Global reset – Monetary decoupling (Part 11: The future of cryptocurrencies)

Global reset – Monetary decoupling (Part 11: The future of cryptocurrencies)

Phuah Eng Chye (6 November 2021)

Digital currencies are part of a broad information revolution that is disrupting how activities are organised. Traditional intermediaries, platforms and start-ups alike are jostling to establish a foothold in the fast-growing cryptocurrency industry. But at the moment they are held back by government indecision on regulation.

Hung Tran notes “globally, the regulatory landscape for Bitcoin is a mixed bag: outright bans of cryptocurrencies, different forms and degrees of regulation, or no regulation at all. According to the Financial Stability Board…many countries – such as Algeria, Bolivia, Ecuador, Nepal, Nigeria, and Turkey – have imposed outright bans. Others have partial bans: Vietnam and Russia bar the use of cryptocurrencies as a means of payment but have not prohibited their citizens from trading and investing in cryptocurrencies. China, for its part, has prohibited registered financial institutions from engaging in cryptocurrency transactions or providing custodian, clearing, and payment services to cryptocurrency users. The European Central Bank, meanwhile, has classified Bitcoin as a virtual decentralized currency but not money or currency from a legal perspective. It has advised financial institutions with exposure to crypto assets to put in place appropriate risk-management frameworks, with further regulatory measures being considered. In Japan, Bitcoin and other cryptocurrencies can be used as legally accepted means of payment, but authorities have not designated Bitcoin as legal tender. Japan’s Financial Services Agency recognizes and regulates Bitcoin exchange operators”.

In the US, different federal agencies define Bitcoin in various ways. Hung Tran reports “the US Treasury views Bitcoin as a virtual decentralized currency but not as legal tender. Entities helping to process Bitcoin transactions are viewed as money transmitters subject to the supervision of the US Treasury’s Financial Crimes Enforcement Network (FinCEN), including being required to make suspicious activity reports. The Internal Revenue Service has defined Bitcoin as property subject to a capital gains tax. The Commodity Futures Trading Commission has determined that Bitcoin is a commodity…falls under its purview. The Securities and Exchange Commission (SEC) has ruled that while Bitcoin as such is not a security, Bitcoin assets or tokens can be defined as a security and thus subject to its supervisory authority”[1]. “US states and municipalities take different regulatory approaches. These range from being friendly to cryptocurrency businesses by issuing, for instance, a new state banking charter, called a special purpose depository institution, for banks that deal mostly in digital assets (Wyoming); to banning cryptocurrency mining; to requiring the registration of exchanges and other companies servicing Bitcoin transactions as money-services companies or money transmitters. New York, Rhode Island, and Arizona have developed reputations as less friendly to cryptocurrency activities because of their attempts to regulate those businesses, while several states have created regulatory sandboxes that exempt cryptography businesses from regulatory oversight for the initial development period”.

China’s crackdown

China’s harsh crackdown represents one extreme. It was surprising as China was an early mover. Kai von Carnap notes “2013 to 2017 were the heyday of small private investors, developers and founders in China, who focused on cryptocurrencies and public blockchains…Chinese startups founded during this time were embedded within the international blockchain ecosystem community…such as the world’s biggest mining equipment producer (Bitmain), the world’s largest cryptocurrency exchange (Binance) and some of the most valuable Chinese cryptocurrencies (VeChain, Neo)”.

However, concerns over money laundering, capital outflows and fraud prompted a drastic policy reaction. Andrew Galbraith and Samuel Shen notes “China’s crypto restrictions date to 2013, when financial regulators banned banks and payment companies from providing bitcoin-related services. In September 2017, China banned ICOs, barred financial firms and payment companies from providing services for ICOs and cryptocurrencies, and banned cryptocurrency trading platforms from converting between legal tender and cryptocurrencies. The restrictions prompted most such platforms to shut down, with many moving offshore”.

Despite this, Andrew Galbraith and Samuel Shen reports “this year’s bitcoin bull run revived cryptocurrency trading in China, prompting warnings from regulators over financial risks and money laundering. With local exchanges shut down, many Chinese investors have switched to platforms owned by Chinese exchanges that had relocated overseas, including Huobi and OKEx, or trade over-the-counter through online platforms and social media trading chatrooms. China-focused exchanges, which also include Binance and MXC, have allowed Chinese individuals to easily open accounts online. They have also facilitated peer-to-peer deals in OTC markets that help convert Chinese yuan into cryptocurrencies. Traders make such transactions through banks or online payment channels such as Alipay or WeChat Pay. Retail investors have also been able to buy computing power from cryptocurrency miners, who design various investment schemes that promise quick and fat returns”.

