With the South African Reserve Bank looking at a cryptocurrency regulatory experiment, it is no longer a question of whether Bitcoin should be regulated or not, but rather who will be doing the regulating.
At present, decentralisation is paramount in the Bitcoin ecosystem – the core principle that no one institution or authority is responsible for the operation, function or governance of the ecosystem is its greatest strength.
In South Africa, it is this core principle that the notions of financial service democratisation and financial inclusion are premised.
This is according to Seshree Govender, associate at Webber Wentzel who cites the recent Bitcoin Scaling Agreement (which set in motion the Bitcoin ‘fork’ of 1 August 2017), as an example of regulation in a decentralised system.
“The stalemate Bitcoin scaling debate, and the plethora of Bitcoin improvement proposals, culminated in a New York meeting of various players within the Bitcoin economy in May 2017, and with that, the Bitcoin Scaling Agreement came into being,” said Govender.
Simply put, this was an agreement that the Bitcoin community would move to a separate, parallel currency to increase efficiency such as transaction times and fees.
As of May 2017, the signatories of the Bitcoin Scaling Agreement represented:
- 58 companies located in 22 countries;
- 83% of hashing power;
- $5.1 billion monthly on chain transaction volume; and
- 20.5 million Bitcoin wallets.
The signatories of the Bitcoin Scaling Agreement represent the critical mass of both the technical and economic communities within the global bitcoin ecosystem.
Bitcoin in South Africa
According to Govender, the scaling agreement has two very important lessons for the currency in South Africa – (i) how the decentralised network makes decisions and (ii) the where the decision-making power lies.
“The key point to note about the Bitcoin Scaling Agreement is that the scaling solution was adopted by those market players who chose to adopt it, which happened to be the majority of the Bitcoin ecosystem,” she said.
While this did not mandate the dissenting market players to adopt the same solution, failing to do so could have potential operational consequences due to the interdependence between the Bitcoin communities within the ecosystem.
However, Govender noted that the regulatory experiment has grown far beyond the initial intention of ensuring that innovation is not hindered by regulation, and now faces unique social and political challenges in regulating the industry.
How SA can regulate
Govender said that a self-regulatory organisation (SRO) model is one of the most likely ways forward for Bitcoin in South Africa.
This is because it is a well-known and implemented concept with the South African financial markets, with SRO status already conferred upon the JSE Limited and the central securities depository (Strate).
The concept of self-regulation does not mean that the SRO is regulating itself, but rather that it is tasked with regulating the market it services.
These organisations are permitted to regulate the affairs of the market which it services by creating rules, supervision protocols and disciplinary mechanisms.
“Under our currently regulatory regime, the SRO model has been determined to be an efficient and cost-effective mechanism for regulation, (despite) its inherent challenges such as conflicts of interest and adequate governance,” said Govender.
While these are centralised SRO models, the idea of a decentralised SRO model is also worth exploring, said Govender.
Under this system, various Bitcoin communities may form an SRO on which the regulator may confer power to regulate the cryptocurrency/asset market it services.
“The internal mechanisms and regulations applicable to market players within such cryptocurrency/asset communities may be affected through the conclusion of smart contracts which may operate akin to that of interoperability agreements.”
This would be similar to the manner in which the decentralised autonomous organisation was established under Ethereum, save for the point that such smart contracts will be subject to outcomes or rules based regulatory principles of the financial regulatory regime.
“The smart contracts and the formation of the SRO would need to be in accordance with the objects of the FMA (Financial Management Act) such as protecting investors, reducing systemic risk and ensuring fairness and transparency within the market,” she said.
While the SRO model would be ideal for the parties involved in South Africa, the implementation of the Twin Peaks regulatory system in the FSR Bill could mean a centralised authority such as the Reserve Bank or government will regulate the currency.
“Initial public comment phases on the FSR Bill have indicated the legislature’s intention to increase the supervisory functions and powers of the Twin Peak regulators, which may result in the weakening of the SRO model,” said Govender.
“Once again, we see that the core notion underpinning the concepts of governance and supervision under the FSR Bill is that of a centralised system or authority, thereby excluding an effective means of regulating a decentralised system.”
While regulations legitimising the cryptocurrency/asset market are needed, regulations that are rendered outdated and inapplicable, upon promulgation, by the evolving complexities of cryptocurrencies/assets, will not do the market or its consumers any favours, Govender said.