By Jason de Mink
Ongoing innovation creates opportunities to improve the general wellbeing of mankind but with the advent of new technologies also comes great challenges for nations and their citizens. Cryptocurrency (also known as ‘virtual currencies’ or ‘cryptographic money’) is one such innovation, rapidly becoming a significant reality in the modern financial world and making major inroads into the areas once dominated by traditional payment methods.
The South African National Treasury has cautioned the public to remain extremely vigilant of the risks and benefits which accompany cryptocurrencies. They evolve rapidly and have a number of attributes making them attractive as a payment method. These are the ability to instantaneously transcend national borders while providing anonymity and security due to high-level encryption.
Cryptocurrencies, therefore, present governments, institutions and law enforcement agencies with complicated challenges, having been linked, inter alia, to crimes related to financing for assassinations, corporate espionage, pornography, drugs and weapons.
While currently unregulated, this emerging technology is being carefully monitored and strict controls may be imposed at any moment due to its wild price fluctuations, potential for fraud, and undoubted potential for use by criminal elements.
However, despite the negative perception in some quarters, it is clear that cryptocurrencies and the block chain technology that underpins them provide a refined, efficient and adaptable peer-to-peer platform, which empowers the average citizen to deal with their finances without government and bank interference.
The rise of cryptocurrency
In a recent World Economic Forum Report: The Future of Financial Services (2015), The World Economic Forum (WEF) described traditional value transfer across geographies as ‘[a] centralized model, rife with cost and complexity’ with its basic elements having ‘been in place for more than 150 years, since telegraph companies began “wire transfers”’. The WEF has identified that the payment industry is undergoing a major revolution that has enormous implications for providers of payment services as well as the end-users of these services.
Virtual currencies have been identified as ‘compelling alternatives to traditional value transfer’, with Bitcoin being mentioned as a method to ‘radically streamline the transfer of value’ via a ‘simpler, faster and more efficient process, in which payment and settlement happen simultaneously within a closed system that is highly transparent to both sender and receiver’ and free of the ‘complex process relied upon in the traditional method’ which makes it ‘potentially vulnerable to fraud’ (http://reports.weforum.org, accessed 1-11-2017).
A cryptocurrency, such as Bitcoin, is a digital or virtual currency utilising encryption (cryptography) for security. A cryptocurrency is difficult to counterfeit because of this high-level security feature. A defining feature of a cryptocurrency is its ‘organic nature’; it is not issued by any central authority and is not denominated in any national currency, rendering it theoretically immune to government control, intrusion or exploitation (www.investopedia.com, accessed 1-11-2017).
Bitcoin is a decentralised, anonymous/pseudonymous payment network (D Bryans ‘Bitcoin and money laundering: Mining for an effective solution’ (2014) 89 Indiana Law Journal 441 at 443). It operates on a peer-to-peer platform, meaning that transactions occur directly between users, without the need for a wider institutional framework (ie, the bank). Bitcoin is by its very nature international in scale, is more secure than previous electronic payment methods and carries within it protection against inflation (https://bitcoin.stackexchange.com, accessed 1-11-2017). All-in-all, Bitcoin is viewed by many as a superior payment mechanism.
At the same time, the viability and growth of these innovations have led to heightened concerns about their use, as they allow both legal and criminal users to transfer money nearly instantly across jurisdictions. Coupled with features such as low/no costs, ease of access, virtual anonymity and no public records, it is evident why cryptocurrencies are on most countries’ regulatory radar (D Bryans (op cit) at 447).
Some governments are concerned that anonymised, peer-to-peer private payment systems will weaken measures to control the value of their own currencies, in the worst-case scenarios making them potentially vulnerable to catastrophic and unprecedented attack by speculators. Naturally, uncontrolled anonymous outflow of value is also of grave concern to nation states.
These concerns have led to actual or potential regulatory measures in various jurisdictions:
Canada appears to be a leader in the field of regulation, with the most cogent, detailed and sophisticated legislative measures to regulate Bitcoin, being the first jurisdiction in the world to introduce concrete legislative measures to regulate Bitcoin (T Ahmad ‘Canada: Canada Passes Law Regulating Virtual Currencies as “Money Service Businesses”’ www.loc.gov, accessed 13-11-2017). So far, however, in the United States there has been little attempt at regulation while the cryptocurrency is currently unregulated in South Africa (SA).
