Cybercurrencies are Internet-based stores of value, which are used and created for much the same purposes as physical currencies. However, cybercurrencies have no physical representation in reality – they are created, stored and transacted electronically. Cybercurrency transfers are instantaneous and borderless and many have been designed so that users can transact in relative anonymity. These elements of their functionality present exciting opportunities for financial technology (fintech) innovation but also create a myriad of challenges for financial sector regulators and law enforcement agencies.
Although cryptocurrencies provide great promise with regards to revolutionising financial services; significant barriers still exist to widespread adoption. These include volatility in value, risk of cyber theft, relatively poor uptake in both on- and offline merchants willing to accept cybercurrencies as a viable alternative to fiat currencies…
A number of high-profile investigations and prosecutions suggest that Bitcoins, one of the most prominent cryptocurrencies, are becoming the currency of choice for many criminals. They are being used to buy and sell illicit drugs, Cybercrime-as-a-Service and other illicit items on online dark marketplaces such as Silk Road 3, Alphabay and Valhalla. They are also being used to launder funds through online games and fund acts of terror. In 2012, the FBI expressed concerns about the difficulty of tracking the identity of anonymous Bitcoin users and remonstrated how law enforcement agencies were experiencing difficulty identifying suspicious users and obtaining records for Bitcoin transactions. Unfortunately, these difficulties and challenges still persist today.
Although much of what we hear about cryptocurrencies is negative, cryptocurrencies, and blockchain technology in particular, have many significant benefits which can positively impact the financial quality of life of people in developing and developed nations. For example, they enable the two billion “unbanked” or “underbanked” people across the world, living without traditional financial instruments and services, to operate a cybercurrency account using their mobile phone. A further, and perhaps more significant, benefit of cryptocurrencies is their capacity to revolutionise the remittance industry by reducing the often excessive transaction fees charged by other financial service and remittance providers.
Bitcoin’s promise as a financial technology platform has increasingly garnered the interest of government and private sector leaders alike, especially the Australian Stock Exchange, as a more efficient means of post-trade settlement, and the banking industry, who have expressed an interest in trialling blockchain-enabled trading. On 21 March 2016, the Australian government released a statement on its top priorities for the country’s fintech future. In doing so, it expressed its clear intention to become a global leader in emerging financial services technology. Treasurer Scott Morrison indicated the government’s keen interest in exploring the applicability and utility of Bitcoin’s distributed ledger technology to mainstream financial service providers, particularly as it relates to international money transfers and investment; a development he believes can transform the Australian economy.
Although cryptocurrencies provide great promise with regards to revolutionising financial services; significant barriers still exist to widespread adoption. These include volatility in value, risk of cyber theft, relatively poor uptake in both on- and offline merchants willing to accept cybercurrencies as a viable alternative to fiat currencies, which ultimately undermines a large portion of its utility. There is also an increasing incidence of cyber currency providers finding themselves de-banked by their financial institution due to concerns about them posing an unacceptable anti-money laundering/counter terrorism financing (AML/CTF) risk.
A number of countries have started to look at regulating cybercurrencies. These include Australia, Canada and the United States. In 2014, Canada became the first country to create legislation specifically dedicated to regulating Bitcoin and other cybercurrencies. The Bill C-31 was introduced to make important regulatory amendments to Canada’s Proceeds of Crime (Money Laundering) and Terrorist Financing Act (2000). The Bill is progressive in that it explicitly defines “virtual currencies” such as Bitcoin as ’money services businesses’ for the purposes of its AML law. As a result of the Bill’s amendments, businesses dealing in Bitcoin (for example, Bitcoin exchanges) are required to register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC). Furthermore, money service businesses need to institute compliance regimes, keep and retain prescribed records, report suspicious or terrorist-related property transactions, and determine if any of their customers are ‘politically exposed persons’. The law applies to businesses based outside of Canada’s jurisdictional borders, but which provide services to persons or businesses within Canada’s borders, and prohibits banks from opening and maintaining accounts for businesses dealing in Bitcoin that are not registered with FINTRAC. To date, the Bill has been well-received by both the Bitcoin industry itself, and Canada’s law enforcement sector, indicating its value as a positive step toward achieving a balanced regulatory approach for Bitcoin. Interviews with Canadian Bitcoin industry leaders have been indicative of a general consensus that the law will provide a long-awaited amount of regulatory clarity and recognition for Bitcoin, as well as a sense of greatly needed legitimacy.
