Regulatory Beginnings : the emergence of a cryptocurrency regulatory framework
Analysing the Policy Making Process of the Fifth Anti-Money Laundering Directive
Student: Laurens Perdok (12888567) Supervisor: Dr. Eelke Heemskerk
Master Thesis: Political Science : (Political Economy) Global Economic Transformations
Word Count: 19506 Completion Date: 26/06/2020
2 Table of Contents 1.0: Introduction………...………. 3 2.0: Evolution of Money……… 7 2.1: Barter Economy……….………. 8 2.2: Coinage………...……….………. 9 2.3: Fiat……….……..……… 11 2.4: Virtual Currencies……….………. 14 3: Cryptocurrencies……… 16 4: Theoretical Framework……….……… 31 5: Methodology………..………. 35 6: Discussion ………..………..38 7: Problem Stream………..……… 39 8: Politics Stream………. 42 9: Policy Stream……….…………. 46
10: Merging of Streams (Policy Window)………. 48
11: Conclusion………. 50
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Introduction
“Technologies are created by narratives, and then they are regulated by narratives.”
(Fairfield, 2014)
This statement rings especially true for the burgeoning field of cryptocurrencies. Cryptocurrencies represent the emergence of a new form of currency, one that has the potential to completely overhaul the hitherto used monetary system (Redshaw, 2017). This monetary innovation was formulated through an anti-establishment lens, born out of the failures of the financial world in response to the global financial crisis of 2008 (Baldwin, 2018). Initially, it was believed the cryptocurrencies would not become viable for widespread adoption. It was thought to be reserved for the fringes of society (Dupont, 2017) .Thus, it was deemed a currency for individuals and organizations operating in a legal ‘grey zone’ or a currency used by criminals. However, According to Spenkelink (2014)The newly formed cryptocurrency market grew rapidly in size as the underlying technology was considered ground breaking. Therefore, as these currencies began to garner more attention from the public government scrutiny also began to rise (Hughes & Middlebrook, 2015).
Cryptocurrencies were deemed highly enticing due to numerous key aspects that were built into their technological architecture (Christian, 2014). Namely, full transparency and increased accuracy due to the blockchain application, decentralization which erodes the need for a trusted third party, higher levels of security, low transaction costs and anonymity (Bunjaku et al., 2017). These aspects are considered a welcome innovation which has brought along with it many benefits. However, it has also produced various new problems that, to date, have not yet been present in the financial paradigm. Due to the borderless nature and anonymity of cryptocurrencies existing regulatory regimes no longer provide a sufficient level of consumer protection (Koutmos, 2018). Moreover, these inherent aspects result in the lack of any accountability (Doguet, 2013). These novel issues have resulted in regulatory debates arising surrounding cryptocurrencies.
After a decade of the wait and see approach various legal instruments have now been put in place globally to regulate the cryptocurrency market. In the European Union this scrutiny
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has resulted in the implementation of the 5th iteration of the anti-money laundering directive1. As of the 10th of January 2020, this directive has been enacted. This represents the first step towards a more comprehensive regulatory framework which will be expanded on an ad hoc methodology (Dibrova, 2016). It was done in such a way to formulate sufficient responses to emerging problems. The emphasis on anonymity, peer-to-peer networks and borderless nature have all resulted in increased possibilities for tax avoidance. According to Fairfield (2014) organizations tasked with monitoring financial compliance often rely on information sharing with central authority organizations. This source of information is no longer available with cryptocurrencies. Therefore, the newly implemented AMLD5 targets the cryptocurrency exchanges in order to transform them into proto-central authorities2. Moreover, it is in the space of cryptocurrency exchanges that most problems arise and there is a higher likelihood for fraud as more and more payments occur through these services (Hughes & Middlebrook, 2015).
Under the new AMLD5 regulations exchanges are required to adhere to stricter know your customer protocols. This requires the collection of personal data on individuals who are participating in the payment network3. No longer can online wallet providers offer services to unknown individuals. This is an interesting development to monitor as it goes against the fundamental logics of cryptocurrencies. They were created in order to move out of a space requiring trusted third parties (Nakamoto, 2008). Know your customer regulations would effectively create new trusted third parties, the cryptocurrency exchange platforms. This increased collection of data is broadened towards the exchanges themselves as well. Exchanges will now be forced to register in the Member State which they are located within and further register with the pertinent organizations throughout European member states (BaFin of Germany etc..). This creates accountability. If gross misconduct if performed by the exchanges in monitoring fraud or facilitating criminals the individuals in charge can be held accountable. This goes a long way in fostering acceptance of these new currencies in order to attain higher implementation.
A regulatory framework is a key element in the adoption of a new technology, especially in the paradigm of finance (Moosa, 2015). The in place framework lays out what is possible and what is allowed, thus, it gives individuals a clear guideline on how to use new
1 Implementation of the fifth Anti-Money Laundering Directive: Rise or Demise of the German Crypto Market? (2019, July 3). Plus Company Updates. Retrieved from https://link-gale-com.proxy.uba.uva.nl:2443/apps/doc/A592372496/ITOF?u=amst&sid=ITOF&xid=0a7579c9 2https://www.sygna.io/blog/what-is-amld5-anti-money-laundering-directive-five-a-guide/
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technology to their best outcomes. However, regulating a new technology is a daunting practice (Mandel, 2009). Especially, when they hold such potential. According to Baumol (1990) if the market is over regulated it will no longer be stimulated. This will result in a lack of adoption cases and lead to diminished benefits. If a market is subject to no regulation whatsoever there is a high risk of fraud cases which in turn also reduce the adoption rate. Therefore, regulators are tasked with finding a balance between implementing regulations and allowing markets to develop organically (Minniti, 2008).
Understanding the intricacies that go into formulating a regulatory response is highly important in burgeoning markets. This is especially the case when a disruptive technology enters the market. Insights generated by such research could aid in future regulatory endeavours. Therefore, this thesis will be directed towards ascertaining and analysing the regulatory process adhered to in the European Union regarding cryptocurrencies and its underlying technology of Blockchain. Through the Multiple Streams Approach developed by Kingdon (1984) it will focus on the policy making process.
This thesis will use a multiple streams approach as developed by (Kingdon, 1984). Kingdon developed this methodology in order to understand why certain policies emerge and others do not. In his words “What makes an ideas time come?”(Kingdon, 2013, p. 1) . Moreover, what influences the final formulation of new regulations. Seeing as the regulation dealt with in this thesis represents the first step towards a more comprehensive regulatory framework concerning cryptocurrencies such an approach will be useful for future amendments and regulations.
