State of the Virtual World: International Regulation of Cryptocurrencies
The rapid rise of cryptocurrencies has created an uneven but evolving regulatory environment around the globe. Government responses to crypto-economy developments have varied from instituting complete bans, drafting legislation to regulate and facilitate transactions, to exploring state-backed cryptocurrencies. The following outlines some governmental efforts to address new challenges posed by cryptocurrencies.
State Efforts to Ban Cryptocurrencies
Some countries have taken the approach of banning or declining to provide regulatory protections to cryptocurrency investors.
China has adopted strict measures to block trading in cryptocurrencies. Last fall, the government demanded Chinese Bitcoin exchanges and trading platforms halt all services. After the domestic ban, however, investors began using international platforms to complete transactions. Now, Chinese regulators are taking steps to remove access to onshore and offshore platforms related to cryptocurrency trading or initial coin offerings (ICOs). The ban in China sent many traders to the Japanese exchange market.
Nigeria’s Central Bank banned the use of virtual currencies in January 2017. The Central Bank warned in a circular that the money laundering and terrorism financing risks posed by virtual currencies necessitated the ban, largely because the transactions were untraceable and anonymous. However, just months later, the Deputy Director of the Central Bank of Nigeria’s Banking and Payments System, Musa Itopa-Jimoh, explained that the Central Bank has no plan to stop bitcoin usage. “We are not the issuing authority for bitcoin. It’s not our currency. We do not control it. We don’t issue it, we don’t control it.” If Nigerians decide to trade or use cryptocurrencies, Mr. Itopa-Jimoh explained the Central Bank would not provide consumer protection because Bitcoin “is not within our control.” Underscoring the need for a cooperative effort to regulate virtual currencies, he asked “how can the Central Bank of Nigeria, not central bank of the world, stop the running and implementation of bitcoin?”
Nepal, Bolivia, and Ecuador have banned virtual currencies. Algeria is currently considering whether to make owning and trading in cryptocurrencies illegal.
States Permitting Regulated Cryptocurrency Growth
Many states have accepted cryptocurrencies as part of the global financial market. While most countries have recognized the inherent money laundering, terrorism financing, and fraud risks in virtual currencies, economic leaders like the United States and the European Union are actively developing regulatory strategies to mitigate such risks, while permitting the growth of cryptocurrencies. If virtual currencies cannot be regulated by existing frameworks that govern money laundering and terrorism financing, states are exploring creating new regulatory schemes.
US regulatory policy reflects its longstanding concerns regarding illicit activities, including money laundering, funding of terrorism, tax evasion, and fraud. US Treasury Secretary Steve Mnuchin has stated that the US government considers cryptocurrency exchanges to be subject to the same regulations as banks.
Nonetheless, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) held a dedicated hearing on how to address virtual currencies on February 6, 2018. The financial regulators discussed their oversight role in virtual currencies and suggested Congress may need to grant them new powers in order to adequately protect consumers from fraud on virtual currency exchanges.
The SEC is already devoting significant resources to the initial coin offering market. At the end of January 2018, the SEC obtained a court order to halt an initial coin offering. In an article in the Wall Street Journal, the SEC chairman and chairman of the CFTC explained “[t]he CFTC and SEC, along with other federal and state regulators and criminal authorities, will continue to work together to bring transparency and integrity to these markets and, importantly, to deter and prosecute fraud and abuse.” Because the markets are new and international, they require regulators “to be nimble and forward-looking.” Since the beginning of 2018, the SEC and CFTC have filed lawsuits, initiated investigations, and issued warnings to investors regarding cryptocurrencies. Both regulators have emphasized their support of increased oversight by the US government into the virtual currency market. Domestic state regulators have also shown an interest in overseeing cryptocurrencies.
On April 1, 2017, Japan’s Payment Services Act was amended to allow “virtual currencies” as a legal form of payment. The Japanese government also required cryptocurrency exchange operators to register with the government. After Chinese cryptocurrency exchanges were shut down by the Chinese government, the Japanese crypto-exchange market surged, suggesting many Chinese-based traders simply moved their activities to Japan, which is currently the largest cryptocurrency exchange market in the world.
The increase in trading volume in Japan underscores the concern many regulators share about international cooperation. At the beginning of 2018, the Korean Financial Services Commission met with its Japanese and Chinese counterparts to discuss oversight of investments in virtual currencies. The chairman of the Financial Services Commission noted South Korea hoped to establish a “detailed system of cooperation” with China and Japan.
At the end of January 2018, Japan’s Financial Services Agency (FSA) conducted a spot inspection on Coincheck, Inc.—its first raid on a cryptocurrency exchange—after hackers stole approximately $530 million in virtual money from the exchange. Following the hack, the Japanese government is expected to bring more regulation over exchanges. Japanese regulators look to raid multiple virtual currency marketplace operators in the near future following the massive hack of Coincheck, hoping more intense oversight will prompt these businesses to take stronger security and consumer protection measures.
