By Bill Cunningham From Cayman Financial Review August 2, 2016
Should virtual currencies be regulated and if so, how? This question has been explored extensively even before Bitcoin and other crypto-currencies emerged. It has been the subject of regulatory and legislative hearings, judicial deliberations and calls for information from national and state governments and numerous industry groups.
So far, it is a split decision. The issue, however, should be much more settled than it appears to be. Across the spectrum of virtual or digital currency businesses should, and in most cases can, be regulated in the same way as their counterparts in traditional payment transaction models.
For many years, public policy concerning the movement of money has been implemented through legislation and regulation to protect consumers, provide safety and soundness, and prevent money laundering and terrorist financing. The years of experience and multitude of debates that led to this regulation should not be ignored simply to accommodate new technologies, which in many ways allow us to perform the same old functions simply in a new way.
With virtual currencies it is important to look past the “cool” aspects of the technology and instead focus on the actual function being performed. Virtual currencies facilitate value transfer between persons – natural or legal – whether locally and globally, in the same manner and for the same reasons as fiat currencies. In fact, transferring value just like fiat currency is the very argument virtual currency advocates use in promoting adoption.
They simply point out its greater efficiency for making payment. The opportunity to prey on a consumer or finance illegal activity, however, is no different between fiat and virtual currency although the properties of certain virtual currency might make it easier, especially considering the systems have inherent anonymity or pseudo-anonymity characteristics. And, even where virtual currencies businesses are regulated, a potentially large regulatory gap exists. The customer may transfer the crypto-currency to another wallet not held with the regulated business, where the ability to have customer identification review and verification, and transaction monitoring is close to impossible.
In the U.S., the federal government determined that transferring virtual currency should be subject to regulation in the same way as transferring fiat currency. The U.S. government first laid down this principle in a 2008 plea settlement with e-gold Ltd. requiring the digital currency system to register as a money service business and seek money transmission licenses in states where such licenses were required. This position was enunciated by the government after a federal court had determined that money transmission can occur even if it does not deal in currency. That decision by the court was the key factor that lead to the plea. The 2013 guidance from FinCEN effectively ratified this position by “clarifying” that businesses transferring or exchanging virtual currency were money services businesses for purposes of the Bank Secrecy Act.
Many jurisdictions in the U.S. and outside the U.S. require either registration or licensure with statutes that are broad enough to consider any medium of exchange. It is likely in the U.S. that more states could bring these systems under regulatory control by accepting the FinCEN guidance and/or the court precedence. In other situations, where the medium of exchange is specifically defined as national currency, a simple expansion of the definition of “money” or “monetary value” or “funds” could open the way for existing rules to be applied. For example, a number of states define money in money transmission as sovereign currency, or the legal tender of a country. In the EU, “funds” are considered fiat currency. Expand “funds” or “money” to include virtual or digital currencies in which they are a digital representation of monetary value that can be used in replacement of, converted into, redeemed for, or exchanged for fiat currency; and existing regulation could apply nearly everywhere.
Two arguments are most often presented for not regulating virtual currencies or at least minimizing regulations. First, these new payment mechanisms are so unique, traditional guidelines do not apply and therefore special considerations need to be developed. This uniqueness may exist to some extent with the technology, but in terms of moving value, it is more perception than reality. In order to be in line with public policy intent, regulations should be implemented and enforced in the same manner as with “traditional” money transmitters.
Second, it is argued that enforcing regulations for these new virtual currency related businesses would stifle innovation. This argument has merit, but it has the same merit for any new ideas, not just those dealing with virtual currencies. It is always a good idea to ensure that any regulation while achieving the objectives presented by legislation be enacted in a way to reduce any adverse effect on the generation and implementation of innovative concepts. This argument is applicable across the board, not solely with virtual currencies.
This lack of regulatory control around emerging virtual currency-related businesses also creates an uneven playing field for traditional banks and money services businesses putting them at an increasing competitive disadvantage. Proper compliance involves substantial efforts to obtain licenses/approval, as well as ongoing efforts to maintain compliant systems, are plagued with time delays to market, geographic constraints and significant costs. Virtual currency-related businesses that do not adhere or are not held accountable to existing regulations obviously are not burdened with these delays, constraints or costs. Even the few virtual currency start-ups that try to follow regulatory guidelines are severely handicapped, if not entirely crippled, in their efforts to develop customers, revenue or investment when compared to less compliant virtual currency-related businesses which simply start without regulatory controls.
Not ensuring virtual currency-related businesses adhere to the same regulatory guidelines as traditional systems puts at risk the very objectives the regulations are designed to meet and the persons they are intended to protect. Persons wanting to defraud consumers or move money for illegal activity can much more easily accomplish their objectives by avoiding regulated entities and using those who make no effort to comply.
However, this is not to say that many of the current and emerging virtual currency-related businesses cannot operate, or are not already operating, within a regulatory compliant framework of money services businesses or other types of financial services companies. In fact, there are some that do. In order for a virtual currency-related business to meet these standards it must:
Conduct customer identification review and verification proactively on all users of their system or service. Have knowledge of both counterparties to a transaction with which their system or service is involved. Maintain an adequate and sufficient level of transaction monitoring; have in place processes and procedures to detect, report, and prevent illegal and illicit activity.
The market needs to take a step back, unwind from the technology, and apply what legislators and public policy makers intended. The bigger picture for application of this intent should prevail, not the details of a specific regulation. When viewing this larger picture, the question and answer become clearer. Where money and monetary value can be interpreted to include a broad national money substitute, apply existing rules. Where the definitions are narrow, simply expand them within existing law.