Innovation v regulation: two sides of the same crypto coin

By Paul Kelly

The first and best-known cryptocurrency, Bitcoin, emerged in 2009 but interest in it and alternative digital assets (altcoins) like Ethereum and Tether has recently exploded. Critics of digital money raise concerns about its volatility and call for controls to protect public interest. Cryptocurrency fans view such demands cautiously, claiming strict rules will stifle invention and discourage peer-to-peer transactions. 4,000 cryptocurrencies are currently available in a market worth $1.5 trillion having quadrupled since October. There are 106 million users worldwide, many of whom hope for rapid capital gains due to the asset’s unpredictability. How can we define ‘cryptocurrency’ and what measures are individual governments adopting towards its formal supervision?

Essentially, cryptocurrencies are digital or virtual currencies protected by complicated computer coding so they’re almost impossible to counterfeit or double-spend. Many are decentralised networks based on blockchain, a distributed ledger technology across a network of computers. A key feature is that cryptocurrencies are generally not issued or controlled by a central authority, meaning they’re theoretically resistant to government interference.

The Bank of England has long been critical of cryptocurrencies. Its Chairman, Andrew Bailey, commented at financial trade body TheCityUK’s annual conference earlier in June that work is needed domestically and internationally to thoroughly understand the market and safeguard public interest. Calling for “tough love”, Mr Bailey argued that financial stability could be defended by regulation while still allowing “a robust form of innovation” to thrive. “What we cannot have is a world where innovation gets a free pass to ignore the public interest. The odds of such an approach not ending well are too high.”

Christine Lagarde, President of the European Central Bank, is similarly forthright about the asset’s capacity for involvement in “funny business” and “totally reprehensible money laundering activity.” In a January interview the President asserted “There has to be regulation. This has to be applied and agreed upon… at a global level because if there is an escape that escape will be used.”

There is a disjointed approach to regulation currently. Some countries like Japan have passed legislation recognising cryptocurrencies as legal property and placing them under Financial Services Agency supervision. Conversely, others including India are looking to ban the sector. The Indian government was due to introduce a bill in March that would have made cryptocurrencies illegal.

Moves towards market supervision have been looming for some time, prompted not only by fears cryptocurrencies’ anonymity provides the perfect cover for illegal transactions but also because governments are keen to assert control over crypto assets’ influence on the global economy. Government-issued currencies (fiat money) give central banks power to regulate how much money is printed.

Since May, China has cracked down on cryptocurrency transactions and warned financial institutions against accepting the assets as payment due to their volatility. In a joint statement on the People’s Bank of China WeChat account, banking industry stakeholders said speculative cryptocurrency trading is “seriously infringing on the safety of people’s property and disrupting the normal economic and financial order.” China’s action sent the price of cryptocurrencies plummeting; over six days to June 21st, Bitcoin lost 20%. Some UK retail banks have also suspended transactions towards exchange platforms due to concerns about involvement in financial crimes. Barclays, Monzo and Starling Bank imposed temporary suspensions due to growing numbers of suspicious transactions and will lift them only when confident adequate verifications and checks are in place.

According to an Action Fraud report, £63 million was stolen in 12 months through fake online investments and about 45% of the scams related to cryptocurrencies. The lack of consumer protection deters many, 75% of thirty-something investors saying they’d want a financial safety net before buying.

The Financial Conduct Authority (FCA) began registering all cryptoasset firms in January 2020 and intended to have registration completed by July 2021. Only five companies have successfully registered to date, however, with several dozen still operating under temporary status. 51 have withdrawn their applications after the FCA indicated they were unlikely to grant approval and the deadline has been moved back to March 2022. FCA registration affords only limited protection in any event, regulating cryptocurrency exchanges against money laundering and counter-terrorist financing. Since cryptoassets aren’t specified investments under the Financial Services and Markets Act 2000, investors are not protected by the Financial Ombudsman Service or the Financial Services Compensation Scheme. Author of ‘The CryptoTrader’ Glen Goodman clarifies, “if you invest in the stock market and the trading platform goes bust… you’re eligible for up to £85,000 compensation. If the same thing happens with a crypto platform, you may lose everything.”

In view of the substantial risks involved, industry groups are making a case for the UK’s government and regulators to set global standards to exploit the booming sector and attract business with the certainty of robust rules “while ensuring they don’t inadvertently squash good ideas before they can mature and flourish.” (Miles Celic, chief executive of TheCityUK).