In this episode of Coffee Chat with CastleHill, Managing Partner Tim Carbery is joined by Vice President of Business Development Joe Santangelo to discuss cryptocurrency: its pros, its cons, and the increasing buzz from regulators as they piece together exactly what to do with it.
For many, cryptocurrency’s defiance of definition is one of its most attractive qualities. With approximately 2,500 different kinds of cryptocurrency circulating the market for an estimated 252.5 trillion dollars, its boundaries remain elastic.
This resulting gray zone is one of the initial hurdles regulators face when implementing new requirements. “One of the challenges relative to cryptocurrency is that it’s not defined,” Says Carbery. As cryptocurrency is such a broad field that contains numerous different offshoots, usages, and purposes, any conversation around regulating cryptocurrency must carefully define its base interpretation.
Perhaps the simplest example of cryptocurrency is as a digital coinage. “It’s very interesting as a straight currency. In many countries, you can buy a hamburger with it. You can go and buy a drink with it. In Spain, they are actually using it to pay soccer players,” describes Carbery. “It’s something which has caught a lot of attention in, and has a lot of opportunity for, countries that either have challenges with their monetary supply or just physically getting money into people’s hands.”
Digital coinage— a replacement for cash and credit— is essentially straightforward. The situation becomes more complicated when considering potential investors.
Take Tesla, a company which has invested upwards of 1.5 billion dollars into one of the most predominant forms of cryptocurrency: Bitcoin. “That’s an investment asset style activity, which has its own set of criteria regulations, rules, and traditions around how you do certain things,” Carbery explains.
Additionally, cryptocurrency and its underlying blockchain possess great potential as a foreign exchange vehicle. All of these uses would likely be subject to different regulations than cryptocurrency strictly as financial tender.
“Anytime you want to talk about a regulation or usage of cryptocurrency, you have to define which of those areas you are talking about, and that’s a big challenge.”
How to Regulate Cryptocurrencies
At the end of 2020, The Financial Crimes Enforcement Network (FinCEN) proposed a series of know-your-customer (KYC) regulations that would impose similar requirements used in a traditional banking system for cryptocurrencies. The rules would enforce the submission of personal records for crypto users interested in moving currency above a certain sum from centralized exchanges into personal wallets.
Certainly, government agencies such as FinCEN face a challenge when it comes to regulating cryptocurrency, especially in the face of potential security threats. “Anti-money laundering is a global problem, and cryptocurrency is a global phenomenon,” Carbery points out.
Here is a prime example of the gray zone of cryptocurrency coming into play. “You look at an organization like FinCEN. It doesn’t consider cryptocurrencies legal tender, but they want to be able to monitor all exchanges of cryptocurrencies,” Santangelo remarks.
FinCEN’s proposed KYC regulations would treat cryptocurrency as a straight equivalent to cash, independent of FinCEN’s rejection of digital coinage as legal tender. As cryptocurrency proves increasingly valuable to emerging markets, the question of how to effectively regulate its use is crucial; but are the rules of traditional banking sufficient to create a framework which adequately regulates cryptocurrency?
“It’s a big deal, right? Anti-Money Laundering, Bank Secrecy Act— these are rules that were based on challenges that happened just as banking systems were becoming fully digitalized,” Carbery explains. “The very fact that cryptocurrencies have a level of privacy associated with them, the duality between the publicness of the blockchain together with the privacy of your digital wallet, it’s a very different kind of situation than those rules were originally created for.”
Cryptocurrency on a Global Scale
FinCEN is not the only agency proposing increased scrutiny around cryptocurrency.
“We’re going to see an avalanche of different rules and regulations, not only from the United States, but even around the world,” Predicts Santangelo. He points to Christine Lagarde, President of the European Central Bank (ECB), who has called for global regulations regarding cryptocurrencies.
In such an instance, the definition of cryptocurrency shifts towards foreign exchange. “The big fear is that the banks and the federal banking systems are going to lose control over the actual transaction, right?” Carbery reflects. “There is no middle person, no middle line entity inside of those things that they have long standing traditions of compliance or rules or regulations for. That’s where there are some concerns.”
Many regulatory bodies are in favor of implementing cryptocurrency. Their focus is on eliminating its uncertainty by introducing regulations intended to improve its financial and digital security.
“You have Hester Peirce of the SEC… even she said that regulations are needed because there’s so much uncertainty that it’s not facilitating the development of markets or how people will work with it,” Notes Santangelo. Similarly, Janet Yellen has expressed an interest in cryptocurrency for its ability to improve the efficiency of the financial system.
New regulations have an opportunity to shore up cryptocurrency’s intrinsic self-regulation process by solidifying risk management practices. In the European Union, the Digital Operational Resilience Act may serve as a useful template by which other organizations can identify and respond to digital risks in the cryptocurrency sector.
“This is another one of those dualities with cryptocurrencies: if you lose the transaction, if the blockchain is in any way altered or manipulated… you lose that money, right?” Carbery explains. “There have been large losses that have been publicized as part of cryptocurrency, but by the same token, we’ve had situations were fraud has occurred, and regulators have actually been able to get the money back because of blockchain. Parts of the system are working. That’s where folks like Hester Peirce are going.”
Sufficient risk management for processing Third-Party Risk related to cryptocurrency will be crucial. “As these digital currencies expand, you will need to monitor organizations that you’re doing business with,” Carbery points out. “You’re talking about third parties and nth party type situations… it’s not just about you as the recipient of data, it’s about your third parties. Are they following regulations? Are they protecting their usage of Bitcoin in such a way that its not financing terrorism, not financing drug activities?
“You end up with all these different participants in your company who might be impacted from a risk management perspective by using cryptocurrencies in day-to-day business.”
Learn more about the potential of cryptocurrency, including its recent impact on Third-Party and ESG risk, by joining us at Coffee Chat with CastleHill.