Do we need to establish legal regulations to regulate Bitcoin?

According to technology media Wired, "Bitcoin has failed." "Bitcoin represents the future of money." "Bitcoin cannot be regulated." "Bitcoin needs to be regulated." For years, the debate over Bitcoin, the decentralized virtual currency, has been filled with discordant voices, and now lawmakers around the world are wondering whether the time has come to regulate this emerging technology.

As I have said before, Bitcoin as a virtual currency will bring considerable challenges to regulators. However, since we do not fully understand the impact of blockchain technology on innovation, competition and regulation, we should not rush into regulation.

With a market cap of $5 billion, Bitcoin is slowly being integrated into the digital economy, with more and more merchants, including Overstock, Newegg, Expedia, Dell, and Microsoft, trying to accept Bitcoin as a new payment method. Of course, regulation will eventually need to be in place to address risks and maximize the benefits of technology. But for now, it is difficult to regulate an advanced technology that we don't know much about. Given that blockchain technology is still in the experimental stage, its possible uses and applications are still largely unknown, and regulatory regulations should be carefully considered and balanced to avoid overly cautious legislation that limits the future development of these new technologies.

Why Bitcoin needs regulation

Last month, the European Parliament held a public hearing (organized by the Economic and Monetary Affairs Committee) to discuss the need and possible ways to regulate virtual currencies. Representatives from the European Commission and the OECD, experts and practitioners from the private sector were invited to attend the hearing. I also attended the hearing as a representative of the academic community.

Since Bitcoin is a decentralized payment system independent of any government or central bank, people can trade on a peer-to-peer basis without going through any financial intermediary. This means that the Bitcoin network is not subject to any legal provisions and its construction is a blank in the scope of judicial regulations. Given the lack of a central regulatory agency, people can operate anonymously and do not need to reveal their identity to anyone. This provides opportunities for criminal activities, including tax evasion and money laundering.

However, on the positive side, Bitcoin does bring good news to consumers: it can help people transfer funds across borders at almost no cost, making cheaper and faster international remittances possible and promoting the efficiency of remittance business.

In the United States, the first regulatory response was the passage of the New York State BitLicense, a law that aims to regulate virtual currencies by regulating the behavior of commercial operators (such as wallet providers). The so-called commercial operators include ordinary financial operators or money transfer operators, requiring them to comply with anti-money laundering laws, KYC policies and relevant laws and regulations on money transfers. These regulations have been strongly condemned for imposing harsh conditions on Bitcoin operators and making it difficult for small businesses and startups to operate. More importantly, in fact, if similar regulatory measures are extended to other blockchain-based applications, it will also seriously inhibit innovation in the field of blockchain technology.

Blockchain is a powerful technology

The real innovation beyond Bitcoin is not the currency itself, but its underlying technology - the blockchain. The blockchain is a decentralized, transparent public ledger - it enables people to collaborate and transact with each other in a distributed manner without any regulator or central clearinghouse.

First, blockchain is an important accounting innovation that will ensure greater efficiency and transparency for many financial applications. It will also reduce the cost of regulatory compliance, thanks to special features (such as multi-signatures) and technical mechanisms used to enhance the transparency and accountability of traditional trust institutions (such as verified solvency).

In particular, when it comes to regulation, blockchain technology can be seen as a regulatory technology that enables laws to be enforced transparently and efficiently. The main advantage of blockchain to regulation is that it solves the problem of “who monitors the regulator” - a common problem for many trust institutions.

So, from a regulatory perspective, if virtual currencies present a host of challenges in terms of taxation, money laundering and terrorist financing, the real challenge is to figure out how to regulate them without compromising the tangible benefits that blockchain technology brings, such as transparency, accountability, consumer protection and compliance.

Whether blockchain technology can be used as a powerful tool to improve transparency and accountability in financial institutions was a question raised at the World Economic Forum in Davos, Switzerland, in early January. Similar requests were made in an IMF report on virtual currencies and a recent report by the UK Government Science and Technology Office, describing how blockchain technology can be used in both the public and private sectors to improve governance and regulation.

The goals of regulation are the same - but the regulatory mechanisms to achieve them are different. These can all be achieved in a better, faster, and cheaper way by relying on blockchain as a regulatory technology.

Challenges of drafting laws and regulations

The problem, of course, is that the same technology could be used by other organizations or individuals to engage in illegal activities. Take the Silk Road anonymous drug market, for example, where Bitcoin was used as a payment system to trade illegal drugs. So, it’s clear that this disruptive technology needs some kind of regulation.

The challenge is that most regulations today are defined by the products they are meant to regulate. Legal regulations are therefore vertical, while the innovation enabled by blockchain is more horizontal: it is a cross-cutting innovation that will impact many different sectors of society. The debate around categorizing this technology as cryptocurrency actually falsely limits the challenges and opportunities of this new technology.

Blockchain is an emerging technology that has yet to realize all its potential. What we see today is just the tip of the iceberg; we don’t yet know how this technology will develop and what opportunities it will bring. However, by analogy, the application of blockchain technology can be understood as many things we know: it can be seen as a currency, a security, or a commodity, etc.

The problem is that none of these characteristics properly explain the horizontal nature and universality of blockchain technology. I believe this is an important concept that can help us better understand this new technology and come up with a sound regulatory framework without being distracted by the current hype against Bitcoin and other cryptocurrencies. [Compiled by Jing Yuzhen]