The rise of decentralised finance (or ‘DeFi’ to those in the know) in the past five years has created a new class of assets that exist outside of the control of governments and central authorities. It has also liberated the related cryptoasset businesses from the conventional restraints of nationality, geography and physical infrastructure usually required in financial services.
The use of cryptocurrencies for unlawful purposes is nothing newHowever, the same features that have led to its success also mean that crypto is regarded by regulators and law enforcement agencies all over the world as a significant threat with regard to the facilitation of crime, particularly money laundering.
The use of cryptocurrencies for unlawful purposes is nothing new. In 2011, the notorious darknet marketplace Silk Road became one of the earliest commercial adopters of bitcoin. At a time when nearly all means of electronic value exchange could be easily tracked, bitcoin offered an alternative for those who wanted to buy and sell the drugs, guns and stolen data on offer without risk of being traced by those following the money.
While the blockchain ledger recorded the currency moving, the bitcoin addresses on either end did not reveal the identity of those involved in the transactions.
Cryptocurrencies and associated services have continued to evolve and now allow the possibility of almost total anonymity in certain circumstances.
By using privacy wallets, anonymity-enhanced coins and third-party tumbler or mixer services, criminals are able to obscure both themselves and their digital dealings from any unwelcome gaze. Combined with the relative ease of transfer across borders, cryptocurrencies are an obvious choice for laundering ill-gotten gains.
Different responses
With this in mind, how have regulators responded to the risk of cryptocurrency being used to facilitate crime, and in particular from allowing its proceeds to be integrated into the mainstream economy?
One response is that adopted by China, which has outlawed all cryptocurrency transactions. While this approach may seem to eliminate the risks in one fell swoop, it comes with one significant objection and one significant challenge.
The significant objection is that while crypto does present risks to individual consumers exposed to fraud, hacking and unprecedented market volatility, and also to societies and economies through facilitation of crime, it also presents opportunities and benefits. In particular, cryptocurrencies have huge appeal for those involved in frequent and/or lower value cross-border transactions, by offering lower fees and eliminating the need for foreign exchange.
If nothing else, cryptocurrency offers a new form of competition for the existing international money transfer market, which if properly regulated should result in benefit for consumers.
Some of the existing players in those markets have already recognised the opportunity (or perhaps threat) of cryptocurrency, as Visa, Mastercard and Paypal now all incorporate some kind of cryptocurrency offering.
Outside of regulation
The significant challenge of trying to stifle crypto entirely is neatly illustrated by the Financial Conduct Authority’s actions in respect of Binance Markets UK Limited, a subsidiary of the world’s biggest cryptocurrency exchange Binance.
In August 2021, the FCA published a stern supervision notice, which revealed that Binance Markets' permission to carry out regulated activities in the UK had been withdrawn and that, in the FCA’s opinion, Binance Markets was "not capable of being effectively supervised". While this might sound like the death knell for Binance in the UK (and indeed many reputable publications ran with headlines announcing that Binance had been ‘banned’), in reality it made little practical difference.
Buying and selling cryptocurrency itself (as opposed to derivatives such as futures or options based on the value of cryptocurrencies, or securities such as crypto ‘stock tokens') is not a regulated activity in the UK.
As such, the core Binance cryptocurrency exchange (not provided by Binance Markets, or operated from the UK at all) can continue to serve customers in the UK unhindered, while the FCA is powerless to do more than warn consumers that crypto is not covered by the protections offered by regulated activities.
Regulators in other countries, limited by their jurisdictional reach, will face similar problems in trying to tame a beast that was built to avoid centralised control.
These examples illustrate the difficult balancing exercise faced in this still relatively nascent stage of cryptoassets’ development. Regulators need to pick a careful path between the competing interests of protecting consumers and preventing money laundering, while recognising opportunities and encouraging innovation.
Lack of consensus
What is clear is that cryptocurrencies and their perceived risks are a worldwide issue, and unilateral attempts to address its challenges are bound to fail. At present, there is an evident and problematic lack of joined-up global thinking, as neatly demonstrated by one country (China) banning what another (El Salvador) has adopted as legal tender.
While there is no quick fix, it is right to say that any hope of suppressing cryptocurrency entirely is almost certainly in vain. Furthermore, significant differences in the approach to regulation are very likely to undermine each other.
As such, there will need to be a much greater degree of worldwide concession and compromise than is currently on offer if any meaningful regulation is to be achieved. That being said, crypto currently faces what may turn out to be a crucial point in its development.
Bitcoin and a handful of other market leaders are on the verge of becoming household names. However, crypto has yet to establish the kind of mainstream credibility that could turn it from a cult success to a global industry.
If anyone can achieve some kind of global regulatory consensus on their crypto offering, then the potential rewards are enormous.
Claire Cross is a partner and Nick Barnard is a senior associate at Corker Binning
