CRYPTOCURRENCIES are all the rage at the moment. There is a lot of excitement about the potential for distributed ledger technology to disrupt almost every facet of our lives. It appears that just about anything can be reduced to a blockchain and tokenized.
Despite almost having broken into the mainstream, cryptocurrencies continue to have a shady reputation and are still seen by many as subversive. Criminals and dark web users were early adopters of cryptocurrencies; using these as a way of transferring value outside of the traditional financial system.
The public yet anonymous nature of a blockchain makes it difficult to identify a wallet address as belonging to a particular individual. Transactions are traceable but are generally not attributable (short of finding an individual in physical possession of the private keys).
Regulators around the world are currently coming to grips with a number of facets of cryptocurrencies. Anti-money laundering is high on the list. In August of this year, the Australian Government announced that movement of digital currency would be brought under the remit of the Australian Transaction Reports and Analysis Centre (AUSTRAC). It proposed that cryptocurrency exchanges and digital currency wallet providers be obliged to enrol as reporting entities with AUSTRAC.
This creates an obligation to report suspicious transactions and to report all transactions involving fiat currency having a value of A$10,000 or more. These reporting entities must also develop an anti-money laundering (AML) program.
In a more expansive move, Japan recognised cryptocurrency as legal tender with effect from April 1 2017. This had the effect of immediately bringing cryptocurrency exchanges within the existing AML rules applying to banks and financial institutions.
These two recent regulatory moves serve to highlight both the direction of travel by regulators as well as the limitations of their reach. Cash in hand transactions already pose a money laundering risk. The best that regulators can do is to impose controls on the physical movement of cash and to reduce the denomination of bank notes. In the same vein, there is really nothing that regulators can do to stop transactions in cryptocurrency.
Anyone can generate a wallet address and start transacting in cryptocurrency on a peer-to-peer basis. It is only when this cryptocurrency is converted to traditional fiat currency via an exchange that reporting may arise.
In the near future, when cryptocurrency is more readily accepted by retail vendors, it will not be necessary to interact with an exchange to extract some value from cryptocurrency. Hence, imposing regulations on exchanges and digital wallet providers is clearly not a complete solution, but it seems to be all that regulators can do for now.
A foreseeable development in this space is the inclusion of cryptocurrency accounts within the automatic exchange of financial account information. This program of information exchange between countries is championed by the OECD. It is modelled on the US FATCA and was devised to combat tax evasion via offshore structures and accounts. Cryptocurrency exchanges will bear the brunt of this reporting obligation if they are brought within its scope.
Another evolution may be a requirement for exchanges to more comprehensively understand the source of funds for incoming transfers of cryptocurrency. For large transactions, particularly those involving a transfer to fiat, it is possible that an exchange may wish to audit the movement of cryptocurrency by studying the transaction records on the blockchain.
Apart from the AML questions posed by cryptocurrencies, regulators are also coming to grips with the initial coin offering (ICO) which is a cross between a crowdfunding campaign and an IPO. Many coin offerings are public issues of tokens which are intended to carry value. The rights attached to these tokens are crafted with the intention that they are not securities, as this would bring the issuer within the heavily regulated realm of securities law.
Investors choosing to participate in an ICO do so at their own risk. There are little legal mechanisms that an investor in an ICO can invoke in the event that the token issue is a scam, or a promoter embarks on a pump-and-dump of their coins. Recent warnings from the US, Chinese, Hong Kong and Singapore authorities have thus far not dampened the level of ICO activity.
For the most part, it has just led to the exclusion of investors from these jurisdictions. Additionally, if an investor believes that a coin is about to 'moon' or 'pump' then they can typically acquire it via an exchange shortly after the completion of the ICO.
The explosion of interest in cryptocurrencies have caught regulators a little off guard. An appropriate regulatory response would help to bring credibility to this rapidly developing sector of the global economy. The real world uses of distributed ledger technology are immense and it will be exciting to see this take shape.
Stephen Banfield is special counsel at Withers KhattarWong
