Published on February 24, 2014
INITIAL THOUGHTS ON REGULATION FOR BITCOIN AND VIRTUAL CURRENCIES MARK MCKENZIE REGULATORY GOVERNANCE & COMPLIANCE EXPERT MARK MCKENZIE CONSULTING FEBRUARY 23, 2014
Objective of Presentation To promote discussion on the way forward for regulating Bitcoin and Virtual Currencies
Purpose of Regulation Promote markets which are fair, efficient, orderly and clean; and ◦ Market failure test – Regulation is deemed necessary if we determine that the Bitcoin market is unable to produce an efficient outcome – e.g. can Mt. Gox resolve its challenges without creating disruption in the wider market? ◦ Cost/benefit test ◦ – Regulation will do more good than harm for Bitcoin ◦ – E.g. in light of the Liberty Reserves case regulation can be deemed necessary to mitigate the risk of abuse by organised crime groups Ensure that Bitcoin customers get a fair deal.
Purpose of Regulation A key consideration: How best to implement regulation that will be pragmatic while at the same time enhance the growth and technological development of Bitcoin? ◦ The key is tp allow for Bitcoin innovation while controlling risks Some parallels for Bitcoin can be drawn from mobile and Internet banking: ◦ Poor or the absence of regulations can constrain business models, ◦ Prevent motivated players from participating in ecosystem (e.g. traditional banks and Financial Institutions) and ◦ Absence of regulation might adversely affect uptake, competition and result in sub-optimal customer experience.
What Should Legislators Be Concerned? Bitcoin Market seem: Fragmented and opaque The creators seem to control enormous power Bitcoin is gaining greater/wider acceptance from the general public (speculative?) Without appropriate checks and balance, the risk of abuse be realised Regulation can enforce accountability and transparency of Bitcoin and market discipline.
What Might Regulation Entail? A system of registration/licensing requirements. A point noted by the Lawsky, the superintendent of New York Financial Services Department – he called it BitLicense. What will be the conditions for registration/licensing? Who will be allowed to register? Should Bitcoin be considered merely as a risky alternative investment? Capital requirements – what will be the requirements for capital? Fit and proper requirements for company directors and management including competency This will call for more information on the people behind Bitcoin.
What Might Regulation Entail? Requirements for liquidity and reserves Will we get to point where virtual currencies are backed by gold reserves or some other form of reserve currency or basket of currencies? Will Bitcoin eventually be replaced by Vitual USDs or EUROs or another
What Might Regulation Entail? Requirements for governance, internal controls, risk management, privacy and security. Bitcoin/Cryptocurrencies are sophistication and complexity ◦ ◦ ◦ ◦ The safety, integrity, and balance of all ledgers guarded by miners Miners actively protect the network by maintaining a high hash-rate difficulty for their chance at receiving a randomly distributed small fee. Subverting the underlying security of a cryptocurrency is mathematically possible, but the cost may be unfeasibly high. Transaction ID (TX ID) However, Malleability – Denial of Services Attacks - Mt. Gox and Bitstamp - of concerns to regulators Traditional banks and financial institutions use complex internal quantitative models for capital, credit, operational and market risks ◦ Basel 111 and Internal Capital Adequacy Assessment Process (ICAAP) Could regulation disclose of information on their capital, risks and models used to determine value/pricing?
What Might Regulation Entail? Requirements for AML/ATF compliance to mitigate money laundering and terrorist financing risks. An Effective AML Compliance Regime A designated compliance officer + professional team Written policies and procedures + operational controls: Licensing, renewal and reporting procedures Registration, record-keeping and report filing procedures KYC and EDD Monitoring, analysis and investigating procedures Sanction check and terrorist financing check list Response to official information requests Privacy and information security protection protocols
What Might Regulation Entail? An Effective AML Compliance Regime An on-going training program An independent compliance auditing function AML requirements could impose significant regulatory costs on Bitcoin operators It will likely look like rules for MSBs.
What Might Regulation Entail? There may even be requirements for the creation of safety net similar to a depositors’ insurance scheme. ◦ On the traditional financial system we already have discussions taking place on the too big to failure issue. ◦ Taxpayers should not have to pay for failure of any Bitcoin firms that might spillover into the financial system. ◦ Increasing market discipline by introducing regulations and capital requirement can reduce this risk. Regulation can be useful to guard against crises, speculation and abuse. Should Bitcoin firms should be left to their own devices? Should the state set and enforce rules for Bitcoin? Will Bitcoin form a key component of the financial system of the future?
What Might Regulation Entail? Registration and capital requirements seem a must for the future of Bitcoin and virtual currencies. Firms should be required to demonstrate their resilience to crises. For example, Mt. Gox should be required to demonstrate that it can address its challenges in an orderly fashion. What types of activities or trades should be permitted? What should be banned?
What Might Regulation Entail? There has to be increased transparency. At the same time governments and regulators including law enforcement need appropriate tools and skills to monitor and regulate Bitcoin and guard against abuse.
Are there any other concerns? Yes. The regulation that emerges should not hinder technological development and progress It should be pragmatic. Regulations should not force Bitcoin underground.
Mark McKenzie Regulatory governance and compliance expert firstname.lastname@example.org 1-647-406-4622
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