In 2021, enforcement intensified. Global Times report Sichuan, Xinjiang, Inner Mongolia and Yunnan Province curbed Bitcoin mining; suspending 90 percent of mining capacity or one-third of global crypto processing power. “China’s biggest cryptocurrency mining machine-maker Bitmain announced that the company has suspended selling machines in the spot market”. China’s miners are reportedly shifting their operations overseas with North America, Texas, Kazakhstan, and Russia among the hotspots”. Several industry associations have also banned crypto-related financial services while banks and payment firms were urged “to thoroughly check client accounts, identify those involved in cryptocurrency transactions and promptly cut their payment channels…through which mainland Chinese traders have acquired cryptocurrencies to trade offshore”.

Shalini Nagarajan reports in September 2021, “the PBOC also said all crypto-related transactions are not allowed under the law. Activities considered illegal cover a range of operations, such as buying and selling virtual assets as a central counterparty, and providing intermediary or pricing services for crypto transactions. It also includes token issuance financing, crypto derivatives transactions, and other activities suspected of illegal sale of tokens…The provision of services by overseas virtual currency exchanges to Chinese residents through the internet is also an illegal financial activity.” “Those who carry out related illegal financial activities (that) constitute a crime shall be investigated for criminal responsibility”.

Global Times adds the National Development and Reform Commission (NDRC) called for “cryptocurrency mining as a sector to be eliminated. The authorities ban the addition of new virtual currency mining projects, and require local governments to adopt a scientific timetable and approach to accelerate the exit of current projects on the basis of a stable transition…the government agencies…clarify the boundary between mining and high-tech industries like blockchain and cloud computing, prohibit to carry out mining activities in the name of data center, developing the digital economy or strategic emerging industries”. Government agencies were asked will step up enforcement to “firmly stop electricity generation firms, especially smaller ones, to provide electricity for cryptocurrency mining activities”.

El Salvador’s bitcoin gambit

At the other extreme, in September 2021 El Salvador became the first country to endorse bitcoin as legal tender. It is interesting because El Salvador is a dollarized economy which legalised the USD as its official currency in 2001. Its financial system is under-developed. Seventy percent of its 6.5 million population don’t have bank accounts or access to credit.

The bitcoin launch was inauspicious. Tomio Geron notes it “met with a crash in bitcoin prices and headaches with its new digital wallet as businesses and consumers grappled with difficulty in actually using the country’s new currency…Protests also erupted from citizens who opposed the move to bitcoin”. El Salvador’s digital wallet Chivo (slang for cool) struggled with capacity problems and its launch was delayed. “President Nayib Bukele tried to put a good face on the launch, saying he bought the dip by purchasing bitcoin for the government’s treasury at lower prices. He retweeted videos of people paying with bitcoin at businesses such as Starbucks, Pizza Hut and McDonald’s. It’s unclear how many small businesses that lacked the technological resources of a multinational corporation were accepting bitcoin”. “The country has outsourced its bitcoin plan to at least five private companies, with others like OpenNode[2], which McDonald’s is reportedly using for bitcoin payments…With so many players involved, there doesn’t seem to be a central organization offering technical support or education. What about individuals who don’t have a mobile phone, or can’t access a bitcoin ATM, which seems to be the main plan to access physical cash? What if businesses need something more sophisticated than a consumer-oriented wallet app to receive payments? There were some Chivo kiosks set up at plazas across the country, but they weren’t very active…At times, Bukele himself offered technical support on Twitter”.

Lila MacLellan notes “under the country’s Bitcoin Law, businesses would be obliged to accept bitcoin or the US dollar, the country’s other official currency, as payment. Either could be used to pay taxes or bank loans…Salaries and pensions would still be paid in dollars. The government will spend up to $75 million to airdrop $30 worth of bitcoin into Chivo wallets…That funding would cover the cost of seeding 2.5 million users with bitcoin…The government has also created a $150 million fund to support bitcoin to USD conversions and is rolling out Chivo ATMs. Using bitcoin will be totally optional…and…bitcoin wallet are not limited to the Chivo app”.

Gian M. Volpicelli notes that although Athena was “initially tipped to install 1,000 ATM machines in the country will start with just 14”. “Even the Bitcoin Law looks like unfinished business: its redrafting of an entirely new monetary system is hastily sketched in two pages and 16 articles, which is why it is expected a more detailed regulation to be issued soon”. “Some have pointed out that only 45 per cent of the country’s population has internet access – and that an internet connection will be required to use the app”.