The EU and the UK
In a May 26, 2016, resolution, the European Parliament noted that virtual currencies “entail risks, which need to be addressed appropriately,” including the possibility of “black market transactions, money laundering, terrorist financing, tax fraud and evasion, and other criminal activities.” In December 2017, the European Parliament and the European Council, the Parliament’s executive body, agreed to an amendment to the Fourth Anti-Money Laundering Directive to include stricter measures targeting exchange platforms for cryptocurrencies. In addition to identifying users, the new measures limit the use of pre-paid payment cards, include transparency requirements for trust owners, and give national investigators access to more information, including national bank account registers. In addition to greater due diligence, online platforms in the EU will also be required to report suspicious transactions.
National governments across Europe are also expected to introduce regulations on cryptocurrencies to mitigate the money laundering, terrorism financing, and tax risks posed by the virtual cash. The UK government was involved in the negotiations to amend the fourth anti-money laundering directive to bring cryptocurrency exchange platforms and wallet providers into counterterrorism financing and anti-money laundering regulations. The amendment enables national UK authorities to oversee cryptocurrency companies’ activities for these risks. Traders in virtual currencies will be required to disclose their identities, eliminating the anonymity that allow illegal activities to flourish. At the upcoming G20 meeting in March 2018, Germany and France are expected to suggest global regulation of virtual currencies.
Although Europe is focused on increasing regulation and oversight of cryptocurrencies, many countries have adopted taxation schemes that will also facilitate their growth. Switzerland, Finland, and Belgium, for example, have exempted cryptocurrencies from a value-added tax, and Germany exempted virtual currency transactions held for over one year from a 25% capital gains tax. Nevertheless, national regulators are also actively monitoring the industry. The German Financial Supervisory Authority (BaFin) recently ordered one Berlin-based crypto-exchange to immediately stop acting as a broker because it was not authorized by BaFin.
Russia appears ready to embrace but regulate virtual currencies, so long as cryptocurrencies are not defined as legal tender, which is reserved for the ruble. Money laundering, tax evasion, and terrorism financing are also recognized risks posed by virtual currencies.
The Russian Ministry of Finance and the Bank of Russia recently presented a bill for the regulation of initial coin offerings and cryptocurrencies, which is expected to be adopted in March 2018. The bill defines key concepts, like “digital financial asset” and “mining,” and might permit Russia-based miners to incorporate as a legal entities. Although the proposed bill permits initial coin offerings, it also imposes some restrictions, like limiting the maximum amount of funds raised in ICOs and capping transactions by certain investors.
As set forth below, Russia also appears interested in establishing a state-backed or multinational cryptocurrency.
Belarus has unequivocally embraced the emergence of cryptocurrencies, keeping virtual payment systems largely free from existing regulations. At the end of 2017, Belarus officially legalized transactions in virtual currencies and exempted virtual currency businesses from legislation covering the securities market. The country’s anti-money laundering laws, however, will still be applied to the crypto-economy. As investors and entrepreneurs face increasing scrutiny from regulators and cryptocurrency transactions are banned in some countries, Belarus is trying to attract virtual money businesses by creating a stable environment. Belarus has legalized initial coin offerings and transactions in virtual currencies, including exchanging cryptocurrencies for Belarussian rubles, and has exempted all trades from taxes for the next five years. Companies and individuals can mine, purchase, and even donate and bequeath cryptocurrencies. Further, the decree signed by President Alexander Lukashenko permits local companies to operate, in part, under English law, introducing English legal institutions like option agreements and compensatory damages. The move will likely attract foreign investors by enabling them to avoid the complexities of the Belarussian legal system and instead rely on English law in investment disputes.
Certain governments, including Russia and Venezuela, have an interest in state or multi-national based cryptocurrency. The international sanctions regime likely has informed these interests as a way to circumvent existing sanctions.
Certain Russian officials have explored the idea of a crypto ruble. One of the perceived benefits of a Russian state-backed cryptocurrency is that “[w]e can settle payments with our business partners all over the world regardless of sanctions.” The Russian Central Bank also recently proposed the creation of a multinational cryptocurrency for BRICS (Brazil, Russia, India, China and South Africa) and Eurasian Economic Union countries (Armenia, Belarus, Kazakhstan, Kyrgyzstan, and Russia). The multinational virtual currency would allow member states to increase investments in cryptocurrency technologies.
Last month, Venezuela introduced its own cryptocurrency, the “petro.” Venezuela planned to issue 100 million tokens, each valued and backed by the equivalent of one barrel of oil, and claims its presale raised $725 million in the first day. The Venezuelan government has discussed the petro as an opportunity to overcome US sanctions and provide a way out of the country’s economic crisis while the US Treasury Department warned that the plan could violate international sanctions. The opposition in Venezuela claims the “petro” cryptocurrency should be prohibited because it is illegal to use oil reserves to issue debt.
Technologies enabling cryptocurrencies are changing the world. The development of the crypto-economy has prompted varied responses from government regulators that have generally struggled to keep pace with technological changes. The only certainty going forward is that further change is inevitable.