Cryptocurrency (Blockchain) trading, CB concerns and regulation

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Blockchain coins/cryptocurrency(Crypto) have been viewed with caution by Central Banks(CB) world wide.  There have been a range of reactions: acceptance, silence, total ban, and so on. Developing economies are concerned with the economic instability that a dominating Crypto could create in the future while advanced economies are more concerned about money laundering issues.  

Broadly CB/government concerns are in the following areas:

  • Loss of control on the monetary policy and money supply
  • Investor protection
  • Tax on gains made on crypto assets
  • Money laundering and payment transactions for dubious activities
Lets look at the above issues in some detail. 

Crypto trading is open to a global market and doesn't have any link to local regulatory or CB controls. Implementing controls would keep that country out, but wouldn't stop the trading or asset exchanges in other countries. Crypto market cap is fairly large, USD 1.78 trillion, so its no longer a phenomenon that can be ignored by governments. 
If a country "A's" citizens have a significant exposure to a Crypto currency "C1", which is also held by a few Crypto whales(individuals or entities who hold a significant percentage of the total Crypto C1 coins in circulation) domiciled in another country "B",  "A" could face economic risks as the C1 price or trading volume can be manipulated affecting C1 holders and their notional wealth and A's CB may have little control.
As money flows from bank deposits to Crypto currencies in say country "A", the credit available from local regulated banks will reduce. Country "A" citizens may be forced to borrow from international Crypto companies on unfavourable terms. CB of country A may have no influence to address the issue. 
We can see some similarities in the EU region where countries in the common Euro currency and interest rate monetary program sometimes struggle to cope up with an external policy framework.
The Government/CBs would have to think of new economic policy tools to cover monetary policy. The traditional approach of tinkering interest rates and money supply may not be good enough in the future. With the prevalence of cryptocurrency CBs would be moving to a new globalised economic setup, the repercussions of which are still not clear.  

Moving to the second point on "Investor protection". This is a simpler issue to address than the one above. Crypto trading currently don't go through a clearing house, regulated exchange and a centralised asset registry. In the traditional asset trading such entities provide the necessary investor protection. Today most of user Crypto-trades are made through (with the help of) private institutions who can be regulated by the CB. The Crypto rules are often in the hands of a few "Crypto whales" so not quite democratic as one may think. The retail Crypto trading model is similar to a dealers market and the prices are quoted by the dealer who is often the custodian. A close analogy to Crypto trading is CFD/Spread betting in some markets like UK and Australia (CFD/Spread betting is not permitted in countries like US and India). Some rules that regulators could consider are:

  • Dealer market place entities should be required to hold a percentage of the retail user digital positions in the appropriate digital asset. (e.g. A dealer selling a bitcoin to a retail investor may not actually buy the bitcoin as it could be squared off with someone selling their bitcoins) 
  • There should be guidelines on quoted prices (buy/sell spread) of Crypto assets. This could be similar to EUs MIFID "Best price rule", but modelled in the FX Over-The-Counter(OTC) market
  • Applying a rule similar to US SEC's "Regulation SCI - Systems Compliance and Integrity".  This regulation is designed to reduce system issues in any marketplace or financial intermediary and strengthen resiliency.

Moving to the next point on "Taxing Crypto asset gains".  A full proof way to implement this is hard.  It's relatively easy to apply taxes on Crypto transactions and gains within the realm of a private entity/fintech offering the services.  But if the user withdraws the Crypto asset to a personal wallet and trades directly, it could be harder to trace these transactions. Another issue, if  the Crypto currency is used to buy regular shopping items like clothes, electronics, etc, how could one apply capital gains tax?  Such situations are similar to cash transactions with foreign currency notes.  We exchange local currency for foreign currencies at a particular rate, but while spending the currency or reconverting it to the local currency it may have appreciated. 
Its important to have some rule/laws on dealing/trading with Crypto assets/currency as a starting point. The technicalities of enforcement and tax collection will improve over time.

The final point is on "Money laundering(ML)". This is a challenge faced by regulatory authorities in all countries East or West.  Anti-ML(AML) laws and tools have been there for a while and the rules and mechanisms have significantly improved over the years.  The payments made between parties is not only monitored for the value but also aspects like nature of business, destination country,  purpose of transaction, transaction value w.r.t organisation size, etc.  In Crypto world with transactions done using personal wallets this can be hard to decipher. Law enforcement would need to monitor the public ledger of Crypto assets and device algorithms to detect potential illicit transactions or the public addresses of such persons. Globally if there are laws restricting Crypto-Fiat currency conversions to KYC compliant entities/individuals it will give a big fillip for AML initiatives. 

Any country which has a large parallel economy also called "Black money" and haven't controlled this should be comfortable with the ambiguity of Crypto assets. Though we tend to have this egalitarian view of moving to an alternative world with no country borders or capitalistic organisations with the advent of Cryptocurrency and the upcoming Metaverse, there are practical limitations to this. One will still need regular main street organisations to simplify the entry to and usage of such innovations for the common citizen. With main street organisations being central to this Govt. regulation is not far away.

Governments will find it hard to digest radically new technology or business models. In the upcoming days one must expect periods of "wait and watch" or rash regulations followed by amendments, before we reach a new equilibrium. Whether Crypto assets are useful to society or not is at best a speculative debate at this point. Only time and Crypto's penetration into the deeper parts of society will give us the answer.  

Related articles on this topic:

Cryptocurrencies – An assessment, Keynote address delivered by Shri T Rabi Sankar, Deputy Governor, Reserve Bank of India - February 14th, 2022 -https://rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1196

Money and Payments: The U.S. Dollar in the Age of Digital Transformation - BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM




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