Remittances[3] is a key aspect. Carla Mozée notes “remittances from the US[4] in 2018 made up 21% of El Salvador’s GDP and that Bukele has estimated Salvadorans spend $400 million a year on remittance fees. Chivo members can make withdrawals and recharge accounts at the ATMs and can use the wallet app to send either bitcoin or US dollars to people in El Salvador”. There are currently 50 commission-free Chivo ATMs[5] in 10 US cities. Advocates argue bitcoin offers considerable savings. This is disputed by Steve H. Hanke, Nicholas Hamlon and Mihir Chakravarthi who estimate from remittance to conversion to USD, bitcoin remittance fees are considerably more expensive than the average 2.85% fee for traditional remittances[6].

Some critics think Bukele’s bitcoin gambit is intended to divert attention from his political problems[7]. Others point out El Salvador risk upsetting international regulators. Tomio Geron notes “the IMF, with which El Salvador is negotiating a debt package,” does not support the legalisation of bitcoin as it could lead to macroeconomic instability, hurt financial trust and is susceptible to money laundering or other criminal activities. “The views of international lenders matter a lot, because the country is in debt and relies on international loans. Moody’s downgraded the country’s debt because of the bitcoin moves. The World Bank said it would not help with the bitcoin plan. If the country moves full steam ahead, there is no guarantee that the IMF or others will bail out the country’s financial system if it doesn’t work”.

On the other side, Lila MacLellan reports “Bukele’s daring move was widely celebrated by the bitcoin community…The shift is also meant to attract foreign investment and entrepreneurs in the crypto space”. Gian M. Volpicelli notes bitcoin entrepreneurs visited the country due to its image as a “friendly jurisdiction”. In addition, El Salvador has offered “anyone ready to invest three bitcoin (today, about $100,000) will be immediately granted permanent residency, and that capital gains on bitcoin will not be taxed. Bukele has also talked up the country’s volcanoes as ideal locations for bitcoin miners hungry for cheap geothermal energy amid China’s crackdown on cryptocurrency”. Chainbytes, a Bitcoin ATM manufacturer, “decided to relocate his company’s production here…We were having a lot of shipping problems with China…We’re gonna export them from here to the United States.”

Lila MacLellan asks “who wins in El Salvador’s bitcoin future? Is it a pipe dream or is Bukele going to prove the doubters wrong? No one can say, just as it’s unclear whether bitcoin will one day be worthless code or a reliable and more predictable store of value. But critics argue that instead of serving citizens who have been forced to flee the country in the face of violence, poverty, corruption, and the effects of climate change, the president’s move is mostly aimed at tech migrants and wealthy foreigners eying beachfront properties they can buy with the crypto coin, without paying the capital gains tax they’d face in the US and elsewhere. The country is already unable to influence the value of the US dollar it adopted over the colón in 2001, so why would it adopt a risky asset without any central control? Nevertheless, Bukele’s gamble may soon be followed by others”.

On balance, El Salvador has opened up opportunities by acquiring first mover advantage and brand recognition as a pioneer while additional risks appear marginal. Citizens and business will usually adopt and find their own solutions to manage volatility and cyber risks. It will be interesting to revisit El Salvador in a couple of years to review its progress.

Cryptocurrencies take off in emerging economies

China and El Salvador reflect the extremes of policy choices. While the major economies and international regulators favour CBDCs and are reticent on cryptocurrencies, enthusiasm is growing rapidly in emerging economies. Dimitris Drakopoulos, Fabio Natalucci and Evan Papageorgiou notes “the total market value of all the crypto assets surpassed $2 trillion as of September 2021 – a 10-fold increase since early 2020. An entire ecosystem is also flourishing, replete with exchanges, wallets, miners, and stablecoin issuers”. “Surveys and other measures suggest that emerging market and developing economies may be leading the way”.

MacKenzie Sigalos reports “global adoption of cryptocurrency has taken off in the last year, up 881%, with Vietnam, India and Pakistan firmly in the lead, according to new data from Chainalysis. Most of the top 20 countries are emerging economies, including Togo, Colombia and Afghanistan. Meanwhile, the United States slipped from sixth to eighth place, and China, which cracked down on crypto this spring, dropped from fourth to 13th”.

Camomile Shumba adds Chainalysis reported “Africa’s digital-asset market has grown over 1,200% by value over the last year, making it the third-fastest growing cryptocurrency economy in the world…Kenya, Nigeria, South Africa, and Tanzania all ranked in the top 20 of the 2021 Global Crypto Adoption Index. Chainalysis also said Africa also has a bigger share of its overall transaction volume made up of retail-sized transfers than any other region at just over 7%, versus the global average of 5.5%”.

