Cryptocurrencies and the Regulatory Challenge

Allan C. Hutchinson

• Publisher: Routledge
• Year: 2021
• eBook ISBN: 9781000466805
• Topic: Law
• Subtopic: Law Theory & Practice
• Index: Law

As a social process that places great stock in its stability and predictability, law does not deal easily or well with change. In a modern world that is in a constant and rapid state of flux, law is being placed under considerable stress in its efforts to fulfill its task as a primary regulator of social and economic behaviour. This challenge is particularly acute in the realm of technology and its profound ramifications for social and economic behaviour. The innovative Techno-Age not only offers fresh ways of handling old problems, but also throws up entirely new problems; traditional ways of thinking about and responding to these old and new problems and their optimal resolution are no longer as tenable as many once thought. One such example is the burgeoning world of cryptocurrencies – this peer-to-peer digital network presents a profound challenge to the status quo of the financial services sector, to the established modes of state-backed fiat currency, and to the regulatory authority and reach of law. Taken together, these related challenges demand the urgent attention of jurists, lawyers and law reformers. It is the future and relevance of legal regulation as much as cryptocurrency that is at stake. This book proposes an approach to regulating cryptocurrency that recognises and retains its innovative and transformative potential, but also identifies and deals with some of its less appealing qualities and implications.

1 Law’s regulatory value and virtue

An introduction to the crypto-world

DOI: 10.4324/9781003222071-1

As a social process that places great stock in its stability and predictability, law does not deal easily or well with change. Lacking a certain institutional nimbleness, law is particularly challenged by fast-moving events and unanticipated upheavals. Whether by way of legislation or common law, there is a distinct conservative impulse that slows down its institutional response to shifts in social views and changing socio-economic circumstances; basic legal thinking is very much characterised by an attitude that recommends that reliance on the past is a preferable way to handle present challenges and to direct future conduct. Although law has always been buffeted by the winds of change, those pressures to transform itself and adapt have not only been increasing, they have been doing so at a much more rapid rate in the modern era. If law is to remain relevant and useful, it must adapt and remain stable at one and the same time – this is a tricky, but unavoidable responsibility.¹

On occasion, this lack of agility in adapting quickly is no bad thing. Neither the law generally nor society at large is helped by a legal process that chops and changes with all and every shift in social attitudes and conditions; it needs to be selective in ensuring that those changes are more lasting than faddish. Of course, in a modern world that is more in a constant and rapid state of flux than ever before, law’s adaptability (or lack of it) is coming under enormous stress and strain. As such, there are occasions and circumstances on which law needs to be more deft and responsive than has traditionally been the case. It might well be argued that, if law is to retain relevance and legitimacy within society as one of its primary modes of regulation, it will have to do better at adapting to and addressing significant changes in society that law both shapes and responds to. It has been emphasised that these challenges are now occurring to such an extent that law’s efforts to fulfill its task as a primary regulator of social and economic behaviour is becoming increasingly questioned and tested. In such a climate and context, law is as much the problem as the solution in doing a better job at meeting social expectations and fulfilling its own regulatory mandate.

1 See ALLAN HUTCHINSON, EVOLUTION AND THE COMMON LAW (2005).

Into the cryptic

This central challenge to law’s relevance and vigour is particularly acute in the realm of technology; its strides forward have profound ramifications for social, economic and political behaviour. In the past few decades, law has struggled to keep pace and, if truth be told, is falling further back in the race to get level with, let alone ahead of the technologically driven game of social ordering. The innovative and almost revolutionary Techno-Age not only offers fresh ways of handling old problems, but also throws up entirely new and wide-ranging problems. For instance, being both enabling and disruptive, artificial intelligence, robotics, virtual reality, digital biology, 3D printing, blockchain databases, gene splicing, and global gigabit networks will all offer enormous challenges to conventional ways of working, socialising, parenting, educating, trading and much more.² Although people will likely be able to accommodate (for good and bad) those changes and thereby turn them into the new ‘normal’, such shifts have transformed the way people live their lives and, as importantly, think about their life and its possibilities. The global and local impacts of the Covid pandemic have only increased the pace and pressure of such forces as people struggle to adapt to changed conditions; technology has proved to be both a boon and a blight.

