Why Nobody Understands Cryptocurrencies

By The Enforcd Team

Before we can adequately regulate cryptocurrencies and the blockchain we have to work out what they are.

The FCA has begun the process of defining its approach to cryptocurrencies. But as it and other regulators around the world start getting to grips with crypto and the blockchain they face a common problem – not everyone is entirely sure what it is which makes it devilishly difficult to regulate.

Crypto assets have been thrust into the regulatory spotlight over the last couple of years, both because of their popularity but also because of their volatility. This month the FCA announced a consultation into how it should regulate the sector.

In doing so, it is responding both to requests from the industry and the Government’s own Cryptocurrency Taskforce which was issued its report back in the summer of 2018.

While the size of the market is currently low, as the FCA, reports it is growing rapidly. The number of initial coin offerings have surged. By April, the number of ICOs had already surpassed the total number in 2017. By June it had already doubled. Although cryptocurrencies lost their value, by and large, in 2018 there still seems to be a steady string of retail investors keen to get involved.

While it’s the cryptocurrencies which are garnering all the interest, it’s the technology underpinning it which could prove to be more important – the distributed ledger, better known as the blockchain. According to the hype this has the potential to transform everything from international money transfers to online voting. It’s the flag-bearer for the digital revolution which promises to sweep all before them.

Unfortunately, as with cryptocurrencies, this suffers from a serious problem. Few people are really feel comfortable explaining what it is. This is partly because of the complexity. Cryptocurrencies are virtual currencies which often have little real-world value. It’s a form of money which isn’t money and its decentralised nature is tailor made to be independent and beyond the scope of regulators. This makes it difficult to guarantee the kind of protections the FCA would like to see or even to develop a coherent regulatory approach.

The blockchain, meanwhile, requires detailed knowledge of a host of disciplines including mathematics, algorithms, finance and politics. In addition it is also defined in a number of different ways. According to Wikipedia it is a an “open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way.” Others, however, would insist it is tied to a cryptocurrency, and some systems which are labelled as blockchain, such as the one created by several financial institutions, are not publicly viewable.

Bitcoin’s blockchain is a large network of strangers transacting with one another without the need for a trusted intermediary thanks to Bitcoin’s proof of work system. Banks on the other hand have so-called permissionless blockchains use small networks of trusted and vetted. Somewhere along the line they cease to be blockchains in the same form as the original Bitcoin model.

Marketers are also jumping on the bandwagon and labeling all sorts of systems blockchain. The result is an excessive hype from an over inflated view of how widely it is being used, which makes it difficult to assess its benefits and drawbacks. For importantly, the lack of a common global definition and approach makes the task of developing an effective regulatory framework that much more difficult.

The FCA will publish its guidelines later in the year which will firstly provide a welcome layer of certainty, and also lay down a marker for others to follow. The move is certainly being welcomed on all sides. Authorities and established financial institutions are concerned about the risks proposed to the financial system from these new structures while the cryptocurrency sector will see new regulatory protections as a clear incentive for new participants who would previously have been wary of getting involved. Unfortunately, until all stakeholders develop a clearer idea of what cryptocurrencies and the blockchain are, regulation will remain a challenge.