05/07/2023 Alexander

What aspects of digital asset technology regulation should be borrowed from traditional finance regulation?

Pawel Kuskowski converses with Hadyn Jones, Managing Director at Kroll. Kroll is the leading global provider of crypto compliance, risk, and investigative services working side-by-side with crypto companies, investors, and law enforcement since the introduction of the first virtual assets in 2009.

The current regulatory situation

When Pawel asks Haydn about his views on what is happening right now, Haydn says that the HM Treasury just closed the consultation on what can effectively be a framework for crypto. The  Treasury Select Committee have said that crypto can be treated the same as gambling. However, Hadyn argues that it is very important that crypto is not labelled as “gambling” if they are to be treated the same as traditional finance in the future. 

Europeans have been working for two long years on markets in crypto-assets, so the regulation on this technology should be given a bit more sophistication.

In the US, the challenges in terms of crypto or traditional finance mechanisms is that there is a lot of fragmentation state-by-state with differing views on what this technology is about. 


Crypto as gambling

There might be some merit in the argument that crypto is gambling. Hadyn explains that there are 24,000 cryptocurrencies so you will find pockets of digital currencies where putting money on them is akin to putting money on a horse race. However, the challenge is, how do you deal with 24,000 cryptocurrencies? 

If you look at Bitcoin, you can use these technical indicators:

  1. moving average conversions
  2. divergence related strength indicators

You could trade bitcoins like you could trade equities but because the capital declines exponentially, the market liquidity becomes thinner. So partially, these trades do become random in nature in the way that they perform but considering the future potential of the technology, it should be treated as proper securities like debt and equity. 


Crypto and blockchain in the broader financial segment 

In theory, an opportunity exists in crypto but the challenge is that if this theory failed, the US would not step in to save this. If we are to put $120 trillion dollars of traditional assets into blockchain, it needs to be robust. If you look at the way we settle securities in the UK and the way we move payments, everything pyramids up to the central bank which acts as the arbitrator who determines if there are securities and debt which can be swapped, eventually removing the credit risk. Haydn thinks that if the central bank issues digital currency, it can function as programmable stable coins that could be used to settle securities. A lot of the frictional costs in the back office can be taken out of the current infrastructure. 


The biggest risk for crypto businesses

Having an aggregated data view on where the addresses have been tainted and how it is happening in a real time view where you can see the most tainted addresses sit and where we have evidence of transactions that are linked to that address is the biggest risk for crypto businesses. On one hand there is Bitcoin with pseudonymous data but ultimately it is about bringing lots of data together so that we have a real time view of what the threat geography looks like and how tainted is the Bitcoin framework is and what channels Bitcoin links to for criminal activity.


Will we still have clear and clean Bitcoin? 

There is only going to be 21 million Bitcoin and it is divisible to a finite level. So it is possible that in the future, we can determine which ones are clear and clean Bitcoin and which ones have been tainted via a hack, online gambling, theft and one’s who have been physically grabbed from someone’s device.

It is very different to what we have with conventional money and there is a possibility that in the future, the Bitcoins which are not tainted would have an increase in their value. 


Recovery of stolen crypto assets 

Pawel mentions that if someone knows how to steal, launder and transfer crypto in the right way, it is almost impossible for that person to be caught. However, “developers of Bitcoin networks might owe a fiduciary duty to Bitcoin owners”. Haydn says that it is a very small number of actors that are actually perpetrating these crimes and they are reinventing themselves so it boils down to taking and mining the data. There will be structured/unstructured patterns in the data and the foresting linguists will look at the pattern of the language that has been used in the same way that ChatGPT works and they will then look for weights that points to criminal activity. 

However, it is fascinating that someone who codes a normal software has a duty of care which is a contractual duty to deliver that software properly.  Since Bitcoin has a value, the term fiduciary means looking after things of value and therefore creating a legal framework that imposes a different type of responsibility on the individual as compared to a contractual duty or a tortious duty of care. 

If we have communities of people who are creating things that look and behave like money that we allege are a store of value that are impinging upon society, then it is sensible to have the same sort of rules on them because you cannot say that you are going to regulate only half the infrastructure and not the other half. In order to ensure that people are protected, it is important that the whole sector is regulated. 


Money is important 

If you choose to use money that is not protected, regulated or supported by the state in any way, you will have to face the risks that it will fail and that you might not be able to interact with  society properly because we need guardrails in the same way we need guardrails around planes. The reason why these sectors are highly regulated is because, if they fail, they can have huge adverse impacts on society. 


What is the possibility of a blockchain supply chain connection?

Theoretically, it is possible but the challenge  is that classic organizations are incredibly complex in terms of their IT infrastructure and the way it is all put together. It is still unproven at a big enterprise scale. The other challenge is that it is not only about the owner of for example an ice cream company, but all the way back to the farm from where the vanilla comes from, making this a big structural challenge. However, we are headed into times when this technology can potentially be implemented making the process quicker and cheaper – it will just take time.