The first central bank was founded in 1668 and since then central banks have gone a long way to gaining credibility. But the question arises as to whether central banks should have a “natural monopoly”. There are obvious reasons to believe that they have every right, but as technology improves it offers a fresh type of decentralized private money that can possibly have more advantages. Illegal activities coming from technological advancements should certainly be pointed out and be discouraged, but should we reject the favourable along with the unfavourable?
In my opinion, it would be wrong to eliminate good just to get rid of something bad that can potentially be controlled. Therefore, under a unified monetary structure and related regulation, stability and effectiveness could be mutually reinforcing the goals of fostering innovation, competition, and the financial system.
I would like to emphasize that blockchain technology and cryptocurrencies can do more good than harm. Africa has always been regarded as a risky place to do business for foreigners. In fact, 33% from credit card transactions coming from this area were fraudulent. This negative reputation caused bad implications. However, with the use of cryptocurrencies, people can recognise when funds are good and cross-border transactions are completed much quicker.
Moreover, it could be argued that cryptocurrencies are used for illegal transactions hence they must be banned or heavily regulated and I share this opinion to some extent. This is not the truth as real money have also been used for illegal transactions in the past and “cash is still the king”. The Silk Road case in the U.S. gained media attention, as Bitcoins were the only form of payment involved and the F.B.I. was able to shut down the operation by tracking down people’s addresses using the blockchain technology as again, no information can be altered or erased. This case was significant as the government proved that there are important benefits in dealing with cryptocurrencies.
Challenges to central banks
The problems of central banks and the inefficiencies of their payment systems have been exposed since cryptocurrencies went mainstream. In particular, cross-border transactions take more time and are more expensive therefore, cryptocurrencies have a competitive advantage over the banks. Here comes Ethereum into play. Ethereum by the use of blockchain technology and its lighting network completes transactions much faster. Therefore, Central Banks have to redefine their policies and the concept of money as a means of payment. Ethereum, the second-largest by volume cryptocurrency, poses significant challenges to banks as it promotes decentralized finance and lending with its permission-less open-source protocols which is believed by some that in the next decade it will impose a threat to mortgages offered by traditional banks.
Central banks try different ways to protect themselves from the challenges imposed by cryptocurrencies, one way is by prohibiting private issuance to accepting these currencies but other banks adopt the saying “if you can’t beat them, join them” strategy with the aim not to miss out and to take advantage of this opportunity. Sweden is an example as cash is declining and therefore, Riksbank is considering removing the legal tender and introducing an electronic version of the Krona (e-krona).
However, a European Parliament’s Committee on Economic and Monetary Affairs report in 2018 states that cryptocurrencies do not impose a threat to central-bank controlled currencies and they believe that cryptocurrencies features impose limits on their power to replace official money who have come this far and proved their “ price stability and legal status”. This is the right conclusion to a large extent as the control over the value of money is an important power to have therefore, checks must be placed to avoid the stability of the society.
Challenges to regulators
Anti-Money laundering
A big challenge to regulators is anti-money laundering (AML) and fighting the financing of terrorism (CFT). Regulators are discussing whether the rise of cryptocurrencies allowed AML/CFT activities to take places and whether existing measures to tackle them are evaded through cryptocurrencies. As mentioned above, cryptocurrencies are anonymous which makes it difficult to quantify the extent to which they are used to prevent capital controls, taxes or participate in illegal operations. But incidents like the Silk Road case discussed in the Summary above indicate that there are many examples where cryptocurrencies are being used for illegal reasons.
Consumer and investor protection
Digital theft is a prevalent issue. Due to the size and weakness of distributed ledgers, along with elevated transaction fees, most users access their cryptocurrency holdings through external parties such as the exchanges. Ironically many investors who switched to cryptocurrencies out of fear of banks and regulated authorities have therefore ended up depending on exchanges that can be hacked. The greatest example is the Mt Gox exchange. This exchange has fallen victim to hacking attacks in 2014 filed for bankruptcy due to the theft/loss of 744,000 bitcoins. Scam issues also outburst in initial coin offerings (ICOs). While many countries lack(ed) regulations around ICOs, many investors fell in the trap of investing to opaque business projects with limited information being available that turned out to be fraudulent Ponzi Schemes. In 2018 alone, at least £650 Million was lost to this type of projects.
