Blockchain And Digital Finance: Regulatory Issues And Possibilities – Technology

INTRODUCTION

Over a decade ago, Satoshi Nakamoto, the unknown person or group
behind bitcoin described how blockchain technology could be used to
solve the double-spending problem. Over a decade later and
blockchain is now completely changing the ways we think about and
use digital currencies. From the widespread acceptance and use of
cryptocurrencies enabled by blockchain to central banks adopting
digital currencies that are based on blockchain technology.

With more people using cryptocurrency as a medium of exchange
and for trading purposes, there are increasing regulatory concerns
especially due to the decentralised nature of blockchain which is
the underlying technology. The subject of regulation of
cryptocurrency and blockchain has been widely debated among various
governments. Some governments have issued regulations and guidance
relating to blockchain technology while some have remained
undecided and have not put out any official statements regarding
this technology. Some other governments have decided to completely
ban cryptocurrency because they believe it will cause a loss of
economic power and cause a shift towards decentralised economies
globally. This means that currently, no uniform regulation of
blockchain technology exists globally.

This article puts forward the idea that regulation of this
technology is necessary, but not just any type of regulation. The
regulation of this technology must be efficient and smart, this
article explores the type of regulatory provisions that can be
applied to blockchain technology.

WHY DOES BLOCKCHAIN MATTER

When it comes to digital finance and virtual currencies,
cryptocurrency is at the forefront of most people’s minds.
However, blockchain is the underlying technology that powers most
cryptocurrencies and smart contracts. Blockchain is a decentralised
database that records transactions and assets across a peer-to-peer
network. The transactions are secured through cryptography and
transactions are locked into a ‘block’.

In February 2021, the Central Bank of Nigeria (CBN) issued a
circular that instructed that dealing in cryptocurrencies or
facilitating payments for cryptocurrency exchanges is prohibited.
In effect, this was a ban on cryptocurrency in Nigeria. Blockchain,
however, is not banned seeing as the CBN has issued the eNaira
which runs on blockchain technology. This means that currently,
Nigeria has not yet issued clear regulations on blockchain
technology.

Blockchain is a tremendously disruptive technology, and it is an
area where innovation is not constrained, the potential use cases
for blockchain are still being investigated. Transparency,
traceability, security, and reduced prices are some of the benefits
of blockchain. Once stored on a blockchain, transactions and
information cannot be removed or tampered with/edited. Blockchain
having lower transaction costs than traditional financial
institutions is another major selling point that will spur the
general acceptance of blockchain technology.

Blockchain has the potential to create new foundations for our
economic and social systems.1 Apart
from cryptocurrency, smart contracts are also another
transformative application. Smart contracts automate payments and
the transfer of funds once certain conditions are met. They are
fast, cheaper and a more secure way of managing agreements between
parties.

Cryptocurrency is gaining an unprecedented level of legitimacy
around the world which makes it unreasonable to completely ban it.
The impact of blockchain potentially goes beyond just digital
finance, it can impact other areas like the way we vote, the way
information is generally stored, even the healthcare industry will
also be impacted. Technology with this type of potential cannot go
unregulated and should also not be subject to improper
legislation.

Additionally, regulation of blockchain and by implication
cryptocurrency and smart contracts will be instrumental in
legitimising and increasing public trust in these technologies.
Regulation of blockchain will also go a long way towards mitigating
financial crimes. This is because blockchain is transparent,
everyone who is on the network can see the different transactions
that have been carried out.

CHALLENGES IN REGULATING BLOCKCHAIN

The regulation of blockchain presents several legal issues. One
concern is determining who is responsible if something goes wrong,
as well as jurisdictional issues associated with this. Because
there is no single location where blockchain is located, each
network node may be subject to varied legal obligations depending
on its location.

Because the potential use cases for blockchain have yet to be
fully explored, implementing regulations and laws that are dynamic
enough to successfully cover use cases that do not yet exist will
be a major legal difficulty in the regulation of blockchain.

Another challenge is ensuring that the data recorded in each
blockchain node is accurate. Regulation is required in the areas of
data protection and the authentication of legal persons’
identities. Legal acknowledgement of each block in a blockchain as
immutable is also required.2

Another factor to consider is the legal framework for smart
contracts. Different laws may apply to the parties participating in
smart contracts in different jurisdictions. When a smart
contract’s code has an error and the contract fails, the
problem of liability arises again.3

REGULATION

In view of how the growing importance of blockchain, the
proposed method of regulating this technology will now be
considered. The first way blockchain can be regulated is by
requiring the providers of blockchain technologies like
cryptocurrency exchange platforms to comply with Know-Your-Customer
(KYC) requirements. Compliance with this will address the issue of
the so-called anonymity of blockchain transactions. Blockchain
transactions are anonymous to the extent that each user has a
unique ‘address’ assigned to them and you do not need to
reveal anything about identity in that address, this anonymity is
however limited. If the address given to a user is traceable to a
particular individual, then the anonymity and identification
problem associated with blockchain transactions will be eliminated.
Therefore, requiring blockchain (cryptocurrency) platforms to
collect the mandated information from the users of the platform
will mean the regulators and the government can easily link an
address with the individual.

