Author Trevor Clawson

If virtual currencies represent the wild frontier of the finance and financial services markets, then there is a new marshal in town, in the shape of UK Economic Secretary Stephen Barclay.

Replying to a parliamentary question earlier this week, Mr Barclay announced plans to subject virtual currencies – the most famous of these being the Bitcoin – to tighter regulatory control in a bid to crack down on criminal activity. As the value of bitcoins soared to new heights, the Economic Secretary told MPs that Britain planned to co-operate with European Union member states to ensure that virtual currency exchanges and wallet providers would fall under the scope of existing legislation, designed to prevent money laundering and the financing of terrorism.

“The UK government is currently negotiating amendments to the fourth AntiMoney Laundering Directive that will bring virtual currency exchange platforms and custodian wallet providers into anti-money laundering and counter-terrorist financing regulation,” he said.

And according to Olga Feldmeier, CEO of Smart Valor – a private banking operation that uses blockchain technology as a basis for international crypto-currency transactions – a degree of regulation is no bad thing.  “I think this development is a positive step towards legitimising bitcoin and cryptocurrency both in the UK and globally, particularly in the eyes of traditional banks and financial services,” she says.

Virtual Currencies: The Wild Frontier

With the UK expecting its negotiations with the EU to reach a successful conclusion early in 2018, we could now be just a matter of months away from a regulatory regime that will bring a degree of scrutiny to a section of the financial services market that developed rapidly and ahead of regulation by national governments.

The UK government’s desire to regulate should come as no surprise. Increasing numbers of us are buying virtual currencies, arguably the biggest attraction is the investment potential. Bitcoin values have been climbing at a dizzying pace this year. In January, you could buy a single unit for less than $1,000. On  December 6 that number topped the $12,000 mark having risen $500 in a single day. The total value of  Bitcoins in circulation is said to be $200bn.

But Crypto-currencies – the Bitcoin being the most widely known but there are many more – allow virtual money to be moved around the world and transactions carried out well away from the watchful gaze of national governments and central banks.

As the volume and value of virtual currencies in circulation has grown, policymakers have expressed concern that a marketplace in which there are no monetary controls has the potential to undermine the stability of the financial markets. Put simply, in the conventional currency markets, central banks dictate the volume of currency in circulation. In the world of crypto-currencies, there are no such controls. It’s  a worry that has already prompted  China to curb the use of virtual currencies in funding new businesses through Initial Coin Offerings. Criminal Intent

But concerns extend beyond the impact of virtual currencies on financial markets. Bitcoin and its rivals are held and traded anonymously, even though each transaction is recorded – and available for all other holders of the currency to see  – on digital ledger system known as a blockchain. Critics say blockchain-based systems are increasingly encouraging criminals and terrorists to act with impunity.

There’s certainly plenty of evidence for this.  Bitcoins are already becoming the currency of choice for cybercriminals. For instance, the last few years have seen a surge in so-called ‘ransomware’ attacks in which criminal gangs plant malicious software (malware) that locks down files in a corporate system. To gain access to their files, victims must pay a ransom. Typically the attackers will ask for payment in bitcoins. The theory being that the transactions cannot be traced to individuals.

That same cloak of anonymity – or semi-anonymity – also creates an environment where criminal profits can be converted into bitcoins and effectively spirited away through a series of transactions.

How Anonymous Are Bitcoin Transactions?

In reality, the anonymity of bitcoin transactions is only partial. It’s certainly true that in the world of virtual currencies, Peter can pay Paul without the identity of either being revealed. The currency is simply transferred from one address to another,  with neither individual required to provide a name.

But given that all transactions are recorded, what is certainly possible to do is identify unusual transactions and although these may not be associated with a name, it would be possible to identify flows to tie suspicious transactions to addresses. This would pave the way for further investigation.

Those who wish to remain anonymous can, nevertheless, ‘disappear’/ by using multiple addresses and changing them regularly. Although this could become complicated over time, it is not something that is likely to deter cyber criminals. What’s more, applications such as Dark Wallet promise to ensure complete anonymity.  Added to that, some currencies, such as eCache are designed to prevent any evidence at all that could identify individuals or organisations.

The Role of Exchanges

Thus, the new rules that are currently being thrashed out by Britain and its EU partners are likely to require exchanges and wallet providers (the bodies who enable bitcoins to be traded and bought) to carry out additional checks on the activities of users.  When the new rules come into force, providers will be overseen by the competent authorities in each member state.  Feldmeier believes this will help legitimise bitcoins as transactional tools.  

Putting bitcoin under the AML regulation will significantly help it to gain even more traction beyond speculative use cases. Bitcoin is the first post-national currency, and through applying the same rules as national currencies, governments relieve bitcoin of use by criminals and for money laundering purposes. The share of such transactions will reduce even further – which is exactly what we need,” she says.

Is a Crash on the Way

Feldmeier adds that such regulation is unlikely to affect the popularity of virtual currencies with legitimate users. “I think it will aid in legitimising the currency and increasing its demand from people who are aware of its popularity but have been afraid to invest out of the very concerns the regulation is targeted at.”

Arguably a bigger danger to the ongoing uptake of Bitcoin and its rivals is the likelihood that the value of the currency will crash and crash badly.

If the current $12,000 value represents a peak before the fall, anyone who has bought into the currency in the last few months could potentially lose a lot of money. Such is the danger that the chief economist at the investment bank, UBS, Paul Donovan recently compared the rise in bitcoin values to the soaring price of Tulips in the 17th century. “Amsterdam 1636. Cash-settled futures in the tulip bulbs market starts. Prices soar. February 1637, prices crash. We’ve been here before,” he said  Some commentators believe Bitcoin values have a long way to rise, but some sort of correction seems inevitable.

So all in all, regulators have a lot to worry about:  from the stabilising impact of currencies not controlled by central banks, through dangers of criminal activity, to the possibility of an awful lot of small and relatively inexperienced investors losing large sums of money. Added to that is the potential impact of ‘invisible money’ on national tax revenues.

Thus, regulation is likely to increase. The question is: can regulators keep pace with the speed of technological advance.