Author: Rebecca Parry, Hakan Sahin & Alex Kastrinou
Rebecca Parry is a professor at Nottingham Law School, Nottingham Trent University, UK, and a member of the CIFL Board of Advisors. Dr. Hakan Sahin is a lecturer and Alex Kastrinou is a principal lecturer at Nottingham Law School, Nottingham Trent University, UK. This blog piece is a part of the series which features contributions by the members of our Board of Advisors.
Cryptocurrencies have gained great public attention, but they have also emerged as a threat in many directions, including risks to consumer finances, vehicles for money laundering and undermining of national fiat currencies. In this fast moving and technologically complex area, there are difficult regulatory choices to be made and countries have reacted in different ways. In India, an initial response has been taxation and there are also prospects of a ban on private cryptocurrencies, combined with the development of a virtual rupee. Based on research at Nottingham Law School, there is evidence from another emerging economy, Turkey, that suggests that a different approach might be feasible.
It is firstly necessary to briefly explain some terminology, since not all cryptocurrencies are alike. The earliest and best-known cryptocurrency, Bitcoin, emerged as an anti-establishment approach, whereby transactions are verified without the input of traditional intermediaries. Rather, transactions are verified in a distributed and immutable manner through peer-to-peer proof of work and recorded on a blockchain. We can regard this type as “traditional cryptocurrencies” and rivals to Bitcoin on this model have emerged, such as Dogecoin and Ether. Although these cryptocurrencies emerged as enabling peer to peer transactions, they are more commonly traded using exchanges as intermediaries. Traditional cryptocurrencies rely on a combination of limited supply and increasing demand for their value, which leads to uncertainties in valuation. In contrast, ‘stablecoins’ such as Tether were developed as a response to the volatility of traditional cryptocurrencies. The value of stablecoins is backed by assets and although these can be stable assets, typically US dollars, some stablecoins are backed by assets whose value can be harder to ascertain, such as bundles of non-fungible tokens. Some of the most important questions relating to cryptocurrency are environmental, with criticism of energy intensive proof of work verification and favour towards validator consensus, proof of stake and yield farming verification.
The case of Turkey is interesting because the volatility of the domestic Lira coupled with the distrust towards the government’s economic policies, have caused many consumers to embrace cryptocurrencies. Its example can therefore provide some insights as to the approach of consumers to cryptocurrencies in an unregulated market where there is distrust towards the fiat currency. A research project at Nottingham Law School, involving a pilot study of elite interviews with Turkish industry professionals, has revealed some interesting aspects of this trend.
The main finding of our research was that in Turkey the preference has been to invest in stablecoins as opposed to more volatile traditional cryptocurrencies, such as Bitcoin. In particular, the tendency amongst Turkish consumers is to opt for cryptocurrencies such as Tether, which have monetary backing and whose value is pegged to the US dollar. This approach towards more stable, less volatile cryptocurrencies is perhaps explained by reference to the cultural habits of Turkish consumers, who are no strangers to financial turmoil and have traditionally kept their wealth in assets with relatively stable values, either in gold or US dollars.
Although the Turkish approach towards cryptocurrencies appears to be guiding consumers to safer and less volatile options, this is arguably, not due to a clear governmental policy, but rather largely influenced by cultural trends as well as advertising campaigns and social media. In the absence of specific crypto regulation, our initial finding from the Turkish example may therefore suggest a viable policy of trusting consumers to reach the right decisions once they have been provided with the right information about different types of cryptocurrencies, especially considering that their personal wealth is at stake.
It is therefore of significant importance to have safeguards in place which ensure that consumers have access to the right information, to limit the potential for unwitting investments of life savings in excessively volatile assets. Such an approach can mitigate survivorship bias: the tendency to focus only on successful examples, which can lead to risk of investments in volatile assets being underestimated. Interestingly, an approach of investor information has been taken in the UK, which presently also lacks cryptocurrency regulation. The UK has instead focused attention on fair and clear advertising and has issued warnings regarding the potential for loss from cryptocurrency investment alongside money laundering controls.
Greater regulation of cryptocurrencies is perhaps inevitable and indeed legislation in Turkey is expected, as a report has been issued by the Research Services Department of the Turkish National Grand Assembly. Building on our Turkish study and UK example, it is suggested that a layered-approach, which distinguishes between different categories of cryptocurrencies, is preferable.
- Efforts to regulate the traditional cryptocurrency area are likely to be beset with difficulties since traditional cryptocurrencies such as Bitcoin are designed to operate outside of regulatory frameworks, also their complexity can mean that it may be difficult to regulate in a way which does not leave gaps that can be exploited. In any case, a lack of international standards gives the potential for regulatory arbitrage. Given these difficulties, attention can be focused on public education about the volatility and environmental impact of these assets, including controls on information and advertising. Informed consumers can invest their money as they see fit.
- Some of the risks to economies presented by traditional cryptocurrencies can also be limited through controls on the ability of state and financial institutions to invest in traditional cryptocurrencies.
- Regulatory efforts can focus instead focus on stablecoins, which resemble more traditional financial investments and should be regulated accordingly. Claims that stablecoins offer greater stability therefore need to be backed with substance regarding the underlying assets and with safeguards similar to those of traditional financial investments.
Having completed this pilot study, we will investigate further the implications of cryptocurrencies for emerging and developing economies and the different regulatory approaches adopted.
The views expressed in this article are those of the author and in no way do they reflect the opinion of the Centre for Insolvency and Financial Laws or any of its Board of Advisors.