In August 2015, the New York Department of Financial Services introduced Bitcoin-specific regulation known somewhat colloquially as the state’s “BitLicense”. The regulatory guidelines are admirably comprehensive, in an attempt to address every aspect of running a Bitcoin-related business, from record-keeping to mergers, advertising, complaints and minimum cyber security provisions. However, guidance as to the stringency expected of Bitcoin businesses with regards to monitoring for ‘red flags’ that may signify money laundering, tax evasion, or other illegal activity is lacking. The inherent weakness of ambiguous guidelines such as these is the so-called ‘wriggle room’ they grant budget-conscious Bitcoin businesses to comply, but just barely. It is in this kind of regulatory environment wherein suspicious transactional behaviour and individuals can go unnoticed, regardless of the business’ compliance status. Further criticisms of New York’s BitLicense include the prohibitive cost of compliance, and the sheer reach of the requirements. The non-refundable application fee for a BitLicense is US$5,000. However, prominent Bitcoin exchange, Bitstamp’s Vice President estimates the application cost to a company to be approximately US$100,000, inclusive of all legal and personnel fees. It seems self-evident that fintech and other cybercurrency-related start-ups will be incapable of paying such fees. Furthermore, BitLicense’s remit, which extends beyond those living or owning a business located in New York, to cover any person that is conducting business in New York, regardless of where they are located, has led a number of existing Bitcoin businesses to cease operations in New York, in what New York Business Journal has termed the “Great Bitcoin Exodus”.
The Australian Government’s approach to cybercurrency regulation has been similar to that of Canada’s, their intention is to implement regulation with a “light touch” approach designed to allow fintech entrepreneurs the freedom they require to succeed. Since the release of the Senate Committee’s report in 2015, which in itself was disappointingly non-committal to concrete regulatory reform, the government has taken more meaningful steps towards regulating Bitcoin and other cybercurrencies under its AML/CTF regime.
Earlier in 2016, the country’s Anti-Money Laundering and Counter-Terrorism Financing Act 2006 was the subject of a statutory review, which recommended the Act should be amended to regulate activities relating to digital currency. The review addressed one of the key barriers to subsuming cybercurrencies under Australia’s existing regulation simply and effectively, by suggesting the Act’s definition of e-currencies be expanded to include… [cybercurrencies] such as Bitcoin that are not backed by a physical asset. In early 2016, Treasurer Scott Morrison outlined the government’s plan to allow start-ups considered capable of challenging the processes of banking incumbents to avoid extensive regulatory licence applications by testing their products and systems in a controlled environment. This will reduce the chances of the regulatory licencing process eating up the seed capital of smaller start-ups with good ideas before they are able to achieve any measure of market capitalization, robbing the industry of clever innovations because they were not granted the regulatory freedom they needed to evolve. A sandbox scheme of this kind, working in conjunction with the Australian Securities and Investment Commmission’s (ASIC) Innovation Hub service, designed to help start-ups navigate the complexities of the Commission’s own regulatory requirements, is nothing but a positive development. This is evidenced by Morrison’s articulation of the competitive edge fintech start-ups can provide to the Australian economy when it comes to productivity within the financial services sector.
Cooperation with other jurisdictions with a progressive stance on cybercurrencies, such as Canada, may be key to implementing a consistent, comprehensive regulatory framework of this sort. There are undoubtedly a myriad of further regulatory developments yet to unfold within Australia, which will necessitate further analysis. However, international cooperation should be a key priority for cryptocurrency or cybercurrency regulation, as this will more effectively counter the international nature of criminal activity and will prevent jurisdiction shopping by offenders. A consistent global regulation would lend cybercurrencies greater credibility as a viable fiat currency alternative, and, conceivably, lead to an increase in the number of merchants willing to accept cybercurrency payments.
Dr. Angela Irwin is a lecturer in cyber security and cyber policing and intelligence at the Department of Security Studies and Criminology at Macquarie University in Australia. Her research is focused on understanding how cybercriminals, money launderers and terrorist organisations exploit cyberspace for financial gain. Ms. Caitlin Dawson is completing her Master’s degree in Policing, Intelligence, and Counter-Terrorism at Macquarie University. Image Credit: CC by Zach Copley/Flickr.