New Zealand Law Society - Regulating revolutionary new digital currencies

Regulating revolutionary new digital currencies

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In last month’s column I covered the launch of the Law Foundation’s exciting new Information Law and Policy Project (ILAPP), which provides an independent $2 million fund to develop law and policy around IT, data, information and cyber-security.

I’m now very pleased to say that we already have our first research project under ILAPP, and it deals with one of the most game-changing and challenging technology innovations in the world of business and finance.

Like me, many of you will have heard of Bitcoin, the virtual or “crypto-currency” that can be used to pay directly for goods and services, bypassing banks and credit cards. But you might not realise that Bitcoin is just one of hundreds of different digital currencies that use “blockchain” technology.

University of Auckland Business School Associate Professor Alexandra Sims is lead researcher for the Foundation’s new project examining the regulation of digital currencies that use blockchain technology. She says digital currencies are poised to revolutionise the finance world and beyond, and pose challenges for lawmakers and regulators around the world.

“The Reserve Bank is concerned about the potential ramifications for finance system soundness and efficiency,” she says. “The bank is not saying that these digital currencies are bad, indeed it is agnostic over what technology is used. The danger is that if you regulate too much, you won’t get the full benefits, but if you regulate too lightly, you could see problems such as money laundering.”

A blockchain is a list or digital ledger that records transactions and stores them in secure “blocks.” Each block is then “chained” to the next block with a cryptographic signature. The chains are replicated on each computer on the network. Because crypto-currency transactions bypass banks or other intermediaries, the transactions are almost costless, and the names of the parties involved are hidden.

Blockchain technology and its uses are still evolving, and its progress has been speculative and volatile. Crypto-currency values have fluctuated wildly, creating big winners and losers – another reason for the Reserve Bank’s cautious approach. While traditional money rises and falls in value, it is generally much more stable than crypto-currencies.

Although there have been examples of Bitcoin misuse since its introduction in 2008, Professor Sims says that crypto-currencies can be more traceable than cash. “It’s wrong to say that because a technology can be used for bad things, we shouldn’t use it,” she says. “On that rationale, we wouldn’t use fire. These are powerful technologies, but they carry risks.”

Banks are keenly interested in blockchain technology, because it can reduce costs and improve the security and speed of transactions. Hackers appear to be routinely stealing millions of dollars from banks, but, as Professor Sims explains, theft of crypto-currency would involve hacking into thousands of computers at the same time.

But if digital currencies become widespread, transactions using blockchain-based crypto-currencies will slash banks’ profits. As Professor Sims explains, “with crypto-currencies people and businesses can pay anyone in the world directly, with no need to go through any third parties.”

“Banks are trying to use it between themselves, because the benefits are massive, but they are going to try and limit how others use it,” she says.

Like all Law Foundation-backed projects, the blockchain technology research is independent. Professor Sims points out that the Reserve Bank is very interested in research that is not backed by any vested industry interest. Another strength is that the team is interdisciplinary, combining expertise in law, banking, finance and economics. Indeed, it is a requirement that all the Foundation’s ILAPP projects are interdisciplinary.

Professor Sims says that both New Zealand and Australia are taking a “wait and see” approach to regulating blockchain technology, though other countries have been more active. The United States is well down the path of exploring regulatory models, and Estonia is exploring creating virtual residencies or “e-residencies” using blockchain.

Professor Sims and her co-researchers Professor David Mayes, of Auckland University, and Dr Kanchana Kariyawasam, of Australia’s Griffith University Business School, aim to develop a legal framework for blockchain regulation in New Zealand and Australia.

“We want to ensure the utmost balance between the interests of blockchain stakeholders and the interests of regulators,” she says. “Harmonising Trans-Tasman approaches will improve finance industry stability and regional infrastructure.”

Visit the Law Foundation’s website for more information on our ILAPP project.

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