REGULATING DECENTRALIZED CRYPTOCURRENCIES UNDER PAYMENT SERVICES LAW: LESSONS FROM EUROPEAN UNION LAW.

• Author: Gikay, Asress Adimi

INTRODUCTION

Not long ago, it was acceptable to define a cryptocurrency as digital peer-to-peer currency created by cryptography (1). But such a definition is no longer universally valid because despite the fact that the term currency appears in cryptocurrency, there is a strong argument that a cryptocurrency is not a currency (2) and today there are new kinds of tokens that indeed qualify clearly as security (3), hence negating the notion that cryptocurrencies are peer-to--peer currencies, or at least casting doubt on it.

A further explanation of cryptocurrencies is likely to state that unlike traditional currencies issued by the central banks, a cryptocurrency has no central authority that controls its creation and circulation. (4) Yet, the New Generation Cryptocurrencies (NGCs) created by initial coin offering provide counter-examples to the narrative of lack of central authority running a cryptocurrency (5). Some of the NGCs are fairly centralized and there is an entity which has the upper hand in their creation and distribution (6). Consequently, if there is one lesson to be learnt from the evolution of cryptocurrencies, it is that there is nothing constant in the definition of a cryptocurrency. The only constant is the fast evolution of cryptocurrencies and businesses centred on them and the lack of robust legal framework regulating them in many areas.

This article singles out the European Union's payment services law to analyse whether tailor-made payment services law for cryptocurrencies could be designed. A task of paramount importance for this article is exposing the ideological nature of the debate on the regulation of cryptocurrencies, as a result of which many exaggerated claims regarding cryptocurrencies have escaped unquestioned in literature dealing with law and technology. The result of this uncritical reception of whatever industry experts claim about cryptocurrencies and pretending that nothing happened when those claims turned out to be false or exaggerated is lack of credibility in intellectual debates and of regulatory efforts.

One of the narratives that have been advanced is that cryptocurrencies would help bank the unbanked. (7) This claim has been one of the buzz words that have been spreading around, but when the value of the major cryptocurrencies became unaffordable, not just to the unbanked but to the middle-income earner (8) and transactions in cryptocurrencies are exceedingly technical and risky, it is clear that cryptocurrencies have nothing to do with the unbanked. Just to be clear, the so-called unbanked are those who have no access to financial services such as credit card or debit card (9). The claim that cryptocurrencies would give the unbanked access to financial services was clearly bogus from the very outset and proven to be false now. But the claim is now buried under more junk news reports on the internet and nobody is willing to go to the archives and pull them out to ask the industry experts what they were thinking when they made the claim. Highlighting on the campaign strategy of early bitcoin developers, Former Greek Finance Minister Varoufakis stated:

There is a Bitcoin aristocracy, the Bitcoin early adopters, who accumulated very cheaply Bitcoins from the beginning. They have every reason to talk this thing up and lure people into like a Tulip-like mania or a pyramid, making extravagant claims [...] to (open and use a new Bitcoin ATM). This was all just hype. (10) These are important issues as they demonstrate that the appropriate regulatory policy response for cryptocurrencies must begin with the assumption that the cryptocurrency economy is built on a bubble and the early developers of cryptocurrencies cannot be trusted to offer responsible policy framework for self-regulation.

1. OVERVIEW OF THE CRYPTOCURRENCY SYSTEM

   1.1 DEFINING CRYPTOCURRENCIES

   "Cryptocurrency is a system of currency that uses cryptography to allow secure transfer and exchange of digital tokens in a distributed and decentralised manner." (11) The most dominant cryptocurrency that laid the ground for all cryptocurrencies is bitcoin, which was created by a person or a group identified pseudonymously as Satoshi Nakamoto (12). The white paper of bitcoin defines bitcoin as "purely peer-to-peer version of electronic cash that allows online payments to be sent directly from one party to another without going through a financial institution." (13) The idea of enabling fund transfer to be conducted without an intermediary is one of the reasons for the creation of bitcoin and subsequent other cryptocurrencies. Similarly, to other cryptocurrencies, bitcoin can only be stored on a computer (or a smart phone) (14).

