{"id":2797,"date":"2021-10-20T13:53:58","date_gmt":"2021-10-20T02:53:58","guid":{"rendered":"https:\/\/insight.thomsonreuters.co.nz\/legal\/posts\/5-conversation-starters-addressing-cryptocurrency-risks-and-opportunities-2"},"modified":"2023-03-13T02:40:50","modified_gmt":"2023-03-13T02:40:50","slug":"5-conversation-starters-addressing-cryptocurrency-risks-and-opportunities-2","status":"publish","type":"post","link":"https:\/\/insight.thomsonreuters.co.nz\/legal\/posts\/5-conversation-starters-addressing-cryptocurrency-risks-and-opportunities-2","title":{"rendered":"5 Conversation Starters Addressing Cryptocurrency Risks and Opportunities"},"content":{"rendered":"\n

The commencement of two Parliamentary Inquiries into the cryptocurrency movement<\/a> in New Zealand and Australia will bring home to policy-makers how complex this corner of the FinTech sector really is. As suggested in my earlier Part One article, the evolving technologies powering cryptocurrencies are advancing at a pace that our existing laws cannot handle.<\/h4>\n\n\n\n

That often happens with old-world regulations that were not designed to move with the times. Consequently, decentralised applications are popping up in fields where the rules are unclear. Both governments probably feel the emerging issues of all things crypto need attention.<\/p>\n\n\n\n

There are many issues on the table to explore, and what follows is admittedly selective. It arises from conversations I\u2019ve been having with clients engaged on these Inquiries, and writings from industry peers about the various considerations other nations have been clutching at. <\/p>\n\n\n\n

With twin themes in mind of financial crime risks of abuse, and nascent regulatory frameworks, let\u2019s look at what might surface in Australasia too. At the risk of being a tiny<\/em> bit provocative, here are five crypto-conversation starters.<\/p>\n\n\n\n

1. Investor risk and consumer protection<\/h2>\n\n\n\n

Accumulating intangible money in one place inherently has as much risk of bank robbery (of the hacking kind) as traditional bricks-and-mortar wild-west style heists.<\/p>\n\n\n\n

We might ponder how long a shadow has the Cryptopia liquidation debacle cast over the fledgling currency exchange industry?<\/p>\n\n\n\n

The online trading platform based in NZ\u2019s South Island went spectacularly bust in 2019. A major website hack saw 15% of its stock of tokens\/coins stolen, and traders then deserted in droves. Liquidators are still grappling with the complexities of how to divvy up the remaining holdings (potentially worth NZ$170m) among 960,000 account holders – in different coins, classes, with varying balances and investments at various stages.<\/p>\n\n\n\n

This included a ground-breaking but expensive venture by liquidators into the NZ High Court to have cryptocurrencies declared \u201cproperty.\u201d That helped ascertain the competing rights of creditors\/account holders\/beneficiaries in a series of trusts hence created, but the troubles kept coming<\/a>.<\/p>\n\n\n\n

Cryptopia isn\u2019t the first and won\u2019t be the last exchange to fall victim to a virtual bank heist. Just recenty a De-Fi platform<\/a> and another Japanese exchange was hit<\/a>. There\u2019s even the cruel irony of old-school robbery and new-tech crime merging, in this remarkable story<\/a> of a safe in suburban Auckland being hauled away with critical wallet keys inside.<\/p>\n\n\n\n

When the worst happens, can insolvency regimes do all that much? At the time of June 2021 it seemed almost NZ$12m had been spent<\/a> on the Cryptopia liquidation mess, without much to show for it. Too little, too late, is the reality.<\/p>\n\n\n\n

Parliaments in both countries may be wondering if consumer protection\/prudential deposit-style regulation is necessary. Whilst warning private investors of buyer beware, and not to succumb to \u201cFOMO\u201d, regulators continue to tiptoe around bigger institutional issues in the growing sector.<\/p>\n\n\n\n

For instance, ASIC in July 2021 (Consultation Paper 343<\/a>) kicked around ideas to bring some order and \u201cgood practice\u201d to regulated players who invest by exchange-traded products and other schemes into underlying crypto-assets. It raised some sound points about pricing transparency and manipulation of trading, custody and asset safe-keeping, as well as AML and CFT risk management baselines, and disclosure obligations to retail customers.<\/p>\n\n\n\n

But anything more concrete seems a way off. For now, a piecemeal approach to classification and regulation persists.<\/p>\n\n\n\n

2. Are regulators worldwide now circling on the sector?<\/h2>\n\n\n\n

Heads turned when trans-Atlantic regulators recently piled into Binance, the first or second-largest global exchange depending on what measure you use. A series of investigations and warnings stacked up this year, about operating without jurisdiction or permits, alleged failure to comply with local AML regulations, even potentially market manipulation (although firmly denied<\/a>).<\/p>\n\n\n\n

Coindesk had a good crack at compiling all the various regulatory actions<\/a> in one place. A domino effect indeed. Binance isn\u2019t alone. Another article in ACAMS<\/a> recently highlighted a range of US probes and charges emanating from the OFAC to the CFTC, SEC and the New York Attorney-General. And new Non-Fungible Token (NFT) markets are experiencing their own similar challenges<\/a>.<\/p>\n\n\n\n

Legitimate players in the crypto-sector are generally keen to see action taken against rivals who may be operating in an unregulated fashion. But once a regulatory wave is up and rolling, it can always have potential to surge through the sector as a whole without much discrimination.<\/p>\n\n\n\n

