Cryptocurrency and associated blockchain technology have brought tangible benefits as well as immense risk to the public. This innovation is set to disrupt the banking and payment systems and stock exchanges infrastructure among others with time. However, for investors to have confidence in the digital ecosystem, innovation should satisfy data privacy laws and protect investments and clients, and comply with Anti-Money Laundering (AML), Countering the Financing of Terrorism (CFT), and sanctions regulations. Inadequate regulation breeds corruption, fraud, and this can erode confidence in the whole system.
Digital money is represented on the computer system and on digital ledgers on the blockchain system, while fiat money satisfies the core functions of money.
Our traditional fiat money has the following core functions:
- Store of Value – Stability in its value and should not be volatile
- A Unit of Measurement – It provides a common measure to value goods and services
- A Medium of Exchange – All goods and services can be exchanged with money
- A Standard of Deferred Payments – It can be borrowed and lent within specified contractual obligations and time
The multi-money environment should be allowed to coexist so as to support and stimulate economic activity by giving individuals and institutions a choice in their transactional payment activities. This flexibility allows businesses to choose the mode of payment which best fits their structure of operations. Some businesses around the world are now accepting Bitcoin and altcoins as a means of payment for their services despite the volatility and risk in their values.
The current payment infrastructure should adapt to meet the needs of the new technology and innovation. A modification of existing legislation or a complete overhaul of the current legislation to better meet the new wave of innovation is urgently required for the public good and to create confidence and uphold the integrity of the financial markets system and to stem digital crime.
New technology and innovation should embed Anti-Money Laundering and Countering the Financing of Terrorism parameters within their blockchain technology to enhance strict adherence to existing and upcoming laws. However, in implementing Anti-Money Laundering laws, data privacy laws should not be infringed upon.
Law-abiding citizens and corporates should not have their rights and business operations curtailed in the name of fighting financial crime; hence, compliance and legal processes should work in harmony to protect them through legal instruments that benefit loyal citizens and corporates.
Smart contracts can be used to filter through client data and flag data not meeting Anti-Money Laundering, Countering the Financing of Terrorism, and sanctions requirements. This can be built into the blockchain system to make sure digital currencies are fully compliant with relevant legislation. This automation will free resources to be deployed to other critical areas. In addition, business processes and operations embedding interoperability in their systems will also save a lot of money and time, as their systems can communicate and share data within the confines of data privacy laws and at speed.
Compliance enforcement can be initiated as transactions occur through automation based on predefined criteria and risk indicators instead of being reactive, as is the case today, since most compliance processes are manual. Law enforcement is limited and delayed, as they only start investigations after the generation of Suspicious Activity Reports (SAR). The processes to bring the culprits to book take time, and the delay often results in massive cost and losses to the investing community.
Blockchain finance should be adapted to meet prevailing regulations to better serve the interests of customers. Smart contracts software can be embedded into the transactions using zero-knowledge proofs (ZKP) to protect business metadata and individual data privacy, unless the transaction fails predefined algorithms; hence, it can be flagged or blocked.
Suggestions
- Businesses should collaborate to manage costs so that even small upcoming startups can benefit and comply with new forms of compliance at speed.
- Interoperability – All systems should communicate with each other to better achieve compliance and regulatory regimes, among other benefits.
- Embedding smart contract software in blockchain to better manage blockchain finance needs a new regulatory architecture and conducive regulatory sandboxes to support new forms of technology and innovation.
- Education – Massive public awareness and education should be done to communities so that they cannot be misled into committing their financial resources to technology they don’t understand.
- The financial markets should be structured to make sure that losses are borne by the provider rather than by investors if it’s the provider’s fault.
Conclusion
To better manage new technology and innovation, regulatory sandboxes, interoperability of different systems, automation, continuous public awareness and education, and swift regulation should be part of the process to achieve beneficial outcomes and minimize negative outcomes.
Sources: International Monetary Fund – Financial Stability Board 2023; IMF-FSB Synthesis Paper, Policies for Crypto Assets
