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Regulating digital currencies

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1
REGULATING BITCOIN AND DIGITAL
CURRENCIES
Author: Yuri Livshitz. 306927862
Submitted on 27 April 2021
2
Table of Contents
Introduction ............................................................................................
3
Introduction
The birth of the Internet heralded in a new era of cheaper and more efficient transactions. E-
commerce—has...
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Regulating digital currencies

  1. 1. 1 REGULATING BITCOIN AND DIGITAL CURRENCIES Author: Yuri Livshitz. 306927862 Submitted on 27 April 2021
  2. 2. 2 Table of Contents Introduction ........................................................................................................................... 3 Theoretical Backgroud - What is bitcoin ................................................................................. 5 Bitcoin complexity – Forks and halving................................................................................... 7 Crypto community.................................................................................................................. 8 The Advantages of Digital Currency.......................................................................................10 The problems of Digital Currency...........................................................................................11 Control entities......................................................................................................................14 Regulating crypto systematic level ........................................................................................20 Granting Digital Currencies Membership to the IMF ..............................................................26 Conclusion.............................................................................................................................27 Bibliography..........................................................................................................................29
  3. 3. 3 Introduction The birth of the Internet heralded in a new era of cheaper and more efficient transactions. E- commerce—has brought with it a number of new and complicated social and economic challenges. Many theorized that the advent of the Internet would cause a new kind of money to be born.1 Rather than carrying around paper bills or metal coins, people would instead switch to digital currency: Internet-based money stored on a computer and transferred over the internet. Bitcoin is a private digital currency traded online via a peer-to-peer network.1 Bitcoins are stored as electronic files on a computer’s hard drive, and can be accumulated or transferred just like an e-mail.3 Software algorithms embedded in the online Bitcoin network protect against fraud and ensure that the files (bitcoins) cannot be forged. Bitcoin was designed to operate without the need for intermediaries or any central issuing authority.2 Bitcoin does not rely on a central bank to issue it, a commercial bank to store it, or a credit card company to transfer it. Instead, users interact with each other directly and anonymously and without direct third-party intervention.3 Bitcoin’s ability to serve as regulation-free virtual cash poses a number of difficult legal questions thanks to its transnational and largely decentralized nature. As Bitcoin gains acceptance and continues to grow in popularity regulatory solutions for the challenges it presents have to shift form restrictions and disregard to genuine and collaborate attempt to embrace bitcoin as part of
  4. 4. 4 international finical system. My research will overview what was done so far by international institutions and what can be done to make the Bitcoin and risks related to it manageable. The paper will start with Bitcoin technological overview and then by presenting key academic research on the subject. Then I will present key organization that aim to control bitcoin operation and functionality in the modern economical system.4 In terms of the research question the paper aim is to investigate the possibility of effective control over Bitcoin without alienating the users or slipping to anti-democratic means. Research Methodology - Most research undertaken for this paper was qualitative in nature and involved the summary and analysis of primary and secondary literature including publicly available government documents and communications, academic journal articles and book chapters, and reports from established research institutes. Terminology - This research paper will often refer to the concepts of “bitcoin” and “crypto” or “crypto currency”, sometimes interchangeably. The term “crypto” will be used as general re . “crypto” is the more prevalent term and covers broad range of currencies derived from bitcoin 4 Andreessen, Marc.‘Why Bitcoin Matters’, The New York Times, 21 January 2014, http://dealbooknytimes.com/2014/01/21/why-bitcoin- matters/?_php=true&_type=blogs&_php=true&_type=blogs&_ r=1.
  5. 5. 5 via code forks or used for other purpose and operating on different blockchains . References to “crypto regulation” will reflect on actions taken by nation states and international organizations to mitigate, disrupt, and neutralize potential threats from crypto coins in general to finical system and global AML policies. Theoretical Backgroud - What is bitcoin Bitcoin is two things at once. First, it is a digital currency, which has no paper counterpart. Second, Bitcoin “private currency”: a currency provided by private enterprise aimed at combatting government monopolies on the supply of money. In 2009, a cryptologist calling himself Satoshi Nakamoto created “Bitcoin,” the world’s first digital, decentralized, and partially anonymous currency. Nakamoto was inspired by an article written back in 1998 by Wei Dai, a graduate from the University of Washington. Nakamoto sought to create a medium of exchange that avoided the need for intermediaries in electronic transactions, and one in which government involvement “permanently forbidden and permanently unnecessary.”5 5 Nakamoto, Satoshi. ‘Bitcoin: A Peer-to-Peer Electronic Cash System’, 2008, http://bitcoin.org/bitcoin. pdf.
