Juan Carlos Portilla*
Introduction
Because a paradigm shift is currently underway in the international monetary system, international financial regulators should establish a global standard setter for virtual currencies (“VCs”). This article will refer to such an entity as the Global Agency for the Virtual Currency Economy (“GAVCE”). Two monetary ecosystems coexist today. The first ecosystem involves central banks and depository institutions that supply economies with fiat currency; the second includes VCs. VCs emerged in 2009 “as a means of defiance against a financial system in crisis and ‘captured’ by state regulation and private agents.” For some, VCs inspire a level of confidence that money managed by central authorities might not sustain. Nevertheless, the rise of VCs also implicates important risks including market manipulation and financial crime—and governments across the globe are struggling to regulate VCs because of their disintermediated technological constitution.
Although the European Union agreed in June 2023 on a provisional version of the Markets in Crypto Assets framework, and while some scholars in the United States are making the case for self-regulation in the VC industry, this article argues for some form of global governance intervention in case these or other mechanisms fail. Regulations must protect VC consumers from market failure, asymmetric information, and negative externalities. Yet, most countries have not taken any regulatory action on VCs, creating significant regulatory gaps. According to the World Economic Forum, regulatory systems governing VCs are “fragmented, ineffective, and, in some countries nonexistent.” Because there is no harmonized global regulatory governance for VCs, criminal enterprises can engage in regulatory arbitrage across nations to commit financial crimes, such as the financing of terrorism and money laundering. Therefore, international financial law should establish a GAVCE to regulate VCs.
This article draws upon the interdisciplinary dialogue between international law (“IL”) and international relations (“IR”) scholarship to make the case for a GAVCE. In Part I, the article introduces blockchain technologies and the VC ecosystem. Part II outlines emerging risks related to VCs and discusses matters of law related to the establishment of a GAVCE. Finally, Part III discusses the politics that would emerge while establishing global governance for VCs, which implicate regulatory capture theories and the role of time as an analytical variable, in the rule-making process.
I. Introducing Blockchain
VCs are peer-to-peer electronic cash systems that use blockchain technology to operate without the need for intermediaries (banks). According to a memorandum by presumed Bitcoin creator Satoshi Nakamoto, the peer-to-peer nature of VCs “allows online payments to transfer directly from one party to another without routing through a financial institution.” Blockchain technology, in turn, gathers information (a ledger for transactions) into “blocks” that hold it. Blocks have storage capacities; ledgers for transactions are placed into a block until it is filled. Once a block is filled, it is then closed and immediately linked to the previously filled block. This process forms a chain of information (a “blockchain”), whose blocks are linked through cryptography, creating a peer-to-peer electronic cash system. Thus, VCs “are distributed, open-source, math-based peer-to-peer virtual currencies” that can operate with no central bank involvement, no intermediaries, and no government oversight.
VCs are different from fiat currencies, e-money, and central bank digital currencies (“CBDCs”). While fiat currency is the paper money of a country that is designated to be its legal tender, and accepted as a medium of exchange, VCs are digital representations of value that can be digitally traded, and they are typically neither issued nor guaranteed by governments. VCs are also different from e-money, which digitally represents fiat currency and is utilized to electronically transfer the value denominated in fiat currency. Although some countries have used blockchain technology to issue CBDCs, like the digital yuan of China, CBDCs do not fully encapsulate all of the attractive features of VCs, such as anonymity, decentralization, and governance. While central banks that issue CBDCs decide on the rules governing those CBDCs, the users of VCs control VC networks by making consensus-based decisions.
The VC Ecosystem
Several specific VCs—including Bitcoin and Ethereum—are well-known to the public. Bitcoins, which are convertible units of account composed of unique strings of letters and numbers constituting units of the currency, are decentralized in nature. Since individual users are willing to pay for Bitcoins and other VCs, they have value in the marketplace. Ethereum, Ripple, Litecoin, and Dashcoin came after Bitcoin and utilize a similar form of blockchain technology. Stablecoins, in turn, are VCs backed by fiat currencies, like the U.S. dollar, or commodities, like gold. Tether, for example, is the largest stablecoin by market capitalization and its value is pegged to the U.S. dollar.
Several different actors make up the VC market. The supply side of the VC market consists of exchange firms, such as Binance. Supply-side firms also include administrators, miners, and wallet providers. Exchangers, for a commission, trade VCs for other VCs—or for precious metals or fiat currencies. Administrators are individuals or legal entities that issue VCs, write rules for the use of VCs, maintain central payment ledgers, and redeem VCs. Miners act as market makers; they use computer systems to verify transactions by adding them to the blockchain. VC wallets hold, store, and transfer VCs (examples of wallet providers include Multibit or Coinbase). Finally, users compose the demand side of the VC market. Users exercise their freedom of choice to select VCs and they generally buy VCs for payment or investment needs.
