The advent and speed of financial innovations brought about initially by the Internet that serves as a basis for the transformation of global payment systems inevitably has raised significant concerns among law enforcement agencies about criminal activity. Among the issues are concerns voiced by national central banks about the incorporation of new currencies into the global financial network and governmental apprehensions in their endeavor to protect their citizens from harmful investments. We discuss some of the ongoing efforts by nations and by international agencies to understand and promulgate measures to encourage innovative financial endeavors and thwart inevitable harmful activities.
International Organizations And Entities
The Bank for International Settlements
The Bank for International Settlements (BIS),1 through its Committee on Payments and Market Infrastructures, issued a report on digital currencies in November, 2015. In the report, BIS set forth the supply-side factors that may influence the currencies’ future development which primarily are fragmentation due to the numerous digital currencies in circulation; scalability and efficiency, which at the time of this report, was smaller than traditional payment systems; pseudonymity (not anonymity) inasmuch as the distributed ledger is usually publicly available; technical and security concerns by malicious actors using falsified ledgers; and business model sustainability that will be difficult to achieve. It also noted the demand-side issues of security, cost, usability, volatility, risk of loss, irrevocability, processing speed, cross-border reach, data privacy, and marketing and reputational effects.
The regulatory issue BIS addresses is the degree of regulation that should occur both on a global and national level. It recommends five categories of actions to be addressed, namely: (1) information/moral suasion whereby users are made aware of the risks of partaking in the currencies; (2) regulation of specific entities such as exchanges, merchant acceptance facilities, and digital wallet applications; (3) interpretation of existing regulations to ascertain whether they need updating due to the rise of the new technologies; (4) broader regulation to enlarge regulations applicable to traditional payment methods and intermediaries to cover the new currencies; and (5) prohibition by the various national states.2
BIS also addressed the implications of virtual currencies for central banks and their role in acclimating to virtual currencies. BIS’ emphasis is on consumer protection and the basis for its value predicated on the user’s perception of value. With the decentralized nature of virtual currencies, it will be difficult for central banks to anticipate possible disruptions. There are legal risks due to the lack of a legal structure to govern their use. There are implications for financial stability and monetary policy owing to their impact on retail payment systems, liquidity for central banks, and the degree of interconnection between users of traditional and non-traditional currencies. A future course of action may include banks’ own investigations of the distributed ledgers in payment systems.3
European Union
European Central Bank (ECB)
The ECB, as early as October, 2012, was concerned about virtual currencies shortly after their issuance. It referred to them as “virtual currency schemes,” because of the two aspects of resembling money and possessing their own retail payment systems. After reciting the characteristics of the currencies, it noted the business reasons for their creation and growth, namely, for virtual community users to participate in them; to generate revenue for their owners; to have control over them in accordance with their business model and strategy; and to compete with traditional currencies such as the euro and the dollar.4
After reciting case studies, risks to central banks, and other considerations, the ECB’s conclusion was that at the time of the report (October, 2012), virtual currencies did not pose a risk to price stability provided they remained at a relatively low level; they tend to be inherently unstable and low risk because of their low volume and lack of wide acceptance; are not currently regulated when the report was issued; could pose a challenge to public authorities due to use by criminal elements, money launderers, and persons committing fraud; could impact central banks if the public perceives their abuses as due to a lack of central bank intervention; and do come within central banks’ authority to the extent that they become part of the payment system.5
In a later report in 2015, the ECB noted the dramatic increase in the number of decentralized virtual currencies and the increased dangers to the payment system and, perhaps, more importantly, to the users who are exposed to risks of exchange rate, volatility, counterparty relating to the anonymity of the payee, investment fraud, and other risks. It expressed concern over the lack of co-ordinated governmental efforts from national authorities to mitigate these risks which range from warnings, statements, and clarification of the legal status of the currencies, to licensing, and supervision of their activities. It thus recommended a co-ordinated response by the legislative, regulatory, and supervisory frameworks to the various schemes discussed in its earlier report.6
EU Directive on Money Laundering
The EU enacted the Fourth Anti-Money Laundering Directive on May 20, 2015—its mission is twofold, (1) to counter money laundering used for criminal purposes and (2) to combat the financing of terrorist activities.7 Member states were required to bring the requirements of the Directive into force at the end of December, 2016. The European Union Commission thereafter proposed, among other changes, amendments that virtual currency exchange platforms be incorporated into the Directive. It distinguished virtual currency exchange platforms , which are currency exchange offices that trade virtual currencies for real (fiat) currencies, from virtual currency custodian wallets in which providers hold virtual currency accounts on behalf of customers wherein payments can be made or received.
Virtual currency exchange platforms can be considered as “electronic” currency exchange offices that trade virtual currencies for real currencies (or so-called “fiat” currencies, such as the euro). On the other hand, virtual currency custodian wallet providers hold virtual currency accounts on behalf of their customers by providing virtual wallets from which payments in virtual currencies can be made or received. In the “virtual currency” world, they are the equivalent of a bank or payment institution offering a payment account.8 “Member states are to ensure that providers of exchange services between virtual currencies and fiat currencies, custodian wallet providers, currency exchange an...