  6. 6. 6 Individual Bitcoin transactions are encrypted, logged by a decentralized network running on thousands of computers, and recorded in a public ledger.6 This public ledger records which Bitcoins have been spent or accepted. Bitcoins are transferred from one user to another once the transaction has been cleared by another Bitcoin user on the peer-to-peer Bitcoin network. Transactions occur without the presence of a government, bank, payment network, regulator. In lieu of traditional institutional protections, Bitcoin relies on various technological measures to ensure its transactions are secure.7 Bitcoin operates using a “cryptographic proof” system, which allows users to deal directly with one another without needing a third party to authorize the transaction. Each Bitcoin transaction uses public-key encryption to ensure the transacting parties’ privacy. Public key encryption generates two mathematically related keys. The private key is used to access the Bitcoins kept in the payor’s account. 6 Ibid 7 Davidson, Paul. ‘Is Bitcoin “Money”? The Post-Keynesian View’, Real-World Economics Review Blog, 27 November 2013, http://rwer.wordpress.com/2013/11/27/14335/.
  7. 7. 7 Bitcoin also uses a widely-published “peer-to-peer distributed timestamp server” to verify that the digital coins have not been “double spent”—in other words, counterfeited. A timestamp records the exact time that a Bitcoin is created or a transaction from one user to another occurs.50 These timestamps are aggregated into a master list of transactions involving a particular Bitcoin file called a “block chain.”8 Bitcoin complexity – Forks and halving Bitcoin has very rigid and complex governance system bitcoin logic and operation can be modified via software updates this however have to be accepted by the miner’s network which facilities bitcoin transactions. Any modification in operation, block size or other technical characteristic of bitcoin is subject of popular support. Bitcoin core community is very conservative in its perception of Bitcoin and only security related changes are accepted. Any attempt of modification to operation of Bitcoin creates significant opposition as it contradicts Satoshi design of Bitcoin. Still multiple groups attempted to modify bitcoin to make it faster, cheaper to transact or provide other functional benefits via protocol modification all these proposals weren’t accepted by Bitcoin Core community and the deviants created Forks. Fork is basically different blockchain 8 Davidson, Paul. ‘Is Bitcoin “Money”? The Post-Keynesian View’, Real-World Economics Review Blog, 27 November 2013, http://rwer.wordpress.com/2013/11/27/14335/.
  8. 8. 8 which can run different code parameters this way multiple currencies were created Bitcoin Cash (BCH) , Bitcoin Gold (BTG) and even Bitcoin Satoshi Vision (BSV). Some of the descendent coin supporters share criticism of current Bitcoin functionality and community. They often blame Bitcoin for inability to support fast transaction of large transaction amount. Apart from forks which can potentially challenge the Bitcoin of functional level (if someone creates coin with significant better operation) Bitcoin is also subject to halving by design “For every 210,000 blocks that are mined, the reward for mining a block falls by half. For the first 210,000 blocks in bitcoin’s early days, the reward was 50BTC per block. As more blocks were mined and more bitcoins went into circulation, the first set of 210,000 blocks were mined by 2012, and the reward was cut in half to 25BTC.” Crypto community Crypto community is critical to success of every crypto currency project and Bitcoin’s one in particular. To summarize crypto community is: “A community is referred to as being a social group of any size, sharing common characteristics or interests. The same idea and context apply to crypto and blockchain technology groups where
  9. 9. 9 members share the same interests, ideas, and love for cryptocurrencies like bitcoin (BTC) and thousands of others. Crypto communities are usually present on social networking platforms such as Telegram, Viber, Slack, and Discord, among others.”9 Crypto community creates significant benefit to the project as it consists from people who believe in the project and want to promote its technology or value proposition to others. Since majority of crypto projects are position as an alternative to government money (fiat).10 While the Crypto community by itself often exhibit libertarian values. Core values of crypto movement pursue to maximize autonomy and political freedom, emphasizing free association, freedom of choice, individualism and voluntary association. Crypto enthusiasts share a skepticism of authority and state power. This makes crypto and Bitcoin eco- system anarchic in a way and extremely hard to govern or regulate via traditional financial and legal institutions. Crypto currencies and Bitcoin have different level of anonymity by design which makes them hard to track and complex to seize. 9 https://paxful.com/blog/importance-of-crypto-community/ 10 https://core.ac.uk/download/pdf/230751255.pdf