   Cryptocurrencies are created by mining--solving automatically generated mathematical puzzles towards processing transactions of users (15). In technical terms, "... mining is the competitive process of collecting transactions and adding them to the blockchain in the form of blocks.' (16) "Blockchain is a sequence of blocks, which holds the complete record of transactions (a public ledger) indicating the order in which the transactions occurred." (17)

   The total number of bitcoins to be created is limited by the bitcoin protocol to 21 Million BTC (18), an upper limit that is either different or not applicable to most of the other active cryptocurrencies. To encourage miners in maintaining the system by taking part in the mining process, 50 bitcoins were rewarded initially to a miner that solves the mathematical puzzle, an amount that reduces by half quadrennially (19). As the mathematical puzzles become more difficult and the reward smaller, miners invest more time and resource today in mining (20). Once all the 21 million bitcoins are created, the exclusive source of miners' income would be transaction fees (21). As of September 2017, there are a little over 16-million bitcoins in circulation (22).

   1.2 WHY CRYPTOCURRENCIES?

   Understanding the reasons for the birth of cryptocurrencies gives a complete picture of the regulatory problem embodied in them. It also allows one to appreciate whether there was a realistic vision for the creation of a system of payment or currency. Since the creation of bitcoin coincided with the 2008 global financial crisis, it is commonly suggested that bitcoin is the result of the global financial crisis, although there is no concrete evidence for that (23). The purpose and the core principles of cryptocurrencies do not address the causes or consequences of the global financial crisis. Nevertheless, it cannot be ignored that the lack of trust in government institutions and central banks that ensued during and in the aftermath of the global financial crisis might have been exploited as a marketing tool by the developers and backers of bitcoin and other cryptocurrencies (24). But that remains the only connection between cryptocurrencies and the global financial crisis.

   A strong argument is made that cryptocurrencies have four potential advantages relative to cash money and traditional payment services that justify their creation, i.e., they are cheap payment methods, trustless, decentralized, and pseudonymous (25). But most of these attributes are more talking points than true attributes that withstand even the slightest scrutiny, as examined in the preceding sub-sections. Though these features of decentralized cryptocurrencies are frequently discussed in literature, it is necessary to provide their overview since they are important in examining the feasibility of constructing payment services law for cryptocurrencies.

   1.2.1 CHEAP

   Cryptocurrencies are claimed to lower transaction costs because transactions such as transfer of funds do not involve third party intermediaries that charge fees (26). Discussing the advantage of bitcoin over cash money, Bill Gates stated that bitcoin is exciting because it shows how cheap transfer of fund from one place to another can be (27). Every bitcoin transaction is verified and approved by the majority of the miners on the blockchain (28). The transaction verification entitles the miner to a certain number of bitcoins--50 during the earlier days (29). Due to the limited number of reward bitcoins that can be obtained as more bitcoins are created and the increased difficulty in solving the mathematical puzzle, the reward system is considered to be insufficient to incentivize miners. Today, miners earn bitcoins by charging transaction fees (30). From 2015 to 2017, transactions fees in bitcoin have increased up to 1200 % (31). Hence, the argument that bitcoin is cheap is not valid anymore.

   With regard to other cryptocurrencies as well, the transaction fee is not that cheap (32). It must be noted that there is difficulty in ascertaining how much one pays for each transaction due to the fact that the majority of the cryptocurrencies are expensive and used only by business entities or individuals with high income, which actually makes the cryptocurrency system inaccessible to people with low income or even independent researchers with insufficient fund to conduct experimental transactions. Transaction fees cannot be assessed without conducting transactions. Hence, it should not come as a surprise if evidence regarding transaction fees that come from news sources may be dismissed as unreliable. But some cryptocurrency exchanges today display their transaction fee schedule to users on their webpages. For instance as of February 1, 2018, "Transferring funds from Bitstamp account to a credit card carries a flat fee of $10 for amounts up to $1000 and 2% for transfers above $1000." (33) This means that to transfer 3000 dollar equivalent of Ether or any other Bitstamp traded cryptocurrency to his/her bank account, the user pays 60 dollars. This is not a cheap transaction fee at all. Comparatively, Coinbase discloses the fee at the time the user conducts the transaction. (34).

   1.2.2 TRUSTLESS

   In traditional banking (payment services)...