Table Of Content

Cryptocurrency Regulation This work argues that current cryptocurrency regulation, particularly in the areas of enforcement and compliance, is inadequate. It proposes reflexive regulation as an alternative approach. This book provides strategies for a reflexive regulation approach to cryptocurrencies, developed through the identification of the internal self-regulatory mechanisms of the cryptocurrency system. Apportioning blame for current problems to the regulators’ failure to take into account the inherent technical features of cryptocurrencies, the work promotes reflexive regulation in which the law acts at a subsystem-specific level to install, correct, and redefine democratic self-regulatory mechanisms. It provides strategies for this approach, developed through the identification of the internal self-regulatory mechanisms of the cryptocurrency system. These are identified as embedded in the technical functionality of computer code and consensus- based distributive governance mechanisms respectively. In addition to providing a technical, historical, and legal overview of cryptocurrencies, the book concludes by providing recommendations aimed at redirecting code and consensus towards achieving regulatory goals. In this way, it draws from the theory of reflexive law in order to provide both a substantive and jurisprudential perspective on the regulation of cryptocurrencies and to illustrate how financial technology (fintech) regulation can only be effective once regulators consider both the ‘fin’ and the ‘tech’ in their regulatory approaches. The book will be of interest to researchers, academics, and policymakers working in the areas of Financial Regulation and Jurisprudence, Financial Crime, Banking Regulation, Information Systems, and Information Technology. Immaculate Dadiso Motsi-Omoijiade is an Analyst in Science and Emerging Technology at RAND Europe and was formerly a Research Fellow in Emerging Technology at the Lloyds Banking Group Centre of Responsible Business, University of Birmingham Business School, UK. Studies in Modern Law and Policy Series Editor: Ralf Rogowski, Professor of Law, University of Warwick Also in the series Social Systems Theory and Judicial Review Taking Jurisprudence Seriously Katayoun Baghai ISBN: 978-1-4094-5402-1 The EU Economic and Social Model in the Global Crisis Interdisciplinary Perspectives Edited by Dagmar Schiek ISBN: 978-1-4094-5731-2 Constitutional Evolution in Central and Eastern Europe Expansion and Integration in the EU Edited by Kyriaki Topidi and Alexander H.E. Morawa ISBN: 978-1-4094-0327-2 Central and Eastern Europe After Transition Towards a New Socio-legal Semantics Edited by Alberto Febbrajo and Wojciech Sadurski ISBN: 978-1-4094-0390-6 Democracy, Law and Governance Jacques Lenoble and Marc Maesschalck ISBN: 978-1-4094-0395-1 Global Trade, Labour Rights and International Law A Multilevel Approach Aneta Tyc ISBN: 978-0-367-74801-2 Cryptocurrency Regulation A Reflexive Law Approach Immaculate Dadiso Motsi-Omoijiade ISBN: 978-1-032-18361-9 Cryptocurrency Regulation A Reflexive Law Approach Immaculate Dadiso Motsi-Omoijiade First published 2022 by Routledge 4 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 605 Third Avenue, New York, NY 10158 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2022 Immaculate Dadiso Motsi-Omoijiade The right of Immaculate Dadiso Motsi-Omoijiade to be identified as author of this work has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Motsi-Omoijiade, Immaculate Dadiso, author. Title: Cryptocurrency regulation: a reflexive law approach / Immaculate Dadiso Motsi-Omoijiade. Description: New York, NY: Routledge, 2022. | Series: Studies in modern law and policy | Includes bibliographical references and index. Identifiers: LCCN 2021059378 (print) | LCCN 2021059379 (ebook) | ISBN 9781032183619 (hardback) | ISBN 9781032183626 (paperback) | ISBN 9781003254164 (ebook) Subjects: LCSH: Cryptocurrencies. | Cryptocurrencies–Law and legislation. | Electronic funds transfers–Law and legislation. Classification: LCC HG1710 .M678 2022 (print) | LCC HG1710 (ebook) | DDC 332.4–dc23/eng/20220216 LC record available at https://lccn.loc.gov/2021059378 LC ebook record available at https://lccn.loc.gov/2021059379 ISBN: 978-1-032-18361-9 (hbk) ISBN: 978-1-032-18362-6 (pbk) ISBN: 978-1-003-25416-4 (ebk) DOI: 10.4324/9781003254164 Typeset in Galliard by Deanta Global Publishing Services, Chennai, India Contents List of illustrations vii Abbreviations viii Introduction ix 1 Overview of cryptocurrencies 1 1.1 Introduction 1 1.2 History and development 1 1.3 The cryptocurrency ecosystem 8 1.4 Issues of regulatory concern 15 1.5 Conclusion 22 Bibliography 24 2 Current cryptocurrency regulation 30 2.1 Introduction 30 2.2 International and regional regulatory responses 30 2.3 National regulatory responses 40 2.4 Conclusion 53 Bibliography 55 3 Evaluation of current regulation 61 3.1 Introduction 61 3.2 Enforcement challenges 61 3.3 Compliance challenges 66 3.4 Discussion 76 3.5 Conclusion 79 Bibliography 80 4 Reflexive regulation theory 84 4.1 