Such technological renovations and reformations have an avalanche of significant effects; some are good, others are bad, but most are mixed. From a political and social theory perspective, these changes bring about inevitable alterations and adjustments in the structure and details of governance and organisation. While some will celebrate technological changes as advancing personal freedom and others claim to be indifferent to them, a few maintain that they presage an era in which “democracy and social trust are superseded by the certainty machines, their priests and their owners.”³ This state of affairs strongly suggests that the future is laden with both expansive possibility and dangerous peril: it will further stretch as well as support the limits of human imagination and ingenuity. While it is difficult to be prepared for a future that is unknowable (e.g., the sudden advent of a coronavirus pandemic), it would behoove people to at least turn their minds to the different scenarios that might occur and their likely impact upon people and their terms and circumstances of social living.

In regards to law, this means that traditional ways of thinking about and responding to these new and often unanticipated problems will be put under enormous pressure: some of these may not only not be up to the task of generating optimal resolutions to these transformative problems, but also may prove obstructive or harmful to such constructive efforts. Indeed, as well as confronting law’s current content and apparent direction, the whole idea of law and its capabilities will face unprecedented challenges. In particular, the traditional mind-set and practices that are based upon top-down and command-and-control regulation will likely go the way of the dodo; the perceived strengths that this approach might have had in harnessing the ever-burgeoning sweep and ubiquity of the administrative and welfare state will no longer be successful, if they ever were. In the past decade or so, the legitimacy and efficacy of this way of proceeding has been called into severe question. This skepticism has become deeper and broader with the decentralising, centrifugal and obfuscating tendencies of modern technology. New technologies will demand their own new and different regulatory approaches and tools.

2 PETER DIAMANDIS AND STEVEN KOTLER, THE FUTURE IS FASTER THAN YOU THINK (2020).

3 SHOSHONA ZUBOFF, THE AGE OF SURVEILLANCE CAPITLAISM: THE FIGHT FOR A HUMAN FUTURE AT THE FRONTIER OF POWER 442 (2019).

In some quarters, this realisation has already taken hold. New initiatives are being devised and taken both inside and outside law. The thrust of this shift has been to recommend transformative ways to re-conceptualise the nature and role of law as the institutional and regulative process par excellence for handling and harnessing society’s rapid and disruptive technological changes and social realignments. Abandoning the old ways of thinking and acting, there is now a concerted, if partial effort being made that emphasises the organisational virtues of a more reflexive and collaborative approach, that moves beyond the confines of a public/private mind-set and that looks to blur the lines between self-regulation and state intervention: “the model promotes a movement downward and outward, transferring responsibilities to states, localities, and the private sector, including private businesses and non-profit organizations.”⁴ Being more pragmatic and participatory, this approach works to nurture regulatory projects that give more weight to an intermediated process that explores and experiments with different forms of supervision and accountability. Such a collaborative model does not entirely do away with government’s involvement (as did the ill-fated dalliance with de-regulation and its lingering effects over 20 years ago), but tries to modify and mollify it.

One particular and acute example of these definitive struggles is centred upon the growing world of cryptocurrencies, blockchain technology and society’s response to them. This private peer-to-peer digital network presents a profound challenge to the status quo of the financial services sector, to the established modes of state-backed fiat currency, and to the regulatory authority and reach of law.⁵ Taken together, these related eventualities demand the urgent attention of jurists, lawyers and law reformers. Although not often presented in such terms, it is the future and relevance of legal regulation as much as cryptocurrency that is at stake. Understood in this way, the overall mission of developing a new and appropriate regulatory framework for handling the complex challenges of a techno-world is fraught both with risk and opportunity. It is a task that cannot be ducked, but, in entering that technological, legal and social fray, it is one that lays law itself open to profound and far-reaching changes. In short, the rise of cryptocurrencies and other related processes will oblige theorists and policy-makers to re-examine the nature of law, technology and social ordering in order to recommend a more compelling understanding of their dynamic relationship.

4 See Orly Lobel, The Renew Deal: The Fall of Regulation and the Rise of Governance in Contemporary Legal Thought, 89 MINN. L. REV. 342 at 345 (2004). For a much fuller elaboration of this shift and its intellectual sources, see infra, ch. 2.

5 See WILLIAM MOUGAYAR, THE BUSINESS BLOCKCHAIN: PROMISE, PRACTICE AND APPLICATION OF THE NEXT INTERNET TECNOLOGY 165–68 (2016).

The task for law, therefore, is to come to grips with the workings and ways of cryptocurrency and to script its own best role in dealing with it. In line with the move away from old-style regulation to newer and more innovative means of regulation, the legal process will need to put itself on the line and question its own way of meeting the particular challenge presented by the opaque world of cryptocurrency. As well as asking and answering tough questions about the broader set of interests, public and private, that any regulation is to serve, it will fall to law to rethink its own set of typical responses to be made and resources to be harnessed in confronting cryptocurrency. If society wants to regulate such an innovative initiative as cryptocurrency, then society and law will need to be as innovative as cryptocurrency with its regulatory ideas and efforts. In particular, any regulatory effort will have to explore whether the dynamic and innovative world of Fintech (i.e., the technological organisation and ordering of financial institutions and practices) should be supervised and complemented by an equally dynamic and innovative mode of Regtech (i.e., a set of technological tools and processes that can complement and monitor Fintech).

