Crypto regulation shouldn’t kill innovation but it is needed

Cryptocurrencies are in need of regulation, but it is important that it doesn’t ‘stifle innovation’ according to Jo Torode, a senior financial crime lawyer at Ropes & Gray. 

Cryptocurrencies, and especially initial coin offerings (ICOs) of new digital tokens, have come under increased scrutiny by regulators as the market rises in popularity amongst investors looking for quick cash. With cryptocurrencies become increasingly interlinked with the mainstream financial services industry, some have exploited them and use crypto as a means to hide illicit proceeds in the monetary system.

Europol have estimated that 4% of all criminal proceeds in Europe are currently being laundered through cryptocurrencies, meaning around $5.5bn (£4bn) is illegal money.

As it continues to rise in popularity, regulators worldwide are grappling with ways to control trading. Bank of England governor Mark Carney recently called for cryptocurrencies to be regulated. Speaking at the inaugural Scottish Economics Conference, he said that the currencies themselves could present a future risk to financial stability and called for them to be more rigorously regulated.

“The key to successful regulation of cryptocurrencies is to ensure that regulation does not stifle innovation,” according to Torode. “Appropriate regulation would for the first time offer legal and regulatory protection to individual investors and high street customers seeking to benefit from the opportunities presented by cryptocurrencies and the underlying blockchain technology.

“This is the next stage in bringing cryptocurrencies and blockchain within the regulatory framework, speeding up the march towards legitimisation of an asset class that, until a few years ago, many law enforcement agencies believed had limited legitimate reasons for people to use. The flip side of this is that it will take more time and effort for those agencies to distinguish lawful transactions from those predicated on illegal activity,” Torode added.

If appropriate and settled regulation is in place, particularly for money laundering purposes, this is likely to make investment in cryptocurrencies more viable for certain mainstream and regulated investors.

While the UK is looking at regulation in the future, the U.S. has already made its first moves. The U.S. Securities and Exchange Commission (“SEC”) has already started to act on cryptocurrencies and bitcoin by opening investigations into a number of ICOs. Last year, the regulator filed charges against a former cryptocurrency exchange and its founder. It alleged that BitFunder and its founder Jon E. Montroll operated an unregistered securities exchange and defrauded its users by misappropriating their bitcoins.

The SEC are starting to act on cryptocurrencies and bitcoin and some people have said that this would halt development, according to Torode.

“However, I take a slightly different view. The SEC are undoubtedly taking the issue seriously but this can also be a seen as a gateway to thinking about how cryptocurrencies can be properly integrated into the regulatory system,” she added.

The US and the UK, among others, are seeking to clamp down on Cryptos through regulation, but there is divergence between jurisdictions about what approach to take and how to deal with this.

“Different jurisdictions are taking different approaches. There are some jurisdictions which are considering banning cryptocurrencies and there are others, like Venezuela and Estonia, which are planning to introduce their own cryptocurrencies,” she added.

“The technology is here to stay, and I don’t see how banning them helps. I think regulation that supports innovation is the way forward. Once you have started with an asset class, such as Crypto, trying to outlaw it is almost impossible. People are using them and trading them, and have done for a number of years, it is time to accept that this is a paradigmatic shift. A new reality. “

To be truly effective, Torode suggests that regulation might ultimately need to be on a more global scale and some moves have been made towards this. In December 20, 2017, EU ambassadors confirmed that agreement had been reached between the European Parliament and the Council regarding the latest amendments to the Anti-Money Laundering Directive (AMLD 5) proposed by the European Commission in July 2016. The fifth money laundering directive will regulate virtual currencies for money laundering, but this may take some time. .

“At the moment, we have a global financial system that has different and developing regulatory approaches, as between different jurisdictions,” Torode added. “So, it comes down to how firms can try to manage these diverging approaches and find an approach that works for them across the different jurisdictions in which they want to do business.”

“If, within this space, there are jurisdictions, in which there are no regulations at all, you risk having two different types of blockchain transactions or two different categories or functions of cryptocurrencies. Some of which will be out in the open, under a regulated system and regulated for money laundering and some of which won’t.”

Despite cryptocurrencies being one of the ‘fastest growing issue’ for Ropes & Gray, it is not the biggest according to Torode. The financial services industry is facing a wave of regulations this year including GDPR and MiFID II, to name a couple. With compliance offices scrambling to get their organisations in check, innovation in Technology is promising to fix a number of issues.

“The role of technology in regulation, compliance and financial crime is growing all the time,” said Torode. “I see that on an increasing basis. People are trying to use technology to make things simpler, more cost-effective and to manage risk on a holistic and global scale. When you are dealing with as asset class that is based on technology, a technological approach to risk management is probably the only way to go. Quite what that will look like however, I am not sure. It remains to be seen how this issue will pan out and it ultimately depends on the scope and nature of any regulations that are introduced.”

Copyright © 2018 RegTech Analyst

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