Cryptocurrencies need carefully targeted regulation

INVESTORS will remember 2017 as having been yet another banner year for Bitcoin, the price of which has soared more than 1,800 per cent between January and Dec 26. But despite its spectacular performance, the cryptocurrency has come under scathing criticism, including from some highly respectable quarters.

In September, JPMorgan Chase CEO Jamie Dimon dismissed Bitcoin as "a fraud". Last month, Nobel Prize-winning economist Joseph Stiglitz declared that Bitcoin serves "no useful social function", is mostly used for criminal activities and "should be outlawed". Other critics have variously labelled it "a fantasy", "a Ponzi scheme" and "a collective delusion".

On the other hand, Bitcoin enthusiasts have furiously defended the cryptocurrency on the grounds that it is not created or controlled by governments but by computer algorithms - and therefore, cannot be manipulated; that it enables secure and low-cost fund transfers between people without intermediaries like banks or credit card companies; and that unlike currency notes, it can never be counterfeited.

Both sides are, to some extent, guilty of misinformation. While Bitcoin has been an object of speculation and is prone to bubbles, it is not a fraud. People do use it to transact. And while it has funded criminal activities (as has cash, on a much larger scale) it is mostly used for legitimate purposes. It also does serve useful social functions - for example, enabling fund transfers between people who are unbanked and permitting micro-transactions which traditional payments systems do not. Nor is outlawing Bitcoin a sensible or even feasible option. Attempts to do this would simply drive the activity underground. Moreover, as Bitcoin is operated by a decentralised, globally distributed network, any attempt at a ban would need international cooperation on an unprecedented scale.

But Bitcoin is neither as efficient or safe as its champions claim. Fund transfers are no longer fast and low cost. They can now take several days and cost more than conventional transfers. Mining Bitcoins uses vast amounts of electricity - annually more than the consumption of some small nations. And while Bitcoin-to-Bitcoin transactions are secure within the blockchain that underlies the cryptocurrency, conversions to and from bitcoin to dollars or other currencies requires exchanges, which, as experience has shown, can be hacked, sometimes at great cost to users.

What Bitcoin and other cryptocurrencies need then is neither draconian actions such as prohibitions, nor a laissez-faire approach that permits traders, speculators and exchanges to "self-regulate" as in the past, but a targeted approach to regulation which, while allowing cryptocurrencies to flourish, prevents them from being used for illegal activities, protects users and potentially, guards against systemic risks to the extent that they impact the real economy, given that there are now futures markets for cryptocurrencies and investment banks are starting to trade them. To the extent possible, cryptocurrency players such as exchanges, markets and digital wallet providers should be subject to the same regulations as conventional financial institutions, including capital adequacy and "know-your-customer" norms - which means anonymity will have to go. Cryptocurrency transactions should also be brought under the tax net. Some of these actions have already been taken in various jurisdictions. But more may be needed. As cryptocurrencies continue to evolve, so should regulation, to ensure that they fulfil their promise as vehicles for faster, cheaper and more efficient payment systems.