Michael Kuchar notes other countries are considering following El Salvador’s example. Panama is drafting a cryptocurrency law “to increase the use of bitcoin and Ethereum as a payment option” and “to encourage the use of blockchain technology in the public sector and the financial industry”. The Banco Central de Cuba (BCC) authorized cryptocurrency use on September 15, 2021. The Ukraine Parliament voted almost unanimously to legalize and regulate cryptocurrency and intends to open the bitcoin market to investors and businesses by 2022.

However, contradicting this trend, Aaron Eglitis and Bloomberg reports that Estonia, the first country to regulate cryptocurrencies, is “weighing firmer oversight of what’s become a popular European center for digital coin trading and the accompanying infrastructure”. Estonia’s Financial Intelligence Unit revoked about 2,000 licenses for crypto exchanges and wallets after “a sprawling money-laundering scandal in 2018 that saw Danske Bank’s Estonian unit handle 200 billion euros ($232 billion) of suspicious transactions”. It also revoked the license of Virtual Planet after a related firm – whose ATMs convert clients’ physical banknotes into anonymous digital coins – “was designated a security risk”. “The Estonian government is considering new legislation to tighten oversight across the board. That includes requirements for audited annual reports, higher capital levels, as well as due diligence thresholds on transaction volumes”.

The debate on cryptocurrencies

There is thus a schism in the views on cryptocurrencies. Regulators tend to take a stern view. In its annual report, the Bank of International Settlement (BIS) states “by now, it is clear that cryptocurrencies are speculative assets rather than money, and in many cases are used to facilitate money laundering, ransomware attacks and other financial crimes. Bitcoin in particular has few redeeming public interest attributes when also considering its wasteful energy footprint. Stablecoins attempt to import credibility by being backed by real currencies…only as good as the governance behind the promise of the backing. They also have the potential to fragment the liquidity of the monetary system and detract from the role of money as a coordination device. In any case, to the extent that the purported backing involves conventional money, stablecoins are ultimately only an appendage to the conventional monetary system and not a game changer”.

Hung Tran notes bitcoin as “the largest species of cryptocurrency doesn’t measure up to its promised benefits as a peer-to-peer network, a uniquely quick and efficient payment system, or a store of value”. “Bitcoin’s risks, meanwhile, are sizable. The creation and use of Bitcoin have been associated with a concentration of power among relatively few operators and owners, high energy consumption, market opacity, significant price volatility, and illicit and illegal transactions. Together, these risks and unrealized rewards argue for enhancing cryptocurrency regulation, which currently ranges around the world from nonexistent or partial regulations to prohibitions”.

Hung Tran points out “Bitcoin payments can only be made with a limited number of merchants and remain a sliver of those merchants’ sales: only 5 percent of their transactions…Relative to credit cards, it also takes longer to authenticate and finish Bitcoin transactions: Bitcoin processes 4.6 transactions per second on average, compared to Visa’s 1,700-plus per second. Miners can reject a transaction with a fee deemed too low. A refund? Forget about it. Bitcoin payments are irreversible, excluding redress for error or fraud”.

Hung Tran relates how the big idea of cryptocurrencies “was that individuals could participate in a peer-to-peer network and exchange things of value without the involvement of a central authority or trusted intermediaries like commercial banks. And yet, years out from the cryptocurrency’s origins, Bitcoin advocates seem to have accepted a concentration of power in a handful of miners and holders. It’s a reality at odds with early visions of a democratized and dispersed network”. “Bitcoin ownership, like Bitcoin mining, is concentrated. An estimated 1,000 individuals – known as whales – own 40 percent of the Bitcoin market. Whales are in a position to influence or manipulate the market to the disadvantage of most other participants. The state of the market makes Bitcoin unreliable and unsuitable as a means of payments and settlement for ordinary users. Moreover, gyrating prices make Bitcoin a poor instrument for savings”.

Hung Tran suggests “given the shift in the balance between the potential benefits of cryptocurrencies and their costs and risks, it is important to revamp and update the global regulatory framework governing them”. He recommends reviewing “the distinction between activities within the Bitcoin network and its interfaces with the conventional financial system”; strengthening transparency and investor protection through registration and disclosure requirements; requiring registered financial institutions to establish robust monitoring, risk management, and reporting capabilities for cryptocurrency broker-dealer activities; and tightening monitoring and supervision to protect public security.