Recent trends, case law and legislation
In 2014 a civil case in the Netherlands resulted in a judge declaring that Bitcoin was not money, as it did not meet the criteria of legal tender within the region (P Rizzo ‘Dutch court declares Bitcoin isn’t money in civil trial’ www.coindesk.com, accessed 14-11-2017).
The same result was achieved in the 2016 case of The State of Florida v Michell Abner Espinoza Criminal Division Case no. F14-2923, (Fla. 11th Cir.Ct.2016). The accused and an accomplice engaged in fake transactions with undercover agents through an online marketplace and converted US$ 30 000 of cash into Bitcoin.
They were charged under Florida’s anti-money laundering law but were acquitted on all charges because the court did not deem Bitcoin as money, stating that ‘Bitcoin has a long way to go before it [becomes] the equivalent of money.’ This decision has very recently been taken on appeal.
The Espinoza case characterised the conflicting definitions of what cryptocurrency across the US federal, state and local governments is. Adding to the confusion is the guidance published by the US Department of the Treasury Financial Crimes Enforcement Network ‘Application of FinCEN’s Regulations to Persons Administering, Exchanging or Using Virtual Currencies’ (www.fincen.gov, accessed 14-11-2017) in 2013 that ‘“virtual” currency [cryptocurrency] is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency … [and] does not have legal tender status in any jurisdiction’.
Further, as a direct response to the failure to convict Espinoza, House Bill 1379 was recently passed in Florida, defining virtual currency and prohibiting its use in laundering criminal proceeds.
The resulting outcome is that criminals using cryptocurrencies will be charged with money laundering, as well as the underlying criminal activity.
This trend is being followed in many US states and recent cases in the US mostly seem to accept a wider definition of money into which cryptocurrencies can fall, although divergent views still exist.
The use and legality of cryptocurrency
As a payment mechanism a cryptocurrency can facilitate greater flexibility, efficiency, speed, widen operational reach and may reduce the costs associated with the conventional banking system.
Cryptocurrencies such as Bitcoin are popular for the following reasons:
They have no direct links to the laws, rules or regulations of any government, institution or bank. The interest rates, fees and charges usually payable on a traditional banking account (current, savings, credit card, etc) do not have any effect on the cryptocurrency.
The rate of inflation that can potentially diminish the purchasing power of government-issued currency cannot affect the value of cryptocurrency.
Cryptocurrency provides its users with total anonymity, as opposed to traditional purchases with a debit or credit card where personal information attaches to each and every transaction. It is now recognised internationally that businesses, banks and even governments utilise this information to track individuals and take note of purchases. In contrast, cryptocurrency transactions carry no personal information unless added by the user.
Accounts that hold traditional currency are subject to national laws that allow them to be garnished or frozen completely, while cryptocurrency exists outside the regulations and laws that allow this to happen.
Using credit cards or bank accounts for international transactions lead to delays. Being linked to the legal tender of a specific government can render attempted payments subject to exchange rates, fluctuating interest rates, and country-to-country transaction fees, which can slow the process.
Users worldwide can download the free, open-source software with which they can transfer funds securely, anonymously and virtually instantaneously across vast distances.
Virtual currencies in SA
The South Africa Reserve Bank (SARB) does not currently oversee, supervise or regulate the sphere of virtual currencies. While it does not have any views regarding the effectiveness, soundness, integrity or robustness of virtual currencies as a payment system, the SARB contends that there is no significant risk to financial stability, price stability or the National Payment System (South African Reserve Bank Position Paper on Virtual Currencies December (2014) at 12).
However, while the SARB sees no significant risk in cryptocurrency, it has cautioned end-users, whether individuals or businesses, that any activities performed or undertaken with such currencies are at their sole and independent risk. It has in the past warned that ‘Bitcoin has no legal status or a regulatory framework. Thus it poses a number of risks for those that would choose to transact with it such as the lack of guarantee of security, convertibility or value’ (L Donnelly ‘Bitcoin: Is virtual currency here to stay?’ https://mg.co.za/, accessed 1-11-2017).
