Evidence submitted by Alfio Puglisi (DGC0025)

Alfio Puglisi, response to

 

the Commons Select Treasury Committee investigation on Digital Currencies.

 

Executive summary

  1. On the 22nd of February 2018, the UK parliament has launched an inquiry into cryptocurrency and the technology behind it. This document reviews the main features of Blockchain, main regulatory approaches on Blockchain platforms in the UK.

 

Introduction

  1. Cryptocurrencies, like Bitcoin and Ethereum, are increasingly becoming important in today’s global economy and in the UK.  According to a leading online forum on cryptocurrency, Coin Market Capitalisation, there are currently 200 cryptocurrencies in circulation in 138 different cryptocurrency exchange platforms.
  2. Moreover, Bitcoin can be regarded as one of the most complex product after the 2008 financial crisis, the result of the technology revolution which is disrupting the financial industry.

What is Bitcoin?

  1. Bitcoin is just one of the 100 or more virtual currencies available in the market and operates on a distributed ledger technology. The total crypto currency market capitalisation has increased more than 3 times since early 2016, reaching more than $25 billion in 2017 (Hileman & Rauch, 2017). In the paragraphs that follow, I will explain why Bitcoin is a complex, and often under comprehended phenomenon.
  2. In 2008, after the wake of the financial crisis  “Satoshi Nakamoto” introduced Bitcoin in the “internet” as a peer-to-peer electronic payment system. It is important to note that the Bitcoin was born as a peer-to-peer electronic payment system rather than as a currency as such. The Bictoin white paper makes no reference to currency or crypto currency, instead Satoshi Nakamoto defines coin as a “chain of digital signature” (p.2). I believe this is the start of the cognitive bias on the definition of Bitcoin and will clarify why Bitcoin is not a currency.
  3. Since its creation Bitcoin has evolved from a secure online payment system to a global currency, providing an alternative to government-backed “fiat” systems. Virtual currencies available in the market exhibit different features and functions, notwithstanding they all share one objective: avoiding state-control central banks and taxation systems. Bitcoin is not regulated by a central-authority. It is founded on a system in which the user takes responsibility for its work, making sure transactions between users are not fraudulent. This underpins Bitcoin as technology, which provides transfers of funds, but does not constitute Bitcoin a currency.
  4. These characteristics, which depict Bitcoin as an innovative and attractive “apparatus” to many people, are only possible due to cryptography and are not very recent. In 1991, Scholars Haber and Stornetta published in the journal of cryptology “How to Time-Stamp a digital document”, an enlightening article on the procedures for securely keeping track of the creation and modification of a document, while maintaining privacy of the documents themselves (Haber & Stornetta, 1991).
  5. The potential problem of falsifying or modifying the digital documents was crucial for Haber and Stornett and in order to fulfill those objectives they introduce hash functions together with digital signature. Hash function can be compared to an algorithm, calculated from the data it assigns a digital fingerprint to the original data. This hash is sent to the trusted party acting as time-stamped authority and digitally signed with a private key. To avoid ambiguity, the time-stamped authority can be considered a new form of digital notary (Haber & Stornetta, 1991).
  6. In similar fashion, payments and transaction in a cryptocurrency platform are recorded and verified. To this end, users in the network system, often called miners in order to exchange and trade digital currencies need to solve this difficult hash functions, but the solutions of these hash functions are simple to be checked among the users in the network.
  7. Exchanges and transactions in a cryptocurrency platform occur between users under the form of digital money. As such, cryptocurrency are often defined as digital money. This is concept is also not novel. Most central bank’s money across the world is already digital. Moreover, commercial bank deposits are represented under the form of digital claims (i.e. monetary value stored on a digital ledger). 
  8. To summaries, the main innovations in Bitcoin regards the fact that money supply and money demand is not controlled by a central authority and Bitcoin is a “decentralised” form of money. This is possible thanks to distributed ledger platform and the cryptographic proof.
  9. Bitcoin allows transfer of funds across the globe with a relatively small fee compared to big financial intermediaries in a limited amount of time, without much bureaucracy. Few banks have started developing Blockchain applications. Santander has introduced a Blockchain applications for its customers to transfer funds globally.
  10. In the current framework, central banks across the globe do not share infrastructure to facilitate transactions between them. Moreover, there are only few currencies that are accepted for transactions worldwide such as the Euro, the US dollar, gold and the IMF’s Special drawing right (an international reserve asset).  The vast majority of international payments are denominated in USD – Bank of International Settlements data shows the USD being on one side of 88% of foreign exchange trades in April 2016. People still rely on trusted intermediaries such as commercial banks to transfer their money from one country to another. There is a need for global digital unit of account, accepted by banks. This will major implications for money remittances providers.

Regulations

  1. There are many approaches for Blockchain regulations. For instance Isle of Man financial authorities allow transactions to be paid in Bitcoin. Gibraltar financial authority has introduced Blockchain regulatory frameworks for enterprises.
  2. It is important all UK exchange digital currency providers are subject to AML/KYC requirements and counter financing terrorism requirements.
  3. New technologies may generate confusion for customers. It is important to educate customers on the advantages and disadvantages of digital currencies.
  4. It is also important to monitor future products, which are backed by digital currency. As the market of digital currencies is becoming more liquid, one may expect more digital currencies backed products and/or services

Conclusion

  1. This document has demonstrated that Bitcoin is an application of Blockchain technology rather than currency as such. Digital currency as a sector is very heterogeneous. Governments need to review current legislation in order to protect consumers. I believe we do not need more legislation, current legislation can be applied to Blockchain applications (UK Consumer Directive). Moreover, the UK government should liaise with other UK Authorities (Isle of Mann, Jersey Island, Gibraltar) in order to harmonise Blockchain regulations and foster the FinTech sector.

 

April 2018