Opinion by Seshree Govender, an associate in the Financial Regulatory Practice at Webber Wentzel.
As crucial as BitCoin may be to the growing global financial markets and as much as it may revolutionise concepts relating to payment and economic freedom, its volatile market value, reports of hacking and theft and alleged dalliance with the “dark web” has resulted in the perpetuation of the BitCoin narrative as untrustworthy.
The current BitCoin narrative is attributable to its cyclical nature – people don’t invest in BitCoin because its market value is unstable, and the market value of BitCoin is unstable because people do not invest in it. The lack of demand in BitCoin is partly attributable to an inability to understand its complex technical nature. But BitCoin will continue to remain misunderstood unless there is a demand and increased exposure of BitCoin in the market.
The key to breaking this cycle may be by bringing BitCoin within a regulatory framework to encourage its demand and integration. Whether or not that is likely to happen is going to be determined on 11 March – the day on which the United States Securities and Exchange Commission (SEC) will decide whether or not to approve the filing of the Winklevoss Bitcoin exchange traded fund (ETF) and in doing so, potentially welcoming BitCoin into the financial services regulatory world.
The South African BitCoin narrative was founded in the 2014 position paper published by the South African Reserve Bank. The paper solidified three core principles in the South African BitCoin narrative, namely:
· BitCoin is a decentralised virtual currency and its use, accordingly, is purely to effect a payment system;
· Banking and payment systems regulation does not recognise BitCoin as legal tender and the utilisation of BitCoin operates in a regulatory vacuum; and
· Consumers who choose to participate in the BitCoin market have no regulatory environment to protect them or allow for recourse.
As result, the BitCoin narrative has limited the participants in the BitCoin economy to those who are able to access informative material on BitCoin and have the resources to absorb any potential loss of BitCoin. This is, however, counter-intuitive to the financial inclusion objective that BitCoin advances.
The saviour of the BitCoin narrative lies in finding the right regulatory home. Implemented correctly, regulation could stimulate the demand for BitCoin by legitimising its use and disseminating information about its construct into the market. This increase in demand is essential to stabilising the volatile BitCoin economy and developing more stringent mechanisms of security.
The current South African legal construct of BitCoin is that of a quasi-currency. The concept, use and value of BitCoin in our market is that of legal tender in a peer-to peer payment system, albeit never attaining the status of legal tender. The adoption of the “payment system” label, while apt in 2014, did not account for the ability of BitCoin to grow beyond this – which it has. While BitCoin, paired with the underlying Blockchain technology, creates a payment system exchanging unregulated currency, BitCoin additionally embodies certain economic characteristics that associate it with a different label and maybe a different regulatory home:
· BitCoin has a finite supply and only 21 million BitCoins will ever be mined;
· The supply of BitCoin in the economy is dependent upon the result of mining efforts, and not the issuing of further BitCoin by any entity;
· The minimum denomination in which BitCoin can be held is not 1 – one may own a fraction of BitCoin;
· The percentage of the world’s BitCoin supply held by a particular person is not capable of dilution due to its finite nature;
· Supply and demand for BitCoin is not be dictated a monetary policy; and
· The value of BitCoin is dependent upon the demand for BitCoin in relation to its current supply.
These characteristics largely mimic the economic characteristics of gold and other similar commodities. Value is predicated by demand and supply – not by monetary policy or the ability of any entity to issue more. While BitCoin may operate as a currency on a decentralised payment system, it has economic features that make it an asset, or more accurately, a digital asset. Bitcoin’s inherent economic value is not derived from its worth in relation to another country’s currency denomination, but from its value as a finite asset – the supply and demand of which is extraneous to political, economic and governance polices.
The big question is whether the Winklevoss brothers have the right idea? Is the financial services regulatory environment the home that the BitCoin narrative has been searching for?
Financial products within South Africa are governed by a myriad of legislation, all of which is susceptible to change with the introduction of the “Twin Peaks” regulatory model. The regulatory environment in which financial products operate comprises of two components:
· Regulation that governs the particular financial products in themselves pertaining to the issuing of the product, prudential requirements and requirements to which the structure of such products must adhere; and
· Regulation that governs the manner in which financial products are sold to consumers and traded within the market.
When viewed against the background of the financial product types offered within South Africa, BitCoin, in its digital asset legal structure, would need to only be utilised in financial products that either derive value from or are backed by an asset. The value of the financial product would be linked or limited to the value of the underlying BitCoin asset. Once packaged, the unregulated nature of BitCoin will become framed by the highly regulated nature of the relevant financial product which will change: the way in which BitCoin is accessed; the way in which BitCoin is held; the way in which Bitcoin is traded; and the way in which the inherent value in the BitCoin digital asset is realised.
Integration of BitCoin into financial product wrappers will change the current narrative by legitimising BitCoin through increased use and exposure, and in time, stabilising the BitCoin market by increasing its demand.
The BitCoin economy waits for the SEC’s decision on 11 March, standing on the door step of its financial regulatory home.
by Seshree Govender, an associate in the Financial Regulatory Practice at Webber Wentzel
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