Allan Hutchinson is a distinguished research professor at York University’s Osgoode Hall Law School.
The continuing saga surrounding QuadrigaCX, the cryptocurrency exchange, has many object lessons for would-be critics and regulators. The episode is being held up as an example of cryptocurrencies’ failings. But the lessons to be learned are not what many will think.
It will be remembered that, when the creator and sole operator of the company, Gerald Cotten, died, there was apparently no way to access his laptop on which a suspected $180-million of assets from almost 100,000 clients were stored. He had placed an encrypted key on it that no one knew or could replicate. There were also suggestions that the funds had been embezzled,
First, the use of “currency” to describe these assets seems well wide of the mark. Even the Bank of Canada has declared that cryptocurrencies are not currency as they are neither state-backed nor controlled. It is for others to decide if these pieces of digital code are securities, commodities or an entirely new thing. This is no easy matter and will be a major challenge for regulators.
The fact that they are crypto–currencies means that people should not be surprised that they are hidden and secret. Ironically, Mr. Cotten’s actions confirm the impregnability of cryptocurrencies as others suspect their hackability. He may have been mean-spirited or even fraudulent, but he has demonstrated the security of cryptography.
Another lesson is that, if people speculate in these off-the-grid schemes, they should be prepared for losses. It is foolish to think that cryptocurrency is a guaranteed winner.
Many resist the idea of any regulation at all. One die-hard group who were in at the beginning of the cryptocurrency craze oppose it because they adopt an anarcho-libertarian posture. But others maintain that regulation will only add further legitimacy to a very dubious arrangement.
This approach is also unattractive. There are many things that we regulate in society that we would be better off without, such as gambling. Indeed, the government is the major purveyor and beneficiary as well as regulator of gambling.
There are still others who claim that cryptocurrencies are a poor investment asset as their value seems trapped in a constant boom-and-bust spiral. While it is true that they are highly volatile, they have out-performed the stock market over the last five years by a considerable margin.
A major problem is that the QuadrigaCX is less about the primary network of cryptocurrencies, but more about the secondary investment market. QuadrigaCX was a middle-person between cryptocurrency users and investors; it converts cryptocurrency into dollars and vice-versa. The failings of Mr. Cotten and his company are not necessarily representative of cryptocurrencies in general.
So the regulation of this secondary market, which is as much part of the standard money market as the digital one, seems essential. Imposing similar duties on such entities – disclosure, reporting, auditing, etc. – is necessary.
However, regulation of the broader world of cryptocurrency is another matter. The suspected criminal mendacity of a Gerald Cotten should not be the core challenge. There are perhaps already sufficient criminal and regulatory weapons available to deal with such people (if, of course, they remain alive).
So what to do about cryptocurrencies at large? The CRA already imposes a range of taxes on cryptocurrency transactions and gains. The challenge will be to detect such transactions and gains within a self-reporting scheme. This is where the pseudonymity of the blockchain technology of cryptocurrency is a hurdle.
In implementing a regulatory regime, therefore, it is important to take a broader institutional view. To ban or gut the cryptocurrency system, like China and other countries, would be a mistake (as would ignoring it). Indeed, overregulating would play into the hands of the very institutions that are most threatened by and have most to lose from the existence of an entirely borderless, decentralized, unmediated, self-regulating and politically-neutral medium.
If cryptocurrency is to survive, it must accept that regulation is not only around the corner, but might be helpful. To resist that would be to play into the hands of the banks and other large financial services corporations, the very reason for cryptocurrency in the first place.
The trade-off for cryptocurrency enthusiasts might be that the decentralized and unmediated system will continue at the price of abandoning pseudonymity. This will do much to scare away the criminal element who find the present cryptocurrency system so easy to use for their money laundering and funds-transfer. Contrary to some views, it will also leave in tact the basic structure and security of the process.
Achieving this end will not be easy. Regulators may well have to abandon typical command-and-control and top-down approaches. Instead, they might consider tackling the “law of the code” and require software and hardware providers to install a more open and less “secret” style of blockchain.
None of this is set in stone. But to overreact because of the QuadrigaCX fiasco with harsh regulation is not the way to go. Carrots may do better than sticks in this instance.