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Taking the bitcoin bull by its horns
Publication Date : 18-03-2014
Singapore's regulator last week proposed new rules on exchanges and vendors of virtual currencies, becoming one of the first in the world to do so.
The planned rules will apply to bitcoin, the virtual currency du jour. It will also apply to intermediaries of all virtual currencies, the Monetary Authority of Singapore (MAS) said.
This will affect businesses that buy and sell virtual currencies or that let people exchange virtual currencies, such as the bitcoin, for legal tender like Singapore dollars. These firms will now have to verify the identities of their customers and report suspicious transactions to the police.
The MAS said the move was a pre-emptive one, aimed at thwarting potential money laundering and terrorist financing. Since the bitcoin allows people to transfer digital money between one another anonymously, it is ripe for exploitation for these financing crimes. MAS will put up its proposals for public consultation soon, and plans to turn them into law within the next 12 months.
The move to impose some kind of regulatory structure is a good first step for Singapore to maintain its edge as a financial centre in the digital age. But how it proceeds will determine whether the Republic stays in the lead.
First, some background on the bitcoin, which is a kind of digital cash that people can use to buy and sell things.
Bitcoins can be sent anonymously at low cost over the Internet, without using a middleman such as a bank, which may charge high fees. It has not yet achieved mainstream acceptance, partly due to the relative novelty of the concept and the volatility of bitcoin prices.
The technology for the bitcoin surfaced in 2009. Bitcoins are created – “mined”, in industry lingo – by a vast network of computers linked via the Internet.
Unlike fiat currencies that are controlled by central banks and backed by their reserves, there is no one authority behind the bitcoin. Instead, “miners” earn bitcoins by carrying out complex mathematical calculations on sophisticated computers. The code for bitcoin caps the number of bitcoins in existence at 21 million.
The value of a bitcoin is determined entirely by what people are willing to pay for it and has fluctuated wildly since its inception. The price of one bitcoin spiked to US$1,242 last November – making it briefly pricier than an ounce of gold – before dropping to around US$630 as of last week.
Other virtual currencies include litecoin and linden dollars, but bitcoin is by far the most widely used. It is accepted at online retailers such as Overstock.com, Zynga and OkCupid, and even at the University of Cumbria in Britain, which now takes bitcoins as payment for tuition fees. Some experts predict they will become commonplace in two years.
Singapore’s tech-savvy entrepreneur community has embraced the technology, with local firms setting up some of Asia’s first bitcoin machines here last month. Singaporeans can now buy bitcoins off the street from at least six vending machines. A machine that pays cash in return for bitcoins is expected to be launched this month.
A recent series of recent high-profile meltdowns has thrown the technology’s jagged edges into sharp relief. Last month, the world’s biggest bitcoin exchange, MtGox, filed for bankruptcy after claiming hackers had stolen a staggering US$480 million worth of the bitcoins it stored. A Canadian bitcoin bank called Flexcoin shuttered this month, saying it had lost about US$600,000 worth to hackers.
Rules of the game
Incidents such as these have jolted regulators into figuring out an approach to bitcoins and other virtual currencies.
But because virtual currencies are a fairly new phenomenon, they are still shrouded in uncertainty. The main problem for regulators is pinning down what the bitcoin really is because this affects which rules apply.
Should it be treated as a currency, since it can be used as a medium of exchange? Or is it best regarded as a commodity, given its speculative and volatile nature?
Industry players say the lack of a central authority backing the bitcoin means it cannot be regulated like a real currency.
Greg Unsworth, who heads technology, media and telecommunications at Pricewaterhouse- Coopers, suggests that the bitcoin be regulated as a “hybrid” since it has attributes of both a currency and a commodity.
“Right now it’s being used more as an investment and speculation... But as it’s used more, it could start to look more like (legal) tender. Any regulation should address its different roles.”
Another option is to ban transactions in bitcoin altogether.
Japan has declared that the bitcoin is not a currency and banks in Japan cannot open bitcoin deposit accounts. China’s central bank has barred financial institutions from handling bitcoin transactions, while Taiwan has banned bitcoin ATMs.