Of course, in undertaking such a task, regulators will have to be alert to the dangers that a technocratic and insular world-view might produce. It is imperative, in the effort to develop Regtech strategies, that power is not consolidated within a small clique of coders and programmers; this will work to alienate further the very people and crypto-users whose interests such regulation is supposed to safeguard and advance. Any recourse to techno-experts and Regtech must be offset and balanced by the enhanced participation of stakeholders in a collaborative drive towards better and more adaptive regulation in the broader public interest. Within such a more modern and less traditional understanding of regulation and its formative role, government and public agencies will still have a crucial role. However, it will be in the background as a facilitative co-ordinator as much as a directive front-liner. Although bearing ultimate responsibility and accountability for the overall regulative effort and its success, government will be there to orchestrate as much as order and to oversee as much as operationalise an enterprise of crypto-governance.

Malta, mayhem and mainstream

The powerful television series, Queen of The South, is a contemporary drama about drugs, cartels and much else besides – a morality tale; a social commentary; and a primer on technology. A Mexican cartel boss, Teresa Mendoza, is on the run from both the drug gangs and the authorities. She seeks to establish her own drug-trafficking empire. After some success at doing so, she travels to Malta to strike a deal with a local money launderer who operates a cryptocurrency exchange there (as well as a human trafficking operation). With a significant cut to the crypto-dealer, she deposits US$20 million into the exchange to be converted and stored in crypto-coins. Because she thinks that Bitcoin and Ethereum “have too much movement,” she opts for Pteria (a fictitious e-coin). However, as drama would have it, things do not go well. For a variety of reasons, the savvy, if reluctant Teresa decides that she wants her deposited funds back. Along with her loyal and brutal henchmen, she plans a heist on the bank where the computer servers are located; the aim is to steal and take possession of the hard drive on which her crypto-millions are stored. After much bloodshed, she and her gang prevail and leave with the pieces of hardware in a large carry-all. In line with the disciplining tropes of modern melodrama, the ill-gotten funds are now restored to their rightful, if thoroughly criminal owner.

There is much in this episode that highlights, for good and bad, the growing role and use of cryptocurrency. First, it showcases the high-tech availability of cryptocurrency and its global spread. Malta is one of those places, along with Bermuda, the Isle of Man and Switzerland, that has courted crypto-exchanges and developed a relatively hands-off approach to its use and operations; such countries welcome and facilitate the expansion of crypto-facilities and the boost that they might give to the local economy. Secondly, it exemplifies how cryptocurrency is being used by large narcotics empires to launder and hide their enormous profits; cryptocurrency’s global reach and its much-vaunted discrete nature are seen as attractive to those who want to move around large sums of money for or derived from criminal purposes without detection or official surveillance. Nevertheless, although this has been and continues to be a feature of the crypto-market, its prevalence is much exaggerated.⁶ Thirdly, while these two insights are revealing and helpful in learning more about cryptocurrency, the Queen of The South episode also offers a misleading glimpse at how cryptocurrency and crypto-exchanges actually operate. This is perhaps the most significant aspect of the dramatic episode in regard to cryptocurrencies.

As conveyed by the episode, the idea seems to be that Teresa’s funds are actually stored on one or more hard drives. If she wants to reclaim her money, she needs to take possession and, therefore, control of the physical hardware; this explains why she has to rob the crypto-bank in an old-style heist. But this whole premise is based upon a mistaken, if commonly held view of how cryptocurrency works. Contrary to the episode’s telling, there is nothing physical that counts as cryptocurrency and, therefore, there is nothing to b...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• List of figures
• Preface
• 1. Law’s regulatory value and virtue: an introduction to the crypto-world
• 2. Into the crypto-world: problematics, pitfalls and prospects
• 3. Of pigeons, property and virtualities: a taxonomic appetizer
• 4. Currencies, commodities and securities: square pegs and round holes
• 5. A self-regulated world: a political exercise
• 6. The regulatory challenge: towards a collaborative approach
• 7. Taking regulation seriously: a crypto-regime of its own
• 8. An effort at crypto-regulation: becoming smarter
• 9. Getting with the program: governance and responsibility
• 10. Paying the price: some concluding thoughts
• Index