According to Kingdon (2013) the policy process is not a static one, nor does it occur chronologically. Rather, policies emerge through the convergence of three different ‘streams’. The streams consist of the problem stream, the policy stream and finally, the political stream. Thus, through utilizing a multiple streams approach an inherent structure is given to the thesis. It allows for a clear separation between influencing factors. The problem stream is where problems arise that require legislators attention. In the case of cryptocurrencies one can look towards thefts that occurred at cryptocurrency exchange platforms. Birkland (1998) interprets these as focusing events meaning that legislators are now focused on a specific regulatory gap. However, just because attention is directed towards such a regulatory gap it does not automatically result in solutions. New regulations or amendments take time to be properly formulated. Through the initial ‘policy soup’ as Kingdon calls it many proposals are gathered
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and discussed. Ultimately, these discussions lead towards a finalized policy proposal. The political stream is thus comprised of legislators. These legislators now have various proposals over which they will debate in order to formulate a policy change that is acceptable to all parties involved. According to Kingdon these streams operate separate of each other until a point of convergence. This point of convergence is termed a policy window. Herein, a policy entrepreneur can use the heightened interest to propose new legislation (Cairney & Jones, 2016). Kingdon did not prescribe any specific methods to use concurrently with a multiple streams approach. Therefore, one must decide what methods work best to facilitate the analysis. This thesis aims to use discourse and document analysis. The European Union is a large polity often encumbered with criticisms of democratic deficit. To combat this much of their discourse is uploaded to the internet through numerous minutes of meeting and working documents. These are uploaded by each specific institution and organization. Herefrom, it is possible to ascertain the thought process and follow it chronologically.
The production of such a thesis will have certain contributions to the academic world. Firstly, such a thesis will aid in the development of the academic knowledge in the burgeoning field of cyber regulation. It will allow policy makers to understand certain benefits and pitfalls that arise in the practice of cyber regulation. Understanding such possibilities has been deemed integral due to the fact that our world is becoming ever more digital. Therefore, the field of cyber regulation and its practice will continue to become more important and expand. Secondly, gaining sufficient understanding of regulatory practices in one region of the world could be of great benefit to other regions. This is especially the case in the paradigm of cryptocurrencies (Ponsford, 2015). Cryptocurrencies are a borderless technology and thus have the capacity to exist globally. Therefore, a certain level of regulatory conformity must be had between the major regions of the world. To date this is the case with the European Union, China and the United States of America all implementing similar legislation as of January 2020. Gaining an understanding of one another process can help maintain this conformity for the benefit of all parties involved. Finally, the knowledge that is gained throughout this thesis will be of use in any future regulating endeavours. Especially for further cryptocurrency regulations, which will happen, but also for further cyber regulations.
In order to answer the specified research questions this thesis will be set up in the following manner. Namely, it will start out with a brief introduction to the puzzle that this thesis aims to research. Secondly, there will be a chapter dedicated to informing the reader about the evolutionary paths undertaken by money as a concept. Herein, the chronological path
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will be described how the concept of money has gone from its initial forms to the conceptualization of cryptocurrencies. It will further define what cryptocurrencies are and how they function. This will be followed by a brief introduction to regulations. This part serves to further highlight the regulatory problems that arose through the emergence of cryptocurrencies. Moreover, this part will introduced the reader to the European regulatory process. Thirdly, the methodological chapter will be presented. This chapter will introduce the chosen theory of Multiple Streams Model as developed by Kingdon (1984). It will further explain the methodology taken to gain access to sources and how I plan to match the chosen sources and apply the Multiple Streams Model to them. I will also explain my reasoning behind the choice of theories and methods. Moreover, my case selection shall be developed into more detail. Thirdly, an analysis chapter shall be presented. Herein, my analysis of the regulatory process will take place. This will be conform to the inherent structure of the multiple streams model. Thus, it will start by presenting the problems that have arisen due to the emergence of cryptocurrencies. What issues has led to the need for a new regulatory framework. This will be followed by the policy stream wherein the different proposed policies will be highlighted and explained. Ultimately, the implemented policy is a merger of the different propositions that have occurred. Through the highlighting of these various proposal we can gain a better understanding of the final product. Finally, the politics stream shall be analysed. The European Union is a highly complex polity, the first of its kind. The regulatory process is thus also a highly complex one. There are many different parties involved in the construction of regulations and codes of conduct. In this chapter these different participants will be looked at and their ultimate influence shall be ascertained. Fourthly and lastly, a conclusion will follow which reiterates the main points of this thesis and serves to finalize my arguments concisely.
The Evolution of Money
Money has long been a cornerstone of human society. According to Mishkin (1992) money can generally be defined as any asset that serves the function of facilitating trade as a means of payment. Throughout history the concept of money has undergone many different variations. Each conceptualization can be seen as an incremental step forward. Every new from of money aims to resolve the issues inherent to the previously used model whilst offering similar or superior functionality. Due to this it is not surprising that the concept of money evolves
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alongside the increasing capacity and technology. New discoveries allow for new ideas to take place. Angeles (2019) posits that the evolution of money can be distinguished into 4 phases. Each of these phases represent an innovative application of new technology or capacity to serve as a currency. Firstly, before currency was invented a barter economy was adhered to. Secondly, the introduction of coins as a currency. Thirdly, the emergence of fiat and credit money. Fourthly and finally, contemporary payment system such as digital currencies. These are the four phases in which Angeles analyses the evolution of money. Each successive phase operating at a higher standard than the previous. However, certain issues have remained pervasive throughout each iteration of currency. Issues such as inept financial management have maintained throughout nearly every phase. Moreover, the adverse effects felt from this have worsened due to the increased reliance on the well functioning of these monetary designs. In the last decade a new conceptualization of currency has emerged. Namely, cryptocurrencies. This new form of currency provides highly superior functions and is able to overcome the pervasive issues inherent to previous monetary designs.
This chapter is dedicated to exploring the evolution of money as a concept and its various currency applications. This chapter is structured around the proposed phases of development as stated by Angeles. Thus, a barter economy, introduction of coins, fait currency and contemporary designs will be analysed. The benefits and pitfalls will be ascertained for each of these currency phases. Through such an analysis the reader can begin to appreciate the advantages that the cryptocurrency model brings with it. Moreover, this part will highlight how the pervasive issue inherent to most previous models can be overcome through the crypto paradigm. Once it is understood that cryptocurrencies are superior, and therefore likely to remain and gain higher levels of adoption, one can acknowledge the need for a satisfactory regulatory framework. This will be discussed in the successive chapters.