A possible issue with this approach is that it may be difficult
in terms of international standardization.4 Where some countries require the
satisfaction of KYC standards and some do not, there may be a gap
between transactions recorded in one specific blockchain. There may
also be an issue in terms of cross-chain communication which allows
for communication before different block-chain networks. Some
addresses in a blockchain can be easily linked due to KYC
requirements in the relevant jurisdiction, while some other
addresses remain anonymous.

The government having access to this information may raise data
privacy issues, but the transactions are still secure in the sense
that it is only regulators who can see the true identity linked to
addresses. Also, in relation to this form of regulation, there are
some concerns that this will create more data silos globally.5 However, it is arguable that the
global adoption of central bank digital currencies (CBDCs) that are
run on the blockchain network also creates this same issue.
Furthermore, it is important that we do not forget that regulation
of this technology is essential to the proper legitimisation and
acceptance of cryptocurrency and blockchain technology.

Another approach that can be taken is an amendment of our
Anti-Money Laundering (AML) Laws. The Financial Action Task Force
(FATF), an international monitoring body on money laundering and
financing of terrorism set out some guidelines regarding the
regulation of cryptocurrency. One of the notable recommendations
was for countries to require businesses to collect and store the
personal data of participants in blockchain transactions.6

In the United Kingdom (UK), the AML regulations were extended to
capture the activities relating to most crypto assets. In the
European Union (EU) as well the 5th AML directives for
the first-time captured cryptocurrency and crypto providers, they
now fell under the regulatory scrutiny of the EU.7 So, similarly, Nigeria should extend
its AML laws to cover cryptocurrency and crypto providers so that
they must meet the same standards expected from financial
institutions.

The suggestions mentioned above may address certain issues that
blockchain and cryptocurrency now pose but it is important to
consider regulating the underlying technology and not just the
products of the technology. Usually, regulations relating to the
FinTech industry are applicable to the financial institution, not
the technology it employs in providing its services. It was the
financial bodies such as banks that were the subject of
legislation, they were simply responsible for ensuring the
efficiency of the applications they used to deliver their services.
Blockchain however is decentralised so this form of regulation will
not be effective or smart.

The suggestion here is that in the case of blockchain
technology, the underlying technology should also be regulated in
order to attempt to catch future innovations that may be based on
blockchain technology. A blockchain is a form of distributed ledger
technology (DLT). The nature of this form of technology makes it
very disruptive, this further underscores the need to regulate the
underlying technology. Some features of DLTs and blockchain include
decentralisation, that is, no single party may impose decisions
taken on the content stored and the transactions processed. The
data stored is also stored in multiple locations, it also can not
be changed or deleted. Lastly, the transactions cannot be reversed,
and parties are largely anonymous.

These features make it possible to use a smart contract for
illegal services such as hiring hitmen. Code errors are also
another possible issue, this means the code indicates one form of
behaviour which is what the user requests it to do, but there’s
an error in the code so it performs another request that the user
did not expect. In response to these issues, the method of
regulation suggested is to provide for a ‘supervisory node’
in the blockchain network, similar to what exists in Malta.8

For blockchain transactions, before a transaction is locked into
the network as a block, it must be verified and authorised. This
verification and authorization are usually done by nodes in the
blockchain network. So, a supervisory node will be a part of the
blockchain network and will be supervised by the regulators. The
supervisory node will act as a data reporting entity and a payments
network rule-enforcer, it can also act as an auditor. The
supervisory node may be implemented in various ways, one way being
the regulator will oblige blockchain platforms to provide the
regulatory body with the node(s). Another way places the burden on
the regulatory body to create the node and integrate with the
various blockchain networks.

CONCLUSION

In conclusion, completely banning blockchain or cryptocurrency
or refusing to regulate this technology is unreasonable and is not
feasible. So, the proposed regulatory method to be adopted is one
that fuses compulsory KYC compliance with the provision of
supervisory nodes in various blockchain networks. It is also
advised that the current laws addressing technology and financial
institutions as well as AML provisions are revised and extended to
include blockchain technology.

Footnotes

1. ‘The Truth
About Blockchain’, Marco Iansiti and Karim R Lakhani (2017), https://hbr.org/2017/01/the-truth-about-blockchain

2. Maria Tena,
‘7 Regulatory Challenges Facing Blockchain’ 2017,
(https://www.bbva.com/en/7-regulatory-challenges-facing-blockchain/)

3. Maria Tena,
‘7 Regulatory Challenges Facing Blockchain’ 2017,
(https://www.bbva.com/en/7-regulatory-challenges-facing-blockchain/

4.
‘Regulating Crypto is essential to ensuring its global
legitimacy’, (20), Henrik Gebbing, Wilhelm Noffke, https://techcrunch.com/2021/08/16/regulating-crypto-is-essential-to-ensuring-its-global-legitimacy/

5. ibid

6.
‘Regulating Crypto is essential to ensuring its global
legitimacy’, (20), Henrik Gebbing, Wilhelm Noffke, https://techcrunch.com/2021/08/16/regulating-crypto-is-essential-to-ensuring-its-global-legitimacy/

7. Global Legal
Insights. ‘Blockchain & Cryptocurrency Laws and Regulations
2022’
(https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations/united-kingdom)

8. Regulating
Blockchain, DLT and smart contracts: a technology regulator’s
perspective, (2020), Joshua Ellul, Jonathan Galea, Max Ganado,
Stephen Mccarthy, Gordon J Pace, (https://link.springer.com/article/10.1007/s12027-020-00617-7)

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.