Digital currencies have been around for a decade, yet the regulatory systems governing them are fragmented, ineffective and, in some countries, non-existent. This allows illicit activities to flourish, from fraudulent Bitcoin traders who disappear with your cash to the financing of terrorism and international money laundering.
Digital currencies are the inevitable future, so international coordination and individual country action is required to close the legal loopholes that allow cryptocurrency crime to flourish. Recently, financial and regulatory experts from around the world discussed digital assets and the money-laundering risks they pose in a webinar hosted by Absa, in collaboration with the World Economic Forum (WEF) Global Futures Council and the Financial Action Task Force (FATF).
The challenge for regulators worldwide is to find appropriate regulatory instruments to address the risks emanating from greater adoption of cryptocurrencies. Existing regulatory instruments have limitations in addressing consumer and financial crime and money laundering risks. This has led to increased regulatory scrutiny of cryptocurrencies, as launderers have turned to digital currencies like Bitcoin, Ether and Ripple to “cash out” their profits, bouncing transactions around the world instantly and anonymously.
In a sign of a significant shift in regulatory thinking, the Bank of International Settlements (BIS), owned by 63 member central banks and monetary authorities from around the world, has declared that “cryptocurrencies are not money, but speculative assets that can be used to facilitate money laundering, ransomware attacks and other financial crimes”.
This view comes after more than 60 central banks have embarked on digital currency projects since 2014, suggesting that some central banks consider central bank digital currencies as a preferred path to protecting the integrity of the financial system over time.
The recent volatility of Bitcoin has also raised important questions about the long-term viability of cryptocurrencies as an asset class. Similarly, the rise in ransomware and other financial crime incidents has led to growing concerns about regulation and how to deal with emerging Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) risks.
It is clear that these new forms of money present both opportunities and challenges for the financial industry, policy-makers and consumers. Digital currencies can make international payments more efficient, convenient and secure, while removing the cumbersome operational and security processes linked to the movement of conventional money, which improves overall economic efficiency.
However, as more ordinary people invest in cryptocurrencies and institutional investors add them to their portfolios, their growing prevalence raises important questions around financial stability and preventing money laundering and the funding of terrorism.
When it comes to combatting these crimes, regulators need to work alongside technology experts, so their laws keep pace with the changes. In addition, regulators need to be forward-thinking and design laws that are fit for purpose and not try to prevent the inevitable.
Furthermore, collaboration is crucial and digital assets require regulation through international cooperation, local enforcement and by authorities technologically equipped to keep track of these very fast developments.
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In 2019, FATF introduced guidelines that obliged countries to assess and mitigate the risks associated with crypto asset activities and service providers. It called for service providers to be registered and supervised by competent national authorities. Yet, FATF reports that only a quarter of countries have adopted those guidelines.
While some jurisdictions have put anti-money laundering frameworks in place and sanctioned traders that don’t conform, criminals could quickly move to unregulated countries through this lack of global uniformity. Implementing the so-called travel rule is going to be essential to remove jurisdictional arbitrage. It is also vital to remove the anonymity of asset transactions and collect data about the transactions.
FATF is updating its guidelines and encouraging more information sharing between countries. It agrees that strict regulations wouldn’t stifle innovation but would strengthen the industry and lead to more economic growth.
Here in South Africa, buying crypto-assets isn’t regulated and according to Minister of Justice and Correctional Services, Ronald Lamola, this lack of protection has left consumers extremely vulnerable, with some hopeful investors having lost their money.
Although some trading platforms and financial institutions have implemented the “know your client” (KYC) protocol, this is not a general practice. This renders us vulnerable to syndicates which purchase crypto-assets for money laundering and funding terrorist activities and attempts to circumvent exchange controls and mask illicit financial flows.
Inter-governmental collaboration to create an agile but effective regulatory framework is vital with unified responses to developing trends. While South Africa already has an inter-departmental working group investigating financial fraud, including the police, the Hawks and South African Revenue Services, there are plans to expand that intelligence centre to include crypto-assets service providers.
Other emerging digital assets include CBDCs or Central Bank Digital Currencies. About 20 CBDCs are in development with the People’s Bank of China planning to replace physical cash with a digital currency known as the e-RMB or digital yuan. Chinese citizens taking part in a pilot project in several cities can download an app and enter a lottery to win money to spend with appointed service suppliers.
While it’s a huge infrastructure project, those taking part in the Chinese pilot project agree the digital yuan is convenient, efficient and secure. CBDCs would enhance international trade, and China’s early mover advantage could turn its currency international because of its security.
One challenge is to figure out how to make different CBDCs interact with each other, and the International Monetary Fund is researching the cross-border use of digital money. Questions are being raised which include the impact this “currency substitution” will have if a foreign system is used in parallel to a domestic currency, and whether it will undermine the domestic currency and affect exchange regimes.
Blockchain technology is allowing the world to think differently about money and economic ideas and is creating much-needed innovation in the financial markets. Once scalability issues with blockchain are ironed out and technological solutions reduce the risk of fraud, digital currencies could deliver a positive experience around the world.
Previous financial crises have shown how the world’s systems are interconnected and the speed at which crypto assets could be moved means authorities would struggle to monitor, stop or reverse transactions across those vast networks. Cross-border dialogue is imperative, particularly between technology bureaus to police the situation.
The reality is that cryptocurrencies are a decade old and financial institutions should have responded faster, but tackling issues like the anonymity that allows crypto-crime to flourish can’t be addressed by existing regulations or systems.
We need to do it properly and do it well, so it lasts for the future. This may mean we go a little slower, but if we want to be effective, it’s important that the rules and tools are fit for purpose.
Simi Siwisa is Head, Group Public Policy, Absa Group Ltd.
Steffen Kern is Chief Economist and Head of Risk Analysis, European Securities and Markets Authority, ESMA.
This article was originally published at the World Economic Forum.
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