  10. 10. 10 The Advantages of Digital Currency Digital money offers advantages over traditional, paper-based fiat currencies. First, digital currencies do not require the physical presence of for transaction finality. Transactions can be completed anytime, anywhere, without the need to coordinate direct interaction of the participants. This advantage creates several significant economic benefits. The costs associated with the production, transportation, and handling of physical currency can be substantial. The estimated annual costs of handling central bank currency by US retailers and banks are $194 billion, which includes costs of processing and accounting of money, storage and security. The cost of an electronic payment system is less than 1/8 of a paper payment system.11 Bitcoin also offers a superior store of value - when assessing a currency as a store of value, the key question is whether the currency is viewed as reliable and stable enough to operate effectively. After all, storing wealth in any medium that is easily susceptible to collapse or fraud is unwise. As explained above, traditional currencies are often accepted as stores of value because they are backed by governments which, in turn, gives them a sense of legitimacy and 11 Falkvinge, Rick. ‘The Target Value for Bitcoin Is Not Some $50 or $100. It is $100,000 to $1,000,000’, Falkvinge.net, 6 March 2013, http://falkvinge.net/2013/03/06/the-target-value-for- bitcoin-is-notsome-50-or-100-it-is-100000-to-1000000/.
  11. 11. 11 stability in the eyes of users. But government backing is problematic. If a government decides to inflate its currency, the wealth held by individuals in the form of currency decreases. The problems of Digital Currency Uncertainty - Despite the potential advantages of digital currencies like Bitcoin, their wide-spread adoption faces a number of obstacles. First and foremost, economists are worried about the uncertainty surrounding the operation and growth of digital currencies. Because so much of the data on these currencies is either supplied directly by the issuer or scattered across the Internet, it is difficult reach any solid conclusion on whether these currencies might be widely accepted. Many of the projects suffer from extreme speculation and volatility. In some extreme cases coins can be manipulated. Some of the projects have small community support which can lead to 51% attack on the coin and effectively allow double spending of the coin or even blockchain rewrite. “The Bitcoin Gold (BTG) blockchain has suffered a 51% attack resulting in over $70,000 worth of BTG being double spent. According to a GitHub post by James Lovejoy, a researcher at MIT’s Digital Currency Initiative, the hard-fork of Bitcoin was hit by two deep reorganizations of over 10 blocks on Jan. 23 and 24.”12 12 https://cointelegraph.com/news/bitcoin-gold-blockchain-hit-by-51-attack-leading-to-70k-double-spend
  12. 12. 12 A 51% attack is a situation where a single entity or group controls over half of the hashpower securing a blockchain. This then allows control over verification of new transactions, and the power to reverse transactions, allowing the double spending of coins. Still despite the drawbacks and as a result of COVID-19 extensive money mass creation by central banks Bitcoin and crypto value sharply increased. Despite potential drawbacks, one thing is clear: Bitcoin’s value has skyrocketed. In October 2011, one Bitcoin was worth approximately two US dollars, putting the value of the total number of Bitcoins in circulation at the time at approximately $20 million.13 As of now in 2021 one Bitcoin worth approximately 55,000 dollars with makes Bitcoin overall worth more than trillion dollars. Multiple other currencies emerged with different technical characteristics and total crypto market value reached to more than 2 trilion dollars. Bitcoin ATH (all time high) value reached this year to more than 64,000 $ Significant problem arises from the fact that information and statistics that would be needed in order to assess the speed at which these virtual currency schemes are growing and the point at which they could present a threat. The quantitative information that is available is not extensive and is usually provided by the respective scheme owner. Multiple Bitcoin skeptics blame bitcoin for possible usage of it for terrorism funding. This risk however is probably overblown. Several terrorist organizations like Hamas which tried to accept 13 https://coinmarketcap.com/
