If the cryptocurrency were to be regulated to the same extent as fiat currencies, would it fall into line or remain a fraudster stalwart?
Fraud is big business: in 2021, financial fraud cost the world megabucks. Reports vary on the full extent of financial crime, but a study from analyst firm Juniper Research estimates that online payment fraud will top $343 billion by 2027.
Fraud is hard to contain, and any chink in a system’s armor will open vulnerabilities that cybercriminals will find. Cryptocurrencies have entered the money market without the level of checks that traditional centralized financial structures have taken years to achieve. Even with stringent checks, losses across financial systems are eye-watering.
So, what is the chance for cryptocurrencies to go mainstream without providing ample opportunities for fraud? Can regulations tether the crypto beast, and if they do, will it spoil the very essence of crypto, its decentralization, and transaction privacy?
According to Reuters, there were over 3000 cryptocurrencies in the wild. The ease of introducing cryptocurrencies is partly due to the lack of regulated intermediaries needed to carry out fund transfers. This environment makes it relatively easy to set up a cryptocurrency using a blockchain or stablecoin to handle these transfers. I’ll circle back to stable coins later as they play a role in the future of crypto.
Decentralization is the core differentiator from traditional money transfer systems and the bang for the privacy buck for crypto-traders. However, some fundamental architecture constraints exist in Decentralized finance (DeFi) approaches, including the instability that crypto value has experienced in recent years.
Another is the inherent security issues of the blockchain ecosystem; as discussed in a previous article, “Experts call blockchain “technological fraud.” Yet another, and arguably the most important considering the attractiveness of crypto for cybercrime, is the lack of anti-money laundering (AML) and ‘Know Your Customer (KYC) checks performed by crypto platforms on their customers and owners. This lack of anti-fraud evaluation makes cryptocurrency a handy tool for cybercrime-related financial exchange. This latter issue extends to the people behind the cryptocurrency and the crypto-traders: the OneCoin Ponzi scheme managed to trick legitimate investors into handing over $4 billion before its founder, Ruja Ignatova, disappeared, carrying virtual ‘swag bags’ over her shoulder.
The vast swath of cryptocurrencies presents the world with a problem. How do you stop this financial exchange system from becoming a cybercrime free-for-all?
Enter the regulators, stage left…
Can you regulate the seemingly unregulatable?
Regulations are the mainstay of the financial sector, and the sector is one of the most regulated industries. And it is not just banks and financial institutions that the regulations impact. For example, any business that handles money transfers, such as an eRetailer, must comply with regulations such as the Payment Card Industry Data Security Standard (PCI DSS).
Crypto has bucked the trend of regulation until now. In March 2022, Biden signed an Executive Order “Ensuring Responsible Development of Digital Assets” that will drive the regulation of crypto platforms.
Behind this decision is a US market cap, valued at $3 trillion in 2021, that flourishes off the back of 40 million North American investors. The order has several parts and states that it:
“encourages regulators to ensure sufficient oversight and safeguard against any systemic financial risks posed by digital assets.”
It is not just the US that has woken up to the harms unregulated cryptocurrencies can do. In the UK, the Financial Conduct Authority (FCA), H.M. Treasury and the Bank of England have formed a Crypto-assets Taskforce to regulate digital currencies. Brazil, a long-time innovator in banking, has begun the road to crypto-taxation. In addition, Brazil intends to apply the existing AML laws to virtual currencies.
The seemingly unregulatable looks set to be regulated. However, crypto is based on digital platforms, and digital is always hard to control because of the global nature of the beast. We’ve seen this regulatory quagmire in social media, an example being the recent heated debate between Facebook owner Meta and the Irish Data Protection Commission. They are threatening to block Facebook from sending data from Europe to the US.
Will crypto ‘defi’ the regulation stampede?
As for regulating the crypto platforms, several areas need regulation. Signing up for a crypto account with one of the major platforms, such as Binance, requires an identity document check (e.g., a passport) with a facial recognition cross-check. This is far short of the extensive KYC checks performed by traditional banks when onboarding a customer. KYC checks vary from country to country, but in Europe, the Anti-money Laundering Directive (AMLD) brought in strict Customer Due Diligence (CDD) requirements with AMLD5.
In banking, KYC/CDD is often paper-based, but there are moves to digitize it. However, crypto has landed into the regulation space as a fully formed digital platform; this makes meeting the existing CDD requirements more complex and costly for the platform. These checks' intrusive nature may also irritate people choosing crypto for its privacy and decentralization.
The primary debate raging in crypto is that regulating crypto goes against the principles of the technology. Cryptocurrencies came about to satisfy an ideology based on a movement away from centralized control of money. Many would view regulation as a form of centralized control. But the alternative is a free-for-all with little to no AML checks.
Blockchain analytics company Chainanalysis recorded that 74% of the money received from ransomware attacks in 2021 went to Russia-associated hackers, ransoms handled using blockchain currencies. It seems that without regulation, crypto is the darling child of cybercrime.
But in a world that adores digital, digital currency looks like it is here to stay. From the embers of unregulated crypto, governments worldwide are looking to stablecoins.
What about stablecoins?
Stablecoins are a digital currency, like a digital dollar. They are 'stable' because they are tied to another currency (Fiat) or asset, such as gold, to stabilize the price. Stablecoins can also be backed by a central bank and are known as a Central Bank Digital Currency (CBDC). But, of course, this connection to a centralized system, like a central bank, means that they may be stable, but they are essentially now under state control.
For example, USD Coin (USDC) is backed by short-term US government bonds and cash to stabilize it. One of the upsides to a stablecoin is that being stable, they can be used instead of Fiat to perform cryptocurrency transfers. But these stablecoins are typically also regulated under the same laws as Fiat. For example, USDC is managed by Circle, a regulated financial services organization. Circle is a registered money services business (MSB) with the U.S. Department of the Treasury, so it must comply with KYB/KYC/AML and financial crimes compliance requirements.
But resistance to the transparency of financial regulations continues within the crypto-community. Many Subreddit posts can be found that show the level of anger on regulating crypto. Most center on crypto's decentralization vs. centralization aspect; centralization seen as government snooping and controlling finances.
Regulation and centralization of crypto look like it is mainstreaming, with 91 countries exploring CBDCs. As far as regulations go, as well as many countries building the framework for regulated crypto, the World Economic Forum (WEF) Digital Currency Governance Consortium is developing global standards and regulations in the crypto space.
Whatever your view, it looks like crypto-regs are coming to a platform near you. Will the regulations stop fraud? Probably not, after all, traditional financial structures are heavily regulated and still remain open to massive fraud. However, regulations may stem the tidal wave of cybercrime.
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