Barter Economy
Money has not always been around, however, trade still had to happen on a small scale basis. Before the invention of currency as a tool to facilitates trade a barter economy was adhered to. During this time money was highly conceptual. A barter economy is a cashless economy (O’Sullivan et al., 2003). In this design goods are used as a medium of exchange to be traded for other goods. The saleability of a good was the determining factor of how much they were
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worth and for what they could be traded (Menger, 1892) . If goods were deemed to have similar levels of saleability they could be traded for one another. The barter economy model was an incredibly practical solution which served earlier small scale societies well (Banerjee & Maskin, 1996). However, the barter model suffered from various disadvantages which impeded economy activity and growth (Middelkoop, 2015).
A major disadvantage present in a barter economy is of course the lack of currency. The distinct lack of currency results in an impossibility to formalize a price system (Starr, 1972). There can be no general consensus on the worth of goods. The value of goods had to be ascertained with each occurring trade. This results in a strenuous trading process whereby individuals had to come to an agreement on value before a trade can occur. Another issue inherent to the barter model is the lack of usability of most goods (Jenks, 1964). During this time most goods were not highly durable thus economic value could easily be diminished or even lost. Finally, Jenks (1964) claims trade occurs mostly out of surplus. This is especially the case in a barter model as possessions must be traded away. This only happens if these goods are no longer needed. A subset of goods which did come in surpluses was that of foodstuffs. However, due to foodstuffs being perishable to rapidly lost value.
The barter model was a practical solution which was built to support idiosyncratic trade. Therefore, once societies began to develop and become more economically active this model became inept. It was wholly inadequate to support the growing trade networks. In order to overcome the issues inherent to this design, no price system and lack of medium of exchange, a new invention was needed. A system had to be designed which was able to denote value in other forms than goods. This was achieved through the introduction of coins.
Introduction of Coins
The coinage model represents the first legitimate currency that was created. It was a substantial development from the barter economy as value could now be denoted. According to Ólafsson (2014) the realization that it is possible to denote value through a commonly understood system, such as currencies, has been one of the most far reaching innovations in the financial paradigm. Moreover, coins are the first representation of a currency that adheres to the three core functions of money. These function as laid out by Krugman & Wells (2006) are that of a
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medium of exchange, unit of account and store of value. Formulating a currency which fulfils these criterium has various beneficial economic effects. Firstly, now that there is a medium of exchange trade can occur more easily. Coins could act as an intermediary instrument facilitating more trade as they could later be used to purchase other goods. Secondly, coins served as a unit of account thus making it possible to formulate a price system. The creation of a price system further enhances the possibility of trade and allows for a greater consistency within trades. The time consuming act of bartering can be mitigated. Thirdly and finally, a stable store of value emerges through having a common currency. The value of coins may vary slightly, however, due to the precious metals used in their ‘minting’ they could never lose value outright. Moreover, coins are highly durable therefore they can be used to store value over a lengthy period of time. König (2001) observes that individuals were able to, for the first time, increase their purchasing power and thus broaden their economic possibilities. Currencies were able to initialize the transition from a barter economy towards a monetary economy (Davies, 2002, p. 9). It was able to overcome the limitations inherent to the barter system through the introduction of a commonly understood price system built on a currency which adhered to the three core functions of money. Nevertheless, the coinage model still presented significant disadvantages.
A major impediment implicit to the coinage model was the low availability of coins (Angeles, 2019). This results in a low circulation of currency. This is due to the precious metals used in their creation. In order to give an intrinsic value to coins metals such as gold and silver were used. This allows the value to be derived from the market forces of demand and supply. Due to the high demand of these metals and relatively low supply these coins gained intrinsic value. Moreover, due to the universal demand of these metals coins became valuable internationally. However, this scarcity was a double edged sword. Whilst it gave the coins value it also meant that there was a limited supply. Therefore, as trade networks continued to expand and develop the supply of coins was not sufficient to support this growth. There were simply not enough of them. This is visible through the increasing amount of credit payments that occurred during that time. Credits are a deferred payment system whereby an individual purchases a good with the promise to pay for it later (O’Sullivan et al., 2003). This became such a widely used system that in early modern England on average 80 percent of transactions occurred through credits (Muldrew, 2016).
The introduction of the coinage model also represents the first time that inflation became a key economic issue. As recently discussed, the value of coins was derived from the
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precious metals they were comprised of resulting in a low supply. However, governments discovered the possibilities of debasing their currency (Angeles, 2019). They realized that once a currency had gained widespread adoption and a stable value they could inflate their currency. This means that governments were able to use less precious metals in the minting process whilst not, at least initially, lowering the value of their currency. This could be done because governments were the only issuers of coins, essentially being in complete control of it. This realization led states to having two distinct approaches to managing their monetary supply. States could debase their own currency in order to increase the supply of coins. This would facilitate the continuing expansion of trade networks and ensure that all transactions could be preformed based on this currency. However, this has the adverse effect of inflating a currency resulting in a diminished, or complete erosion of, value. Conversely, states could opt to not intervene. This would maintain the value of their currency, however, would inhibit the amount of economic activity taking place. The end result of both methodologies is underwhelming. Therefore, a new model had to be designed.
The introduction of coins constitutes an astounding development in the evolution of money. It represents the first conceptualization of money which adheres to its three functions (medium of exchange, unit of account, store of value). Through these functions the limitations inherent to the barter model were overcome. However, through the limited supply of medium of exchange the coinage model opened the door for bad management of inflation. Therefore, a new currency design as required. A model which utilized a resource as currency which was widely available as to not encounter a shortage of exchange medium, whilst simultaneously being unique enough to inhibit their free production. These requirements were met through the introduction of fiat money. A currency model that has remained in place till this day.
Fiat Currencies
The introduction of fiat currencies is an important step in monetary development. It completely changes the conceptualization of money. For the first time a currency was not inextricably linked to intrinsic value. According to the European Central Bank (2012) a fiat currency is a legal tender which has been issued by a central authority that lacks any intrinsic value. The value of such a currency is derived from the trust placed upon the central authority. This central authority guarantees the value. Moreover, high levels of trust between all economic actors must
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be had. In the words of Krugman and Wells (2006) “I accept this piece of paper as worthy with the understanding that all other members will do the same”. It is through this trust in the system that a currency could maintain its value and acceptability as medium of exchange. However, the moment this trust is eroded the currency becomes worthless. The conceptualization of money has now become a social construct, like religion, based solely on faith (Shaw, 2016).
Through the introduction of fiat currencies many problems faced by earlier models were able to be overcome. Firstly, fiat currencies adhere to the three basic functions of money. Namely, they serve as a medium of exchange, store of value and unit of account. This allows for the creation of a price registry facilitating trade. Therefore, the inherent issues of the bater model were overcome. Secondly, the fiat model was able to perform similar functions to that of the coinage model although to a higher degree. The fiat model does not suffer from a shortage of medium of exchange. Due to the fact that fiat currencies are usually found in paper form there is not a limited supply. This is in contrast with the coinage model wherein the supply is finite and cannot be increased. Therefore, fiat currencies were able to support the growing economic activities.
