Volatility and Self-Regulation: The Evolving Cryptocurrency Saga

By Andrew Friedman

A number of developments last week at the intersection of the “wild west” coin/token/cryptocurrency world and mainstream U.S. business illustrated how the brick and mortar industry, in the absence of firm regulatory guidance, is attempting to impose some order on the volatile blockchain-driven space.

THE COINRAIL CYBER HACK

The past week included a stark reminder of some risks associated with any digital asset when South Korea-based crypto exchange Coinrail suffered a costly cybersecurity breach. Hackers reportedly took about $37 million in virtual coins as a result of the “cyber intrusion.” Coinrail also disclosed that it moved 70% of coins traded on the exchange to “cold wallets,” unconnected to the internet, to limit losses. The precise cause has not emerged, but the impact on the coin world was immediate; many cryptocurrencies, tokens and coins suffered immediate 10% losses as the news became public. It is worth noting that Bitcoin, which was selling at close to $20,000 per coin late last year, is now selling for less than $7,000.

BITCOIN MANIPULATION

Bitcoin’s abrupt spike in price in November and December 2017 spawned its own investigation. The Commodity Futures Trading Commission (CFTC) and the Justice Department have subpoenaed trading data from the Bitstamp, Coinbase, itBit and Kraken exchanges. Each of those exchanges offer trading in Bitcoin, over which the CFTC asserts it has jurisdiction for fraud and manipulation purposes, and the trading activity on those exchanges has the ability to directly and indirectly influence the final price of the Bitcoin futures contract listed by CME Group (over which the CFTC has expansive jurisdiction). In addition to government agencies, at least one group of researchers at the University of Texas has also concluded the Bitcoin market was manipulated. With regulatory oversight of the coin/token/cryptocurrency space at an uncertain juncture, potentially significant market manipulation and cyber-criminals repeatedly stealing millions of dollars in coins, the prospect of true mainstream adoption of blockchain-based coins as currency seems tenuous.

EXPANDING BARS OF BUYING CRYPTO WITH CREDIT CARDS

Though it probably has little to do with last week’s developments, there have been recent efforts to deal with volatility in this space. Following the lead of several other banks, Wells Fargo recently barred customers from buying Bitcoin and other tokens and cryptocurrencies with Wells Fargo credit cards. Citi, JPMorgan Chase and Bank of America imposed similar measures a few months ago. Lenders may have developed concerns about getting repaid; a study suggested that nearly 20% of crypto investors made their purchases with credit cards, and a significant minority of those purchasers subsequently failed to pay off the credit card debt they incurred when Bitcoin and related prices fell. Each bank’s debit cards may still be used to buy bitcoin.

NEW APPLE STORE CRYPTO RULES

Apple also took steps to limit cryptocurrency mining using iOS devices. Cryptocurrency mining is part of the transactional process used to purchase or make payments with tokens or coins. In a basic transaction, an individual who holds cryptocurrency in a virtual wallet can transfer the currency to another person, using a private “key.” The same individual also has a public key that can verify information about the coin/token/currency. The transaction gets broadcast to the currency’s network and gets confirmed by miners.

“Mining” serves two primary purposes. It adds transactions to the electronic “ledger” or blockchain that is the engine underlying all cryptocurrencies and also operates to release new currency. Mining requires robust computing resources because miners are competing to “solve” a new block in the blockchain, and the unique identifiers associated with blockchain are long and complex – it takes a network of computers several minutes to perform the mining function. Mining also has rewards – successfully mining a block yields a reward, a payment of some fractional amount of Bitcoin or another coin or token.

Apple’s new rules for iOS app developers forbid them from embedding cryptocurrency mining software beneath other apps and forbid mining that occurs on the device. Apple also established rules that apps involved in initial coin offerings (ICOs) are permissible if they come from established banks, securities firms or other approved financial institutions. Apple also continues to allow apps that enable transactions on approved exchanges, so long as the exchange is the source of the app. Through these rules, it seems clear that Apple is attempting to ensure that cryptocurrency transactions occur through legitimate means and in partnership with established players in the space.

Although Apple’s guidance outwardly focuses on “efficient power and resource” usage on iOS devices, the new rules effectively bar any cryptocurrency mining activity for apps purchased through the Apple store. Crypto mining on an iPhone apparently drains the battery at an alarming rate and is highly unlikely to be used as a primary means of mining cryptocurrency because in the race for time, it cannot effectively compete with a traditional computer or server.  Concealing a mining function beneath another app, however, means that someone else’s phone – in fact, a league of mobile phones that have the app – are doing the mining, but only the developer reaps the benefit. Apple’s new prohibition seems to be directed at protecting app users from being unwitting miners for the app developers and prohibiting developers from taking advantage of users.

TAKEAWAYS

The Coinrail situation and the investigation of possible Bitcoin market manipulation serve as fresh reminders that virtual currencies lack comprehensive regulatory oversight and may therefore be vulnerable to misconduct. The fact that large banks and tech companies are taking steps to impose some predictability and stability in the space suggests that industry players may help fill the regulatory void – and will also entertain appropriate participation in this emerging area.

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Andrew Friedman, Shulman Rogers’ Financial Regulatory and Compliance Practice

 


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