  13. 13. 13 contributions in Bitcoin failed to receive significant number of coins. During three months of operation Hamas campaign managed to receive 7500$ worth of bitcoins. As Rand research states “Current concerns about cryptocurrency as a significant enabler of terrorist groups are almost certainly overblown”14 . This is also related to sophisticated analytics solutions which can be used to trace “dirty” bitcoins. Bitcoins aren’t really anonymous as any attempt to convert them to bank money in a significant amount requires work with traditional financial institutions. Governments and financial institutions employee advanced technology to track bitcoin origin and source . Blockchain analysis is the process of inspecting and identifying and visually representing data on a cryptographic distributed-ledger known as a blockchain. The goal of blockchain analysis is discovering worthwhile information about the different actors transacting in cryptocurrency. Analysis of public blockchains such as the bitcoin is often conducted by private companies. Companies like Chainalysis claim capability to: “We provide data, software, services, and research to government agencies, exchanges, financial institutions, and insurance and cybersecurity companies in over 60 countries. Our data platform powers investigation, compliance, and risk management tools that have been used to solve some of the world’s most high-profile cyber- criminal cases and grow consumer access to cryptocurrency safely.”15 14 https://www.rand.org/content/dam/rand/pubs/research_reports/RR3000/RR3026/RAND_RR3026.pdf 15 https://www.chainalysis.com/
  14. 14. 14 So, despite the drawbacks there are both tools and processes exist to provide visibility into major blockchains. In fact, according to available data the extent of money laundering preformed with crypto currencies is negligeable in comparison to money laundering which is preformed using US dollar and euro. Control entities This creates on one hand the need to control bitcoin to prevent usage of bitcoin for money laundering and other criminal activity. Below I will present key regulator and review current policies and the policies potential drawbacks. The International Monetary Fund (IMF) is the international institution tasked with coordinating the international foreign currency exchange. It sets minimum standards for what member nations can do to their individual currencies, in order to preserve global economic stability. Like almost every international institution, the IMF’s rules apply only to nations that have agreed to adhere to them. Every country—with the exception of North Korea—is a member of the IMF and bound by its regulations.16 By ensuring that everyone plays by the same rules, the IMF is able to effectively coordinate global economic policy. 16 https://en.wikipedia.org/wiki/International_Monetary_Fund
  15. 15. 15 Because Bitcoin is not formally backed by a country’s government, it is not bound to the IMF’s guidelines. As a result, Bitcoin poses a serious threat to the economic stability of the foreign currency exchange as it continues to grow in both value and usage. Other digital currencies that entered widespread use like Ethereum poses similar problems. As a result, the IMF is limited in what it can do to intervene in the event that a private digital currency like Bitcoin is used to attack the value of a conventional currency through what is known as a “speculative attack.” A speculative attack occurs when an investor wishes to take advantage of a “weak currency,” a currency that has depreciated in value relative to other currencies.17 If left unchecked, a successful attack can push a weak currency’s value even lower, resulting in a destabilization of the international foreign currency exchange.18 So far policy of IMF and other central banks was complete neglect of Bitcoin as potential reserve currency. Substantial energy was invested by leading financial institutions to portray bitcoin speculative and used by criminals. “Bitcoin has enabled criminal money laundering and needs to be regulated at a global level” -- ECB president Lagarde says this view of Bitcoin as adversary created negative impact and instead of empowering the traditional financial system exposed its conservative and restrictive nature. 17 https://steemit.com/bitcoin/@sean-king/central-banks-need-to-own-bitcoin-to-guard-against-speculative- attack-on-their-currencies 18 Wile, Rob. ‘927 People Own Half of All Bitcoins’, Business Insider, 10 December 2013, http://www.businessinsider.com/927-people-own-half-of-the-bitcoins-2013-12.
