Digital currencies are cutting across borders. Here’s how regulators can catch up

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: John Ho, Head of Legal, Financial Markets, Standard Chartered Bank, Erin English, Director, Thought Leadership and Policy Research at Visa, Visa, Alejandro Rothamel, Chief Legal Officer, Ripio, Shearin Cao, Executive Director, Group Public and Regulatory Affairs, Standard Chartered Bank & Yan Xiao, Project Lead, Digital Trade, World Economic Forum

• Central bank digital currency and stablecoins promise considerable streamlining of global payments.
• Regulation of these complex technologies is fragmented both domestically and internationally.
• The World Economic Forum is working to create frameworks for a more coherent regulatory environment.

Globally, there is an accelerated shift towards digital payments and the ownership and use of digital currency. These innovations have also kickstarted long-overdue conversations not just between private enterprise and regulators, but also among regulators internationally and within jurisdictions. The outcome of these conversations will have profound implications on how society harnesses the potential benefits of digital currencies and avoids unnecessary risks.

Policy debates about digital currency have been going on since Satoshi Nakamoto released his bitcoin paper in 2008. The most recent debates focus on two forms of digital currencies: central bank digital currency (CBDC) and “stablecoins” (cryptocurrencies that peg their value to some external reference point). This is why they are the focus of the current work led by the World Economic Forum’s Digital Currency Governance Consortium (DCGC), which has produced eight policy frameworks to guide industry and policy-makers through some of the most critical challenges, opportunities and decisions related to CBDC and stablecoins.

Many digital currencies claim to be created for the purpose of improving existing payment systems and promoting financial inclusion. For a cross-border payment to take place, multiple intermediaries are typically involved, which slows down the process and increases the cost. Digital currencies claim to reduce transactional friction by bypassing intermediaries altogether. Such ambitions, the complex design behind the technology and the existing legal framework have exposed digital currencies to a fragmented regulatory environment with gaps, inconsistencies and redundancies at domestic and international levels.

The DCGC included in its report a detailed analysis of the regulatory and policy gaps and inconsistencies that exist for stablecoins and CBDC. There are four challenges in particular:

• First, existing laws and regulations may not be equipped to provide a legal basis for the existence of digital currency, or to address risks unique to certain forms of digital currency.
• Second, the complex design of stablecoins and lack of coordination domestically has led to overlapping jurisdiction of different regulatory agencies.
• Third, lack of global coordination has led to gaps and inconsistencies with respect to international stablecoin regulation, despite their potential global footprint.
• Finally, gaps and inconsistencies arise when the same risk across different types of digital currencies is treated differently for each respective one.

While different countries take different approaches towards CBDCs and stablecoins, we anticipate that they may be used in the same way by the consumers, and may even operate on similar blockchains. However, one potential issue is that similar types of risks may be treated differently in each case. The motivation for the recent DCGC paper is to help foster a balanced regulatory and policy environment for both innovations, and a way to examine their risks and how to mitigate them.

While the regulatory approach to digital currencies is still being shaped, some principles in law-making may be helpful to regulators who are trying to bridge the gap between innovation and regulation:

• Inter-agency and cross-border collaborations: Due to the complex design and inherent cross-border uses for digital currencies, regulators must work together, both between different domestic agencies and across jurisdictions. There are existing frameworks that allow inter-agency and cross-border coordination. Such coordination could be used to reduce potential regulatory and policy gaps, particularly in areas that concern the definitions and categorization of digital currencies.
• Risk-based approach: Sandbox and innovation labs are common types of risk-based approaches that have been adopted by many countries. Meanwhile, a proposal for an EU regulation on markets in cryptoassets (MiCA) exemplifies a different type of risk-based approach, which creates different levels of regulation based on the potential risks to which a digital currency may expose consumers and society.

The five-step framework for digital currencies

Policy development for digital currencies needs a consistent framework to avoid creating confusion for the payments ecosystem. Policy-makers will need to identify areas where existing regulations are sufficient – and where new regulations are needed for stablecoins and retail CBDC, and for an ecosystem where they will co-exist with other payment methods.

The DCGC paper proposes a five-step framework for identifying, preventing and addressing gaps and incompatibilities: risk-mapping; agency-mapping; forming a task force; setting priorities; and identifying gaps and inconsistencies. While this framework represents an oversimplified view of the legislative process and it may not be able to address all issues identified in the paper, we hope it provides a way forward in addressing regulatory gaps and inconsistencies in relation to emerging digital currencies.

What is the World Economic Forum doing about blockchain?

Blockchain is an early-stage technology that enables the decentralized and secure storage and transfer of information and value. Though the most well-known use case is cryptocurrencies such as bitcoin, which enable the electronic transfer of funds without banking networks, blockchain can be applied to a wider range of purposes. It has potential to be a powerful tool for tracking goods, data, documentation and transactions. The applications are seemingly limitless; it could cut out intermediaries, potentially reduce corruption, increase trust and empower users. In this way, blockchain could be relevant to numerous industries.

That said, blockchain also entails significant trade-offs with respect to efficiency and scalability, and numerous risks that are increasingly coming to the attention of policy-makers. These include the use of cryptocurrency in ransomware attacks, fraud and illicit activity, and the energy consumption and environmental footprint of some blockchain networks. Consumer protection is also an important and often overlooked issue, with cryptocurrency, so-called “stablecoins” and decentralized applications operating on blockchain technology posing risks to end-users of lost funds and also risks to broader financial stability depending on adoption levels.

Read more about the work we have launched on blockchain and distributed ledger technologies – to ensure the technology is deployed responsibly and for the benefit of all. We’re working on accelerating the most impactful blockchain use cases, ranging from making supply chains more inclusive to making governments more transparent, as well as supporting central banks in exploring digital currencies.

To prepare for the future, digital currency policy-makers must consider carefully how they should structure their laws and regulations, as well as how they create both domestic and cross-jurisdictional coordinated structures. This paper supports a measured, coordinated, multi-jurisdictional and inclusive approach in the creation and implementation of policies, laws and regulations, in order to limit the creation of gaps and inconsistencies from the outset. Such an approach could lay the foundation for sustainable innovation, align regulatory frameworks and foster greater global collaboration.