Ad­dress­ing the dark side of the crypto world

It would not be wise to dis­miss crypto-as­sets; we must wel­come their po­ten­tial but also rec­og­nize their risks.

Financial Nigeria Magazine - - Contents - Chris­tine La­garde is Man­ag­ing Di­rec­tor, In­ter­na­tional Mone­tary Fund. Source: IMFBlog

Whether Bit­coin's value goes up or Bit­coin's value goes down, peo­ple around the world are ask­ing the same ques­tion: What ex­actly is the po­ten­tial of crypto-as­sets?

The tech­nol­ogy be­hind these as­sets – in­clud­ing blockchain – is an ex­cit­ing ad­vance­ment that could help rev­o­lu­tion­ize fields be­yond fi­nance. It could, for ex­am­ple, power fi­nan­cial in­clu­sion by pro­vid­ing new, low-cost pay­ment meth­ods to those who lack bank ac­counts and, in the process, em­power mil­lions in low-in­come coun­tries.

The pos­si­ble ben­e­fits have even led some cen­tral banks to con­sider the idea of is­su­ing cen­tral bank dig­i­tal cur­ren­cies.

Be­fore we get there, how­ever, we should take a step back and un­der­stand the peril that comes along with the prom­ise.

The peril of crypto-as­sets

The same rea­son crypto-as­sets – or what some peo­ple call crypto-cur­ren­cies – are so ap­peal­ing is also what makes them dan­ger­ous. These dig­i­tal of­fer­ings are typ­i­cally built in a de­cen­tral­ized way and with­out the need for a cen­tral bank. This gives crypto-as­set trans­ac­tions an ele­ment of anonymity, much like cash trans­ac­tions.

The re­sult is a po­ten­tially ma­jor new ve­hi­cle for money laun­der­ing and the fi­nanc­ing of ter­ror­ism.

One re­cent ex­am­ple re­veals the scope of the prob­lem.

In July 2017, an in­ter­na­tional op­er­a­tion led by the United States shut down Al­phaBay, the largest on­line crim­i­nal mar­ket­place on the in­ter­net. For more than two years, il­le­gal drugs, hack­ing tools, firearms, and toxic chem­i­cals were sold all over the world through Al­phaBay. Be­fore the site was taken off­line, more than $1 bil­lion had been ex­changed through crypto-as­sets.

Of course, money laun­der­ing and ter­ror­ist fi­nanc­ing is only one di­men­sion of the threat. Fi­nan­cial sta­bil­ity is an­other. The rapid growth of crypto-as­sets, the ex­treme volatil­ity in their traded prices, and their illde­fined con­nec­tions to the tra­di­tional fi­nan­cial world could eas­ily cre­ate new vul­ner­a­bil­i­ties.

So, we need to de­velop reg­u­la­tory frame­works to meet an evolv­ing chal­lenge. Many or­ga­ni­za­tions have al­ready started.

One pos­i­tive ex­am­ple is the Fi­nan­cial Sta­bil­ity Board (FSB), which is look­ing at what new rules might be needed to meet the ad­vance­ments in fin­tech. An­other is the Fi­nan­cial Ac­tion Task Force (FATF) – the body that sets stan­dards for the fight against money laun­der­ing and ter­ror­ist fi­nanc­ing. The task force has al­ready pro­vided use­ful guid­ance to coun­tries on how to deal with cryp­tocur­ren­cies and other elec­tronic as­sets.

The IMF is also work­ing on these is­sues. Stop­ping money laun­der­ing and com­bat­ting ter­ror­ist fi­nanc­ing has been part of our work for the last 20 years. Based on the stan­dards set by FATF, we have con­ducted 65 as­sess­ments of coun­tries' reg­u­la­tory frame­works and pro­vided ca­pac­ity devel­op­ment as­sis­tance to 120 coun­tries. Our ef­forts have fo­cused on help­ing our mem­ber coun­tries grap­ple with the spec­tre of il­licit fi­nan­cial flows.

But we rec­og­nize more needs to be done to get a han­dle on the emerg­ing threat posed by crypto-as­sets and to se­cure a sta­ble fi­nan­cial sys­tem. Where can we start?

Fight­ing fire with fire

We can be­gin by fo­cus­ing on poli­cies that en­sure fi­nan­cial in­tegrity and pro­tect con­sumers in the crypto world just as we have for the tra­di­tional fi­nan­cial sec­tor.

