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Risks and Regulations

Diego Zuluaga talks about the reality of perceived risks of cryptocurrency: criminality, investment fraud, and disruption of global finance.
<v ->My name is Diego Zuluaga</v> and I’m a principal at Fingleton, a boutique consultancy in London. The challenge of cryptocurrencies with regard to regulation is how to regulate something, that is under no specific individual’s control. As we mentioned earlier, the key innovation of cryptocurrencies is that they have no central counterparty, no intermediary, no central owner that manages the whole system. Instead, all of the users in the system are involved in validating transactions, pushing them through and making the system work. Normally regulation targets the owner of a system but in the case of cryptocurrencies, that poses a challenge. Now, regulators around the world have attempted to regulate cryptocurrencies with mixed success.
Although some jurisdictions are considered to lead with respect to others. In terms of the regulatory challenges that cryptocurrencies face, there are three particular issues that are of significant importance. The first one is whether cryptocurrencies could be used for financial crime. The second issue is whether crypto could be used to defraud investors or at least to expose them to losses that they couldn’t afford. The third issue is where the cryptocurrencies could disrupt monetary and financial stability and have wider negative impacts on the economy. Let’s treat each of these in turn. In terms of financial crime, policymakers are worried about the ability of terrorists and other criminals to use the financial system to fund their activities.
In general, they seek to guard against this risk by imposing strict monitoring requirements on banks, stockbrokers, and other financial intermediaries. But because cryptocurrencies are under no one’s control, theoretically a user could transfer crypto funds without being subject to these controls, since there will be no third party that had to report those transactions to the regulator. However, the Blockchain, the ledger of all crypto transactions is public and even though the way it records transactions is pseudonymous, it is still visible to everyone which makes it near impossible to conceal transactions from the authorities because the authorities have the ability to find out who the individuals responsible for individual transactions were.
In addition, most people transacting in crypto, don’t do so directly accessing the ledger themselves and holding funds independently of third parties. Most crypto users do so via intermediaries. They use exchanges, they use digital wallets and those intermediaries do report to the financial authorities. So they are subject to the same regulations as ordinary financial intermediaries. As a result, crypto is in practice much more transparent and therefore much less attractive to criminals than cash, which is the preferred method for financial crime traditionally, because it is anonymous and it can be used without trace. The second issue that policymakers worry about is fraud and investment risk.
Now we all know, especially in the last few years that many individuals whether they know a lot about crypto or not are attracted to it, by hyperbolic reports of its future and by the prospect of high returns in the short term. However, cryptocurrencies have historically been extremely volatile. Just in the last year, the price of Bitcoin, the most popular cryptocurrency has fluctuated between $5,500 and 55,000 a piece. It is currently a little below that value at the time of recording. Now, countries usually have intricate rules about who can invest in different kinds of assets.
And the idea is not only to make sure that investors are well-informed about the risks of investment, but that they’re not exposed to losses that could bankrupt them. Whether these rules are fit for purpose and whether their motivation is sound is not a question I’ll address here, but it is undeniable that there has been a great deal of debate around whether and how these protection should apply to cryptocurrencies. In the USA, the Securities and Exchange Commission, the watchdog up for US stock markets has launched proceedings against several individuals who launched what purported to be crypto projects, but turned out to be scams that only sought to runaway with customer funds.
The SEC has also sued some firms that operated fully illegally but issued cryptocurrencies which the SEC believes are securities and therefore subject to regulation that these issuers hadn’t complied with. The US approach has prompted criticism, as excessively protective and creating uncertainty for innovators and for keeping investors out of potentially profitable opportunities. Unlike the USA, other jurisdictions such as Singapore, Switzerland and the UK have sought to strike a balance between investor protection and regulation. The way they’ve done this is by defining individual cryptocurrencies as typically one of three types. Payment tokens, security tokens and utility tokens. The idea is that depending on their characteristics individual cryptocurrencies should be subject to different regulations.
Bitcoin, for example, typically meets the definition of a payment token and therefore it is subject to the money laundering and financial crime regulations described earlier, but not to securities market regulations like ordinary shares. Other cryptocurrencies might meet the definition of a security token if they’re mainly aimed at investing in a new firm and yet other cryptocurrencies because they mainly serve to exchange goods and services on a platform qualify as utility tokens and therefore deserve less regulation than most other cryptocurrencies. The third issue policymakers are trying to deal with is the impact of cryptocurrencies on monetary and financial stability. Bitcoin builds itself as quote peer-to-peer electronic cash.
And indeed many Bitcoin supporters believe that Bitcoin will eventually displace currencies like the US dollar and the Euro as the leading medium of exchange in many countries. In fact, cryptocurrencies as of now, even Bitcoin which is the most popular are too small in size and too limited in their adoption to pose a meaningful challenge to central banks in the leading economies. It is true that there’s been some adoption of cryptocurrencies as media of exchange in unstable countries, such as Venezuela. Which due to rampant inflation and capital controls have little resort to stable money, whether their own which is very unstable and depreciating very rapidly or the US dollar, which is inaccessible because of capital controls.
In those countries, Bitcoin has proved a comparatively attractive medium of exchange and has been adopted by some people as such. But in general, this is a fringe case and not representative of the larger economies.
In fact, what policymakers are increasingly worried about is not so much the impact of cryptocurrencies like Bitcoin on monetary and financial stability, but of private digital currencies that might be issued by a large technology firm or another type of large player. Using some crypto technology but not really operating under the leading principle of cryptocurrencies which is that there is no intermediary. But which nonetheless, might prove very attractive because they’re aimed at financial inclusion and they operate cross border. In response, some countries are pursuing digital cash projects. What are called central bank digital currencies of their own. And these would involve individuals being able to hold accounts directly with the central bank.
The central bank here being the chief intermediary for individuals. The Fed in the States, the ECB in Europe and the Bank of England are among the institutions that are pursuing these projects. So far they’re at an early stage, but there’s no doubt that as cryptocurrencies continue to develop and as private digital currencies also continue to develop, central banks will be more and more interested in coming up with projects of their own so that they can stay at the forefront of innovation and not be challenged by private parties.

In this video, Diego Zuluaga, Principal at Fingleton, weighs in on some of the purported risks related to Bitcoin and other cryptocurrency and whether regulation offers solutions.

In the last video, you learned how the United States regulates cryptocurrency assets on a federal level. Countries such as Singapore, Switzerland, and the United Kingdom aim to mitigate risk to investors by classifying tokens as payment tokens, security tokens, and utility tokens, and regulating them accordingly.

Diego also talks about the potential of cryptocurrencies to disrupt global financial stability, which would require widespread adoption as a medium of exchange. At this time, no cryptocurrency – even Bitcoin – has enough adoption to impact central banks in leading countries. However, it is being adopted in some countries with very unstable economies.

Discussion: Diego notes that one reason cryptocurrency does not pose a threat to global economies is that it does not have significant adoption. Do you believe we will see widespread adoption of cryptocurrency as a medium of exchange and, if so, when? What factors do you think will impact adoption?

Optional: Read more about how open and public cryptocurrencies can offer some Venezuelans relief from hyperinflation and authoritarian monetary policies.

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Cryptocurrency: Beyond Bitcoin Teach-Out

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