Although the fiat model was able to overcome these issues, like previous models, it was subject to certain disadvantages of its own. However, as opposed to previous problems, which were usually related to the tool used as currency itself or economic constraints placed upon individuals, the issues which emerged from a fiat system pertained mostly towards the governance of said system.
Through the introduction of a fiat monetary system the problems faced by previous conceptualization were able to be overcome. Fiat money fulfils the three criteria proposed for currencies (Hermele, 2014). Namely, it functions as a unit of account, medium of exchange and store of value. Therefore, the issues inherent of a barter economy were overcome.
Furthermore, fiat currencies could be made artificially scarce. As states were the only minters of currencies they could control the supply and limit it. This artificial scarcity allows fiat money to derive its value from supply and demand which results in a more stable currency (Hoppe, 1994). However, in contrast to the coinage model fiat money is only subject to artificial scarcity. This holds that governments can always increase the production of
currency. Therefore, fiat currency is also vulnerable to bad monetary management. This leads into a big point of contention regarding fiat currencies. Seeing as fiat currencies do not possess any inherent value they are effectively under complete control of governments.
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The fiat model has been dominant in our world since its inception (Rose, 2015). The current financial paradigm has been built around it. This has led to claims that certain organizations such as banks are delegated an unproportionally amount of power (Nakamoto, 2008) .The system is reliant on these third party organization to maintain functionality. For instance, banks both host the services which preform transactions and serve as account holders for deposits. Up until now these organizations have been viewed as necessary by most, however, the emerging cryptocurrencies paradigm aims to end this reliance. As Bill Gates already claimed in 1994 “banks are dinosaurs, they represent an archaic system that we can bypass” (Blakstad & Allen, 2018). The fact that so much trust and competences must be placed in such a small group of people / organizations opens up the possibilities to human error. Bad financial management is almost never an outright goal but it occurs far too often to disastrous effects. One of the leading causes towards the global financial recession of 2008 is directly linked to excessive risk taking behaviour exhibited by banks (Williams, 2010). This was followed by the European banking crisis. These are the two biggest economic recessions of contemporary times and are both directly linked to the banking system.
The use of a fiat currency model further opens up possibilities of bad monetary management relating to the management of inflation (Metz, 2013). Technically there is no limit to the amount of currency possible in such a system. Therefore, when in need
governments can always command the further printing of money in order to stimulate the economy. This process is often utilized by governments and has been termed quantitative easing. However, similarly to the issues inherent to the coinage system, debasing your currency too much will lead to hyper inflation which in turn will cause the currency to crash and become worthless. Through these processes we have ended up in a debt economy. Most countries are so far in debt to other nations with no means of ever paying it back. According to Middelkoop (2015) all previous forms of fiat currency have resulted in failure. Thus, why would our conceptualization be any different? Cryptocurrencies aim to take away the
possibility of these glaring human errors of these systems. Finally, a small problem with simple fiat currencies is the lack of durability and the ease of counterfeit ability. Seeing as we are dealing with paper notes they are not highly durable. As soon as they get wet they almost automatically become worthless etc. Moreover, if someone has access to the right materials and printing prowess they could effectively begin to print their own currency notes leading to further inflation.
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The fiat system has been an incredibly useful tool boosting our economy, however, it has increasingly become subject to these issues. The mass lack of confidence in the scheme has resulted in the emergence of newer models such as online virtual currencies.
Evolution Virtual Currencies
Currency evolves alongside technology. Therefore, it would be remiss to not briefly discuss the growing paradigm of online currencies. There have been various previous design for virtual currencies. Due to an increase in the prevalence of the internet and usefulness of this technology it has permeated into multiple facets of our daily lives. Thus, it is not surprising that there have been previous attempts at formulating online currencies. However, each of these was either lacking in scope or applicability. They are merely an electronic denotation of fiat currencies issues by states. They do not represent the same disruptive innovation as cryptocurrencies. There are many different types of virtual currencies, however, they can be placed into three distinct categories (ECB, 2012).
The first category is called a closed virtual currency scheme. The currencies that belong to this categorization are some of the first virtual currencies to exist. They originate from online games. The main characteristic of a closed scheme is that there is no link between the virtual currency and any fait currencies. It exists only within the designated space for which it was created. Due to this lack of connection to the real world such
currencies have never necessitated the need for regulatory scrutiny. Second, there are virtual currency schemes which exhibit a unidirectional flow. This category has a limited interaction with the real world. It is possible to purchase this currency with national fiat currencies, however, it is not possible to then exchange them back into a fiat currency. Therefore, the flow is deemed to be unidirectional, it can only go one way. These currencies normally have very specific functions without the possibility of broadening its scope. For instance, in order to print at the University of Amsterdam one must purchase printing credits. These credits are bought using Euro’s and the amount bought and available is even denoted in euro’s.
However, once purchased the student cannot exchange these credits back into euro’s. Due to the singular direction of these currencies they have a very limited interaction with the real world. Therefore, these currencies have not necessitated the emergence of new rules and regulations. Thirdly, bi-directional virtual currency schemes exist. This is also the currency
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type under which cryptocurrencies fall. These schemes hold that individuals can purchase this type of currency with national fiat currencies and are also able to exchange them back into fiat currencies. Hence the bidirectional flow. Bidirectional currencies represent a complete new online currency which adheres to its own exchange rates (Tsukerman, 2015, p. 1132). Due to the bidirectional flow there is a high level of interaction with the real world. It is from this high level of interaction that regulatory scrutiny is required.
Figure one: Retrieved from European Central Bank (2012)
The first two types of virtual currencies discussed are automatically centralized. They rely on a central authority to design and administer the currency. However, this is not always the case with bidirectional flows. There are forms of bidirectional currencies which are centralized however, these more resemble a surrogate for fiat currencies (Didenko & Buckley, 2018). This is because these currencies are still based entirely on the fiat model. There is central authority which enables and monist transactions. This is unlike cryptocurrencies which resemble an alternative. Cryptocurrencies are not inextricably linked to fiat currencies and can be used completely on its own.
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Cryptocurrencies
The cryptocurrency model represents an innovative application of blockchain technology which has the potential to disrupt the traditional financial system. Here a brief summary of reasons why cryptocurrencies are able to manage this will be given. This will be explained in more detail in the following chapter relating to the design of cryptocurrencies.
