One of the hottest topics of 2017 was cryptocurrencies. The blockchain-derived digital currencies such as Bitcoin, Ethereum, and Ripple were the subject of seemingly endless interest and speculation, in both the media and the markets. In an excitement reminiscent to many of the dot-com boom, cryptocurrency companies rushed to become issuers via initial coin offerings (ICOs). Companies that were previously unrelated to blockchain or any product of the technology changed their names or indeed their entire operational purposes to attract market interest. Investors searched for information and guidance, experimented with the digital currency as both a payment service and a securities holding, and filled social media and dinner table conversation with curiosity and enthusiasm for the disruptive potential cryptocurrencies hold for banking, technology, and the markets.
Inspired by this last development – keen investor interest and the attending needs for disclosure and protection – at the end of 2017 there was a flurry of regulatory activity, with securities industry supervisors and central banks in numerous countries issuing risk warnings or taking preliminary action toward regulating the cryptocurrency markets. Traditional banking organizations have reacted skeptically to the swelling popularity of bitcoin and other cryptocurrencies, viewing it as purely speculative, a bubble, or too primitive in its actual uses to justify the immense attention it has generated. Of course, cryptocurrency developers and enthusiasts view this bearish posture from the financial sector establishment as defensive or protective in light of the competitive challenge digital currencies may present to conventional banking organizations.
Wherever the truth lies in this dichotomy, what remains relevant is that transactions are taking place and representations are being made on an ongoing basis which need to be considered and addressed from a compliance perspective. Regulatory interest and likely supervisory action are motivated by a desire to ensure fair and transparent markets for participants and protections plus possible remediation of violations for users.
These individuals using cryptocurrencies, whether for speculation, payment, technological development, journalistic inquiry, or mere curiosity, find themselves in a gray area. The appeal of digital currencies is at least partly their decentralization, which prevents them from being clearly seen as consumers and investors who are owed duties and disclosures. However, at some point they must be constructively seen as such due to the marketplace and operational framework that has grown up around their activities.
Users, speculators, developers, issuers, and trading platforms and exchanges have all made their ongoing desire to transact in cryptocurrencies clear. With statements from the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission in December 2017 indicating that their interest was becoming less preliminary and more concrete, guidelines and other supervisory expectations could be finally made clear in the near term.
In the meantime, compliance professionals should not wait to take a concrete position on cryptocurrencies from the perspective of insights to be gained and oversight to be proposed within their organizations. Rather than seeking a basic understanding of cryptocurrencies and taking a bystander’s view to the developments, organizations should be pro-active in integrating risk evaluations related to blockchain and digital currencies into their compliance risk management planning. Instead of seeing these advancements as remote, to the contrary businesses should formulate values and expectations for cryptocurrency markets in order to prepare to be productive and responsible participants.
Preparation of a business compliance “wish list” for the cryptocurrencies can prepare organizations to do more than just identify and inventory risks posed by cryptocurrencies, either to their employees who may wish to have personal securities transactions and holdings in them, or to their business activities if they are in the financial sector.
To that end, here are a few basic items that it would be advantageous for business compliance officers to advocate for within their communities and networks, in the hopes of contributing to the foundations of a marketplace for cryptocurrencies which has a better controls framework and a mature understanding of the expectations and obligations which need to be addressed within it:
- Coordinated industry self-regulation plus adequate supervision for platforms, issuers, and exchanges in order to implement federal enforcement; determine equivalency or other standards; and set conduct expectations
- User classification as, where applicable, customers, consumers, and/or investors to create responsible and reliable contractual relationships in markets and with service providers; effectively address disputes or complaints; and ensure that disclosure and monitoring standards such as Know Your Customer (KYC), anti-money laundering (AML) programs and prevention, and client due diligence (CDD), among others, are met
- Comprehensive investor protections to fill any gaps remaining once competent authority regulates markets and private litigation defines terms of engagement and other duties defining market participant relationships and positioning cryptocurrency offerors as securities issuers
- Broad transactional infrastructure to address risks of illicit uses, decrease incentives for continued application in these activities, and extend access and safety for legitimate use in widespread payment services and other banking transactions activities
- Provide space/support for experimental activity and allow innovation to flourish healthily, but in a domain where all participants in the innovation understand and accept its risks and knowingly engage in a “sandbox” of sorts for the sake of experiment and development
As is always the case when regulatory regimes broaden, cryptocurrency users and developers have already sounded the alarm in fear that supervisory attention will kill the industry in its cradle. In reality, the only activity that the above controls, when reasonably and prudently applied, could stifle is pure speculation and illicit use.
In exchange for competent supervision, genuine consumers (both customers and investors) and developers stand to gain credible protections and reliable guidelines for their education and preparation as market participants. Exchanges and platforms could have a level playing field created by a common decision-making authority that also sets objective precedent as market practices evolve. Issuers would be held to a disclosure and transparency standard upon which venture capitalists and other funders or lenders could safely depend. Curious futurists who want to be early adopters, market participants interested in accumulating positions to store potential value or prepare a hedge in the currency futures markets, and blockchain enthusiasts who value the unchecked innovation would all remain undeterred from continuing on as they have been.
In practice, the speculative and illegal activities that still dominate cryptocurrency’s real marketplace do not contribute concretely to the sustainable and purpose-driven deployment of the underlying technology, and therefore emphasis on avoiding scrutiny that only serves to protect these uses does nothing to further cryptocurrency’s long-term development. Instead, participants and entities providing oversight should focus on supporting the managed extension of the technology into traditional banking and payment services activities, while providing a safe space for innovation to continue away from the stability needs of mainstream consumers and retail investors. Cryptocurrency may be in a critical moment between existence and identity, and basic compliance controls can support its growth into legitimacy without stunting the reach of its development.
For a more basic look at relevant topics from 2017, check out this post on blockchain and this post on cryptocurrencies. This year, check back for features taking additional looks at both blockchain and cryptocurrencies, including multidisciplinary approaches combining compliance and law to further examine concepts in and concerns with the digital currencies for market participants, supervisory entities, and business stakeholders.