  16. 16. 16 FATF The Financial Action Task Force (on Money Laundering) (FATF), is an intergovernmental organization founded in 1989 on the initiative of the G7 to develop policies to combat money laundering.19 The objectives of FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing. FATF is a "policy-making body" that works to generate the necessary political will to bring about national legislative and regulatory reforms in these areas. The Travel Rule is a counter-money laundering initiative that obligates traditional financial institutions to share information about their customers and assume the responsibility to report suspicious activities. It is important to note that the “Travel Rule” was initially created in the U.S.20 19 https://www.fatf-gafi.org/publications/fatfrecommendations/documents/public-statement-virtual-assets.html 20 https://www.coindesk.com/is-the-travel-rule-good-or-bad-for-crypto-both
  17. 17. 17 AS United States awarded the presidency of the Financial Action Task Force during 2018/2019, the economic and political powerhouse seized the initiative to push its domestic policy beyond its borders, in order to better regulate virtual assets which are essentially borderless in nature. This strong push helped to break the impasse between the FATF’s 39 member countries on how to decisively deal with the threat of unregulated and anonymously owned cryptocurrencies becoming a mainstream asset class. FATF published multiple regulations regarding usage and risk associated with crypto currencies and services providers to summarize; “The obligations require countries to assess and mitigate their risks associated with virtual asset activities and service providers; license or register service providers and subject them to supervision or monitoring by competent national authorities—(notably, countries will not be permitted to rely on a self-regulatory body for supervision or monitoring)—and implement sanctions and other enforcement measures when service providers fail to comply with their AML/CFT obligations; and underscore the importance of international cooperation. Some countries may decide to prohibit virtual asset activities based on their own assessment of the risks and regulatory context, or to support other policy goals.”21 21 https://www.fatf-gafi.org/publications/fatfrecommendations/documents/public-statement-virtual-assets.html
  18. 18. 18 FATF proposed and then finalized a guidance urging nations to implement KYC requirements for all crypto exchanges. The so-called Travel Rule defined virtual asset service providers (VASPs) as businesses that transfer funds in the form of cryptocurrency (i.e., crypto exchanges, among others) and mandated that the businesses should have KYC information for both the sender and the recipient of these transactions.22 Countries are beginning to implement these recommendations – South Korea recently brought new anti-money laundering (AML) rules into effect, resulting in at least one major exchange shuttering its operations in the country. Multiple crypto exchanges oppose the ruling and operate with complete disregard to the rule most notable of which are: Yobit, Bancor and multiple decentralized exchanges. Exchanges one the other hand are concerned with ability of the rule to deanonymize legitimate users and potential government control over user’s activity. Why personal level bitcoin regulation reduces the risk of criminal activity and money laundering via Bitcoin. Government regulation creates risk and sometimes looks like attempt to counter competition with restrictions and bans. Multiple governments aren’t consistent in the policy they adopt for crypto.23 22 https://kyc-chain.com/an-overview-of-the-fatf-recommendations/ 23 http://www.fatf-gafi.org/media/fatf/documents/recommendations/March%202021%20- %20VA%20Guidance%20update%20-%20Sixth%20draft%20-%20Public%20consultation.pdf
  19. 19. 19 The most recent example is Turkey. Where all crypto payment were suddenly banned by central bank without prior warning other countries parodically create contradicting warning statements. Even USA the leader of “free market” parodically spreads anachronistic declarations . This however can’t stop “the forces of the market” – the global demand for crypto assets and while other countries which can’t be regarded as example of proper monetary policy (Morocco, Nigeria) try to ban bitcoin. Bitcoin and crypto currencies create immense values for investor and future fintech industry alike. This is done via both innovation and new financial instruments. 24 U.S SEC (Securities and Exchange Commission) has very conservative approach to crypto regulation and exchange. Even SEC officials criticize the current policy and decision-making process. “I think we’re certainly falling behind the curve,” said Hester Peirce, one of what will soon be five commissioners at the Securities and Exchange Commission, during an interview at MarketWatch’s Investing in Crypto virtual event series Wednesday. “We’ve seen other countries take a more productive approach to regulating crypto. Our approach has been to say no and tell people wait…we need to build a framework that is appropriate for this industry.”25 24 https://www.bitkom.org/sites/default/files/2020-07/200729_whitepaper_decentralized-finance.pdf 25 https://www.marketwatch.com/story/u-s-is-behind-the-curve-on-crypto-regulations-says-sec-commissioner- peirce-11617824160
  20. 20. 20 The attempt to over regulate crypto alienates the crypto community towards traditional financial institutions. SEC fails to govern some of the more problematic crypto activities like ICO (initial coin offering) . The bitcoin potential is recognized by the SEC “Some of the weakness in our financial system comes from its concentration…you can make a more robust system” by relying more on decentralized elements, like the cryptocurrencies bitcoin”26 Regulating crypto systematic level The International Monetary Fund (IMF) plays an important role in regulating the international foreign currency exchange. It was created in 1944 to help coordinate international monetary policy following the turmoil of the Great Depression. The IMF’s goal is to regulate international economic transactions—including the foreign currency exchange—in a way that helps promote the growth of world trade. It was created to set basic guidelines that all member nations were expected to follow, particularly with respect to the foreign currency exchange, in order to promote a stable international economy. 26 ibid