According to (Vlasov, 2017) cryptocurrencies are a natural development in the course of monetary evolution. This innovative system is capable of providing the same functions as fiat currencies with the same ease of payment. This whilst mitigating the disadvantages of such a system (Cvetkova, 2018). Drainville (2012) observes that these new currencies exhibit the same characteristics the general population is appealed to. Namely, the characteristics of transferability, unforgeability, untraceability, anonymity and security. Through the
architecture of blockchain, the technology upon which cryptocurrencies are built, these functions are provided without the need of a third party organization. The blockchain serves as a distributed ledger system which is able to decentralize the entire currency system. According to Fairfield (2014) this is the true innovate aspect, the possibility to have a decentralized system that allows for scarce and rivalrous digital property. This means that there will no longer be a reliance on such third party organizations (Gilpin, 2014). Instead the economic concept is built upon peer – to – peer ideology. Previous attempts at digital cash, such as cryptocurrencies precursor of Chaum’s digicash, still revolved around a trusted central authority. Due to the fact that cryptocurrencies are an application of blockchain technology they are able to be a currency and a payment system simultaneously. This further restricts the power of central authorities. Currently, payment systems still rely on
organizations such as banks. This has effectively given banks the means to exclude persons from payments systems. Moreover, there are still parts of the world which are not sufficiently included in the traditional financial system. This has made remittances more strenuous then need be. According to Bodó & Giannopoulou (2019) cryptocurrencies represent a good alternative towards current remittance programs. It will foster economic inclusion for people who do not have bank accounts. Ponsford (2015) claims that there are currently 2 billion people who could become financially included through the introduction of cryptocurrencies.
Now that an understanding of the evolution of currencies has been developed one can see the reasoning behind the emergence of a cryptocurrency scheme. Cryptocurrencies are able
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to provide the same benefits as any previous conceptualization of money has whilst being able to mitigate the adverse effects. The next chapter will serve to foster a better understanding on the architecture of blockchain and cryptocurrencies. This will in turn aid in the discussion pertaining the regulatory issues that arise from such a model.
Cryptocurrencies are not the first attempt at digital currencies (Szabo, 2008). However, the technology they are built around, blockchain, allows for an innovative
application and new conceptualization of currency (Boshkov, 2018). The following chapter will highlight the architecture of cryptocurrencies in order to foster better understanding. Understanding how this new technology works gives insights into the regulatory debate and the issues surrounding it. Due to the scope of this paper Bitcoin, the first cryptocurrency, will be analysed. Bitcoin is the archetype of cryptocurrencies and to date has the highest market penetration of all cryptocurrencies. Moreover, its market penetration is exponentially higher than other crypto’s (Feder et al., n.d.). Moreover, the market capitalization of Bitcoin is substantially larger then other cryptocurrencies. Market capitalization is the calculation of the tokens / blocks in circulation multiplied by their price. Therefore, it is a better indicator of how much money / wealth is stored in each crypto. The current market capitalization of Bitcoin equates to around $120 Billion4 (Statista, 2020). This is followed by a mere 15 Billion for the second biggest cryptocurrency Ethereum. Due to this discrepancy this paper has decided to focus more on Bitcoin as this is also the main cryptocurrency which regulators scrutinize. This chapter shall first briefly examine the cryptographic roots that the blockchain is built around followed by an in depth look into their architecture.
The cryptography movement emerged in the 1980’s (Thawte, 2013). During this decade the interest for such practices had grown exponentially. It was believed the through the use of cryptography social changes could be enacted (Narayanan, 2013). Moreover, cryptographic tools had until then been deemed illegal for public use. It was a tool meant for governments. However, through the release of The Codebreakers by Kahn (1967)
cryptographic tools began to make their way into the public sphere. This was a crypto cult classic which highlighted a form of encryption previously used by the American government. This resulted in the average citizen being able to encrypt their own messages and evade total scrutiny by governments and similar organizations. Herefrom, we can already deduce
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https://www.statista.com/statistics/377382/bitcoin-market-capitalization/#:~:text=The%20market%20capitalization%20of%20Bitcoin,circulation%20by%20the%20Bitcoin %20price. Data last retieved on 19/06/2020.
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similarities to the goals of cryptocurrencies. It is a strong internal belief that individuals should be in control of their private domain and what they reveal to the outside world.
The primary step towards the conceptualization of cryptocurrencies as we know it originates from David Chaum’s work. Chaum (1983) paper on blind signatures highlighted the possibilities inherent to cryptography in relation to currencies. Initially, Chaum proposed “blind signatures” these highly resemble the private keys required for a cryptocurrency transaction. These signatures would hide the contents of the message ensuring that only the individuals with access to the right signature to transform the message into something legible. This represents the first public utilization of cryptography. It is through the ideas of Chaum that the cypherpunk movement was born. The cypherpunk movement represents a move towards a more activist style of cryptographic promotion. According to the cypherpunk movement a free society should be a fundamental goal. Inherent to this fundamental goal is extreme levels of privacy. Governments should take a back seat and let citizens “freely live their lives”. Hughes (1993) claimed that individuals should be given the power to selectively reveal themselves to the world, hiding oneself wherever they pleased. Hughes and other cryptography proponents went on to create the cypherpunk mailing list.
The cypherpunk mailing list became an important forum for all cryptography activists (May, 1994). Many discussions on new cryptographic tools were held through this list. Initially these discussions were focused on governmental policies which governed private life. However, soon the idea that individuals should be able to govern their own lives freely was later expanded to also include things such as the market. In line with the Hayekian view the cypherpunks believed that through a complete laissez-fair approach markets and society would take the preferred shape of individuals (Swartz, 2018, p. 627). In order to realize such a goal money as a concept would have to become untethered from the government. This was achieved through the release of Bitcoin. Satoshi Nakamoto (2008), the founder of Bitcoin, released his infamous whitepaper which explicates the architecture of Blockchain and how a currency application could be formalized.
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Architecture of Cryptocurrencies
A blockchain falls under the decentralized ledger technologies. It represents a public ledger wherein information can be stored in a decentralized manner. According to Quintais et al (2018) “the new blockchain ecosystem aims to build a decentralized, disintermediated and distributed technology. This in turn enables a decentralized, disintermediated and distributed mode of social conduct”.
There are two different conceptualizations of blockchains (Wang et al., 2018). There is the open permissionless blockchain and a permissioned blockchain. On a permissionless blockchain any participant is capable of inputting information. Everyone on the network is seen as equal. This is in contrast to a permissioned blockchain. A permissioned blockchain more resembles a traditional construction. It still relies on a central authority to permit and monitor inputs. Both types of blockchain have become prevalent throughout our world having many different use cases (Kazan et al., 2015). However, in this paper the
permissionless blockchain shall be focused on. This is due to most cryptocurrencies being based on a permissionless blockchain to further enhance the decentralized peer – to -peer aspect. Moreover, it is regarding the permissionless blockchain that regulatory issues arise. In order to maintain a decentralized manner cryptocurrencies use cryptography. Cryptography is used to enact secure transactions, verify these transactions and in the minting of new blocks. Thus, replacing the need for a central authority. It does this by using decades of research preformed in the paradigm of cryptography (Back, 2002; Chaum, 1983; Haber & Stornetta, 1991; Malkhi & Reiter, 1997; Merkle, 1987).
