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CBN and the disruption of cryptocurrencies 07 Feb 2017

A circular of the Central Bank of Nigeria, dated 17th January, 2017, warned the deposit money banks not to “use, hold, trade and/transact in any way in virtual currencies.” However, the risk profile of virtual currencies extends beyond proprietary trading in the digital currencies. Accordingly, the CBN also directed the banks to “ensure that existing customers that are virtual currency exchangers have effective AML/CFT controls that enable them to comply with customer identification, verification and transaction monitoring requirements.”

Ban or Regulate

The concerns of the CBN, which border on potential financial losses by the banks and facilitation of financial crimes through cryptocurrency deals, are shared by other regulators around the world. But a growing number of the regulators are also realising that the digital currency ecosystem cannot be defined anymore only by its risks. New opportunities have emerged with it. The CBN seems to realise this. Its circular hinted at possible offing of “substantive regulation” of the cryptocurrency space in the country.  
    
But by also hinting at an alternative “decision” to regulation in the same circular, the CBN leaves room for speculation as to whether it will ban crypto-activities in the Nigerian jurisdiction. In this season of financial totalitarianism in the country, marked by CBN’s capital controls and directive on preferential allocation of foreign exchange, banning is accustomed, even if counter-productive. According to Google Trends, interests in Bitcoin – the dominant virtual currency – spiked in Bangladesh and Bolivia following the banning of the cryptocurrency by the authorities in 2014.
    
Marcus Swanepoel, CEO of the largest bitcoin exchange in Nigeria, Luno, told Bitcoin.com that adoption rate is “definitely growing fast” in Nigeria, although usage is still small compared to some other markets. Bitcoin’s adoption is being driven in the emerging markets by the need to hedge local currencies against depreciation, such as has been happening with the naira. In some markets, remittances have been identified as a driver of digital currency usage. Given that Nigeria is a key destination of migrant remittances, and with the fluctuations in the value of the naira, banning virtual currencies in the local jurisdiction will be counter-intuitive.

Disruptive Qualities

As would have been observed, cryptocurrencies are also known as virtual or digital currencies. They essentially function as innovative payment networks and electronic monies, serving as a store of value, medium of exchange, and are traded on unregulated virtual exchanges. There are a host of digital currencies, including Ripple, Monero, Dogecion and Dash, apart from Bitcoin. Unlike fiat currencies issued by central banks, cryptocurrencies are created by users or “miners”, who are geographically widely dispersed.
    
Since cryptocurrencies are not backed by any monetary authority, they are not legal tenders, including in Nigeria. This means they are not generally recognised as a means of exchange. However, they can be stored in a digital wallet and used to pay for actual goods and services by merchants willing to accept them. The digital wallet is designed to be easily accessible; thus it could be stored on iPhones, Android devices as well as hardware storage devices.
    
As a medium of payment, cryptocurrencies eliminate financial intermediaries. This peer-to-peer model cuts transaction costs to a small fraction of what obtains with conventional finance. The transactional cost-efficiency has contributed to driving usage. In 2010, the daily average value of transactions with Bitcoin was $100,000.00. This has risen to $74.4 million in 2014. As at 19th January, 2017, the total market capitalization of digital currencies was $16.7 billion. Bitcon alone has a market cap of $14.3 billion.
    
Unlike fiat currencies with fixed face value, the value of a cryptocurrency is determined largely by the number of people using it and the ease with which it can be traded or used. This is antithetical to conventional money, whose trade value rise when demand for it outstrips supply.

The Blockchain

The blockchain is a public ledger of all completed transactions by Bitcoin or other cryptocurrencies. The ledger keeps growing as “blocks” of newly completed transactions are added to it. This introduces unprecedented high levels of transparency and permanence to financial transactions. These attributes of the blockchain have been inspiring new interests in the cryptocurrency universe.
    
A consortium of seven of Europe’s biggest banks recently reached a deal to co-develop a new shared blockchain platform. Participants aim to make domestic and cross-border commerce easier for SMEs. Their initiative, called Digital Trade Chain (DTC), will simplify trade finance processes for SMEs, by addressing the challenge of managing, tracking and securing domestic and international trade transactions. DTC will accelerate the order-to-settlement process and decrease administrative paperwork significantly.
    