  21. 21. 21 The IMF’s primary purpose is to ensure the stability of the international monetary system by monitoring exchange rates and enabling countries to transact with one another. One way it accomplishes this is by issuing currency loans to member countries. The IMF holds a currency reservoir created by initial subscription. Upon joining the IMF, each member nation is assigned a quota—roughly equivalent to its relative size in the world economy—which determines its maximum contribution to the IMF’s pool of financial resources. Up to 25 percent of a nation’s quota is payable in widely accepted currencies, such as the dollar, yen, euro, or pound sterling. The rest must be paid in that nation’s own currency. The IMF’s pool of currency is available for lending through a drawing system. A member is allowed to purchase any foreign currency it needs in exchange for an equal value of its own currency. All drawings are subject to the IMF’s approval. Furthermore, drawings are subject to a number of restrictions and charges that make it increasingly difficult to draw a currency once some has already been drawn. A member must eventually repay all drawings that it makes by repurchasing its own currency in exchange for gold or some other convertible currency. The drawing system provides the fundamental means by which IMF members acquire the resources to counter speculative currency flows and to maintain stable exchange rates between their currencies. Thus, the IMF is able to meet member nations’ borrowing needs (via the drawing
  22. 22. 22 system) by ensuring that it maintains a diverse and robust currency reservoir (via the quota system).27 US Treasury plays pivotal role in design and implementation of U.S financial policy. To summarize different Department of the Treasury (USDT) responsibilities are: to act as the national treasury of the federal government of the United States where it serves as an executive department. The USDT also collects all federal taxes through the Internal Revenue Service; manages U.S. government debt instruments; licenses and supervises banks and thrift institutions Yes US treasury crypto operations are mainly focused and implemented by The Financial Crimes Enforcement Network (FinCEN) and share restrictive and prohibitive outlook on crypto and bitcoin in particular. FinCen is known in particular for it’s controversial crypto wallet rule which requires crypto exchanges to apply Bank Secrecy Act scrutiny to transfers from their platforms to so-called self-hosted wallets. Every transaction valued at over $10,000 would require a report to U.S. authorities, while the exchange itself would need to maintain personal records of ownership to any off-exchange wallet that exceeded $3,000 in value.28 27 Cadmus, 3(4), 15. Retrieved from http://cadmusjournal.org/article/volume-3/issue4/cryptocurrencies-challenge- global-governance 28 https://www.theblockcrypto.com/post/99898/what-comes-next-for-the-us-treasury-departments-plans-to- monitor-crypto-wallets
  23. 23. 23 This approach creates strong opposition by blockchain association and different civil rights groups which claim the ruling is unconstitutional. “The proposed rule exceeds appropriate constitutional limits by empowering FinCEN to exercise Congress’ exclusive legislative power.”29 More about Bitcoin’s potential threat - In order to fully appreciate the potential threat Bitcoin poses to financial system, in form of a speculative attack on a currency. The attack occurs when an investor wishes to take advantage of a “weak currency,” a currency that has depreciated in value relative to other currencies. The attack begins by taking what is known as a “short position” in the currency. To do this, the attacker borrows a sum of the weak currency and sells it for a stronger (more valuable) currency, with the intention of buying the weak currency back for less than the attacker sold it for. If the currency continues to depreciate in value after the short sale, the attacker makes a profit when they buy it back.30 29 https://news.bitcoin.com/us-treasury-fincen-cryptocurrency-wallet-rule-unconstitutional/ 30 Malwa, S. (2018, July 5). $1.2 Billion in Cryptocurrency Laundered Through Bitcoin Tumblers, Privacy Coins. https://www.ccn.com/1-2-billion-incryptocurrency-laundered-through-bitcoin-tumblers-privacy-coins/
  24. 24. 24 In order to counteract speculative attacks, banks typically rely on their country’s central bank for assistance. Central banks are public institutions which manage a state’s currency and interest rates. Central banks hold currency reserves which can be loaned out in case of an economic or financial emergency. To counter a speculative attack, central banks can intervene directly into the foreign exchange market by offsetting, or “absorbing,” the maturity losses felt by commercial banks as a result of their forward contracts with investors. This requires the central bank to buy the commercial bank’s excess of the weak currency in exchange for stronger currency at the exchange rate. In order for a central bank to absorb the maturity mismatches of a commercial bank, the central bank must have a reserve of currency upon which to draw. In the event of an emergency, where the central bank does not have a currency reserve, the nation served by the central bank can turn to the IMF for assistance. Herein lies the threat posed by Bitcoin. In the event that a wealthy Bitcoin investors—launch a speculative attack on a currency, what can be done to counter it? who can it turn to? The IMF has no supply of Bitcoins; indeed, it has almost no way to obtain them directly. The IMF obtains currency via the quota system and the IMF can only collect quotas from its members. Bitcoin is neither a member of the IMF, nor could it become one if it wanted to—IMF membership is only open to nation-states.
