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Kryptonite or crypto right?

Heraclitus observed that there is nothing permanent except change. We live in an era of dramatic change, propelled by rapidly developing technology. This challenges the way we think and go about the basic building blocks of life. The cryptocurrency wallet with its many complexities is replacing the traditional wallet. iPhone and iWatch tapping on payment services devices are replacing cash and debit or credit cards. The digital and virtual are the new normal. The choice we face is to embrace and lead the change or be left behind in nostalgia. To adapt is to survive and, with any luck, thrive.

What is “currency”?

In addition to being a medium of exchange for goods and services (which replaced bartering in most parts of the world some time ago), currency is generally understood to be an accepted form of payment, usually issued and backed by a government. If one takes the trouble to examine a £10 note, a bearer bond, meaning that anyone who bears it can avail him or herself of the value it represents, one will readily see an undertaking by the Chief Cashier on behalf of the Governor and Company of the Bank of England which states: “I promise to pay the bearer on demand the sum of ten pounds”.[1]

It is sometimes argued that cryptocurrencies are inherently suspicious as ready facilitators of nefarious purposes and activities. That may well be the case but can the same not be said about most other prominent, internationally traded currencies in circulation?

Whereas non-digital currencies are backed by governments, regulated and generally regarded as integral to the functioning of the financial system as it has existed since the Bretton Woods Conference in 1944 which established the US dollar as the primary international currency, at present, digital currencies are not backed by governments or central banks and are mostly unregulated. They are traded and stored in electronic form. Their tax treatment and classification as an asset class/security varies from jurisdiction to jurisdiction. It is frequently maintained that blockchain (which can be centralised or decentralised) makes digital currencies safer and less open to criminal elements than physical currencies. That is debatable.

Bitcoin and the cryptocurrency boom

Bitcoin, the most well-known cryptocurrency, was created just over a decade ago by a person or persons unknown using the name Satoshi Nakamoto. In 2009, Bitcoin was released as open-source software. Since then, its fortunes have fluctuated with a marked dip between 2017 and 2020. It is presently experiencing a meteoric rise in value and popularity which may be attributable to the perception by some that cryptocurrencies “democratise” money and take the state/sovereign usually associated with the supply of money into the financial system and the real economy out of the picture.

Central Bank Digital Currencies

The difference between central bank digital currencies (“CBDCs”) and other forms of cryptocurrencies must be noted at the outset. The former is an electronic version of the currency of the relevant nation state, backed by a central bank. As part of their public policy objectives, central banks are a generally trusted source of the supply of money. The latter has no such guarantor.

At present, China, India and Russia are at the forefront of introducing a CBDC. There are many uncertainties about CBDCs, including the manner in which different political and economic regimes will approach them and the consequences this may have on the global financial system.

The Central Bank of the Russian Federation noted that the existence of the digital rouble will curb the risks of using other, less reliable payment solutions (presumably referring to cryptocurrencies) in the digital age.

In April 2020, The People’s Bank of China piloted a digital e-renminbi, initially in Shenzhen, Suzhou, Chengdu and Xiong’an, a region near Beijing. This was subsequently extended to several major cities in China last August with wider circulation expected by 2022. The sovereign e-renminbi is expected to be pegged to the existing, physical renminbi.

The Basel Report on Central Bank Digital Currencies

In October 2020, the Bank for International Settlements, an international financial institution based in Basel, Switzerland, owned by central banks with the aim of fostering international monetary and financial cooperation and serving as a bank for central banks, in conjunction with the Bank of England, the US Federal Reserve, the European Central Bank, the Bank of Japan, Sveriges Riksbank, and the Swiss National Bank, published a report on CBDCs. The People’s Bank of China, the Reserve Bank of India and the Central Bank of the Russian Federation are notable exceptions.

The report sets out common principles and core features of a stable and responsibly deployed CBDC. These principles emphasise that, in order for any jurisdiction to consider proceeding with a CBDC, certain criteria would have to be satisfied. In particular, the relevant authorities would need to be satisfied that the issuance of a CBDC would not compromise monetary or financial stability and that a CBDC could coexist with and complement existing forms of money, promoting innovation and efficiency. This is a tall order by any standards, agreed in Basel or elsewhere.