On her part, U.S. Federal Reserve chair Janet Yellen, said blockchain is an “important technology.” She said the Fed is looking at it in terms of its potential and the big difference it could make in the way transactions are cleared and settled globally. U.S. financial giants including JP Morgan and Bank of America last year joined a coalition to implement the blockchain technology in banking. Some others, including Visa, NASDAQ and Citi are committing to blockchain-related services and technology.
    
A U.S. independent research and advisory firm, Aite Group, says blockchain technology has become the next big thing in financial services technology. It is seen as a fundamental infrastructure that can help in mitigating clearing and settlement risk in the financial system. Adoption of the technology in capital markets is rising as IT spend in the markets is estimated to increase from $75 million in 2015 to $210 million in 2017, and almost double by 2019.

Although concern over security of cryptocurrencies persists, experts say blockchain can serve as a tool to prevent cyberattacks and security breaches by increasing security on three fronts, namely blocking identity theft, preventing data tampering, and stopping Denial of Service attacks.

Evolving Regulatory Landscape

In 2014, Canada became the first country to regulate cryptocurrencies under its anti-money laundering and counter-terrorism financing (AML/CTF) laws. The regulation allows digital currencies to be subject to record-keeping and that transactions should be verified and report of suspicious transactions should be made, just as it is required for other money services. In line with this, in its ad hoc regulatory directive to the banks last month, the CBN said that any suspicious transactions by virtual currency exchangers or customers should be reported to the Nigerian Finance Intelligence Unit (NFIU).
    
Although noted for a conservative view of the financial market, the Reserve Bank of India has also taken steps towards lenient regulatory view on cryptocurrencies by recently launching a proof of concept (PoC) on the use of Bitcoin’s blockchain technology in the country’s financial system. Adoption of Bitcoin in the country is rising. And RBI says blockchain is a disruptive technology that can potentially revolutionise the financial industry.
    
There has also been new developments in the fiscal space with regard to cryptocurrency. On 11th January, 2017, Israeli Tax Authority put forward draft tax guidelines to treat Bitcoin as a ‘virtual currency’ for taxation purposes. This means Bitcoin will be considered as an asset; it will, therefore, be taxed using ordinary fixed tax rates. The Central Bank of Israel does not view Bitcoin as a foreign currency when it comes to taxation.  

Anonymity and Scams

However, concerns remain about cryptocurrencies. While the blockchain transaction database is publicly accessible, anonymity remains with cryptocurrencies. Without a centralised administrative authority, almost no one would be accountable in the event of collapse of the virtual currency. And the risk of intrusion and cyber-attack of the exchange platforms should be seen as abiding.
    
Scammers have been taking advantage of the unwieldy cryptocurrency ecosystem. In Nigeria, the Securities and Exchange Commission had to warn investors against investing in Bitcoin. This became necessary as the multi-level marketing Ponzi scheme, MMM Nigeria, claimed to offer Bitcoin as a payment option for investors. Investors’ funds estimated at hundreds of millions of naira are trapped in the defunct MMM Nigeria. Elsewhere, some other Ponzi schemes have attached themselves to certain digital currencies, and there are cryptocurrencies that have been identified as fake.

Conclusion

Two years after noting that digital currencies could become a target for use by terrorist groups, the Australian government in April 2016 moved to regulate e-currencies under its AML/CTF legislations. The laws are aimed at facilitating growth and innovation in the digital currency sector.  
    
It is a safe guess that cryptocurrencies are here to stay. The World Economic Forum has projected that 10% of global GDP will be stored in blockchains by 2027. As the People’s Bank of China did recently – inspecting and pledging to bring Bitcoin exchanges in the country to more regulatory oversight – the CBN should look more at regulating cryptocurrencies. The blockchain principle and technology can serve the Nigerian financial system.

Note
This article is published under the series Finance and Technology, a new platform of Financial Nigeria magazine, promoted by Simplex Business Solutions Limited. Knowledge leaders in the interception of finance and technology are welcome to contribute to the industry platform. Editorial contributions should be submitted to editor@financialnigeria.com.