In­deed, the same in­no­va­tions that power crypto-as­sets can also help us reg­u­late them.

To put it an­other way, we can fight fire with fire.

Reg­u­la­tory tech­nol­ogy and su­per­vi­sory tech­nol­ogy can help shut crim­i­nals out of the crypto world. More broadly, we are see­ing crypto-as­set ex­changes in some coun­tries that are sub­ject to know-your­cus­tomer re­quire­ments.

These ad­vances will take years to re­fine and im­ple­ment. Two ex­am­ples high­light the prom­ise of this ap­proach over the long term:

Dis­trib­uted ledger tech­nol­ogy (DLT) can be used to speed up in­for­ma­tion-shar­ing be­tween mar­ket par­tic­i­pants and reg­u­la­tors. Those who have a shared in­ter­est in main­tain­ing safe on­line trans­ac­tions need to be able to com­mu­ni­cate seam­lessly. The tech­nol­ogy that en­ables in­stant global trans­ac­tions could be used to cre­ate reg­istries of stan­dard, ver­i­fied, cus­tomer in­for­ma­tion along with dig­i­tal sig­na­tures. Bet­ter use of data by gov­ern­ments can also help free up re­sources for pri­or­ity needs and re­duce tax eva­sion, in­clud­ing eva­sion re­lated to cross­bor­der trans­ac­tions.

Bio­met­rics, ar­ti­fi­cial in­tel­li­gence, and cryp­tog­ra­phy can en­hance dig­i­tal se­cu­rity and iden­tify sus­pi­cious trans­ac­tions in close to real time. This would give law en­force­ment a leg up in act­ing fast to stop il­le­gal trans­ac­tions. This is one way to help us re­move the “pol­lu­tion” from the cryp­toas­sets ecosys­tem.

We also need to en­sure that the same rules ap­ply to pro­tect con­sumers in both dig­i­tal and non-dig­i­tal trans­ac­tions. The U.S. Se­cu­ri­ties and Ex­change Com­mis­sion and other reg­u­la­tors around the world now ap­ply the same laws to some ini­tial coin of­fer­ings (ICOs) as they do to of­fer­ings of stan­dard se­cu­ri­ties. This helps to in­crease trans­parency and alert buy­ers to po­ten­tial risks.

But no coun­try can han­dle this chal­lenge alone.

In­dis­pens­able in­ter­na­tional co­op­er­a­tion

To be truly ef­fec­tive, all these ef­forts re­quire close in­ter­na­tional co­op­er­a­tion. Since crypto-as­sets know no bor­ders, the frame­work to reg­u­late them must be global as well.

The suc­cess­ful clo­sure of Al­phaBay, for ex­am­ple, in­volved the co­op­er­a­tion of Europol and law en­force­ment agen­cies in the United States, Thai­land, the Nether­lands, Lithua­nia, Canada, the United King­dom, and France.

Coun­tries will have to de­cide col­lec­tively that this path is worth pur­su­ing. Promis­ingly, the Group of Twenty (G-20) has agreed to put crypto-as­sets on the agenda of its Novem­ber 2018 sum­mit in Ar­gentina.

The IMF will play its part in this ef­fort. With our near-uni­ver­sal mem­ber­ship and ex­per­tise, in­clud­ing in bat­tling mon­ey­laun­der­ing and ter­ror­ist fi­nanc­ing, we are uniquely sit­u­ated to be a fo­rum for help­ing de­velop an­swers in the evolv­ing cryp­toas­set space.

What comes next for crypto

The volatil­ity of crypto-as­sets has prompted an in­tense de­bate about whether they are a bub­ble, just an­other fad, or a revo­lu­tion equiv­a­lent to the ad­vent of the in­ter­net that will dis­rupt the fi­nan­cial sec­tor and even­tu­ally re­place fiat cur­ren­cies.

The truth is ob­vi­ously some­where in be­tween these ex­tremes.

As I have said be­fore, it would not be wise to dis­miss crypto-as­sets; we must wel­come their po­ten­tial but also rec­og­nize their risks.

By work­ing to­gether, and lever­ag­ing tech­nol­ogy for the pub­lic good, we can har­ness the po­ten­tial of crypto-as­sets while en­sur­ing that they never be­come a haven for il­le­gal ac­tiv­ity or a source of fi­nan­cial vul­ner­a­bil­ity.

IMF Man­ag­ing Di­rec­tor Chris­tine La­garde

Im­age de­pict­ing Bit­coin min­ing

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