The report starts by explaining that: “Central banks have been providing trusted money to the public for hundreds of years as part of their public policy objectives. Yet the world is changing. To evolve and pursue their public policy objectives in a digital world, central banks are actively researching the pros and cons of offering a digital currency to the public (a “general purpose” CBDC”. It concludes that: “A CBDC robustly meeting these criteria and delivering the features set out by this group could be an important instrument for central banks to deliver their public policy objectives. This group of central banks will continue to collaborate and explore the practical implications outlined in the report”.

Facebook’s Libra and other considerations

The report was, in large part, triggered by the announcement of Mark Zuckerberg, the Founder and CEO of Facebook, in June 2019, about Facebook’s proposed launch of LIBRA, the first global digital currency. Following a strong negative response from governments, central banks and financial regulators (the established financial system) based on a number of grounds, including consumer protection, privacy, national security and monetary policy concerns, the development of LIBRA was aborted. Or so it seemed. At the time, Mark Carney, then governor of the Bank of England said that there was a need to keep an “open mind” about new technology for money transfers, but “anything that works in this world will become instantly systemic and will have to be subject to the highest standards of regulation”.

On 1 December 2020, Libra Association (the body responsible for making LIBRA happen) was renamed Diem Association. Is the spectre of LIBRA alive and well after all? Diem describes itself as follows:

Diem (formerly known as Libra) is a permissioned blockchain-based payment system proposed by the American social media company Facebook, Inc. The plan includes a private currency implemented as a cryptocurrency. The currency and network do not exist yet. The launch was originally planned to be in 2020 but only a rudimentary experimental code has been released. The project, currency and transactions are to be managed and cryptologically entrusted to the Diem Association, a membership organization of companies from payment, technology, telecommunications, online marketplace, venture capital and non-profits. Before December 2020, the project was called “Libra”.

The proliferation of digital currencies is rapid. At the beginning of 2021, there were around 4000 cryptocurrencies in circulation globally. The use of digital payments platforms such as Alipay, owned by Alibaba’s Ant Financial, backed by Jack Ma, and WeChat Pay, owned by Tencent, are widespread in China. The Russian Federation has been opposed to accepting cryptocurrencies as legitimate means of payment.

In December 2020, the government of the Russian Federation put before the Duma (the Russian Parliament) Bill No: 1065710-7 on Amendments to Parts I and II of the Tax Code of the Russian Federation. The Bill recognises cryptocurrencies as an asset and provides for the tax treatment of such an asset. It requires that the citizens of Russia, individuals and legal persons operating in the Russian Federation declare cryptocurrency holdings and provides for tax liability for failure to disclose information and declarations of false information about cryptocurrency transactions. The Bill is expected to be enacted into law in the near future.

In April this year, the Ontario Securities Commission in Canada approved the world’s first regulated direct custody Ethereum exchange-traded fund, having approved the first Bitcoin exchange-traded fund earlier this year. Ethereum is a decentralized, open-source blockchain with smart contract functionality. Ether is the native cryptocurrency of the platform. It is the second largest cryptocurrency by market capitalization, after Bitcoin. Etherium is the most actively used blockchain. One of the co-founders of Etherium is Vitaly Buterin, a Russian born, Russian-Canadian programmer and writer aged 27.

Three other developments are worthy of note. First, the announcement by The Central Bank of the Republic of Turkey earlier this month to ban the use of cryptocurrencies for payments from the end of April 2021. The reasons given for the ban include: the volatility of market valuation of cryptocurrencies and an absence of supervisory mechanisms. Second, in March 2020, in a case brought by the Internet & Mobile Association of India against a decision by the Reserve Bank of India which prohibited banks from dealing with cryptocurrency exchanges the Supreme Court of India overturned the decision of the Reserve Bank of India. The Supreme Court of India ordered the Indian government to take a position and draft a law on cryptocurrencies. At present, the Indian Ministry of Finance, the Central Bank of India and the Reserve Bank of India are collaborating on a law to ban trading in or holding cryptocurrencies in India. The bill is expected to criminalise possession, issuance, mining, trading and transferring cryptocurrencies. Third, the People’s Bank of China made it clear earlier this year that it views cryptocurrencies as illegal. The reasons given include that they are not issued by any recognised monetary institution and they have no legal status equivalent to money.

Rishi Sunak’s announcement on exploring a CBDC in the U.K.

On 19 April 2021, Rishi Sunak MP, the U.K.’s Chancellor of the Exchequer, announced the launch of a new taskforce between the U.K.’s Treasury and the Bank of England to coordinate exploratory work on a potential CBDC. Some financial commentators have hailed this as “Britcoin”.

