Does the introduction of CBDCs mean increased crypto regulation?

28 May 2021, 48 mins ago

As usual following any price drop, numerous (and varied) reasons have been mooted, one of the more publicised being that in China, three industry bodies (self-regulating agencies under the supervision of entities including the People’s Bank of China) have recently reminded their associated members not to engage with or service crypto businesses.

The rise of CBDCS

This “crackdown” on cryptocurrencies comes at a time of reports that China is leading the global pack in terms of developing a Central Bank Digital Currency (“CBDC”).  Indeed, Thomas Cattee of Gherson’s White-Collar Crime team recently provided comment about the introduction of CBDCs, including China’s stance, for a FSTech article “What would a digital pound mean for UK financial services”.

Is there, however, a connection between the rise of CBDCs and increased crypto regulation? The Financial Times observed in a recent article entitled “Bitcoin gyrates on fears of regulatory crackdown” that “The development reflected China’s campaign to limit institutional activity in cryptocurrencies as it prepares to launch its own digital currency”.

Recognition of the potential effects of the introduction of CBDCs on cryptocurrencies is not a new phenomenon. In 2018 it was even argued that CBDCs would “destroy” cryptocurrencies.

Why could this lead to increased crypto regulation?

It is perhaps an overstatement to say that the introduction of CBDCs will result in the destruction of cryptocurrencies. However, there is an argument to be made that it will prompt further regulation and scrutiny.

In a recent blog, Gherson’s White-Collar Crime team noted that no country has yet introduced a CBDC, and answered questions concerning what is a CBDC, and how does a CBDC differ from a cryptocurrency. In relation to this second question, the blog observed that whilst a CBDC and a cryptocurrency are both Digital Currencies (i.e. only take a digital form), they differ in relation to characteristics including the extent of decentralisation.

It was then argued that decentralisation provided some benefits in terms of financial regulation and compliance and that when a CBDC is eventually introduced, the extent to which it is decentralised is very important. Indeed, and as was also discussed in Gherson’s White-Collar Crime team’s recent blog Tech And Crime Series: Cryptoassets And Financial Crime and associated Finextra article, decentralisation can cause concerns relating to the potential for financial crime.

It is, in fact, the approach to decentralisation that goes to the heart of why CBDC introduction could lead to increased cryptocurrency regulation. It is through defining the extent of decentralisation that governments, regulators and policymakers can still assert some influence over any CBDC.

As such, it is not hard to envisage an emerging tension between a Government-created CBDC and the current crop of cryptocurrencies. A CBDC could be designed to bring many of the benefits of a Digital Currency, e.g. no cash, reduced anonymity, real-time tax collection and improved transaction monitoring, AML and KYC benefits, less potential for fraud and financial crime, more consumer protections and easier regulation.  However, this would be without the potential downsides of cryptocurrencies e.g. anonymity, no control over issuance, more difficult regulation and more potential for financial crime.

Of course, there may also be those who see the very existence of cryptocurrencies as a threat to the introduction of a CBDC.

Conclusion

In response to China’s recent stance on crypto businesses, Henri Arslanian’s (Global Head of Crypto at PWC) commented in the Financial Times that

“I would not be surprised to see other regulators and policymakers do the same [as the Chinese restrictions] over the coming weeks as they warn investors of speculative trading or crypto market volatility”.

Further, a recent Yahoo Finance article quoted Neil Wilson, Chief Market Analyst at Markets.com, with the view that “China has for some time been putting pressure on the crypto space, but this marks an intensification” adding “Other countries might follow now as central banks make strides towards their own digital currencies

Of course, correlation does not necessarily mean causation. Generally, however, and whilst not all countries will take China’s approach, there is certainly evidence of increased scrutiny by both regulators and prosecuting authorities.  In the UK, for example, the FCA has, since 10 January 2021, required all UK cryptoasset firms to register with the Financial Conduct Authority under regulations to tackle money laundering.  In the US, CNBC has recently reported that cryptocurrency regulation will be a top priority in 2021. More specifically, Bloomberg reported on 13 May 2021 that Binance Holdings, one of the world’s largest cryptocurrency exchanges, is facing a federal investigation by the Department of Justice and the Internal Revenue Service.  Reuters reported on 13 May 2021 that India’s Central Bank, the Reserve Bank of India, has been requesting lenders to sever ties with cryptocurrency exchanges. Finally, Gherson’s White-Collar Crime team have recently written a blog about cryptocurrencies and tax, and there are reports from the US that the Treasury Department will require any transfer worth $10,000 or above to be reported to the Internal Revenue Service.

This is certainly an area subject to increasing attention from both regulators and prosecuting authorities. This is only likely to increase going forward.  Specifically, as countries expand development of (and eventually implement) CBDCs, there will be further fundamental changes to the financial regulation and compliance landscape, including in relation to cryptocurrencies.

It is, therefore, imperative that any organisation or individual that is involved in any way in this area has one eye on the future, and equally importantly, is in a position to respond to upcoming changes.

Gherson’s White-Collar Crime team are able to offer expert advice in this regard and are reachable via the contact us page or e-mail. Please follow Gherson on Twitter to stay up-to-date.

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