BIS calls for ‘redrawing of regulatory boundaries’ around crypto

Regulation will have to adapt to “new reality”, says BIS, suggesting new ways the underlying technology could improve financial efficiency

Regulators should monitor whether and how banks deliver or receive crypto assets as collateral, the BIS says

The Bank for International Settlements (BIS) has called for regulatory boundaries to be “redrawn”, now that crypto assets have become a mainstream feature of the world economy.

In an early release chapter of its annual report, the bank for central banks analyses the role played by crypto assets in today’s economy and considers whether such instruments have the power to displace traditional forms of money.

“[Crypto assets] garner attention because they promise to replace trust in long-standing institutions… with trust in a new, fully decentralised system founded on the blockchain and related distributed ledger technology,” the BIS says.

Concluding “decentralised cryptocurrencies” such as bitcoin suffer from a number of shortcomings that mean they “do not work as money”, the BIS turns its attention towards other possible applications and subsequent regulation.

Fraud, investor protection, anti-money laundering and terrorist financing are among the BIS’s key concerns around the oversight of crypto assets, since the anonymity granted to those currently using blockchain infrastructure can facilitate criminal activity.

Both the G20 and several central banks already recognise the need for strengthened or new regulation to monitor crypto asset activities, but given the instruments “do not fit easily into existing frameworks”, the BIS notes work has yet to get under way.

Cryptocurrencies live in their own digital, nationless realm and can largely function in isolation from existing institutional environments or other infrastructure… As a result they can be regulated only indirectly

Bank for International Settlements

“Cryptocurrencies live in their own digital, nationless realm and can largely function in isolation from existing institutional environments or other infrastructure… As a result they can be regulated only indirectly,” it says.

The BIS has therefore called for regulators to be given “enhanced” regulatory capabilities and for a “redrawing of regulatory boundaries”, given the “novel risk profiles” of the new assets.

The new boundaries must “fit a new reality in which the lines demarcating the responsibilities of different regulators within and across jurisdictions have become increasingly blurred”.

The BIS says the new regulation will need to be explicitly targeted. Currently, financial products based on distributed ledger technology need, ultimately, to be converted into sovereign currency. Regulators should begin to monitor whether and how banks deliver or receive crypto assets as collateral, the BIS says. “Regulation could focus on the point at which a cryptocurrency is exchanged into a sovereign currency”, ensuring AML/CFT regulation is abided by.

Regulation applied to payment services in terms of “safety, efficiency and legality of use” could also be made applicable to crypto asset infrastructure, while tax and capital treatment rules for those wishing to trade the new crypto-related assets could also be adapted.

Blockchain constrained by use cases

In its analysis of possible use cases, the BIS coins the term “cryptopayment” – a centrally controlled payment system that transacts in sovereign money, but over a blockchain network. It says permissioned cryptopayment systems “have promise” with respect to small-value cross-border payments, which is important for countries with a large share of the workforce living overseas.

Currently, international payments involve multiple intermediaries, which often leads to high usage costs. A cryptopayment infrastructure would get rid of these additional costs, the BIS believes.

“More important use cases are likely to combine cryptopayments with sophisticated self-executing codes and data-permission systems,” it adds.

Some decentralised crypto protocols already allow for smart contracts to “self-execute” derivatives payments, but the BIS claims the efficiency of these systems is “constrained by the low liquidity and intrinsic inefficiencies of permissionless cryptocurrencies”.

“The underlying technology can be adopted by registered exchanges in permissioned protocols that use sovereign money as backing, simplifying settlement execution,” the BIS says. “The added value of the technology will probably derive from the simplification of administrative processes related to financial transactions… crucially, however, none of the applications require the use or creation of a cryptocurrency.”

This article originally appeared on Risk.net’s sister website, CentralBanking.com.