The position taken by the Bank of England is that a CBDC would represent a new form of digital money, issued by the Bank of England for use by individuals and legal persons. It would exist alongside cash and bank deposits, rather than replacing them. The taskforce is expected to engage widely with all relevant stakeholders on the benefits, risks and practical implementation of a CBDC. Matters such as how the Bank of England would be able to integrate a CBDC into the economy, how consumers would use it and how it would affect financial stability are likely to be central to the considerations of the taskforce.

The Bank of England and the U.K. Treasury are expected to:

i. coordinate exploration of the objectives, opportunities and risks of a potential U.K. CBDC;
ii. guide evaluation of the design features a CBDC must display to achieve its intended goals;
iii. support a rigorous, coherent and comprehensive assessment of the overall case for a U.K. CBDC; and
iv. monitor international CBDC developments to ensure the U.K. remains at the forefront of global innovation.

Rishi Sunak’s announcement follows the listing on Nasdaq stock market in New York of Coinbase, a cryptocurrency exchange with a valuation estimated to exceed $75.9 billion on 14 April 2021. On 15 April 2021, share trading of Coinbase opened at $381.

So, what does it all mean?

There seem to be two main questions. The first question relates to the valuation, trading, tax and regulatory treatment of cryptocurrencies and cryptocurrency exchanges in different jurisdictions. Can a virtual “currency” ever be a currency properly so called? Is the function of a currency changing? How is a virtual currency valued and who is best placed to perform such valuation? Given the high volume of trading and the capital involved, do cryptocurrencies have the potential to pose serious systemic risk to the financial system and a threat to global financial stability? The second question relates to CBDCs and trust in the political and economic regimes in which they are developed. Is there still a global system in which trust can be placed? Was there ever? Can there be one? Who should supervise the supervisors? Is global competition trumping cooperation? Is the spirit of Hans Christian Andersen, ably assisted by a cohort of nameless, unaccountable co-authors with vested interests, ghost-writing The Emperor’s New Clothes Part II? Should we sit back and wait to see what happens next or, insofar as it is possible to do so, lead or at least participate in leading the change?

The British position to CBDC has hitherto been cautious. Andrew Bailey, the governor of the Bank of England has previously expressed the view that cryptocurrencies fail to act as a stable store of value or an efficient medium of exchange, making them ill-suited to serve as a currency and a risky bet for investors.

Conclusion

We live in an era of major transition where the way we are accustomed to thinking and going about the basic building blocks of life is challenged by rapid technological advances which are often difficult to understand. This is often uncomfortable. It is comparable to learning and having to operate in a new language, not necessarily of one’s choosing. Fast! It is not just the development of this new language (which may well enable a better way of communicating and achieve generally desirable objectives in the end) which is relevant. It is also the manner in which digital currencies are developed and how they are used and integrated into existing monetary system frameworks which should be regarded as deserving of the utmost effort, most anxious scrutiny and global cooperation.

A new system of finance is in the making. The race to be the first to develop and adopt a CBDC is on. First mover advantage is just that. In this context, it has wide ranging consequences not only for global financial stability but also for the balance of international power, cyber security, national security, competition, human rights, social exclusion and consumer protection. The U.K. has what it takes to lead the way in the responsible development and deployment of cryptocurrencies and CBDCs. Leaving aside the merits and demerits of the new reality we find ourselves in, it is hoped that the U.K. will rise to this particular geopolitical challenge. Cryptocurrencies need not represent to the global financial system what Kryptonite represented to Superman. The development of internationally co-ordinated principles of governance and regulation for the responsible use of this relatively new phenomenon should be able to achieve the right balance between global financial stability, the sovereignty of the nation state and innovation in an equitable manner.

 


[1] The Oxford English dictionary defines “currency” as: “a system of money in general use in a country; the state or period of being current”. The same dictionary defines “money” as: “a means of payment in the form of coins or banknotes; wealth; payment or profit”. An “asset” is defined as: “useful or valuable thing or person; property owned by a person or company”.

 

Edite Ligere

Edite Ligere is Politeia’s Director, a barrister at 1 Crown Office Row Chambers and an advisor at Galileo Global Advisors in New York. Her special interests include artificial intelligence, insurance, human rights and cyber security. She was appointed to the Bar Council of England and Wales in 2020. She has written for the OECD on 'Insurance: can systemic risk get any more systemic post-COVID–19? '.

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