While many countries around the world have taken different steps to regulate cryptocurrency within their borders, most are not seeking to completely restrict or write off digital currencies altogether.

At the 2018 G20 international forum, finance ministers and central bank governors from 20 of the world largest industrialized or emerging nations called for more insight on how to regulate cryptocurrencies, while still affirming their place in the global economy.

At the core of the G20’s approach to cryptocurrency is a complex truth about blockchain technology: While it can help support a more transparent and more compliant financial system, it can also significantly undermine the system as well.

In a communique in late July 2018, the 20 countries agreed that crypto assets “can deliver significant benefits to the financial system and the broader economy.” But they added that such crypto assets, which include cryptocurrencies, tokens, and ICOs, “raise issues with respect to consumer and investor protection, market integrity, tax evasion, money laundering and terrorist financing.”

The 20 countries also called on the intergovernmental Financial Action Task Force on Money Laundering (FATF) to explore how anti-money laundering standards can apply to the cryptocurrency space.

Harold Crawford, managing director for the Financial Industry Advisory Services group at professional services company Alvarez & Marsal, noted the FATF’s take on cryptocurrencies is important because the taskforce gives guidance to regulators in the U.S. and other G20 countries. But Crawford believed that it was going to be a “significant challenge” for the FTAF to address how financial regulations can apply to the cryptocurrency space given the way many crypto assets operate.

Indeed, one of the main reasons cryptocurrency can enable illicit financial transactions or crimes is because they are often traded and owned anonymously. “When one looks at the cryptocurrency space, the idea was clearly to be anonymous in who owns it, who transacts and for what purposes,” Crawford said.

Alex Lakatos, partner at Mayer Brown, also noted that since cryptocurrencies operate on autonomously on decentralized blockchains, they are harder to track and regulate. “A lot of the classic statutory requirements that banks have around anti-money laundering are very hard to apply here because the crypto space is not operating through bank gatekeepers.”

Still, cryptocurrency is not entirely untraceable. Lakatos noted that from a technical perspective, “some cryptocurrencies are far more transparent than others while some of them are designed to be less transparent.”

What’s more, Crawford added that owners of cryptocurrency will likely lose their transparency when they move to exchange their digital currency for conventional cash.

In the US, for instance, entities that exchange cryptocurrency “are regulated as money services businesses as they meet the definition of a covered financial institution,” and are required to comply with financial laws and reporting, he said.

In addition, cryptocurrency can be stored digital wallets owned by cryptocurrency exchange companies. If these companies are registered in some US, they may be required to retain identifying information of their users.

In a recent case in Delaware, attorneys for a cryptocurrency investor who was a victim of fraud were able to successfully subpoena a cryptocurrency exchange platform to reveal the identity of one of its users, flagged as the alleged fraudster.

To be sure, cryptocurrency can change hands many times before leaving the digital ecosystem or ending up in a specific exchange. But if all transactions operate on a single, public blockchain, it can be possible to trace them over a long periods of time.

“A blockchain that can be deciphered can tell you not just about one transaction, but they can you about all the transactions over the history of that cryptocurrency or that blockchain,” Crawford said.

This is where blockchain’s potential to enable financial compliance comes into play. Tracing a financial transaction in a world of conventional currency requires following it through multiple separate financial institutions, which may or may not keep adequate records, to its recipient.

If a financial transaction happened on a single blockchain, it could be relatively easily traced from beginning to end. Since the blockchain is a decentralized network that connects multiple parties, it would act as a single digital master ledger for an entire financial system.

Nicolette Kost De Sevres, partner at Mayer Brown, added that deploying a blockchain for financial tracking could also be more cost effective for many financial companies. “I think the main thing they are looking for and hearing about is of course transparency, but I think they are also looking for a big improvement in terms of resources,” she explained.

Because of these benefits, many anti-money laundering compliance professionals and financial institutions are excited about the technology, Crawford said. But he added while “a lot of folks are looking at it,” there is no certainty that using blockchain for such compliance will pan out as planned.

Development in blockchain technology, after all, is relatively nascent, and cryptocurrency is still  just small part of today’s global financial system. The cryptocurrency market, “when compared to US dollar, is still somewhat diminutive,” Crawford said, noting that that the market value of all cryptocurrencies in circulation is around $200 billion. By contract, the market value of US currency in the US alone is about $1.5 trillion.

Reprinted with permission from the Aug. 6, edition of Legaltech News© 2018 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.