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It can be frequently realized that commercial developments and social changes happen much faster than governments and legislation are able to cope with. In the case of crypto currencies, just a few years have elapsed since, in 2009, Bitcoin broke into the market and as a consequence of its quick adoption by users, hundreds of crypto currencies followed suit. Even if it is not an exact figure, nowadays about 1,500 crypto currencies are being used worldwide (more than 7 times the number of official government-backed currencies). And yet, the response of governments has so far been none, or at least, extremely slow.

Given that they are the product of decentralized creation and trade, and that there is no supervisor in charge of creating crypto currencies and controlling their value, – circumstances which are at all times based on trust, on individuals permanently connected to the system, – one may conclude that crypto currencies are at odds with regulation. Essentially, governments can effectively control and regulate conventional currencies, but crypto currencies are powered by a shared ledger technology whose data are shared between companies and individuals, far from governments and conventional powers. Banks and authorities may block customers from wiring conventional currencies whenever they come from crypto currency transactions, but this cannot be the case if the crypto units are not converted into conventional currency.  A further reason for explaining the lack of regulation might be that governments tend to think that if they regulate crypto currencies, they would be undermining the general trust in statutory currencies, and thus risk leading the system to collapse. On second thoughts, one might conjecture that they do not really know how to deal with this phenomenon and if it is worth having it regulated at all.

The fact is that more and more, particularly young people and millennials, are embracing crypto currencies not just as a way of payment, but also as a way of investment. Recently, one young man justified purchasing Bitcoins saying that his savings could not allow him to buy large assets, whereas the crypto currency is affordable, usable and one can expect a quick increase in value in a short time. Perhaps, he forgot that the investment can also plummet in a matter of hours, but generally speaking and in spite of well-known setbacks, facts are proving him right.

But, should we consider crypto currencies as money or as an intangible commodity/asset? Voices claiming that crypto currencies are a mere subject of speculation and are tools of financing illegal activities should perhaps be contrasted with the fact that the value of many other assets is equally based on trust, and can be also used as a means for rewarding illegal services or purchasing arms, such as gold or diamonds.   Then, why is more credit given to a conventional asset than to a crypto currency?

The approach of the markets seems to back the concept of asset instead of currency.  In December 2017, crypto currencies started being traded on futures exchanges and exchange trading funds, with notable success in as much as their high volatility allows potential quick revenues. According to recent news, the best performing fund in 2017 made a return of 87 % thanks to crypto exposure.  Then, the market is treating crypto currencies as assets, not as a generally accepted and officially acknowledged means of payment, even if they are actually –although not only– a means of payment, and so far, they are more in line with a barter economy than the way conventional currencies work. They can be used as a means of payment, and that is so because of mutual trust between payer and receiver, just on the same basis as in a barter economy, where for a certain good or service the seller receives another asset of alleged equivalent value. It is all about the perception of the value of the crypto currency and the trust in its current and future value. However, it is hard to call them “money” since this concept embodies legal concepts and they must meet certain legal recognition by the nominal powers in order to be accepted as units of exchange. Crypto currencies share the same backbone: they are decentralized “money” but should we consider them as a legal tender equivalent to conventional money, officially backed by governments and central banks?  No, not, at least, for the time being.

Whereas most countries have not made up their minds on the legal nature of crypto currencies, India has recently refused to consider them as a legal tender.  Instead, whilst referring to them as crypto “assets” it has announced measures to crack down on their use to fund illegal activities.

The Spanish Finance Minister concluded in 2015 that crypto currencies act as a means of payment and on account of their specific characteristics must be considered as “other effects of trade”, thus their transmission, is subject to, but exempted from V.A.T.