  25. 25. 25 In its current state, the IMF would be unable to supply the currency needed to counter the destabilizing effect of a speculative attack by Bitcoin users on a member nation’s currency. In short, the ability to increase interest rates and the ability to borrow currency from central banks and the IMF work best in conjunction with one another. Without a reserve holding of Bitcoins, the IMF is severely restricted in what it can do to assist member nations facing a speculative attack by Bitcoin users. In effect, the IMF’s inability to contribute leaves nations with only one option: to raise interest rates. And, depending on the state of that nations’ economy, that option may prove economically disastrous. As Bitcoin usage continues to grow, so does the potential threat it poses to the stability of the foreign exchange market. Although particular attention has been given to Bitcoin in this regard, the same can be true for any digital currency that grows enough in terms of usage and value to be traded for substantial amounts of foreign currency. Without the ability offer digital currency as part of its currency reserves, the IMF is ill-equipped to ensure global economic stability in a future where digital currency is a major player.31 31 https://fee.org/articles/imf-head-predicts-the-end-of-banking-and-the-triumph-of- cryptocurrency/
  26. 26. 26 Finding a way to regulate Bitcoin is critical in light of its potential destabilizing effects on the foreign currency exchange. Due to bitcoin wide adoption and increasing price. Bitcoin can be controlled only if it's accepted as medium of reserve. Otherwise, it will coexist with traditional system and threaten is more and more as Bitcoin value will increase.32 Granting Digital Currencies Membership to the IMF IMF could collect Bitcoins directly from Bitcoin users. Article II, Section 2 explicitly states that membership to the IMF is only open to other countries.33 Rather than expanding membership to 32 Cadmus, 3(4), 15. Retrieved from http://cadmusjournal.org/article/volume- 3/issue4/cryptocurrencies-challenge-global-governance 33 Harvey, T. (2014, May/June). Cryptocurrencies opening fraud gates. Retrieved from Fraud Magazine: http://www.fraud-magazine.com/article.aspx?id=4294982435 Jacobs, G. (2018, May 28). Cryptocurrencies & the Challenge of Global Governance*.
  27. 27. 27 include non-state actors, Article II could be amended to include a new section, Section 3, which provides a membership status for digital currencies. Section 3 would allow the IMF to recognize Bitcoin as an “IMF-official” digital currency once the IMF has obtained a certain number of Bitcoins.34 The trade-offs would be mutually beneficial. Bitcoin users would sell Bitcoins to the IMF for an equivalent value of other currencies. In exchange, Bitcoin users would benefit from the increased legitimacy that official IMF recognition would bring. Direct interaction with the IMF would, in turn, bolster confidence in Bitcoin as a globally accessible digital currency and would increase the potential market for Bitcoins. The IMF, on the other hand, would benefit from having the Bitcoin reserves it needs to counter a speculative attack without requiring member-nations to take any domestic action. Conclusion During the paper we introduced Bitcoin challenges in conjunction with the IMF, Sec and US treasury in order to demonstrate the possibility what is done to regulate crypto and potential drawbacks of the process. The peer- to-peer, decentralized, and largely unregulated system that is Bitcoin has the potential to threaten the global economic stability. As more and more people come to understand the advantages of digital money over paper money, the threat it poses 34 Virtual Currencies and Beyond: Initial Considerations, Ms.Yasmin Almeida,International Monetary Fund, 20 Jan 2016 p110-121
