time. As public interest in cryptocurrencies continues to grow, participation in the future of digital money is sure to become a major concern for global governments. The Bank for International Settlements (BIS) has recently highlighted the importance of Digital Currencies for economic development, and regulators advocating for a ban on cryptocurrency have been compared to early critics of the internet.
The need for effective regulation
As global interest grows, some regulators have viewed cryptocurrencies through the same lens as they would other securities. Statements from the US Securities and Exchange Commission (SEC) make clear their stance that initial coin offerings (ICOs) should fall under securities registration laws, while research from the Cato Institute decries this approach as needlessly onerous.
Notably, some regulatory bodies are willing to consider a more liberal approach to the regulation of crypto. The US Office of the Comptroller of the Currency (part of the Treasury Department) has publicly voiced support for digital currencies, backing calls for the development of a regulatory framework.
Building and applying a framework
Regardless of how regulators choose to tackle the topic, it is clear that well thought out regulation in some form is needed. With many retail investors now trading cryptocurrencies as they would stocks, measures are needed to protect individuals, safeguard the integrity of the markets, and combat illegal activity. There is also a demonstrable need for oversight of cryptocurrency exchanges which show an alarming lack of accountability.
To date, more restrictive jurisdictions have attempted to address these key concerns through direct regulation. Viewing cryptocurrency as if it were any other financial instrument, they have sought to regulate the code, protocol, developers, design features, wallet providers, and users.
While this centralised approach to controlling crypto-assets is arguably incompatible with the decentralised nature of the underlying distributed ledger technology, it is worth noting that the networks may still be subject to a degree of control from developers and other parties. Nonetheless, the various bans on cryptocurrency have illustrated that a blanket prohibition is not only costly to enforce, but also highly impractical given the largely intangible nature of crypto-assets. Evidently, what is needed is a more balanced and flexible way forward that properly takes into account the complicated aspects of the crypto-infrastructure. Alongside other measures, this could incorporate one or both of the following:
1. Building common understanding and legal frameworks
In line with the views of the US Office of the Comptroller of the Currency, the development of common standards could guide future regulation. The treatment of crypto-assets should be differentiated based on their core characteristics, and regulators applying existing frameworks for registered securities to this new class of assets , without reviewing their suitability, may prove troublesome.
Rather than prescribing a single ‘catch-all’ policy approach, a recent London School of Economics (LSE) paper by Ousmene Mandeng proposed five key areas of focus that should be developed to promote innovation alongside adequate regulation:
· Constructive engagement
· Classification
· Consumer protection
· Cryptography and technology
· Constancy
The ‘5 Cs’ are intended to create a unified framework, allowing the authorities to effectively regulate cryptocurrencies from a position of common understanding. An agreement to develop and abide by these principles could facilitate the harmonisation of governing standards and create a platform from which to build a stronger body of regulations.
2. Decentralised, indirect regulation
Additionally, it may be that indirect regulation of cryptocurrencies is more effective than the current direct approach. In his paper on the subject, Hossein Nabilou argues for regulatory measures that focus on cryptocurrency exchanges rather than individual currency owners, users, and traders.
Indeed, businesses that facilitate the trade in cryptocurrency occupy the upper application layers of the blockchain. These layers and the business models built upon them introduce a degree of centralisation and so it becomes easier for regulators to apply common standards that could protect individuals, maintain the integrity of the markets, and monitor for criminal activity.
A better way forward for cryptocurrency regulation
As crypto-assets gain further traction amongst institutional and retail investors, many sceptics (and some regulators) have so far treated it as a passing fad. Prohibiting the trade and use of this emerging asset class is counterproductive since doing so may stifle desirable innovation. Effective regulation, on the other hand, may increase market confidence and promote wider adoption of crypto-assets by consumers. This in turn could itself support and encourage innovation within the legal framework.
As with any new area of financial or technological development, striking the appropriate regulatory balance remains difficult. There is no clear answer as to how crypto-assets should be regulated, but the strategies proposed in this article could help to shape a constructive approach. that protects investors, tackles crime, and stabilises the markets. Before any of that can happen, regulators must engage with businesses and experts to devise a framework that could inform and support their efforts.
With expert legal knowledge and technological proficiency, Blockchain Legal Consultancy can provide guidance and support to businesses and international regulators alike. For more information, please contact our team by emailing info@blockchainlegalconsultancy.co.uk.
[1] Depending on the underlying technology and functionality, crypto-assets consist of a variety of different tokens and coins.