An integral cryptographic tool that is used in cryptocurrencies is that of hash
functions. A hash function is a mathematical algorithm that possesses three distinct functions (Tschorsch & Scheuermann, 2015). Namely, hash functions are able to take in an input of any size. This holds that there should feasibly be no cap on the amount of information that can be stored. The hash function must then also transform these inputs into a fixed size output. This is what the blocks of the blockchain are. The blocks are a fixed size encrypted output of inputs. Finally, the encryption must be efficiently computable. Therefore, it cannot require too much computing power to perform the encryption otherwise the network would become inefficient and require too much time to preform transactions. Through the use of a hash function it is possible to consistently create fixed size block outputs which comprise a blockchain. However, in order to ensure the validity and ownership of blocks a further
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addition of cryptographic tools is required. Seeing as we have a reliable method of encryption, how do we restrict the amount of individuals who are able to decrypt the message. This is done through the introduction of ‘keys’.
Most prolific cryptocurrencies utilize an asymmetric key encryption model (Houben & Snyers, 2020). This holds that every user is allocated two distinct keys. A public is a key that is visible to all other participants on the network. It is your “address” where other individuals send their messages to. In the cryptocurrency application of blockchain this serves as your online wallet where coins are sent to. A private key is a secret key which serves to verify the source of the input. It more resembles a digital signature. It must therefore meet a few requirements (Dumortier, 2007). A private key must be a specific signature
known to and signed only by you. However, anyone should be able to verify it. Moreover, individual signature must be tied to specific documents otherwise signatures, especially of the digital variety, are able to be copied and placed elsewhere. Through the use of a private key the author of an input can sign their message verifying their identity.
The asymmetric key model has often been compared to an envelope (Rashed et al., 2013). For example, Alice and Bob represent an input sender and input receiver respectively. Both Alice and Bob are in possession of a public and private key. If Alice wishes to send an input or coins to Bob she would encrypt her message using Bobs public key. This effectively seals the input in an envelope. Alice then verifies her identity through hey private key. This ‘envelope’ is then put through a hash function and sent to Bob. Bob is then able to decrypt the received ‘envelope’ through use of his private key. Now that Bob has securely received the input he can move onto verifying that Alice is the true source of the input. In order to do so Bob must use Alice’s public key onto her digital signature. If the two keys are part of a set Alice’s identity has also been verified.
Another benefit of using such a protection methodology is the immutability aspect of the blockchain (Wang et al., 2018). Once the message has been encrypted and placed upon the blockchain it cannot be altered. Through any alteration of the message the coinciding hash function encryption would change drastically thus alerting the other nodes on the network that a change has been occurred, the original message has been altered. The public key represents the security mechanisms provided by cryptography. In order to ensure the validity of the source of the input the private key is used.
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Consensus Mechanisms
Another cryptographic function that the blockchain is built upon is that of consensus
mechanisms. A consensus mechanism is a predefined specific validation method that ensures a correct sequencing of transactions on the blockchain (Narayanan, 2013). These consensus mechanisms serve to achieve a consensus between all nodes on the network in a decentralized way. Due to the fact that some blockchains, like cryptocurrencies, are permissionless and thus are allowed to be extended upon by any participant. However, a modicum of validity must be ensured. A methodology to combat faulty transaction is to be put in place. Our current
financial system relies on third party organizations such as banks to scrutinize transactions for fraud. In order to alleviate this reliance in the crypto paradigm consensus mechanisms are the tools used for this job. Achieving a method for decentralized consensus has always been a pitfall for electronic cash. Due to the currency only being represented in a digital manner it was always very easy to commit fraud, just copy and paste the digital coin and you can send it again. This is what is known as double spending (Nakamoto, 2008).
In order to overcome the double spending problem consensus mechanisms are used. They rely on a transformation of the Byzantine Generals agreement problem (Wang et al., 2018). In this dilemma there are multiple generals one different sides of Constantinople aiming to attack the city together. However, in order to be successful the attacks must be carried out simultaneously by all generals. This whilst there is a possibility that one or more of the generals is disseminating false information on when and how to attack. Thus, how do you deem a message to be valid. Consensus mechanisms. There are currently two widely used and accepted decentralized consensus mechanism used throughout the cryptocurrency world. Namely, there is Proof of Work and Proof of Stake. Both of these conceptualizations have their benefits and pitfalls.
Proof of Work is currently the most prolific consensus mechanism. It is also the consensus mechanism utilized by Bitcoin (Nakamoto, 2008). It is a puzzle friendly conceptualization which relies on an incentive based system. Nodes which are active on a network try to compute the hash of the constantly changing block header (Wang et al., 2018). A target is given and the solution must fall into the target category. If a node successfully computes this hash it is able to broadcast it to all the other nodes active on the network for verification. If this new hash is verified by all other users on the network, through verifying the transaction history engraved into the block, this new hash will be used as the “previous
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hash” in the chain. This effectively creates a new block. This process is called mining. The node which first calculates the correct hash is rewarded a specific amount of coins in order to remunerate their efforts. This specific amount of coins given out to miners in Bitcoin started at 50 coins per successful mine, however, is subject to a series of halving events. This creates a predictable monetary supply and thus combats inflationary pressures. Through a decrease in the issuance of new coins Bitcoin becomes deflationary. The coins in circulation become more scarce and in turn rise in value. Moreover, it allows for the process of mining to be profitable until approximately the year 2140 when the last blocks are mined and the market cap of 21m is reached.
This has led to the claim that there will be a tragedy of the commons – ergo, miners will stop preforming their task at a certain point because the rewards attained are not equal the input that must be delivered. As soon as the mining reward falls to 0 the only
renumeration obtained is that of transaction costs which are minimal.