Then there is pure political risk. Since publishing my earlier article<\/a> on this rapidly evolving issue, the People\u2019s Bank of China and other Chinese state agencies announced that all transactions of cryptocurrencies are illegal, and it banned digital tokens and trading. The Bank\/Party intends to work closely to maintain a \u201chigh pressure\u201d crackdown on speculative trading, and prosecute those involved in \u201cillegal financial activities\u201d including any foreign websites providing such services to China.<\/p>\n\n\n\n

To some this came as a shock considering the scale of China\u2019s influence as arguably the real world and virtual world\u2019s largest markets. Cue more fluctuations and volatile falls in the price of Bitcoin and other cryptocurrencies, at least temporarily.<\/p>\n\n\n\n

But China has been here before \u2013 it started cracking down on Bitcoin a few years ago, along with other digital-led companies like Twitter and Facebook. Trading crypto-currency on exchanges in China has been officially banned since 2019 but since continued through foreign exchanges and mechanisms. And energy-sapping mining operations have also been targeted in the past. So, it should have been less of a surprise.<\/p>\n\n\n\n

Speculation about the implications of all this is now rife. Investment Week<\/a> amongst others showcased the wide range of opinions amongst experts about whether Chinese abhorrence of crypto will make much difference, long-term.<\/p>\n\n\n\n

3. De-banking<\/h2>\n\n\n\n

One thing an exchange, or at least its customers, still needs is a bank account. Or the means to exchange the fruits of speculation back into flat currency at some stage. Unless the Parliamentary Committees recommend bravely following El Salvador<\/a> to recognise bitcoin as legal tender, or start to experimentally allow crypto credit card shopping<\/a> transactions, for those wanting to buy real, physical assets the mainstream banking sector still holds a form of veto.<\/p>\n\n\n\n

De-risking has been a real concern in this sector for years. How to reconcile the banking sector and FinTech\u2019s acrimonious past has become a topic of interest in both Parliamentary Inquiries.<\/p>\n\n\n\n

Recently, we saw banks retreating fast from Binance, but it has been happening to others regardless of any regulator enforcement action. In parallel money transfer or new payment technology fields, de-banking across Australia and New Zealand has been brutal. Recent oral submissions to the Senate evoked sentiments from the ACCC\u2019s foreign exchange remittance non-competitiveness hearings in 2018. Everyone from FinTech Australia\u2019s head<\/a> to the self-styled Bitcoin Babe of NSW<\/a> had a story to tell of rough treatment.<\/p>\n\n\n\n

Genuine crypto players locally are keen to be regulated, as reported in the AFR<\/a>, to achieve some level of respectability and retain banking relationships. That was partly why NZ\u2019s Department of Internal Affairs (DIA) was happy to expand its reach and announce it was capturing the Virtual Asset Service Provider (VASP) sector for AML compliance purposes in 2019<\/a>. Both AUSTRAC and the DIA have a good understanding of the perceived VASP high risks and red flags, involved in and following international FATF guidance and updates each year as a comprehensive start to addressing money laundering risks.<\/p>\n\n\n\n

It remains to be seen how polarising this de-banking issue will be, and how to attempt reconciliation. The Australian Senate explicitly recognised it as a problem within its terms of reference, and it seems inevitable that it will creep into the NZ Parliament Inquiry too. We can contrast the submitting views of the Australian Banking Association and crypto mining company Cosmos Capital. The ABA told the Senate (Second Interim Report pg 89<\/a>) it believes virtual assets have many potential benefits, but without proper sector regulation digital currency exchange providers:<\/p>\n\n\n\n

\u201crisk becoming a virtual safe haven for the financial transactions of criminals and terrorists\u2026\u201d<\/p><\/blockquote>\n\n\n\n

– and:<\/p>\n\n\n\n

\u201cthere is a key risk for banks to be that the identity of users of virtual assets are often unknown to banks and sometimes not adequately known to the operators of the exchanges were virtual assets are traded.\u201d<\/p><\/blockquote>\n\n\n\n

Mr James Manning, Founder and Managing Director of Cosmos Capital (pg 95) perceived this to be:<\/p>\n\n\n\n

\u201c\u2026 part of a larger fear, including from banks, about exposure to cryptocurrencies and possible Anti-Money Launder and Counter Terrorism Financing Act issues. There a ‘a raft of legal issues as to chain of title, who has owned the bitcoin prior to you, whether you knowingly or unknowingly are participating in some form of activity’, resulting in Australian banking groups finding it easier to say no than to try to understand the space.\u201d<\/p><\/blockquote>\n\n\n\n

As a result, lack of access to mainstream fiat banking and insurance services may still be the single greatest impediment to FinTech firms on either side of the Tasman operating in a growth-enabling environment.<\/p>\n\n\n\n

4. Do the means exist to regulate it all?<\/h2>\n\n\n\n

Cryptocurrencies represent an existential challenge for any single nation\/regulator aspiring to control them. How to move unilaterally, ahead of other countries? And which of many potential regulatory buckets should you place these sectors into?<\/p>\n\n\n\n

On social media channels, the regulatory topic sometimes descends into polarisation of debate, where investors and crypto-aficionados argue that a decentralised, virtual, stateless form of money needs no regulation. On the other hand, exchange businesses and brokers who still need to accommodate a sceptical financial mainstream may \u201cbeg for regulation\u201d.<\/p>\n\n\n\n

In New Zealand, at least, enthusiasm may have to be tempered by reality. There is not yet even a form of Electronic Money Institution licence, like the UK has, for mainstream online payments providers, let alone a strong record in getting to grips with crypto or NFT technology developments.<\/p>\n\n\n\n

Which inevitably leads to another issue: who should be the regulator? Agencies domestically in both countries have differing remits and powers, sometimes overlapping. Any of these Kiwi and Aussie agencies could lay claim to a slice of the regulatory action:<\/p>\n\n\n\n