Anonymity, one of the intrinsic values of cryptocurrency, is under intense scrutiny by certain world governments and central banks. While adoption of cryptocurrencies has increased across the globe, regulators and other authoritative bodies are amplifying directives that aim to verify and identify users of virtual money.
The European Parliament recently published a report detailing directives to prevent the use of the financial system for the purposes of money laundering or terrorist financing. On March 15, 2017, members of the European Parliament published a new draft of the proposed legislation known as “Amending Directive (EU) 2015/849.”
The report states:
“Recent terrorist attacks have brought to light emerging new trends, in particular regarding the way terrorist groups finance and conduct their operations. Certain modern technology services are becoming more and more popular as alternative financial systems and remain outside the scope of Union legislation or benefit from exemptions that may no longer be justified.”
The “modern technology services” discussed in the report point to cryptocurrencies and their usage to launder money derived from the illicit trade of firearms, drugs, human trafficking, and other organized crime. Citing these forms of illicit trade as vehicles for terrorist financing, the report identifies virtual currency as the supporting mechanism of this criminal ecosystem.
According to the report, because cryptocurrency exchanges and wallet providers are under no obligation to identify suspicious activity, terrorist groups are able to transfer money into the EU’s financial system, taking full advantage of the degree of anonymity provided by virtual currency platforms.
The report states:
“To combat the risks related to the anonymity, national Financial Intelligence Units (FIUs) should be able to associate virtual currency addresses to the identity of the owner of virtual currencies. In addition, the possibility to allow users to self-declare to designated authorities on a voluntary basis should be further assessed.”
What the EU is trying to combat is understandable, and the language in the report suggests a fair approach as it pertains to the rights of individual virtual currency users. Section 26 of the report outlines a balanced approach that would limit the identifying data to the general public (or public ledgers/systems) that would also need to be clearly defined, “so as to minimize the potential prejudice to the beneficial owners.” Furthermore, the section states that the data obtained from virtual currency holders should only pertain to an individual’s businesses and trusts and must only concern the their economic activity.
While the directive aims to strike a balance between privacy and financial scrutiny, it also seeks to publicly disclose some of this information so that third parties and civil society at large can know who holds what currency and potentially even how much. The language of the report identifies “national registers” or a system of interconnected registers where the information can be stored and cross-referenced.
Although not using the word “blockchain,” we can surmise that some form of a blockchain may be the solution sought by the EU that would satisfy both regulators’ need to know while protecting user privacy. According to the report, this move (and others) would solve tax avoidance as well as the misuse of legal entities and legal arrangements, potentially used to defraud or abuse financial holdings.
In addition, the Parliament proposes the role of a “custodian wallet provider” as an entity that would provide services to safeguard customers’ private cryptographic keys that are used to hold, store, and transfer virtual currencies. How exactly this will manifest is anyone’s guess, as users will essentially need to trust custodians with access to their personal funds.
With so much legality to discuss, the directive must now be read by the European Council before any policy or regulations can be adopted. The directive has until June 26, 2017 for all EU member states to be compliant – closing the two-year window for implementation by the terms set on June 25, 2015.
While the outcome of this directive is unknown, Amendment 26, proposed by the Commission In the “Committee on Legal Affairs” paper, may offer insights as to the attitude and position the EU will take on this matter.
“‘Virtual currencies’ means a digital representation of value that is neither issued by a central bank or a public authority, not attached to a legally established currency, which does not possess the legal status of currency or money, but is accepted by natural or legal persons as a means of exchange or for other purposes, and can be transferred, stored or traded electronically. Virtual currencies cannot be anonymous.”
The People’s Bank of China (PBOC) is similarly drafting new guidelines that, if enacted, would require cryptocurrency exchanges to adhere to banking regulations and verify client identities.
After months of uncertainty as to the future of China’s bitcoin exchanges (BTCC, Huobi, OKCoin), the move indicates the PBOC’s willingness to experiment with how bitcoin and other virtual currencies are bought, sold, and traded.
According to the Wall Street Journal, Chinese bitcoin exchanges would be required to collect information to identify customers as well as to install systems “for collecting and reporting suspicious trading activity to authorities; China’s central bank would be in charge of handling violations by the exchanges.”
China’s latest position on this matter may finally set a cryptocurrency precedent, not only within the nation but globally as well. At the end of February 2017, ETHNews reported that the PBOC had been exploring the development of a nationally recognized digital currency, seen by many as an “if you can’t beat em’, join em” approach to bitcoin and other virtual currencies.
According to a story published by CalvinAyre:
“Zhou Xuedong, director of PBoC’s Business Administration division, recently said authorities need to explore ‘long-term regulatory mechanisms’ and licensing requirements for all digital currency exchanges at the national level.”
Furthermore, Zhou has vowed to place uncooperative exchanges on blacklists that do not follow directives set by the PBOC.
Reasons for China tightening its grip on cryptocurrency have run the gamut from Chinese investors using bitcoin to get money out of the country, to the struggling and depreciating Yuan. Whatever the actual motivation, initiatives like this and others, such as the EU’s latest directive, are expressing the eagerness of central banks and governments to know more about exchanges and individual users of cryptocurrencies.
Coinbase, one of the leading cryptocurrency exchanges, has even gone so far as to require certain registrants to verify their identity through the use of a webcam photo. Citing KYC (know your customer) and AML (anti-money laundering) compliance, Coinbase’s methods may become a standard for popular exchanges who want to be on the right side of the law. Users seeking to remain truly anonymous have already jumped from exchanges like Coinbase to peer-to-peer services, such as Localbitcoins, that require little more than a functioning email to register and use their site.
Additionally, new blockchain-based technologies like Internet of Coins’ “Hybrid Asset” pose a threat to authoritative identity verification, by building protocols that would allow individuals the ability to store and swap digital assets (including cryptocurrencies) peer-to-peer without the use of exchanges. Internet of Coins’ technology would allow this process to occur anonymously, which could either provide users an alternative to government regulations or be in stark opposition to central banks and their methods.
To Be Continued
For now, the issue of anonymity will need to be further tested so that the pros and cons can be weighed and fairly assessed. While transparency may help solve world problems such as terrorism and organized crime, individual privacy could be at stake. This is similar to how the current centralized internet has proven to be less than secure – an effect not originally intended when the internet was created.