Four major US cryptocurrency exchanges - bitflyer, Bitstamp, Bittrex and Gemini - have come together to form a self-regulatory body called the Virtual Commodity Association (VCA).

Posting on blog site Medium, Gemini owner Cameron Winkelvoss wrote that the VCA would take its lead from other self-regulatory authorities like the National Futures Association, an industry-sponsored body which deals with the US derivatives market.

He said: “The promise of virtual commodities and their impact on the future will be profound - but individuals and institutions need to feel safe and secure when transacting on marketplaces....We believe adding a layer of oversight on virtual commodity cash markets, in the form of self-regulation, is important for consumer protection and to ensure the integrity of these markets.”

These statements could not have come sooner.

Millions of Bitcoin and other altcoins have been stolen from exchanges in the past 12 months in high-profile hacks.

Security breaches saw $500m in cryptocurrency stolen from Japan's Coincheck in January 2018, while June 2018 saw two South Korean exchanges hit, with $40m in tokens taken from Coinrail, and $31m in crypto swiped from Bitthumb.

And because the vast majority of these exchanges are not insured or regulated, traders have no recourse to authority if they lose their investment

The VCA is led by the Cameron and Tyler Winkelvoss, the serial investor twins who famously lost out on the rights to Facebook while at Harvard with Mark Zuckerberg. Between them they own Gemini, the fiat to crypto exchange that offers trading on Bitcoin, Ethereum and privacy coin ZCash.

ZCash uses enhanced zero-knowledge cryptography to secure its transactions, so that neither the sender nor the receiver knows the identity of the other. It is of such great concern to anti-money laundering authorities that the US Secret Service has called for special regulations specifically targeted at such privacy coins.

In the US, the Securities and Exchange Commission (SEC) has shown willingness to work with this industry, perhaps not surprising given the sector has a market cap north of $200bn.

The Winkelvoss twins have twice been denied agency approval for a Bitcoin ETF, or exchange-traded fund. An ETF pegged to the price of popular cryptocurrencies would allow more cautious investors to gain limited exposure to baskets of funds and hence introduce greater liquidity into crypto markets. There is conflict in the ranks, however.

The regulator’s own lead commissioner Hester M. Peirce broke with her agency’s line to state on Twitter: “Apparently, Bitcoin is not ripe enough, respectable enough, or regulated enough to be worthy of our markets. I dissent.”

This did not stop the Commission from today (23rd August) denying further Bitcoin ETF applications from Proshares and Direxion.  In their reasoning, the same justification was given as in the Winkelvoss application, the threat of market manipulation or fraud is still too high.  Proshares and Direxion tried to avoid this by pegging the price to Cboe and CME futures, as opposed to the NASDAQ, which was favoured by the Winkelvoss application. The SEC felt these markets were too small.

Worldwide

Across the globe, government-mandated regulation for this sector is lagging far behind the industry. Many countries remain in a state of caution with partial, piecemeal regulation.

And self-regulation tends to be greeted with cautious optimism, although in practice it is difficult to see how it works better than independent oversight.

Cryptocurrency is no special case, of course. Tech giants in Silicon Valley have also attempted self-regulation of a kind. Facebook’s own practices surrounding the Cambridge Analytica data scandal and the influence of Russia on western elections have come under intense scrutiny. Elsewhere, Youtube and Twitter have been heavily criticised for allowing unpalatable or extremist content to exist on their platforms, consistently citing freedom of speech as a shaky defence.

Governments are caught in a trap between penalising cryptomarkets and stifling innovation, and protecting businesses and individuals. This tension becomes all the greater when we start talking about institutional investors, who invest not just their own money, but that held by hedge funds and pension funds across the world.

Big banks, big money

Some, if not all, banks have at least some exposure to cryptocurrencies, as would be expected with any popular new asset class.

The head of the Bank of England, Mark Carney, told a meeting of G20 finance ministers in July that money laundering practices like ‘wash trading’, pump and dump schemes and spoofing - where traders place large buy or sell orders to shift markets in one direction or another, before pulling those same orders - should be of serious concern to authorities globally.

The UK does have its own cryptocurrency self-regulatory body: CryptoUK. It was instituted in February 2018, when seven of the world’s largest cryptocurrency companies came together: exchanges Coinbase, CEX.IO and BlockEx, sidechain SaaS tool CommerceBlock, brokerage eToro, investment research firm CoinShares and the data company CryptoCompare.

Between them they want to attract more institutional investors into crypto markets.

The fact we can't ignore is that self-regulation, however noble in intent, tends to be self-serving by nature, and is intended to blunt or deflect hefty regulation which could stifle not just innovation, but profits.

As expected, CryptoUK acts more like a lobbying group, pressuring MPs and policymakers to take a liberal line on regulation, even while Parliament’s powerful Treasury Select Committee continues its long-running investigation into digital currencies.

The legal status of cryptocurrencies is still under review, even in major economies across the world.

Some, like Belarus, Gibraltar or Mexico have allowed cryptocurrency markets to operate, with specific laws underpinning their usage. Others, like China, have issued outright bans.

One trend we are seeing is small GDP, low population countries like Malta, dubbed ‘Blockchain Island’ by its own government, taking advantage of the lack of regulatory certainty elsewhere to attract cryptocurrency companies to their shores. These in their way will become akin to the tax havens of the British Virgin Islands, Vanuatu, or the Cayman Islands.

The VCA is wasting no time, for its part. The new body is scheduled to hold its inaugural meeting in September 2018. The industry is keeping a very close eye on what comes next.

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