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Cryptocurrencies need regulation-lite

Asia should lead with rules that hit market abuses but allow innovation

Cryptocurrency regulators need to strike the right balance between security and technological advance.   © Reuters

Digital thieves are making crime scenes out of Asia's most promising financial centers.

Japan, Vietnam and India each suffered headline-grabbing cryptocurrency heists this year. Not the image officials hope to project as they seek a piece of the financial boom industry of the moment. That is especially so as two of Asia's most closely watched exchanges move to tiny Malta, where regulations are less onerous.

The Mediterranean island state, population 440,000, is positioning itself as a "natural destination" for businesses in the virtual economy space. First to go was Hong Kong-founded Binance, the world's largest cryptocurrency exchange. Next is OKEX Technology, ranked No. 4 by traded value among virtual currency venues. Asked why OKEX is headed to Malta, Hong Kong-based Chief Executive Officer Chris Lee credited its "forward thinking" government.

That is a wake-up call for Asian governments thinking they are on the cutting edge. Yet the crime tape strewn across Tokyo, Ho Chi Minh City and New Delhi also warrants taking a step back.

Hackers can and will penetrate any system, of course. But the sheer number of thefts in Asia speaks to the region's enthusiasm to harness a movement disrupting the global finance game. Regulators, even in rich countries, are struggling to catch up.

Japan, for example, is positioning itself as cryptocurrency central. Since a massive $530 million digital money heist in January, authorities directed Japan's 16 government-registered exchanges to create a self-regulatory body. In 2017, Japan became the first government to oversee cryptocurrency dealing on a national level.

Japan was still smarting over the 2014 Mt. Gox scandal that saw $470 million of Bitcoins vanish. In January, though, another Tokyo exchange that had not yet been approved, Coincheck, got hacked, tarnishing Japan Inc.'s hopes of leading a young, promising industry anew.

If risk-averse, rules-obsessed Tokyo is running into trouble, what hope do less developed and less transparent governments have? Take Vietnam, where an alleged $658 million scam involving Modern Tech JSC has become a central issue for Prime Minister Nguyen Xuan Phuc. He is struggling for a coherent response. On the one hand, he directed regulators to strengthen "the management of activities related to bitcoin and other virtual currencies." On the other, he urged financial companies to avoid handling cryptocurrency transactions, which authorities had previously said are illegal.

Vietnam is emblematic of the balancing act taking place across Asia: harnessing the business potential of blockchain technologies, while curbing the mania driving valuations into the stratosphere. Yet it is fair to say that less-developed markets, like Vietnam, will be chronic targets of hackers eyeing lapses in cybersecurity and regulatory loopholes.

Asia seems particularly vulnerable as thieves find weaknesses by exploiting one of the region's strengths: an entrepreneurial spirit highly open to new ideas. Asia has raced ahead with fintech innovation. This early-adopter imperative, though, seems to have collided with a get-rich-at-all-costs approach that attracts the most innovative cyber thieves.

What is needed is a global authority that creates a regulatory framework for cryptocurrency issuance, trading and security. Asia could lead the charge, making the case for an international body. One with supranational powers, but also staffed by regional representatives to provide input, local intelligence and help supervise decision-making. That way, even one-size-fits-all solutions would incorporate Asia's unique needs.

This will sound anathema to virtual currency dogmatists. Yes, government involvement defeats the purpose of Bitcoin. The whole idea is, after all, anonymity and finding a space outside conventional finance. Yet the cybercurrencies are almost certainly on a collision course with governments like Donald Trump's and Xi Jinping's. The first whiff of intelligence that even hints at ISIS, drug cartels or North Korea moving funds via cryptocurrencies will see Trump's U.S. Treasury Department and Xi's People's Bank of China pounce.

The answer is industry and governments devising clear regulations that ensure transparency, reduce fraud risks and spell out taxation procedures. Far from killing the market, an official infrastructure would bestow greater legitimacy and trust in initial coin offerings, secondary trading and both retail and commercial transactions.

Asia could jumpstart the process by creating a cybercurrency equivalent of the International Swaps and Derivatives Association, or ISDA. This New York-based trade organization created standardized contracts for over-the-counter contracts -- including legal and policy priorities -- used in 57 countries.

It is hardly a perfect system. From the collapse of Barings Bank in 1995 to an ill-starred role in the global crisis of 2008, derivatives have a very checkered past. American investor Warren Buffett, for one, called them "weapons of mass destruction (WMD)."

But with cryptocurrencies the extra risk is how they can enable those wanting to buy actual WMDs with "black money." The days of having to smuggle suitcases of $100 bills -- weighing nearly 10kg per $1 million -- would be over. In their place, vast sums of cash can be spirited around beyond the reach of intelligence agencies and tax authorities. Stolen, too -- and without any recourse.

One idea floated is creating a central bank of sorts for cryptocurrency exchanges. In September, the Switzerland-based Bank for International Settlements published a widely circulated paper on the pros and cons of central banks either issuing cryptocurrencies or pulling them into conventional payment systems. The PBOC is mulling the former, while Asia's monetary authorities grapple with the latter. While keen to foster innovation and keep Tokyo's options open as a Bitcoin hub, the Bank of Japan seems down on issuing BOJcoin.

Exchanges might have to create a hybrid that acts a bit more like fiat money. Again, doing so might strike purists as the death knell of the Bitcoin phenomenon. Whereas the supply of cryptocurrency is predetermined, a hybrid medium would enable monetary authorities to regulate supply and demand. Among those experimenting are Sweden's Riksbank and Bank of Canada.

Yet the tension inherent to the digital currency craze can be found in recent comments by International Monetary Fund head Christine Lagarde. On April 16, Lagarde acknowledged that the genie is out of the proverbial bottle. There are already as many as 3,500 cryptocurrencies with a market capitalization approaching the $300 billion mark. That is bigger than Bangladesh's gross domestic product or Singapore's stockpile of foreign-exchange reserves. A market this size is here to stay.

The IMF is prodding central banks to stay ahead of the curve on digital money to guard against risks and inefficiencies. "We need to remain alert and vigilant," Lagarde said. "We must act quickly to close the knowledge gaps that inhibit the effective monitoring of crypto-assets. There should be systemic risk assessment and timely policy responses, as well as measures to protect consumers, investors, and market integrity.

"The sweet spot, as Lagarde sees it, is finding a "combination of having a framework that protects, and not stifling innovation, that can lead to cost efficiency."Words that may spell doom in the hearts of Bitcoin cheerleaders. But they are also marching orders for Asian officials on the frontlines. Simultaneously staying ahead of Malta and hackers with dollar signs in their eyes may be an impossible feat. If Asia can find a happy medium, its economies could ride the Bitcoin boom to greater prosperity.

William Pesek is a Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades." He has written for Bloomberg and Barron's.


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