True guardians of the system

As concerns rise over the security and stability of cryptocurrencies, PAUL COCKS spoke to CHRISTINA SCICLUNA, Senior Associate at Mamo TCV Advocates, to ascertain what is being done to protect investors and to safeguard against money laundering and tax evasion

Senior Associate at Mamo TCV Advocates, Christina Scicluna
Senior Associate at Mamo TCV Advocates, Christina Scicluna

In just under a month, the crypto-market has lost over $500 billion as prices of all the major digital currencies took a plunge. Two weeks ago, Bitcoin’s price fell to a low of $5,995.58, its lowest since mid-November, though it is still worth five times more than it was a year ago. How sustainable are such losses? Is this the beginning of the end for Bitcoin and cryptocurrencies in general, or are they here to stay?

The extreme price fluctuations surrounding cryptocurrencies have always been at the forefront of the controversy surrounding this new currency and, yes, the price of Bitcoin is currently lower than what it stood at a couple of months ago, (although at the time of replying to this question, the price of Bitcoin increased to $11,325.08).

The increase in interest and hype surrounding Bitcoin and cryptocurrencies in general during 2017, coupled with the low to negative interest rates charged by the banking sector in addition to investors seeking return on their investments, has attracted mainly speculators seeking gains with little understanding of the underlying technology to buy Bitcoin, rather than genuine users willing to transact in cryptocurrencies. Speculators are the main drivers of volatility which results in increases in price spikes and crashes.

Furthermore, fear and uncertainty over strict regulation and outright bans by certain jurisdictions – such as is the case with India, which remains cautious in its adoption and implementation – cause speculators to exit the crypto market fuelling additional volatility. The sustainability of Bitcoin in the long term is dependent on a growing number of users transacting with Bitcoin as a peer-to-peer monetary system over such price speculators. If on the other hand speculators drive out the genuine user base then such losses will not be sustainable.

We are seeing a huge increase in the understanding of how cryptocurrencies function which has also geared support and acceptance from various players in the market. Indeed, on 8 February 2018 the Arizona Senate passed a Bill to give its residents the possibility to pay their taxes in cryptocurrencies using electronic peer-to-peer systems. This follows similar moves by the canton of Chiasso in Switzerland and wide acceptance as a payment method in Japan. Such adoption is considered positive and the trend is likely to continue and will promote further development and usability of cryptocurrencies with additional wider adoption. We foresee that cryptocurrencies are likely here to stay and will continue to have the support from users who value cryptocurrencies as a decentralised peer-to-peer network and a secure medium of exchange.

Parliamentary secretary Silvio Schembri said the MFSA is studying the process of regularisation of Bitcoin. In the US, SEC Chairman Jay Clayton and J. Christopher Giancarlo, Chairman of the United States CFTC, said that federal authorities were mulling new laws to scrutinise virtual currency trading and investing, and that they believed that the introduction of new legislation could be necessary in the future. With the anonymity surrounding Bitcoin, ethereum and the others, can cryptocurrencies ever be accepted as mainstream currency?

There seems to be a misconception with respect to the anonymity surrounding Bitcoin and cryptocurrencies. Firstly, it is good to note that transacting in physical coins and paper money (i.e. FIAT currency) provides pure anonymity and yet, despite attempts to move towards cashless economies, no one doubts their validity as mainstream currency. Secondly, the underlying technology of most cryptocurrencies requires a record of every transaction on a public distributed ledger called a blockchain. This audit trail of transactions provides an invaluable feature of cryptocurrencies which is slowly beginning to be appreciated by authorities. Furthermore, in order to acquire Bitcoin or other types of cryptocurrencies through a reputable and recognised exchange platform, customers are required to provide multiple tier recognition and verifications (such as the submission of the user’s ID card and/or utility bill and in certain instances also bank references) in order to sign up and transact.

The push for regulation surrounding  the buying/selling of cryptocurrencies  by government authorities is required to strengthen investor protection and support the innovation surrounding the new technology, whilst ensuring financial stability and market integrity. This is also reflected in the discussion paper issued by the MFSA on the proposed regulation of initial coin offerings, virtual currencies and related service providers, which aims at ensuring effective investor protection whilst still ensuring support for the innovation surrounding the technology.

The debate as to whether cryptocurrency is accepted as a mainstream currency or otherwise is to be seen in the context of whether cryptocurrencies are viewed as an investment asset or as a currency. Bitcoin today is probably considered primarily as an investment asset with financial experts comparing it to gold, although Bitcoin and other cryptocurrencies are predominately designed to be used for payments. This notwithstanding we are seeing Bitcoin being used more frequently as a medium of payment even in Malta, where we are seeing certain companies offering payment of salaries to employees in Bitcoin.

With the increase in the number of users, which is currently in the region of about 100 million, as well as an increase in the number of merchants/authorities accepting cryptocurrencies as a form of payment,  there is a high possibility that cryptocurrencies will be adopted as an alternative mainstream currency. Naturally there are obstacles which will need to be overcome before we see cryptocurrencies adopted as mainstream currency, one of which is the high transaction fees when it comes to small casual transactions, such as buying coffee. The price volatility of Bitcoin is another obstacle which Bitcoin will need to overcome in order for it to be more widely accepted as a mainstream currency.

