Deng Jianpeng: Bitcoin risks and regulatory responses

In May 2017, the Wanna Cry virus infected computers in many countries and demanded that the victims pay ransom in Bitcoin, making Bitcoin the focus of global public opinion again. However, the virus incident itself has little to do with Bitcoin, but Bitcoin just happened to become the "medium" of ransom. Although digital assets such as Bitcoin are new things in the field of financial technology since 2009, they have a huge influence, mixed with many misunderstandings and related risks. Therefore, relevant regulatory agencies should form reasonable regulatory ideas in a timely manner to prevent risks.

1. The main risks of Bitcoin

In recent years, the main risks in the Bitcoin field include: First, digital assets represented by Bitcoin are affected by the policies of various countries and speculation by speculators, and the risk of currency fluctuations is very high; second, some countries lack government supervision, and some executives of Bitcoin trading institutions take the opportunity to swindle customer funds; third, the trading institutions’ own network security precautions are not in place, and the network is attacked by security attacks, resulting in the theft of digital assets stored by the trading institutions, causing heavy losses to investors; fourth, some lawbreakers take advantage of Bitcoin’s partial anonymity, cross-border full network circulation and payment convenience to purchase contraband and engage in criminal activities. Ransomware is one example; fifth, in recent years, some criminals have engaged in pyramid schemes and fraud in the name of "digital currency."

Although Bitcoin has the above-mentioned risks, it does not make much sense for a single country to directly ban the use or trading of Bitcoin. Bitcoin is a decentralized, peer-to-peer global digital asset, and it is difficult to "ban it" just because of a piece of legislation. In addition, Bitcoin was defined as a virtual commodity by a 2013 document of the People's Bank of China. It belongs to the network virtual property stipulated in the General Provisions of the Civil Law, and there is no legal basis for prohibiting its trading. Bitcoin can realize peer-to-peer transactions. As long as the Internet exists, Bitcoin transactions cannot be banned in reality.

As more and more countries pass legislation to recognize the legal status of Bitcoin, the right attitude is to face up to the risks associated with Bitcoin and take appropriate regulatory measures to prevent risks.

2. Misunderstandings about Bitcoin

The total amount of Bitcoin is limited, and it is unlikely to pose a threat to the central bank's legal currency, nor can it challenge the currency creation or credit expansion of a large country. However, due to the convenience of Bitcoin's partial anonymity, it has become an "accomplice" to some criminal activities to a certain extent. For example, some criminals use Bitcoin to engage in illegal activities such as money laundering, pyramid schemes, fraud, illegal fundraising or illegal transactions. After the "Wanna Cry" virus appeared, some people mistakenly believed that Bitcoin was a virus.

However, Bitcoin itself cannot be simply equated with crime (tool). The above-mentioned crimes have always existed, and they still exist without Bitcoin. Cash transactions and other online virtual commodity transactions may become alternatives for criminals. Furthermore, almost all new business models and technologies are easy to be used by criminals after they appear, until legislation is continuously improved and technical means of combating and preventing crime are continuously improved.

3. Correctly understand the significance of Bitcoin

Digital assets represented by Bitcoin are backed by blockchain technology and rely on the Internet. In fact, they are global assets. Due to its standardized, divisible and Internet-based attributes, Bitcoin can be used as an efficient financial tool in some scenarios.

Bitcoin and other digital assets are the most mature applications of blockchain technology, with strong experimental value and demonstration effect. China encourages the development of digital assets such as blockchain and Bitcoin, which has national strategic significance. China is a major country in Internet application, but not a technological power. The standard setter of Internet technology is the United States. Blockchain may become the technical standard of the financial industry in the future. China's research and development and application in this area are not significantly different from those of European and American countries. China has the basis for seizing the commanding heights and should take the initiative to guide the formulation of future financial technology standards and seize the commanding heights.

The United States, Japan and other countries have successively brought Bitcoin trading institutions under regulatory control. Japan recognizes Bitcoin as a means of payment, and Germany even recognizes Bitcoin's status as a private currency. Their open vision is worthy of consideration and reference by regulators.

IV. Regulatory challenges and regulatory “handles”

The development of peer-to-peer value Internet - blockchain technology, while bringing about the liberalization of financial transactions and the improvement of transaction efficiency, also brings regulatory challenges to governments around the world. As mentioned earlier, the decentralized nature of Bitcoin makes it a global credit asset, but it is also easy to be used for illegal activities, bringing new challenges to global supervision. Therefore, for decentralized Bitcoin, regulators must seek a suitable "handle".

Bitcoin has formed a complete ecological chain around generation, storage, trading and application. Among them, the social impact of the trading link is the most extensive. According to statistics from the National Internet Financial Security Technology Expert Committee in early June 2017, the trading volume of the three major domestic trading institutions accounted for more than 80% of the national trading volume. There are about dozens of other small trading institutions. Conservative estimates put the number of traders at more than 10 million. In the trading link, Bitcoin has a typical crowd-related nature. The risks generated by trading institutions are currently the most concentrated, including money laundering, huge price fluctuations, market manipulation, information leakage, trading institutions running away and hacker attacks, etc. Therefore, in this industrial chain, trading institutions are the best "handle" for supervision.

This type of digital asset trading institution is different from traditional trading institutions. Large digital asset trading institutions have a high level of technology in digital asset storage and system security, real-time asset liquidation, and 365-year uninterrupted service, forming certain technical barriers. Trading institutions provide centralized trading venues to improve trading efficiency, transparency, and regulatory compliance. Due to the existence of centralized trading institutions, under the premise of strict supervision, a large number of legal trading demands can be concentrated on the market, reducing regulatory costs. In this way, the cost of over-the-counter transactions is increased, and it is difficult to form a large number of transactions, which objectively greatly increases the cost of using Bitcoin for illegal activities.

On the contrary, if there is no centralized trading institution, investment demand will be concentrated in the gray area of ​​OTC that is more difficult to regulate, and the regulatory cost of countless trading individuals will be far greater than the regulatory cost of limited centralized institutions. Globally, large compliant exchanges such as Coinbase in the United States, Bitflyer in Japan, and Kraken in Europe are strictly regulated by their own governments and play the role of digital asset trading intermediaries in their own countries.

V. Explore Reasonable Regulatory Approaches

As global financial technology advances by leaps and bounds, we should encourage entrepreneurship and innovation on the one hand, and focus on preventing risks on the other. Bitcoin-related regulatory work should stay away from the dilemma of "arresting once chaos occurs, and killing once arresting", and prevent going from one extreme of governance to another.

For digital asset trading institutions, regulators mainly focus on anti-money laundering and user identification, network security, protection of trader rights, adequate information and risk disclosure, third-party custody of trading funds, and third-party custody of Bitcoin (and other digital assets), and put forward strict standards, formulate rules, and require trading institutions to comply with them. The author believes that for innovative things in the field of financial technology, it is more reasonable to make corresponding adjustments through continuous trial and error, and to establish a friendly environment for legal, compliant and healthy development under the premise of promoting innovation.

(The author is a professor at the Law School of Minzu University of China and a legal research expert at the Internet Society of China)