Generally, regulators believe the risks and costs outweigh the potential benefits of recognising cryptocurrencies as legal tender. Tobias Adrian and Rhoda Weeks-Brown point out “the most direct cost of widespread adoption of a cryptoasset such as Bitcoin is to macroeconomic stability. If goods and services were priced in both a real currency and a cryptoasset, households and businesses would spend significant time and resources choosing which money to hold as opposed to engaging in productive activities. Similarly, government revenues would be exposed to exchange rate risk if taxes were quoted in advance in a cryptoasset while expenditures remained mostly in the local currency, or vice versa. Also, monetary policy would lose bite. Central banks cannot set interest rates on a foreign currency. Usually, when a country adopts a foreign currency as its own, it imports the credibility of the foreign monetary policy and hope to bring its economy – and interest rates – in line with the foreign business cycle. Neither of these is possible in the case of widespread cryptoasset adoption. As a result, domestic prices could become highly unstable. Even if all prices were quoted in, say, Bitcoin, the prices of imported goods and services would still fluctuate massively, following the whims of market valuations”.

In addition, “financial integrity could also suffer. Without robust anti-money laundering and combating the financing of terrorism measures, cryptoassets can be used to launder ill-gotten money, fund terrorism, and evade taxes. This could pose risks to a country’s financial system, fiscal balance, and relationships with foreign countries and correspondent banks”. “Further legal issues arise. Legal tender status requires that a means of payment be widely accessible. However, internet access and technology needed to transfer cryptoassets remains scarce in many countries, raising issues about fairness and financial inclusion. Moreover, the official monetary unit must be sufficiently stable in value to facilitate its use for medium- to long-term monetary obligations. And changes to a country’s legal tender status and monetary unit typically require complex and widespread changes to monetary law to avoid creating a disjointed legal system”.

Tobias Adrian and Rhoda Weeks-Brown notes “banks and other financial institutions could be exposed to the massive fluctuations in cryptoasset prices. It is not clear whether prudential regulation against exposures to foreign currency or risky assets in banks could be upheld if Bitcoin, for instance, were given legal tender status. Moreover, widespread cryptoasset use would undermine consumer protection. Households and businesses could lose wealth through large swings in value, fraud, or cyber-attacks. While the technology underlying cryptoassets has proven extremely robust, technical glitches could occur. In the case of Bitcoin, recourse is difficult as there is no legal issuer”.

Despite regulatory reservations and tough enforcement actions, cryptocurrencies continue to blossom. China has struggled for 7 years to stamp out cryptocurrencies[8]. Users counter central bank restrictions on cryptocurrency exchanges (e.g. Nigeria[9], Kenya) by shifting out from exchanges like Binance to peer-to-peer (P2P) platforms like Paxful and Remitano as an on-ramp into cryptocurrency for remittances and commercial transactions.

However, there are different motivations at work in emerging economies. To be clear, cryptocurrencies are not a tool for achieving monetary stability. Rather it serves as a tool to cope with an underdeveloped financial infrastructure and an unstable monetary environment. Factors such as a weak currency, high inflation, capital controls, a young tech-savvy, and a large emigrant-immigrant population favour widespread adoption of cryptocurrencies. Citizens and businesses (including multinationals) find cryptocurrencies an expedient solution for bypassing government controls and managing the costs and risks from an inefficient international payments system. Some emerging economies may also find it is not worthwhile to launch a CBDC (due to high costs, lack of scale and technological expertise) and prefer instead to ally with fintech firms to use cryptocurrencies as a substitute.

The future landscape

The digital currency ecosystem is in its infancy but its development is accelerating as both CBDCs and cryptocurrencies have gained considerable momentum this year. It should be noted CBDCs and cryptocurrencies are not competitors but are complementary. In fact, the roll-out of the regulatory, market and settlement infrastructure for CBDCs will prove favourable to cryptocurrencies because it will provide more opportunities for seamless connectivity and complementary activities.

CBDCs and cryptocurrencies will thus co-exist. Developed countries will probably discriminate in favour their own CBDCs. CBDCs will enjoy superior legal treatment and dominate the “lit” and ring-fenced financial zone of the economy. In addition, the possibilities for CBDCs are greater due to their superior information bundles which facilitate the use of algorithms. CBDCs also have an advantage in retail payments as the high volumes, low values and processing of chargebacks can overload the verification process, lengthen processing time and result in relatively high transaction costs for cryptocurrencies.

Cryptocurrencies will most likely flourish in areas where CBDCs are lacking; namely in the shadow banking system and informal economy. For example, the transparency of CBDCs will cause more users to flock to cryptocurrencies for anonymity and to evade regulatory oversight. Cryptocurrencies will also be used to bypass inefficient intermediation nodes as they offer the attraction of real-time settlement speed which will substantially reduce price and payment risks.