The crypto-market has been pounded by news of crackdowns by governments including in China, Russia and South Korea, one of the biggest markets for the sector. Does cryptocurrency need global official acceptance to succeed, or can it survive by being accepted and traded in only select markets and jurisdictions?

At the very core of Bitcoin, as seen in Satoshi Nakamoto’s whitepaper which was published in October 2008 and was the first paper which introduced Bitcoin, is the elimination of third parties for payment  processing through  the introduction  of a peer-to-peer decentralised monetary network, allowing two willing parties the possibility of entering into a transaction without the need to rely on a third party. This in itself does not require governments nor central banks to globally and officially accept cryptocurrencies.

In essence the use of cryptocurrencies is one which does not require permission and is censorship resistant  in that any willing and able individual can participate  without the need to obtain permission or authorisation from any third party. Cryptocurrencies rely on a peer-to-peer network to be globally successful and acceptable. This being said, the crypto market does to a certain extent also rely on traditional banking measures for purposes of processing users’ FIAT transactions to exchanges for acquisition of cryptocurrencies or vice versa.

In September, 2017 J.P. Morgan CEO Jamie Dimon became notorious after he called Bitcoin a “fraud,” triggering the very price volatility the bank now cites as a “challenge” crypto assets face. Dimon subsequently claimed he was “not going to talk about Bitcoin anymore,” while last month he was publicly disclosing he “regretted” making the mentioned comments. In January 2018, Dimon flatly refuted the idea that he was a “sceptic” on Bitcoin.

In economies which suffered or are suffering from hyperinflation (e.g. Venezuela), capital controls (e.g. Greece and Cyprus) or a large portion of which are unbanked (e.g. Kenya) alternative forms of currency are rapidly being adopted as a replacement for national currency.

The head of the Bank for International Settlements, Agustín Carstens, has warned that central banks must take action against cryptocurrencies because they put consumers at risk and serve as a vehicle for tax evasion and money laundering. He described Bitcoin as little more than a “ponzi scheme”, a “bubble” and an “environmental disaster”, while speaking at Frankfurt’s Goethe University two weeks ago. How can the danger of using cryptocurrency for money laundering or financing of terrorism be tackled?

A percentage of fraud is unavoidable with any medium of exchange. There will always be individuals/users who have bad intentions and who will exploit any platform/medium of payment. Indeed banks have served as such a vehicle for decades. In a recent study it was found that less than one percent of Bitcoin transactions involved illicit activity. The challenge for legislators is to ensure suitable regulation that mitigates the risks of money laundering and financing of terrorism without such impositions being too rigid or over-bearing so as not to discourage adoption or use.

We have seen that the use of cryptocurrencies has been adopted under the fifth Anti Money Laundering Directive to combat terrorism financing, which tackles terrorist financing risks which may be linked with cryptocurrencies. These measures do not seek to prevent the use of cryptocurrencies but will require cryptocurrency service providers to implement customer due diligence measures (just as banks do now) and impose the same responsibilities in relation to application of customer due diligence controls and ongoing monitoring of certain transactions, imposing obligations of reporting suspicious activities to government entities. With respect to the issue surrounding user anonymity, transactions performed on the blockchain are traceable to users not by their name but by virtue of their public key. Transactions are therefore pseudonymous and not anonymous, in that every transaction involving a user’s address is forever recorded on the Blockchain.

The Muscat administration has shown what many consider to be a rather surprising amount of interest in blockchain technology. Why is it important for Malta to be a leader in blockchain and distributed ledger technology?

Malta is one of the world’s smallest and most densely populated countries, and comfortably the smallest of the 28 EU member states. Our size did not stop us from becoming a centre of excellence in online gaming, attracting a significant number of gaming companies to our shores. The positive attitude which Malta has taken towards blockchain technology and cryptocurrencies is welcomed by the industry which we trust will draw parallels to the success achieved in the online gaming sector.  We have seen potential  investors  of blockchain and cryptocurrencies  alike approaching Malta due to its strong reputation as being a jurisdiction which is open to new industries and quick in reacting to innovative business. This is also backed by the fact that Malta boasts a robust legal framework equipped with knowledgeable professionals and experts who understand the way the industry functions and the issues it faces.

We have seen that this new industry has, and will continue to develop and grow at a much faster pace than we have ever experienced.  Issues which we were looking at only a few months ago are today either non-existent or redundant, and accordingly being quick in reacting to this innovative opportunity is crucial to ensure that Malta is not left behind as a jurisdiction which may reap the potential of this new industry.

The government consultation document which was issued on 17 February 2018 on the establishment of the proposed Malta Digital Innovation Authority and the proposed framework for the certification of distributed ledger technology platforms and related services providers and a Virtual Currency Act, are a testimony to the intention of Malta to become a leader in Blockchain and distributed ledger technology regulation.

This Q&A is not intended and does not purport to give any sort of legal, tax or financial advice.

 

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