According to the South African Reserve Bank Act 90 of 1989, the SARB governs the management of currency and has the sole right to issue coins and notes, commonly known as ‘legal tender’. Bitcoin, however, falls outside of the definition of legal tender. Consequently, it may be possible to argue that payments made via Bitcoin in SA may not discharge a debtor’s monetary obligation and purchasers run the risk that their Bitcoin payments are not recognised by SA law. Merchants are also not legally obliged to accept Bitcoin as legal payment, whereas they may not refuse legal tender.
Additionally, virtual currencies are not defined as securities in terms of the Financial Markets Act 19 of 2012. They are, therefore, not subject to the regulatory standards that apply to the trading of securities.
Bitcoin operates without the authority or administration of any state or banking institutions. This leads to various issues, including concerns about –
Its ease of use and low transaction costs provide an attractive alternative to traditional banking, but clearly raise sufficiently serious concerns to place it on most governments’ radar.
Cryptocurrencies are not illegal per se. They are regularly utilised by consumers to conclude all manner of legitimate transactions. These highly secure payment methods allow rapid funds transfers effortlessly across national borders without being linked/pegged to any particular country’s currency or being impeded by exchange controls, banking costs etcetera.
Potential dangers
Clearly, cryptocurrencies can be harnessed by criminals to further their illegal aims and provide a platform for, inter alia, money laundering and the financing of terrorism (South African Reserve Bank Position Paper on Virtual Currencies (op cit) at 5). In the early days of cybercrime, only extremely knowledgeable and skilled criminals could effectively harness the Internet for nefarious purposes.
With modern criminals becoming increasingly technically proficient and with systems becoming simplified, cryptocurrency is being embraced by a far wider demographic within the criminal classes.
There is a widely held view that an entirely new knowledge base will need to be developed by law enforcement and anti-money laundering agencies to identify and investigate suspicious transactions (J Mari, and P Warrack ‘Blockchains and Money Laundering’ https://slidelegend.com, accessed 13-11-2017).
Conclusion
Cryptocurrencies are prevalent in almost every country in the world. They offer a potential benefit by increasing access to simplified and efficient payment methods, but they also create potential risk for nations and individuals, as they may be harnessed by criminals to enhance their capacity to carry out money laundering, terrorist financing and other cybercrimes.
It is accepted that criminals are inclined to exploit services with weak or nonexistent anti-money laundering and customer identification programs. Those systems generally flourish in countries with poor regulatory oversight and ineffective enforcement (B Nigh and CA Pelker ‘Virtual currency: Investigative challenges and opportunities’ https://leb.fbi.gov, accessed 1-11-2017).
The true danger of cryptocurrency is that it is not a traditionally-valued or backed currency; it has the value ascribed to it by its users. It is instantaneous, virtually untraceable, and can allow individuals, groups, companies or even entire countries to exit traditional value-based markets. Imagine a ‘Brexit’ that included the introduction of a currency available to every human being on the planet, with no rules, no values, just cold, hard exchange, free of regulation, laws etcetera. Taken to its worst case scenario, global superpowers could fund terror via a cryptocurrency without there being a possibility of any sanctions. If you ‘opt out’, then the traditional methods of ‘punishment’ do not apply.
While many jurisdictions are still struggling with implementing appropriate anti-money laundering, know-your-customer and customer due diligence programs (Acting Assistant Attorney General Mythili Raman Testifies Before the Senate Committee on Homeland Security and Governmental Affairs (www.justice.gov, accessed 1-11-2017)), the use of cryptocurrencies by both law abiding citizens and their criminal counterparts is set to increase (B Nigh and CA Pelker (op cit)).
The use of cryptocurrency clearly presents law enforcement with various unique challenges but these difficulties are by no means insurmountable. Regulators and investigators will still be able to employ traditional investigative techniques, adapted as necessary to address modern criminal capabilities (B Nigh and CA Pelker (op cit)).
It is apparent that the developments in the sphere of cryptocurrency will require a more coordinated and internationally integrated regulatory framework in future. The challenge for each jurisdiction, as well as global organisations, is maintaining a balance between the introduction of comprehensive, adaptable and robust regulatory systems (criminal, financial, legal) and protocols, while enabling and supporting technological innovation and growth.
Jason de Mink BA LLB LLM (UCT) Certificate in Money Laundering Detection and Investigation (UP) is an attorney at De Mink Attorneys in Cape Town.
This article was first published in De Rebus in 2017 (Dec) DR 30.