A robust multi-layered cryptocurrency ecosystem will evolve, its landscape shaped by information effects. At the product and venue layer, the principle of abundance dictates the private digital currency space will be fragmented and subjected to long-tail dynamics – a few highly successful products and an elongated long-tail of marginal products that functions more like game tokens, collectibles and novelties. Success will be determined by the product and venue features (access, conveniences, privacy, liquidity and reliability) and cost structures (environmental, transaction fees, fraud, cyber theft).

In contrast, the intermediation space will be concentrated with a few “winners” that are able to scale their user base by offering specialised services and customised solutions. For example, market makers, financiers and investors will emerge to offer products and services to reduce payment and price risks. In this context, the price of mainstream cryptocurrencies, such as bitcoin, will rise due to wholesale demand for large denominations. A high bitcoin price will lower transaction costs on a percentage basis for wholesale transactions. At the retail level, costs can be reduced by immobilising[10] bitcoin, breaking it into micro denominations and tracking payment use on a centralised ledger.

Many players are getting ready to contest for their spot on the cryptocurrency ecosystem. Among them, Facebook has not abandoned its dream to launch a global digital currency. Michael Garbade notes after being embroiled in regulatory disputes on Libra, Facebook “decided to strategize and launch a different global digital currency later in 2021, after rebranding the project to Diem”. “Facebook Diem is a soon-to-be-launched permissionless payment system based on blockchain technology”. “The Diem coin will be a stablecoin backed by cash equivalents and government securities. It will run on a blockchain network and use an open-source code to facilitate scalability and use a Novi wallet app which is likely to support integration into WhatsApp, Messenger, Instagram and other platforms. In the initial stages, only Diem Association members[11] can process transactions. However, Diem plans to fully transition into a permissionless proof-of-stake system within the first five years of its launch”.

In conjunction with this, Francisco Rodrigues notes Facebook “tapped Coinbase and Paxos for its Novi digital wallet project that kicked off its testing phase in the U.S. and Guatemala on October…The pilot program allows users in both countries to download the Novi digital wallet app for iOS or Android devices and fund their accounts with a debit card. The wallet allows them to send and receive Pax dollars, which are dollar-pegged stablecoins issued by Paxos. Novi customer funds will be custodied with Coinbase, which manages over $180 billion in assets…the pilot phase allows the company to evaluate the wallet’s core functions and showcase operational capabilities”. Facebook’s digital currency plans reveals “the company’s rebrand to focus not on social media, but the metaverse. The metaverse is loosely defined, but it’s often seen as a digital reality combining aspects of social media, augmented reality and online gaming and cryptocurrencies together”.

But progress on ecosystem development is generally stalled until regulators shed light on their intentions. In relation to this, blockchain and cryptocurrency associations[12] are keen to develop self-regulatory organisations (SROs) – to establish industry rules and mechanisms – in lieu of formal regulation. The precedent is that historically informal or industry self-regulation preceded formal regulation (i.e. laws to establish and empower regulators). But it is unlikely SROs will be an effective solution as the “virtual” nature of the cryptocurrency industry makes it impossible to mandate membership and establish disciplinary mechanisms.

Many countries are already reviewing the regulatory framework issues. The Australian Senate select committee recommended establishing a classification system for digital assets; a licensing regime for participants; a framework for custodial and depository services for digital assets; an adaptation of the Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) regulations to digital assets; to clarify the legal structures of Decentralised Autonomous Organisation and the operations of blockchain-based organisations; and to clarify the taxation rules for new types of technology structures and digital asset transactions.

Hugh Harsono points out US regulators seem to be getting “on board with providing support to the crypto-asset industry…moving to the cautious acceptance of crypto-assets. The fact that regulators are encouraging typically traditional investment vehicles such as ETFs to participate within the cryptocurrency ecosystem is particularly critical for ensuring the successful integration of crypto-assets within traditional banking services, and subsequently, mainstream financial offerings. By normalizing cryptocurrency-related banking, the American government can help develop a more mature ecosystem to support the crypto-asset space, helping to reduce risk while encouraging growth in the years ahead…Framing cryptocurrencies and their impact through traditional investment vehicles such as ETFs, while treating virtual currency operators like their traditional counterparts, may be just some of the options for crypto-asset ecosystem participants to steadily increase buy-in from key regulatory stakeholders. It will also be interesting to see how proposed CBDCs interact with crypto-assets in this respect, with the goal of financial inclusion for all combined with driving better, more compliant, and more consistent integration of crypto-assets and traditional banking services for economic growth”.