In contrast, New York’s top financial services regulator asked prospective virtual currency exchange operators to submit formal applications last week, as a first step towards regulation. It plans to put up proposed rules by the end of June.
The United States’ commodities derivatives watchdog also said it was studying whether the bitcoin fell under its purview.
Ahead of the pack
Singapore could move ahead of New York if it puts up proposed rules for consultation before New York does. Its approach is highly targeted, in that it is sharply focused on cutting the risks of virtual currencies being used to filter money for terrorism and money laundering activities.
This is why it targets exchanges, which are companies where you can buy and sell virtual currencies. A money- laundering outfit could for example use ill-gotten gains to purchase bitcoins, and then sell them again, for legitimate money.
MAS wants to make it mandatory for exchanges to verify the identities of people who use their services. The Inland Revenue Authority of Singapore also levies goods and services tax (GST) on the sale of bitcoins, which it treats as a service for tax purposes.
But those interested in transacting in bitcoins must understand that MAS rules do not offer them any consumer protection. MAS has repeatedly said it will not recognise virtual currencies as legal tender or as securities. It warns users of the “significant risks associated with virtual currency transactions”. MAS has made clear that its new regulations do not extend to the “safety and soundness” of virtual currency intermediaries.
This means consumers use bitcoins at their own risk. The value of bitcoins is not regulated and could plunge to a fraction of what you paid for it. And if you spend thousands of dollars buying bitcoins from a company and it goes bust, chances are you will get neither bitcoins nor the money back.
Some experts such as lawyerturned- tech entrepreneur Aidil Zulkifli think MAS’ proposed rules strike the right note in targeting infrastructure providers such as bitcoin exchanges as these promote liquidity and movement in the market.
Bitcoin entrepreneurs themselves are divided on the importance of regulation.
Norma Sit, who runs bitcoin vending machine provider Numoni, said her company already self-regulates, for instance, by capping a customer’s daily and monthly transactions.
“These checks are similar to what payment systems might have to spot irregularities and unusual activities,” Sit said.
Luv Khemani, who runs an exchange called FYB-SG, fears regulation will “drive up costs for me, end users and taxpayers for no benefit to anyone”.
Onerous rules could also drive firms offshore or underground, and raise “artificial barriers to entry, leading to cartels and stagnation in innovation”, he said.
David Moskowitz, who runs Singapore-based bitcoin broker Coin Republic, said bitcoin companies here already provide strong security as a way of differentiating themselves from rivals.
“A free market is able to handle the changing bitcoin landscape better than regulations can,” he argues. “Financial privacy is an important right... Simply because someone wants to be able to freely move money from one place to another, we should not put them into the same category as drug dealers or terrorists.”
Some bitcoin bosses favour regulation. Zann Kwan, director of bitcoin vending machine provider Bitcoin Exchange, said light rules would likely widen the acceptance of bitcoins, while hasty, heavy regulation could “erode the momentum of this exciting trend”.
“Singapore could potentially play a big role on the global stage” if it were to introduce a sound regulatory framework, she said.
But most experts agree on one thing: Regulating bitcoin exchanges to reduce the risk of them being exploited for money-laundering and terrorism- financing activities is just the first step.
As bitcoin usage spreads, there will be a need to extend regulations to cover consumer use, said Jonathan Kok, a partner at law firm RHTLaw Taylor Wessing.
MAS could have chosen to ban bitcoin use outright or left it to market forces to decide its fate. But as a nimble tech and finance hub, it chose to take the bitcoin bull by its horns.
Its move to introduce a regulatory framework moves it ahead of the pack in both innovation and regulation. Continuing to keep an open mind about virtual currencies while remaining vigilant about systemic risks to the financial system would help it stay that way.
But as Rajesh Sreenivasan, a technology lawyer at Rajah and Tann, warned, rules must be flexible and adapt to fast-changing tech realities.
“It’s still early days. Exchanges seem to be the hot thing today, but they could become redundant in future. The bitcoin could be the flavour today but not tomorrow, and we need to be ready for that.”