An emerging issue with the proof of work consensus mechanism is the exponential increase in computational difficulties. This does result in a high degree of security relating to consensus. However, seeing as the puzzles becoming increasingly complex, so too does the energy and computational power required increase. This as led to claims that such a
methodology will only result in recentralization after an extended period of time. This is currently already happening and can be concluded from the warehouse structures which have emerged in places such as Iceland. Here big companies acquire a lot of computing power purely to mine for new coins. This means that regular nodes on the network do not stand a high chance of being able to mine blocks anymore as they cannot compete with such an amount of computational power. The increase in electricity needed also results in an increase in energy footprint. According Malone & O’Dwyer (2014) the energy used in the mining of new bitcoin is equal to the energy consumption of the nation of Ireland. Another issue is that of the 51 percent ownership. If this recentralization does continue to happen the moment a single organization or node holds 51 percent of more of the mining power of a network they are basically in charge. They can validate blocks that they want to validate and invalidate the ones they do not want.
Another widely used mechanism for Consensus is that of Proof of Stake. This
methodology does not rely on a continuous increase in computational complexity. Therefore, it does not require the same amounts of energy and is not subject to centralization of mining.
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Instead this consensus mechanism is built around the ownership of coins. The more coins held by the individual the more minting power they obtain. In this model of consensus the minting of new blocks is called forging. An issue with this model is the requirement to hold a sum of coins in order to mine. This results in less spending of the currency taking valid coins out of circulation and enhancing the artificial scarcity. Moreover, this model also has the potential to result in a trend of recentralization. The single richest node participating in the network has a continuous advantage over other mining nodes. Furthermore, this is an
advantage that is hard to lose, if you own most of the coins in a system it is hard for someone else to suddenly have more, especially when you’re the one mining most of the coins
Regulatory Issues Concerning Cryptocurrencies
In the former chapters if this thesis the emergence and technical specifications of
cryptocurrencies, mainly bitcoin, have been discussed. This was done in order to foster a better understanding of the technology. The author believes that this understanding will be instrumental in realizing that cryptocurrencies should be seen as the next evolution of money as a concept. Moreover, through an explanation of the technical architecture it was
highlighted why they should be deemed as the next iteration. This chapter will be directed towards the regulatory struggle surrounding cryptocurrencies. Due to the architecture and their general anti-establishment nature a new regulatory framework had to be adopted. This ultimately resulted in the amendments of the monumental anti-money laundering directive which has served the EU well throughout its time. This chapter will start by explaining what a regulatory framework is and why it is used. It will then move onto a discussion on what ‘good’ regulation is and how good regulation can be a power stimulus for new yet beneficial technologies. Moving on, the inherent difficulties towards regulating cryptocurrencies will be ascertained. This is where a better understanding of the crypto architecture comes into play. Finally, the different possible regulatory approaches will be highlighted moving towards an explanation of why the amendments of the AMLD directive were chosen.
A regulatory framework is a tool used by governments to tackle market failures. Where the market forces are inept at delivering a satisfactory result government through the implementation of such a framework. A satisfactory result is achieved through “the
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social, business and political actors” (Levi-Faur, 2010, p. 9). In the sphere of the European Union there are two main legislative approaches which are used to implement new regulatory frameworks. Firstly, a regulation. As stated on the official European Union website5 a
regulation is a binding act that is implemented across the European Union in the same style and timeframe. There is no leeway delegated to the Member States in deciding how to attain the goals as set out by the Union. A directive is the second tool. A directive is a legislative act which serves to prescribe a certain goal or standards that must be met. It is then up to the individual member states to implement these standards into national legislation due by the specified timeframe. Through both legislative modes the end result is the same, however, the legislative process is vastly different. A directive allows more freedom towards the member states. Furthermore, member states can choose to implement more stringent regulatory frameworks. In the case of cryptocurrencies this is especially pertinent. Due to the varying perspectives on cryptocurrencies a directive is more appropriate. It still entails the
implementation of an EU wide framework that provides the same level of base protection whilst letting more cynical member states implement stronger rules.
Understanding what makes a regulatory framework ‘good’ has been a longstanding question in the social sciences field. Yet throughout time a suitable answer is still to be found. This stems from the fact that regulations must be analysed on a case by case basis (Wagner & Sternberg, 2004). This is especially the case with emerging technologies, more so when these new technologies hold such a vast amount of potential. It has long been ascertained that the introduction of regulations will have an effect on the development of a new technology (Edler et al., 2016). However, the question remains; how can a regulatory framework stimulate new technologies?
According to Moses (2007) regulators should adopt a tech neutral perspective when dealing with new technologies. She claims that it is not up to regulators to determine whether a technology is good or bad. Moreover, technology cannot be one of these things. It is only a tool to be used. Therefore, she states that a regulatory framework must be set up in this light. It should inhibit the possible illicit use cases whilst not stifling positive use cases. However, this has proven to be challenging. Bos (2018) claims that regulating an emerging technology is a daunting task. If a technology and its use cases are not wholly understood regulators run the risk of implementing ineffective regulations. This could result in the promotion of risks as
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opposed to inhibiting them. Therefore, regulators must adopt a combination of ex post and ex
ante approaches (Reyes, 2016). This allows regulators to implement a base level of protection
in the short term whilst giving room to further understand the technology. Once this understating has been fostered a more comprehensive regulatory response can be enacted. This is in line with the law if disruption. This holds that technological changes occur much more rapidly than social or legal changes (Downes, 2009). Technology undergoes disruptive innovation whilst social and legal system are subject to incremental changes. Therefore, the social and legal system struggle to keep up. However, in this struggle the balance must be found between stringent and facilitating rule sets.
Baumol (1990) equates regulations to the ‘rules of the game’. According to him the rules of the game have to be set up in a manner that is conducive towards further innovation. This is especially the case for burgeoning technologies. These technologies are still
developing and thus need a margin of freedom to attempt new applications or use cases. Implementing stringent ‘rules of the game’ would have the adverse effect of disincentivizing innovation and development. Renda et al (2014) further state that highly stringent rules will result in heightening compliance costs. These can be seen as a barrier to market entry resulting in a lower adoption rate. This in turn has the adverse effect of disincentivizing further development. New use cases for emerging technologies are disincentivized through increasing ‘red tape’.
On the other hand, the implementation of a regulatory framework can prove to be a powerful stimulus to further development (Pelkmans & Renda, 2014). Through such an implementation a industry standard can be set. This has the positive effect of reducing
uncertainty in a market. If there are standards in place all market participants are able to have a certain ideas and expectations about how to interact with each other. This creates a more level playing field. Moreover, through industry standards the quality of product or service is also guaranteed. Therefore, industry standards are seen as an effective communication tool towards consumers. Consumers are then able to ascertain that the government has a positive outlook towards these specified applications. This essentially removes burgeoning
technologies from operating in a legal grey zone which most do in the beginning stages of development. Boshkov (2018) concludes that regulations pertaining to newer technologies must therefore find the balance between consumer protection, business development and technology development. A regulatory framework which is able to include these criterium will be deemed a ‘good’ regulatory framework.