Hugh Harsono notes in October 2021, “the Securities and Exchange Commission (SEC) granted the greenlight for futures-based Bitcoin exchange-traded funds (ETF)…these futures-based ETFs would track future contracts and would not be a direct investment in Bitcoin…providing the industry with a certain legitimacy through SEC approval…This may be a potential window into future legislative action by the SEC; if the crypto-asset industry is able to provide finance-specific use-cases for cryptocurrencies, the SEC may be more willing to provide further approval and legitimacy to the traditionally nascent cryptocurrency legislation ecosystem. This can have the effect of aligning crypto-assets with mainstream financial services for the benefit of both industries”. In addition, the Office of the Comptroller of the Currency (OCC) 2022 Bank Supervision Operating Plan went so far “as to directly place cryptocurrency-related activities as among its top supervisory priorities…the OCC has made it easier for other, more cautious regulators, to follow in its footsteps of supporting crypto-asset ecosystem growth”.

Nonetheless, regulatory concerns on financial stability[13] persist. Dimitris Drakopoulos, Fabio Natalucci and Evan Papageorgiou points out “as crypto assets become more mainstream, their importance in terms of potential implications for the wider economy is set to increase”. There is particular concern over “stablecoins – which aim to peg their value usually against the US dollar – are also growing at lightning speed, with their supply climbing 4-fold throughout 2021 to reach $120 billion. The term stablecoin, however, captures a very diverse group of crypto assets and can be misleading. Given the composition of their reserves, some stablecoins could be subject to runs, with knock-on effects to the financial system. The runs could be driven by investor concerns about the quality of their reserves or the speed at which reserves can be liquidated to meet potential redemptions”.

Within this, they note many “entities lack strong operational, governance, and risk practices. Crypto exchanges, for instance, have faced significant disruptions during periods of market turbulence. There are also several high-profile cases of hacking-related thefts of customer funds…Consumer protection risks remain substantial given limited or inadequate disclosure and oversight. For example, more than 16,000 tokens have been listed in various exchanges and around 9,000 exist today, while the rest have disappeared in some form. For example, many of them have no volumes or the developers have walked away from the project. Some were likely created solely for speculation purposes or even outright fraud…The (pseudo) anonymity of crypto assets also creates data gaps for regulators”

Dimitris Drakopoulos, Fabio Natalucci, Evan Papageorgiou suggest “as a first step, regulators and supervisors need to be able to monitor rapid developments in the crypto ecosystem and the risks they create by swiftly tackling data gaps…Additionally, the crypto ecosystem falls under different regulatory frameworks in different countries, making coordination more challenging. For example, most transactions on crypto exchanges happen through entities that operate primarily in offshore financial centers. This makes supervision and enforcement not only challenging, but nearly impossible without international collaboration”. Hence, “policymakers should enhance cross-border coordination…National regulators should also prioritize the implementation of existing global standards. Standards focused on crypto assets are currently mostly limited to money laundering and proposals on bank exposures. However, other international standards[14] – in areas such as securities regulation, as well as payments, clearing and settlements may also be applicable and need attention”.

Recently, the President’s Working Group on Financial Markets (PWG) recommended the enactment of “legislation to ensure that payment stablecoins and payment stablecoin arrangements are subject to a federal prudential framework on a consistent and comprehensive basis…and adequately address risks across a variety of organizational structures. Such legislation would complement existing authorities with respect to market integrity, investor protection and illicit finance, and would address key prudential concerns…legislation should require stablecoin issuers to be insured depository institutions…legislation should require custodial wallet providers to be subject to appropriate federal oversight…meet appropriate risk-management standards…legislation should require stablecoin issuers to comply with activities restrictions that limit affiliation with commercial entities. Supervisors should have authority to implement standards to promote interoperability among stablecoins”.

Generally, cryptocurrencies will not be allowed to go mainstream in developed countries if the traditional regulatory requirements particularly in relation to the location of accountabilities (licensing) and safeguards (investor protection, market integrity, risk management, anti-money laundering and prudential requirements) were not satisfied. It is more likely the questions over the legal framework for cryptocurrencies can only be settled once the legal framework for CBDCs is established. This is because of the need to ensure consistency in the legal frameworks which will probably also be extended to cover all monetised forms of digital assets.

Therefore, the debate is whether it is appropriate or fair to subject the cryptocurrency industry to traditional regulation. The approach by developed countries to expand the traditional regulatory perimeter to cover the cryptocurrency industry could end up negating the attractions of using cryptocurrencies in the first place. In my view, there exists two zones. The protections for the ring-fenced and lit zone should not be weakened as they anchor investor confidence and financial stability. Cryptocurrencies will flourish in the shadow banking or informal zone. Therefore, regulation should focus on managing the participation of licensed entities in shadow banking activities and ensuring adequate safeguards against contagion and scams. Overall, an optimal regulatory regime will probably balance maximum safety with minimal information requirements.

