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Business Commentary Through a digital glass darkly: Regulating cryptocurrencies

Allan C. Hutchinson, distinguished research professor, Osgoode Hall Law School

In all the coverage of the recent G20 summit in Argentina, one of the more important initiatives adopted was largely overlooked by media. In a rare show of unity, the member countries announced that they would be taking concerted action to regulate the shadowy world of cryptocurrency. This is no small feat.

With guarded praise for the technological innovations that come with the creation of cryptocurrency and that have led to significant benefits to the global economy, Group of 20 countries called for some substantial and serious regulation of cryptocurrency in order to deal better with a range of issues – money laundering, terrorist funding, excessive risk speculation and the co-ordination of cross-border taxation.

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The G20’s aim is to have regulations in place by 2020. At present, there is a patchwork of national procedures for such monitoring. Some countries, such as China, have taken a no-cryptocurrency position, while others, such as Malta, are enthusiastically open for business. The basic plan is to rely on the standards created by the Financial Action Task Force (FATF), established by the Group of Seven in 1989, which cover areas including record-keeping, reporting of suspicious transactions and transparency.

In dealing with the unlawful exploitation of the crypto-verse, the central challenge will be to generate and implement ways of regulating cryptocurrencies that curb its criminal excesses, but preserve its innovative and decentralized strengths as an alternative market to money issued by governments. This is no easy task.

The cryptocurrency world was originally created to be outside state regulation and international control. As envisaged by its elusive founder, Satoshi Nakamoto, it was intended to be an entirely borderless, decentralized, unmediated (without banks), pseudonymous, self-regulating and politically neutral medium. Although there are now hundreds more, the first cryptocurrency, bitcoin, was introduced as early as 2009.

In essence, cryptocurrency is a high-tech way to for people and organizations to trade and pay for goods and services under the government radar. A digital coin acts as an alternative form of currency. Being a mode of exclusively private ordering, its appeal is obvious; it skirts, if not entirely eludes, the reach of government oversight and taxation.

This touted benefit is offset by its potential for improper and unintended use. It has, of course, been leaped upon by criminal gangs and terrorist groups to shift funds across borders and around the world with relative secrecy. It has also inevitably become a vehicle for high-stakes speculative investment and gambling. Over its short life span, cryptocurrencies have fluctuated wildly in value. In the past year alone, it has been very volatile and swung more than 70 per cent in value.

These twin threats have led many, including Nobel-laureate Paul Krugman, to condemn cryptocurrency as nothing more than a dangerous and overinflated economic bubble waiting to burst. In this, it is considered to be much like Ponzi or pyramid schemes or like the Dutch tulip and South Sea Co. bubbles of 17th- and 18th-century Europe. These critics think that heavy regulation to the point of banning and even criminalizing cryptocurrency is in order.

Others have been more open to regulation-lite. Ironically (in light of its laissez-faire origins), some self-styled cryptocurrency purists have welcomed the prospect of more invasive regulation; They claim it will allow cryptocurrency to get back to its original purposes as a legitimate and alternative mode of private ordering and be consistent with technology’s potential as an unburdened and experimental medium for innovative entrepreneurialism. Although a tad idealistic and naive, there is appeal even to those who hold an anti-Big Brother ethic.

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However, the G20 is unlikely to exercise a light touch in regulating cryptocurrency. In combatting criminal and terrorist activity, there will likely be a more heavy-handed approach. Innately suspicious of any effort to evade public scrutiny and oversight, governments will find it difficult to resist introducing a raft of restrictive and intrusive measures. The tax possibilities alone are enticing.

Yet, how to regulate cryptocurrencies, even with a light and sensitive touch, is by no means easy or obvious. There are some deep and perilous shoals to be navigated in the already treacherous waters of technology and high finance. At the heart of the issue is: Should cryptocurrency be considered a form of money or legal tender and be regulated accordingly? Or is it better characterized as a traded asset or commodity? Or, even further, should it be treated as a special and of its-own-kind entity?

Within existing processes of control and taxation, its characterization has massive effects on how we think about the problem and, therefore, what form of regulation is best suited to the different modes of cryptocurrency and the blockchain technologies used to enable them. In particular, it will orient and allocate the to-be-regulated activity to different government agencies and regimes. For example, if it is treated as a kind of asset or security, traditional securities regulators will be tasked with checking the Wild West aspect of cryptocurrency and bringing it into line with other traded assets and offerings.

Canada has already made moves on several fronts to corral the crypto-verse. It is not considered to be cash or legal tender and so should be handled accordingly. Indeed, Canada Revenue Agency has characterized cryptocurrency as a commodity and stated that the use of cryptocurrency to pay for goods or services should be treated as a barter transaction. This can lead to both income and capital-gains taxation as well as the levying of HST.

If Canada sticks to this path, there will be tough questions about how to establish reliable and safe cryptocurrency exchanges, while still leaving cryptocurrencies themselves outside the reach of detailed regulatory intervention. There will also be the pressing need to devise appropriate ways to tackle how to regulate initial coin offerings – that can so affect the valuation of cryptocurrencies – in similar or different ways to more familiar initial public offerings.

It may be that, in light of the coming G20 commitments, Canada might well have to rethink its characterization of cryptocurrencies and regulate them differently. And perhaps that would be no bad thing. As with other challenges in the new world of technology, simply pouring new wine into old bottles will not always result in a regulatory outcome that satisfies the needs of producers, customers or the public interest.

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Whatever route is taken, it seems that there is agreement that some regulation of cryptocurrency is urgently needed. After all, despite the prognostications of some economic commentators, the world of cryptocurrency is here to stay. Rather than keep its head down, Canada has an opportunity to seize the cryptocurrency day and introduce a regulatory regime that is matched to the unique openings and deep pitfalls of a digitalized financial world.

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