Chinese regulators shook market watchers in September when they introduced extensive restrictions on cryptocurrencies, including a ban on fund-raising initial coin offerings. The moves contributed to a short-term collapse in the price of bitcoin and other digital currencies. Regional competitor Japan, conversely, has adopted a more permissive approach. At the same time as their Chinese counterparts were introducing restrictions, Japanese regulators approved 11 cryptocurrency exchanges as part of a scheme that some believe positions Japan as one of the world’s most cryptocurrency-friendly countries.
Regulators must find the right balance between mitigating risks and allowing the sector to develop. Advocates of private digital currencies warn against regulations which may unduly curb legitimate activities and stifle innovation. A desire among some parties for decentralised monetary arrangements was one of the motivating factors behind the rise of cryptocurrencies. But traditional financial safeguards were not designed for trading based on blockchain technology, the electronic ledgers of transactions that are updated and visible to market participants.
The activity underpinning these networks can change quickly. In August technical disagreements about the blockchain prompted bitcoin to fork into two branches, namely ‘bitcoin’ and ‘bitcoin cash’. Regulatory schemes, therefore, must be nimble to be effective. Investors could be at particular risk if cryptocurrency exchanges – which allow people to convert bitcoins and other cryptocurrencies into standard currencies and vice versa – are not properly managed.
The collapse of Tokyo-based Mt. Gox, once the world’s largest bitcoin exchange, is a case in point. The exchange had been subject to hacking attacks over several years.
When it filed for bankruptcy protection in 2014, it announced that around $473m worth of bitcoins had gone missing.
While bitcoin remains the most popular cryptocurrency, numerous others have grown. Ethereum, the biggest alternative by market capitalisation, launched in 2015 with the promise of extra features such as ‘smart contracts’ and is estimated to have around 57% of the market share for initial coin offerings. One worry is that some of these rival currencies offer users greater anonymity than the bitcoin architecture provides, which could increase the risk of illicit transactions.
In May Japanese legislators passed a law on digital currencies, which was seen as giving confidence to the sector. Days after it came into effect, Japanese electronics retailer Bic Camera announced it would trial accepting bitcoin payments in several of its stores. Japan’s Financial Services Agency asked cryptocurrency exchanges to register with the body by the end of September. The resulting exchange of information could help inform policy-makers elsewhere.
China has been less accommodating. The People’s Bank of China and other regulatory bodies said in a joint statement in May that initial coin offerings were believed to be linked to criminal activities such as illegal securities issuance, financial fraud and pyramid schemes. China, nonetheless, remains a centre for financial technology innovation, and the statement and introduction of measures since then were interpreted as only a temporary setback for digital currencies.
Regulators should constantly review their approach given the fast-changing nature of cryptocurrencies. Working closely with industry players and maintaining dialogue with regulators in other countries is essential, as is sharing insights across borders given the sector’s growing global significance. Even if countries do not introduce their own digital currencies, the blockchains underpinning them are likely to become much more widely used.
Policy-makers should develop clear communication strategies to inform the public about potential dangers. Japan’s Financial Services Agency has already issued a brochure explaining the risks and warning people to be on alert for fraud and Ponzi schemes.
Regulators must keep pace with cryptocurrency developments to ensure safeguards are appropriate. In the process, they may discover that the underlying technology can open new and more efficient avenues for payment systems and service provision.
This is an edited version of an article from Global-is-Asian, the digital platform of the Lee Kuan Yew School of Public Policy, and reproduced here with the permission of the National University of Singapore.