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According to Quintais et al (2018) cryptocurrencies are subject to a Janus face. He posits that this technology can be used both for good and bad. Therefore, a suitable regulatory framework must be set up as the current framework has been deemed inadequate (Burilov, 2019; Nabilou & Prüm, 2019; Reyes, 2016). As previously discussed, there have been earlier introductions of a digital currency, however, these did not represent a disruptive innovation in the financial paradigm (Tedeschi, 2001). Most previous versions are merely a digital
representation of a government issued fiat currency (Ponsford, 2015). Therefore, existing regulatory frameworks were easily applicable. However, this is not a possibility with cryptocurrencies. Due to the innovative nature of cryptocurrencies regulation has proved challenging. When faced with a new technology that operates outside the scope of existing legal frameworks regulators are confronted with an issue of adopting an ex post or ex ante approach (Reyes, 2016). A combination of the two methods must be put in place which inhibits the illicit use cases of cryptocurrencies whilst allowing the beneficial applications to flourish Therefore, it is highly important to find the right balance between laissez-fair and intervention. According to (Bace et al., 2006) extremely stringent rules will have the adverse effect of disincentivizing further innovation. It would stunt the development of
cryptocurrencies. In contrast, no regulations would result in rampant fraud and illicit uses. Therefore, a satisfactory framework must be set up. Through regulation it is possible to set standards. This in turn gives participants in the cryptocurrency sphere legal certainty, contract enforcement and resolve collective action problems (Bodó & Giannopoulou, 2019).
However, certain problems have arisen which makes regulating the field of cryptocurrencies challenging.
Ponsford (2015) claims that there are three aspects of cryptocurrencies which are problematic and require regulation. Namely, there is no oversight occurring anymore. Due to the peer – to – peer nature of the technology banks can no longer monitor transactions and preform the role of middleman. Secondly, the transactions that do occur on the blockchain are irreversible (Buterin, 2014). There is no escrow system put in place to inhibit scams from taking place. The cryptocurrency model has transferred the duty of protection to the consumer away from a central authority (Schrepel, 2019). Finally, due to the field of cryptocurrencies being so new the currencies have yet to fully stabilize. They are highly volatile currencies and therefore often held as an appreciating asset. However, due to the volatility these currencies can depreciate and become worthless. Consumers need to be protected from these issues. However, this has proved challenging.
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According to Nabilou (2019) the issues faced by regulators can be categorized in three distinct issues. Namely, there is a lack of competency, trouble identifying regulated parties and the issue of regulatory arbitrage. The lack of competency issue is especially pronounced in polities like the European Union. The European Union is a multilayered institution which hosts various regulating bodies. Each if these regulating bodies has an area of expertise / competence for which they can propose regulation. For instance, in the EU the European Banking Association, European Central Bank, EU securities and markets authority and securities and markets stakeholder group have all proposed different regulatory
approaches regarding cryptocurrencies. Moreover, cryptocurrencies have been constructed in various conceptualizations, depending on their inherent structure they can be considered financial instruments, electronic money or none of these (Burilov, 2019). Some
cryptocurrencies have such a broad range of applications that they do not fall under a single definition. This poses serious problems to the formulation of a new regulatory framework. All types of conceptualizations adhere to different mannerism which in turn require different modes of regulation. In this paper we will adopt the perspective that cryptocurrencies are bidirectional virtual currencies. This qualification is highly contested, however, it is in line with the reasoning of governments when regulating thus far (European Central Bank, 2012; Ólafsson, 2014).
Due to the removal of a third party organization regulators have found it tough to find the right target for regulation. The traditional financial paradigm is built around these central authorities functioning as gatekeepers. These organizations further aid government agencies in the monitoring and halting of criminal / illicit activities. According to Fairfield (2014) the current regulatory system relies on intermediaries to preform oversight functions. However, these are no longer present in a cryptocurrency paradigm. Therefore, a new target must be found to direct regulation against. One of these targets has been online cryptocurrency exchanges. Cryptocurrency exchanges are online platforms which allow users to convert cryptocurrencies into fiat currencies and vice versa. Moreover, they bring individuals in contact with each other who want to buy and sell cryptocurrencies. Most activity in the crypto paradigm occurs through these exchanges (Hughes & Middlebrook, 2015). Therefore, they have become a sort of proto-central authority. Due to their prolific use they have become viable targets for regulation.
A third issue that arise when regulating cryptocurrencies is their borderless nature. An adverse effect of a borderless technology is the lack of jurisdiction. According to Reidenberg
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(2005) any internet based technology will result in jurisdiction problem. No single government or entity has sole regulatory competence over the internet (Barlow, 2016). Therefore, similar levels of regulation must be put in place across jurisdictions otherwise individuals will merely locate themselves in a lenient jurisdiction. Through such a
methodology they would still be able to interact with consumers in heavily regulated places whilst not having to adhere to these stringent rules. Pflaum & Hateley (2014) observe that during the initial stages of regulation the regulatory landscape surrounding cryptocurrencies has become inconsistent internationally. This has the adverse effect of stimulating regulatory shopping. Due to the borderless nature a more global effort is required. This is further
corroborated by Ponsford (2015) who claims international organizations such as the World Economic Forum should be involved in the regulation of cryptocurrencies.
Although new and challenging there have been advancements in the regulation of cryptocurrencies. According to Tsukerman (2015) rules and regulations regarding
cryptocurrencies fall under one of two categories. The implemented regulation can serve to protect the purchasers of cryptocurrencies from fraud or the regulatory framework can serve to protect society from the illicit uses of cryptocurrencies such as money laundering. Reyes (2016) states that there are three regulatory modes that can be adopted in relation to
cryptocurrencies. Firstly, a self regulation model could be adhered to. Secondly, governments could aim to prohibit the use of cryptocurrency, Thirdly, broaden the scope of existing
legislation to also include cryptocurrencies.
Up until now an emphasis has been placed on self regulation. Self regulation is a product that arises through continued economic exchanges wherein all parties involved look out for their own interests (Molly Cohen & Sundararajan, 2015). Seeing as the people
involved in the cryptocurrency industry are early adopters and big believers in the technology they usually want what is best for the development of the technology. This further allows governments to adopt a wait and see approach until they fully understand the intricacies of this innovative technology. This is often deemed as desirable by people active in the paradigm (Kesan & Gallo, 2005). Cohen and Sundararajan (2015) propose four
characteristics that must be met in order to be a successful form of self regulation. Self regulation only work s though the use of credible organizations. Credible organizations can enhance their reputation through “good” acts. This can then become an instrument through which good practices are enforced (Doguet, 2013). There must also be sufficient enforcement capabilities. Through self regulation the regulatory responsibility is transferred to participants