The key player in the evolution of the cryptocurrency landscape is the US. The US faces a dilemma in that CBDCs and cryptocurrencies could disrupt its payments and reserve currency dominance. First, the cryptocurrency ecosystem will parasite the inefficient parts[15] of the centralised international payment network – components such as SWIFT, CHIPs and correspondent banking. The outcome will be a fragmentation of the centralised (US-dominated) payment network into multi-asset peer-to-peer networks.

Second, cryptocurrencies could drain USD liquidity. In effect, cryptocurrencies are derivatives[16] on the future value (exchange rate, interest rate) and supply of the USD. This implies that similar to options, cryptocurrencies can be valued on the price, volatility and interest rates related to the underlying asset, the USD. Cryptocurrencies provide a cost-efficient and leveraged means of calibrating portfolio risks and the liquidity and volatility of cryptocurrencies could eventually overtake that of the underlying (USD). Third, the potential for two-way contagion transmission rises as linkages between USD and cryptocurrencies tighten. A reduction in USD supply or rise in US interest rates could trigger deleveraging and a sell-off in cryptocurrency which would transmit contagion effects to the US monetary system.

The US policy decisions will have a far-reaching impact. US endorsement will boost the global legitimacy of cryptocurrencies. The intriguing question is whether China made a mistake chasing out the cryptocurrency industry and whether the US should aspire to establish itself as the global center for cryptocurrencies? The US seems to have decided to integrate the cryptocurrency industry within its financial system. This will facilitate retention and attraction of talents to enable the US to become a leader in related areas of blockchain and other technologies, decentralized finance and fintech. It would also facilitate the US to compete with other digital currencies (especially the digital yuan) and to strengthen its oversight over cryptocurrencies. The downside is that US could be cannibalising its own share of the global currency market and that cryptocurrencies are a double-edge sword that could turn into a major enforcement headache in the future.


The cryptocurrency landscape is changing quickly. It is maturing from the “wild, wild west” or “boiler rooms”. But cryptocurrencies are likely to continue to operate in a global regulatory mishmash because of varied regulatory approaches. Some recognise cryptocurrencies as legal tender; some will regulate it; some will ignore it; and others will ban it. It is also unclear, given geopolitical tensions, how countries will be able to reach agreement on global interoperability, oversight and enforcement arrangements. It can be expected that cryptocurrencies may soon undergo a “test” of how it survives a “fallout or run” and undergo a period of consolidation.

In any case, cryptocurrencies – like the shadow economy and markets – cannot be eliminated. They will exist as long as they satisfy user financial needs – primarily to evade government controls and oversight. Despite the risks, many private firms and several governments seem ready to take the plunge. As cryptocurrencies move mainstream and become increasingly subject to regulation, cryptocurrencies will drift further away from their original ideals to be a substitute for fiat money, resistant to debasement and free from control by governments and financial intermediaries.


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[1] Hung Tran notes initial coin offerings, collective investment arrangements investing more than 40 percent of their assets in cryptocurrencies and exchanges facilitating trading of Bitcoin assets need to register with the SEC. Exchange-traded funds based on cryptocurrencies require approval.

[2] OpenNode is a Lightning Network-based payments processing platform based in California.

[3] See Julia Bersch, Jean François Clevy, Naseem Muhammad, Esther Perez Ruiz and Yorbol Yakhshilikov.

[4] It is estimated more than 2.3 million Hispanic people of Salvadoran origin live in the US. See Carla Mozée.

[5] See Elizabeth Saul.

[6] As a matter of comparision, the World Bank reported in 2020 that sending money to Africa via traditional bank transfer cost an average fee of 8.9% compared to the global average of 6.8%. See Camomile Shumba.

[7] See Ezra Rosser.

[8] See Chang Che on China’s thriving ecosystem of startups and entrepreneurs working on decentralized finance technology, or DeFi.

[9] Nigeria recently launched its CBDC, the eNaira, as a direct liability of the Central Bank of Nigeria.

[10] See

[11] The Diem Association is a governance oversight body with members from technology, fintech, telecoms, venture capital and nonprofits.

[12] See Coinbase submission

[13] See International Monetary Fund.

[14] See CPMI-IOSCO consultative report on the “Application of the principles for financial market infrastructures to stablecoin arrangements”.

[15] By-passing nodes where latency costs are high or latency speed is slow; and altering or hiding information to by-pass official gatekeepers.

[16] See “Global reset – Monetary decoupling (Part 9: Information perspectives on digital currencies)”.