It has recently been suggested that monetary authorities should be open to creating digital currencies, in parallel with the customary issuance of notes. That is to say, central banks would be issuing digital currency to the public, meaning that an individual or a legal entity could become a holder of crypto currency accounts and deposits located in the cloud and the private key to operate them would be kept by a central bank. In this way, the central bank might intervene in the operations carried out by crypto currencies and, at the same time, would become legally accountable before the deposit holder. But, one should ask oneself of the benefits of such a scheme and the potential popularity of such a conception, bearing in mind that crypto currency investment is driven by anonymity. Secondly, if the crypto currency crashed, should a government bailout people who invested in crypto currencies aiming at cashing in on a large profit, having betted on their extra high volatility? Would a government bailout someone heavily investing in futures; if the answer is no, then, why should it do so with crypto currencies?

Some countries such as Russia or China are developing their own crypto currencies, and others, such as Japan and Belarus have passed legislation to regulate exchange operations with crypto currencies, instead of forbidding or hampering their use. A further governmental approach is to become the world capital of crypto currency, like Switzerland that has already stated its wish to be a “crypto-nation”, and one would be surprised if other countries or territories well known for their lack of tax transparency do not follow suit this way in the short term.

What about banks? Their approach is cautious, in as much as there is no regulatory framework, although they know that blockchain technology is changing the landscape of financial trading; for instance, if used by a sufficient number of banks, blockchain would eventually displace SWIFT payments. That said, the value of crypto currencies is linked to a seamless connection to the network, and if this fails, then, what would happen to their actual value leaves a large question mark? Very high volatility is a further reason for banks to stay out of the crypto currencies market for the time being. Yet they seem to be deeply interested in the technology lying beneath. In the case of Ripple, more than 100 banks and other financial institutions have adopted at least one of its products and leading banks are investing in Ripple, since they do not want to miss out on developments and the business opportunities deriving from the blockchain technology.

Are crypto currencies safe? Last week we woke up to shocking news regarding this matter of particular concern for the market and investors. In the small hours of the 26th of January, crypto currency units worth in excess of USD 500 M were stolen from the Japan-based Coincheck store of XEM coins after a hacker broke into the company’s security and found a bounty in a hot wallet, the latter being a computer connected to the Internet. The robbery affected some 260,000 investors, most of them Japanese, to which the company has offered partial compensation of up to USD 420 M.

It is appropriate to mention that in April 2017 Japan passed the world’s first regulation on crypto currency exchanges. The legislation set forth a large number of requirements, both financial and technical, for potential traders, aimed at establishing trustable and solid fundamentals for safe trading with crypto currencies. Having such an administrative filter in place to restrict the entrance of players in the market had the effect of giving public credibility to the crypto exchange system. The Japanese Financial Services Agency (FSA) issued the first 12 exchange licenses by the end of September 2017 (there are some 16 licensed exchanges as of today) and as from then we witnessed a rocketing trend in the value of Bitcoin and other digital currencies, partially due to the generalized entrance of Japanese small investors who conducted their operations through said exchanges. Incidentally, Coincheck operated without an FSA license, but their activity was allowed due the fact that the exchange was already trading at the time the new legislation was passed. The cornerstone of the investors’ decision for buying XEM –  mainly millennials with limited economic means – was trust in the system (including “security”) and the expectation to gain large profits in a very short time. No one could say that the risk was not there, since a similar case happened in 2014 with the exchange “Mt Gox”. According to US authorities, between 2009 and 2015, as many as 1/3 of exchanges were hacked, although it is very unlikely that the ordinary investor is aware of this and other facts concerning the risks of trading with crypto currencies. In the light of the Coincheck case, the sufficiency of the legal framework set out by the Japanese FSA is being questioned, as the regulations proved insufficient to prevent the hacking. But in the defence of the FSA, it would not be unfair to say that the solution to prevent crime is not fully in the hands of the financial authorities, in as much as the blockchain technology is still under development, but in the technology itself.  Be that as it may, we feel that what is needed is a basic and unavoidable rule for exchanges to explain to potential investors the fundamentals of crypto currency exchange (before investment is allowed), as well as the concepts of the technology sustaining them, and last but not least, information on the security risks inherent in this kind of assets and the transactions related thereto.

Eduardo Vilá

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February 9th, 2018

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