Introduction 84 4.2 Overview of reflexive regulation 84 vi Contents 4.3 Reflexive regulation vis-à-vis established regulatory theories and strategies 88 4.4 Discussion 98 4.5 Conclusion 101 Bibliography 102 5 Self-regulatory mechanisms of the cryptocurrency system 104 5.1 Introduction 104 5.2 Code 106 5.3 Consensus 117 5.4 Discussion 129 5.5 Conclusion 130 Bibliography 131 6 Reflexive strategies for enhancing and supporting internal self-regulatory mechanisms 134 6.1 Introduction 134 6.2 Strategies for the reflexive regulation of cryptocurrency as code-based system 135 6.3 Strategies for the reflexive regulation of cryptocurrency as a consensus-based system 143 6.4 Conclusion 148 Bibliography 150 Conclusion 153 Index 158 Illustrations Figures 2.1 Regulated financial products, activities, and institutions. 54 5.1 Bitcoin transaction confirmation. Source: bitcoin. o rg (Bitcoin .or g, ‘Bitcoin Developer Examples’ (Bitcoin .org, 2017) <https://Bitcoin .org /en /developer -examples #testing -applications> Accessed 24 July 2017.) 108 5.2 Bitcoin unlimited vs Segwit support. Source: Node Counter (Data from Node Counter <http://nodecounter .com/ #Bitcoin _classic _blocks> Accessed 27 January 2020.) 121 5.3 Cryptocurrency cognitive openness scale—relationship between regulability and formalisation 125 6.1 Hashrate distribution—market share of largest mining pools. Source: blockchain .c om (Blockchain .co m, ‘Hashrate Distribution’ (Blockchain .com , 2017) <https://www. blockchain .com /en /pools> Accessed 1 June 2018.) 141 Tables 3.1 Legal implications of cryptocurrency technical features 79 6.1 Overview of system features, recommendations, and target regulatory goals 149 Abbreviations AML Anti-Money Laundering BIS Bank for International Settlements BOE Bank of England BTC Unit of Bitcoin (also denominated in lower case bitcoin) CDD Customer Due Diligence CFT Countering the Financing of Terrorism CFPB United States Consumer Financial Protection Bureau CFTC Commodity Futures Trading Commission CTF Countering terrorism financing DAO Decentralised Autonomous Organisation DLT Distributed Ledger Technology EBA European Banking Authority ESMA European Securities and Markets Authority FATF Financial Action Task Force FCA Financial Conduct Authority (United Kingdom) FinCEN Financial Crimes Enforcement Network (US Treasury) Fintech Financial Technology FINTRAC Financial Transactions and Reports Analysis Center of Canada HMRC Her Majesty’s Revenue and Customs ICO Initial Coin Offering IOSCO International Organization of Securities Commissions KYC Know Your Customer (requirements) MAS Monetary Authority of Singapore MSB Money Services Business NYDFS New York Department of Financial Services OECD Organisation for Economic Co-operation and Development P2P Peer-to-Peer PoW Proof of Work Consensus Algorithm Regtech Regulatory Technology SAR Suspicious Activities Reporting SEC US Securities and Exchange Commission Suptech Supervisory Technology Introduction In October 2008, Satoshi Nakamoto published a white paper entitled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’.1 Circulated at the height of the Global Financial Crisis (GFC), where a severe economic crisis was occurring in a cli- mate of extreme distrust and disillusionment with the global banking system, Nakamoto’s paper sought to address the inherent weaknesses of the trust-based model for commerce on the internet, which relied exclusively on financial institutions serving as trusted third parties in the processing of electronic payments. Nakamoto’s paper proposed an alternative to this system, providing the blue- print for ‘an electronic payment system based on cryptographic proof instead of trust’.2 This, and the accompanying open-source software released a year later, was the birth of Bitcoin, the first of what are now known as cryptocurrencies. Cryptocurrencies are a form of digital or virtual currency generated and distributed exclusively online, that ‘rely on a cryptographic protocol to regulate the manner in which (and the extent to which) currency can be created and/or exchanged’.3 Early academic research into cryptocurrencies immediately identified the dual- ity of cryptocurrencies, which can be seen as both a ‘regulatory nightmare’ and a ‘libertarian dream’.4 This is because whilst cryptocurrencies present an exciting and innovative alternative to conducting commerce over the internet, providing benefits such as privacy, cost reduction, and the ability to ‘make non-reversible payments for non-reversible services’,5 cryptocurrencies also present considerable challenges to regulatory and law enforcement agencies. These challenges primar- ily have to do with the manner in which cryptocurrencies are able to operate beyond the reach of the law, due to technical design features such as operating 1 S Nakamoto, ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ (Bitcoin .o rg, 2009) <https:// bitcoin. org /bitcoin .pdf> Accessed 27 May 2018. 2 Ibid., 1. 3 P De Filippi, ‘Bitcoin: A Regulatory Nightmare or a Libertarian Dream’ (2014) 3 Internet Policy Review 2. 4 Ibid. 5 Nakamoto (no. 1), 1.