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Risk Fraud & Compliance

5 questions about cryptocurrency’s regulatory environment

Gina Jurva  Manager for Thought Leadership in Corporate & Government at Thomson Reuters

Gina Jurva  Manager for Thought Leadership in Corporate & Government at Thomson Reuters

We speak with two cryptocurrency specialists and get answers to 5 questions about the state of crypto-regulations and what might develop in the future

We’ve reported extensively on emerging cryptocurrency regulations including in our recent Special Report: Cryptos on the rise, which examines some of these developments as well as the risks and benefits of this next iteration of digital transformation.

In a recent webinar titled Cryptocurrency and Emerging Regulations Around Digital Money, I spoke with one of the report’ authors, Todd Ehret, senior regulatory intelligence expert for Thomson Reuters Regulatory Intelligence; and Gabe Hidalgo, managing director at K2 Integrity.

Here are some of the questions from the webinar along with the panelist’s answers.

1. How many countries have adopted cryptocurrency as legal tender?

Ehret: On June 8, 2021, the Salvadorian Congress voted in favor of President Nayib Bukele’s proposal to make bitcoin legal tender in the country. With 62 out of 84 possible votes by lawmakers, El Salvador became the first and still the only country to officially adopt the cryptocurrency as legal tender. Bitcoin will become legal tender, alongside the U.S. dollar, on September 7, 2021.

Although several political leaders around the globe have voiced support for the move by El Salvador, and cryptocurrencies such as bitcoin are widely used and accepted as forms of payment in many countries, no others have taken official steps to adopt it as legal tender. Many countries are at various stages of researching or working on their own central bank-backed digital currencies as well.

cryptocurrency
Gabe Hidalgo of K2 Integrity

Pres. Bukele has touted the benefits of bitcoin, tweeting, “It will bring financial inclusion, investment, tourism, innovation and economic development for our country.” He may be correct that it will likely be easier for Salvadorans living abroad to send remittances back home.

The country relies very heavily on money sent from workers abroad. Remittances to the country total approximately $6 billion or around 20% of the country’s GDP, which is one of the highest ratios in the world. Because of this dependence on foreign remittances, El Salvador is in a bit of a unique situation.

Pres. Bukele has also invited bitcoin miners to relocate to the country to take advantage of the country’s cheap, clean, and renewable geothermal energy from volcanoes to power the mining rigs. Whether El Salvador becomes a bitcoin mining and innovation hub, sparking other countries to follow in its footsteps, remains to be seen.

Adopting bitcoin as legal tender is not without challenges or risks, as inflation is an issue in El Salvador and nearly 70% of the population is “unbanked.” Requiring every business to accept bitcoin for goods and services may be a challenge.

The International Monetary Fund (IMF) warned El Salvador in a blog post that its actions were  “step too far.” The IMF said: “Some countries may be tempted by a shortcut: adopting crypto-assets as national currencies. Many are indeed secure, easy to access, and cheap to transact. We believe, however, that in most cases risks and costs outweigh potential benefits.”

El Salvador will be a very interesting test case and is being watched closely by other governments worldwide along with the crypto-community.

2. How can crypto-prices be protected from social media hype?

Ehret: Global financial regulators, such as the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), have regulations that prohibit manipulative trading practices and various activities under anti-fraud rules. Because cryptocurrencies such as bitcoin are not directly regulated by the SEC and CFTC, they exist in a bit of a gray area.

SEC Rule 10b-5 prohibits “the use of any device, scheme, or artifice to defraud.” The rule also applies to misstatements or omissions of material fact. Further complicating matters are that many online comments on social media can be considered free speech. The lack of a Rule 10b-5 for cryptos is a gap that regulators will have to address. Enforcement of such rules surrounding manipulative trading and online hype will also be a challenge.

3. Any recommendations for a financial institution that sees its customers use their bank accounts to purchase cryptocurrency?

Hidalgo: In institutions where customers use their accounts to purchase cryptocurrency, there will be telltale signs. Obviously, a deposit or withdrawal to a recognized exchange will carry with it the exchange’s information on the transaction. However, in some cases, smaller or relatively unknown exchanges will use corporate shells to facilitate the trade. Financial institutions should screen their transactions for unknown corporate entities and ask the customer what the purpose of the transfer is when they cannot locate information through proprietary or open sources.

Todd Ehret of Thomson Reuters Regulatory Intelligence

It is up to each institution to set an appropriate risk tolerance and monitoring program. If the institution does not wish to fund cryptocurrency purchases or receive crypto-based revenue, it needs to setup its transaction monitoring system to detect known exchanges and question transfers to possible shell entities which sole purpose is to facilitate crypto-based transactions.

4. How can you mitigate the risk associated with cryptocurrencies and cross-border transactions?

Hidalgo: The mitigation depends on the type of institution of which you are a part. Banks will deal with the fiat portion of the transactions, so they will not be able to see cross-border transactions using crypto. Instead, they rely on the Virtual Asset Service Provider (VASP) client to institute a robust transaction monitoring program. For a VASP, the monitoring and mitigation of self-hosted wallets is a policy decision. The VASP will need to decide whether they will accept transfers from wallets that have not been identified by their customers as their own wallets.

Unknown third-party wallets will present additional challenges to a VASP for monitoring, and therefore, a VASP should engage a vendor-provided blockchain explorer product to attempt to rate the risk of the third-party self-hosted wallet. This way, the VASP can determine if that wallet presents higher risk activity emanating from Dark Web or identified illicit parties.

5. Should developing countries adopt cryptocurrency as legal tender?

Hidalgo: Every country should decide on its own whether they are ready to adopt a cryptocurrency as its legal tender. The issue with cryptocurrencies that would present issues for any country seeking to make it legal tender, is that the price volatility set by the marketplace would cause the values to move quickly. For example, today, a loaf of bread costs one unit of the crypto-coin and tomorrow, based on market valuations, that same loaf of bread may cost three units of that same crypto-coin.

Consider instead a stablecoin that is tied to a well-regarded reserve fiat currency where the underlying reserves of the stablecoin are transparently reported and audited to ensure that for every one unit of that stablecoin created there is a corresponding one fiat unit at a recognized and regulated depository institution.

As for regulatory frameworks, many countries are still trying to figure out how to best regulate this asset class and, in some cases, they are applying Money Service Business regulatory frameworks to all crypto-related products and services. Overall, however, volatility would emanate from the fluctuations in market pricing for non-stablecoin cryptocurrencies; and regulations would only strengthen the consumer protections and the mitigation as well as the monitoring of transaction flows for potential illicit activity.

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