II. Emerging Risks
Emerging risks related to VCs include consumer panic, market manipulation, and financial crime. Confidence is a bedrock principle of the modern financial system. Unlike traditional financial products (such as savings accounts), Bitcoin and other VCs are presently uninsurable—which undermines investor confidence and heightens the risk of consumer panic. When an individual in the United States deposits money with a bank in a single ownership capacity, he or she has access to up to U.S. $250,000 at the Federal Deposit Insurance Corporation (“FDIC”) if the bank fails for the U.S. dollar is backed by the full faith and credit of the U.S. government. In contrast, government deposit insurance is not available for VCs because they are not regulated or backed by any government. Additionally, the price history of VCs demonstrates that the VC market may in fact be a speculative bubble. Bitcoin investors can manipulate its price; for example, media coverage of Bitcoin or fake news associated with Bitcoin can induce individuals who have not previously traded Bitcoin to invest in it for the first time. In the absence of a central government authority backing the value of Bitcoin, Bitcoin investors could lose their shirts, were Bitcoin to fail.
According to Nobel Prize-winning economist Joseph Stiglitz, VCs are also often used for illicit purposes such as tax evasion. According to the Financial Action Task Force (“FATF”), money launderers, terrorist financiers, and sanctions evaders use VCs as a powerful tool for financial crime endeavors, outside the reach of law enforcement. Indeed, bad actors can and often do use technology and Bitcoin to pursue chaos and perpetrate financial crimes. One example is the May 2017 WannaCry ransomware attack, in which a worm component exploited vulnerabilities in the widely used Microsoft Windows operating system. Ultimately, the cyberattack cost eight billion US dollars in damages. The criminals behind the attack demanded payment in Bitcoin because they have easy access to VC service providers around the world.
III. Global Governance for VC
Multiple instruments, including but not limited to treaties, may be used to create a GAVCE. Traditionally, states have been the primary source for the creation of international organizations (“IOs”), particularly by way of international treaties. Examples of this approach include the International Monetary Fund Articles of Agreement. Nevertheless, many legitimate and powerful IOs have also originated outside of the treaty process. These IOs, with more innovative institutional designs, have increasingly found their way into the international legal order. For example, the central bank governors of the G-10 countries established, without a treaty, the Basel Committee on Banking Supervision (“BCBS”)—the primary global standard setter for the prudential regulation of banks. Likewise, the International Organization of Securities Commissions (“IOSCO”)—the international body recognized as the global standard setter for securities—is not a treaty organization but rather a not-for-profit legal entity incorporated under a private act in Quebec, sanctioned by the Quebec National Assembly. FATF—the global money laundering and terrorist financing watchdog—is similarly not a treaty-based international organization but rather a task force composed of member states who fund FATF on a temporary basis for the achievement of specific mandates. Decentralized government agencies, under the control of the executive branch of national governments, can also form IOs; in 1995, a network of national financial intelligence units established the Egmont Group, which provides a platform to exchange financial intelligence to combat financial crime. In sum, there are multiple legal instruments besides treaties available to create a GAVCE.
Considering the above, domestic regulatory agencies should establish GAVCE outside the treaty-based model, which involves a slow and politically costly ratification journey. Although the establishment of GACVE outside the treaty process may face concerns related to legitimacy or a perceived democratic deficit, a more efficient approach here is warranted because of the urgency of the issuance of global VC regulations as well as the widely recognized success of other non-treaty based IOs like IOSCO.
The proposed GAVCE should also have the capability to influence relations amongst states, market agents within the virtual currency economy, and multilateral financial institutions. GAVCE should build power and influence from the inside out to affect the behavior of states when regulating VCs; to achieve this, domestic regulatory agencies should delegate certain law-making capabilities to GAVCE to regulate VCs. This act of delegation upon GAVCE is feasible because IOs can be explicitly empowered to make international law through a delegated law-making process, which is best explained under the principal-agent theory, mainly associated with corporate law. The principal-agent theory can be applied to the relationship between state actors and global standard setters under international law. According to Ian Johnstone of the Fletcher School of Law and Diplomacy at Tufts University, the simplest form of delegation exists in this context when states explicitly grant authority to IOs, because it is typically fairly straightforward to identify the agent, the principals, and the powers that the principals have conferred.
Although this type of delegation to GAVCE may face criticism related to a loss of sovereignty or the risk of capture by special interests, several distinct benefits of delegation outweigh those concerns. First, the delegation at issue will be limited in scope—exclusively to the world of VCs. As such, there is no significant incursion on state sovereignty. A second benefit of delegation is the standardization of norms across jurisdictions to avert regulatory arbitrage and mitigate financial crime. As previously stated, current regulatory systems governing VCs are fragmented, ineffective, and often nonexistent. Third, there is currently a dire need for regulatory experts to develop technical skills related to the various complex features of VCs, blockchain, and exchangers. The development of such expertise through the proposed GAVCE would in turn help the international community to sow the seeds for a good governance model for the VC market. Under this good governance approach, global crypto policymakers would make decisions, through the proposed GAVCE, based on data and widely accepted methodologies to protect the virtual currency economy from the risks outlined above.