Stability of the financial system
Time will show whether the extensive use of cryptocurrencies will result in fresh economic vulnerabilities and systemic dangers. To tackle these challenges close scrutinizing of developments will probably be required. Considering the risks and the technological advancements there is the need for regulators and agencies with experience and enhanced capabilities.
Risks are posed by the use of cryptocurrencies
Cyber-attack and spoofing
Cryptocurrencies pose risks of financial instability and fraud. Moreover, hackers use phishing and spoofing. These risks come when hackers organise a money-grabbing scheme. For instance, during an ICO, they can change the collection address when ICO opens and subsequently naive investors will send their cryptocurrencies to the wrong address which can never be recovered.
Volatility
The cryptocurrency isn’t backed by a central bank, and therefore it raises concerns to its insurers in regards to systemic risk of the cryptocurrency industry, credit risks, currency inconvertibility, the ability for participants to exit the market. Therefore, the volatility cryptocurrencies reduce their practicality as a currency, further contributing to illiquidity issues. Moreover, when third party institutions fail to meet their obligations, they may be subject to credit and liquidity risks.
Price manipulation
Cryptocurrencies are heavily affected by misinformation and people with a significant amount of power, influence or holding of a specific cryptocurrency may be able to manipulate the price. Naïve people can easily be victims of cyber extortion and market manipulation. “Pump and dump” techniques are used by scammers to manipulate the price where they give out fake information and fake promises to increase the price of their crypto-asset and they then sell at a higher price to make a profit. Therefore, some regulation is needed to allow people to understand which companies or projects should be trusted and which to avoid.
Safe havens
The lack of coordination and clarity on regulatory, financial, tax and legal treatment is a risk. This is a relatively new area and most regulators around the world began to form an opinion about cryptocurrencies during the “winter crypto bubble 2017” when Bitcoin’s price reached an all-time high. Avoiding risks while improving overall market stability in cryptocurrencies takes time as happens in all the aspects of the global financial system.
Ways to mitigate the risks
Regulatory boundaries
There is a grey area above cryptocurrencies and a lack of certainty therefore, it is believed that there is an urgent need for regulatory clarity because the market is expanding exponentially. The limits must fit into a fresh reality where the lines that define the duties of distinct regulators within and across states have become progressively obscured. Since cryptocurrencies are of a worldwide nature, only internationally coordinated regulation has an opportunity to be successful.
The interoperability of cryptocurrencies with regulated financial entities could be addressed
Only controlled exchanges can provide the liquidity needed to be anything other than niche markets for DLT-based financial goods, and settlement flows must eventually be transformed into sovereign currency. Therefore, a way to mitigate risk is by allowing regulators to monitor the way, if, at all, banks deliver or receive cryptocurrency as collateral. Regulators could monitor whether and how banks deliver or receive cryptocurrencies as security.
Target institutions that offer services specific to cryptocurrencies
For instance, government intervention could concentrate on the level where a cryptocurrency is traded into a sovereign currency in order to ensure effective AML / CFT provisions. In regard to payment services, current laws and regulations concentrate on security, effectiveness and legality of use therefore, similar provisions can be applied to crypto wallets to achieve similar results. These principles could also apply to infrastructure suppliers in cryptocurrency, such as “crypto wallets.” It is worth pointing out that regulations should be broadly similar and consistent across different states as cryptocurrencies’ purpose is to be used by everybody around the world.
Final thoughts
I came to the conclusion that some regulations are needed, but complete control from governments and central banks and/or complete ban on cryptocurrencies and the technology is both impossible and it is deemed to fail. Blockchain technology can impose a big threat if it is centralised and controlled by one entity. That entity will have great power and will have data on all the transactions and activities. Blockchain technology and cryptocurrencies can enslave us or free us therefore if regulations are drafted carefully a bright future lies ahead of us.
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