If cryptocurrencies are to work, they may require significant surrender to regulation

Wednesday August 14 2019



Raymond Mugisha

Raymond Mugisha 

By Raymond Mugisha

Like many other enablers of human activity, the future of money is digital. Money will become paperless in years to come. Cryptocurrencies, which are digital assets that use cryptography to secure the environment in which they operate, attest to this.

Bitcoin has been the most known cryptocurrency. Others include ethereum, ripple and litecoin. They represent a major shift in the way money has been perceived, used and regulated over time and therefore, understandably, have met with significant criticism.

Libra is another cryptocurrency planned for introduction to the world by Facebook, in association with a number of stakeholders including Visa, Mastercard, Coinbase, Uber Technologies, Vodafone Group, Mercy Corps and others. Facebook has issued a white paper highlighting key elements of how Libra will operate.

The United States House of Representatives Committee on Financial Services has however requested Facebook and its partners to halt the development of Libra, citing potential perilous implications for the global economy and financial system as well as privacy and security concerns, among others.

Regulators intend to first hold public hearings on the risks and benefits of Libra and explore legislative solutions.

One of the criticisms that have been cited regarding existing cryptocurrencies is that they are not backed. Modern paper currencies, also known as fiat money, derive their value from economic activity. They stand against demand and supply, as well as the stability of governments issuing them.

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The value of cryptocurrencies on the other hand, because they are not issued by Central Banks, is free from monetary policy and economic performance measurements that apply to traditional currency.

Their values depend on their own supply and the demand for them and other competing cryptocurrencies. This creates high-level speculation around these currencies, resulting in uncomfortably high degrees of volatility.

Any highly volatile currency is dangerous, for business purposes. It creates adverse spikes in commodity prices, unpredictability in cost of capital due to spinning interest rates and many more undesirables.

An entity’s profit margins could swing wildly across trading periods and balance sheets could amount to close to nothing in their use for helping to facilitate business decisions since assets and liabilities could register astronomical changes in value over short periods of time. Imagine if bitcoin took the place of the United States Dollar, today.

Assessing and communicating the soundness of business entities for wide usage, lending, raising capital, paying dividends and other routine business activities would be extremely confusing due to swinging value positions.

The process of administering taxes in such an environment would not be any less complicated. The complications of operating a business or reporting in a currency like bitcoin are backbreaking.

For example, by mid-2019 bitcoin had recorded a staggering 160 per cent change in value since January of the same year. Whereas in January 2017, its value played between $750 (about Shs2.7m) to $1,150 (about Shs4.2m) to one bitcoin, the value through numerous up and down spirals had shot to $13,800 (about Shs51m) by December 22, 2017.

By February 2, 2018, it had again fallen to $6,200 (about Shs22m). It fluctuated frequently up to June 2019 when its value rose back to $12,637 (about Shs46m) when Facebook announced Libra. The announcement seems to have reinforced faith in cryptocurrencies, hence pushing the value up.

Other challenges around cryptocurrencies relate to the danger they add to global plight regarding money laundering and terrorist financing threats. Cryptocurrencies have been mainly intended to disrupt the existing system and bypass regulation, resulting in challenges associated with money laundering control.

Going by Facebook’s indications about Libra, it is designed to address many of the above concerns. It is planned to be backed by a reserve of real assets; a collection of low-volatility assets, such as bank deposits and short-term government securities in currencies from stable and reputable central banks, to maintain the currency’s intrinsic value.

The reserve assets work to minimise volatility of Libra so that the currency can preserve value over time. The assets are to be held in currencies from stable and reputable central banks. Facebook also says it will innovate on compliance and regulatory fronts to improve effectiveness of money laundering control.

Regardless of Facebook’s modeling of Libra in order to make it 2.closer to regulation than older cryptocurrencies by far, concerns still abound as to the degree of independence that the system would have from regulators, and the dangers which such a state of affairs would spell.

As such, cryptocurrencies may require deeper embedding into the regulated global financial system to attain ground breaking acceptance and take off. This may take away some of the current attractive characteristics of cryptocurrencies but it is possibly worth it.

Raymond is a Chartered Risk Analyst and risk management consultant

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