Another way to reduce the risks of delegation and institutional capture is for GAVCE to issue soft law rather than hard law. International law is more than just a formalistic set of black-letter rules; a more pluralistic conception of international law, embraced by many scholars today, also considers soft law, which is formally non-binding but habitually obeyed. According to Shaffer and Pollack, states do not always only favor the hard law model when making international law and instead often adopt the soft law approach, as a design choice. Although the concept of soft law may be problematic to legal positivists because it suggests a continuum between political and legal commitments, functionalist scholars argue that soft law norms offer several advantages over hard law, including 1) greater flexibility for states to cope with uncertainty, 2) greater opportunity for states to gain expertise over time through information sharing and deliberation, and 3) lower negotiation costs. In this context, hard law does not provide states with the necessary flexibility to deal with the uncertainties of VCs, because VCs are an emerging, ever-changing technology. Soft law will better accommodate the shifting nature of VCs.
Politics of International Corporate Capture
Concerns about international corporate capture may play a significant role in the establishment of a GAVCE, as corporate capture could materially affect the substantive outcomes of GAVCE’s eventual regulations. Institutional theory, regulatory capture, and the role of time as an analytical variable are all key topics that capture the attention of scholars when analyzing global financial rule-making processes. The politics that revolved around BCBS while it began to regulate international banking set a precedent that leaders should consider in the process of regulating VCs. Indeed, there are different sets of conditions that result in captured regulation, which serves narrow vested interests, versus common interest regulation, which serves the broader public interest.
Indeed, global VC regulators would not be immune to the risk of regulatory capture by self-interested actors and powerful interest groups. If VC firms were to capture GAVCE’s rulemaking, they might pursue policies that would be contrary to the public interest. One hypothetical example to illustrate the risk of VC capture would be a rule allowing the issuers of stablecoins to use an algorithm-based system to maintain their peg to the U.S. dollar instead of a system of cash reserves. History proves that such a rule would have costly effects; TerraUSD—a U.S. dollar stablecoin that sparked a crisis in VC markets in 2022—used an algorithm-based system rather than cash reserves to maintain its peg to the dollar, causing it to lose its price peg during a crisis of liquidity in early 2022. During this crisis, investors expected to be able to cash out the stablecoin for one U.S. dollar at any point, but ultimately were not able to when TerraUSD lost its price peg. The TerraUSD meltdown caused losses of $300 billion across the broader VC market.
To prevent corporate capture and scenarios like the above, scholars have presented theoretical frameworks that emphasize the importance of timing and sequencing in determining rulemaking outcomes in global finance. For instance, a close examination of Basel Committee deliberation records and other key documents provides strong evidence that the first movers in the Basel process, namely powerful international banks, played a key role in determining the Committee’s outcomes. Domestic regulatory agencies should carefully consider time and sequencing to prevent large VC groups from arriving at the decision-making table well before others. The first-mover advantage cannot be part of the regulatory process for VCs. In addition, transparency around lobbying and the establishment of a “cooling off” period after serving in the private sector can prevent powerful VC firms from capturing GAVCE’s rulemaking.
Conclusion
So far, VCs have largely escaped from the regulatory grasp of national governments. Because there is no harmonized regulatory governance regime in place, VCs are often used for illicit purposes. International law must regulate VCs to strengthen the governance of the overarching global financial architecture. Multiple instruments, including treaties and non-treaty mechanisms, are available to create a GAVCE that can issue soft law to regulate VCs. Nevertheless, non-state actors may also pose regulatory capture risks concerning the global VC rule-making process. Global policymakers should take careful measures to avert regulatory capture if they decide to establish a global standard setter for VCs.
*Juan Carlos Portilla is an International Financial Law Professor at Sabana University School of Law (Colombia) & Anti-Corporate Crime Law Professor at the ITAM Law School (Mexico), an ACAMS Speaker, a Legal Consultant and a Compliance Professional at several different global financial institutions including the Central American Bank for Economic Integration (Honduras), Santander Securities LLC, Raymond James Financial Services Inc., Wise Ltd (a fintech company), and Wells Fargo NA. Juan Carlos is a lawyer with a LL.B. degree from Sabana Law School, Colombia. He earned a master’s degree in international law from the Fletcher School of Law and Diplomacy, Tufts University, and completed the Program on Negotiation and Dispute Resolution course at the Harvard Law School.