  28. 28. 28 becomes increasingly real. Since the future of e-commerce entails a transition to digital currencies, it is critical that our economic, political, and legal institutions are prepared. Recognizing the importance of Bitcoin and the context of digital currencies is the first step in understanding how to best plan for the future. Western and liberal set of values which emphasizes freedom of choice and free market has to support Bitcoin. The potential consequences of widespread adoption of the Bitcoin are clear. In order to guard against the global economic destabilization that could occur if and when the world decides to adopt digital currencies, we must consider ways in which our national and international institutions can guide that transition. At present IMF and other institutions try to prohibit or restrict Bitcoin. This however given the data presented in this paper is a failing strategy. Financial institutions have need to shift attitude towards Bitcoin and this will significantly reduce Bitcoin threat to the global law and order. Has at least two options. It can attempt to exercise indirect control over digital currencies via its member-nations by expanding the scope of Article IV, Section 5 of the Articles of Agreement. Alternatively, it can attempt to exercise direct control over digital currencies by offering them a form of quasi-membership status, where increased legitimacy is traded for Bitcoin users’ business.35 35 Virtual Currencies and Beyond: Initial Considerations, Mr.Vikram Haksar,International Monetary Fund, 20 Jan 2016 p43-66
  29. 29. 29 Regardless of which measure is chosen, the potential need for a method to combat speculative attacks using Bitcoin is clear. As the Internet continues to play an increasingly important role in how we conduct commerce, our institutions have to adjust to the new challenges this change creates. The evolution of Bitcoin is no exception. The topic of Bitcoin control requires significant further research as it is related to core values of public policy and democratic discourse. There is now clear answer to some of the challenges that wide Bitcoin adoption can create for the economy and traditional financial institutions. Bitcoin can disrupt banking sector as we know it the potential is far bigger in a way Bitcoin for banks can be as Youtube is for TV. What however is clear from this research that any regulation need to take into account the existing eco system, the crypto community because over regulation might jeopardize community cooperation and create crypto underground. Bibliography • Nakamoto, Satoshi. ‘Bitcoin: A Peer-to-Peer Electronic Cash System’, 2008, http://bitcoin.org/bitcoin.pdf.
  30. 30. 30 • Andreessen, Marc.‘Why Bitcoin Matters’, The New York Times, 21 January 2014, http://dealbooknytimes.com/2014/01/21/why-bitcoin- matters/?_php=true&_type=blogs&_php=true&_type=blogs&_ r=1. • Davidson, Paul. ‘Is Bitcoin “Money”? The Post-Keynesian View’, Real-World Economics Review Blog, 27 November 2013, http://rwer.wordpress.com/2013/11/27/14335/. • Edwards, Jim. ‘Two Guys on Reddit Are Chasing a Thief Who Has $220 Million in Bitcoins’, Business Insider, 4 December 2013, http://www.businessinsider.com/220-million-sheep- marketplace-bitcointheft-chase-2013-12. • Falkvinge, Rick. ‘The Target Value for Bitcoin Is Not Some $50 or $100. It is $100,000 to $1,000,000’, Falkvinge.net, 6 March 2013, http://falkvinge.net/2013/03/06/the-target- value-for-bitcoin-is-notsome-50-or-100-it-is-100000-to-1000000/. • Wile, Rob. ‘927 People Own Half of All Bitcoins’, Business Insider, 10 December 2013, http://www. businessinsider.com/927-people-own-half-of-the-bitcoins-2013-12. • Winner, Langdon. ‘Cyberlibertarian Myths and the Prospects for Community’, ACM SIGCAS Computers and Society 27:3 (September, 1999): 14-19. _____. • Yarow, Jay. ‘Tech People Are Passing Around this Paul Krugman Quote on the Internet After He Called Bitcoin “Evil”’, Business Insider, 30 December 2013, http://www.businessinsider.com/paul-krugmanbitcoin-2013-12. • Virtual Currencies and Beyond: Initial Considerations, Mr.Dong He, Mr.Karl F Habermeier, Mr.Ross B Leckow, Mr.Vikram Haksar, Ms.Yasmin Almeida, Ms.Mikari Kashima, Mr.Nadim Kyriakos-Saad, Ms.Hiroko Oura, Tahsin Saadi Sedik, Natalia Stetsenko, Ms.Concha Verdugo Yepes,International Monetary Fund, 20 Jan 2016
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