Encrypted risks of cryptocurrency

  • IKIM Views
  • Tuesday, 13 Mar 2018

Bitcoin has plummeted over 75 percent this year from a peak of $20,000 touched in December as retail investors piled into a one of the largest bubbles in history.

FIRST, let’s get this straight – cryptocurrency or the digital coin is not a currency. A currency is a symbol of a country’s sovereignty.

It is acceptable as one only when it is officially recognised as a legal tender by the country’s monetary authority.

This is a pivotal constituent in upholding economic stability and justice as well as a fundamental principle of the Islamic code of conduct.

Digitisation has a strong impact on the financial services industry and it is forecasted that we will see the third wave of the development beginning 2020.

The EY Fintech Adoption Index 2017 shows that one in three digitally active consumers used two or more fintech (financial technology) services last year. It is significant enough to suggest that fintech has reached mass adoption.

Because the banking and finance industry is highly regulated, the digital coin cannot survive within it. Hence, the growth of the digital coin would have to take place mainly beyond the reach of the banking regulators. This indicates that there must be a more concerted effort to strengthen the regulatory and governance framework.

Amid the rise of the digital economy and the digital token investing craze, startup companies are raising millions of dollars online to fund their projects via initial coin offerings (ICOs) driven by “white papers” that detail their business plans and by impressive corporate websites.

Through such crowd sales, the anonymous digital token issuers are able to engage directly with contributors in exchange for other digital tokens such as Bitcoin and Ethereum (ETH).

They do not need intermediaries like venture capital firms and banks.

The digital tokens or assets are issued with claims that they potentially function as money. They are actually known as cryptocurrency.

Crypto itself is not a currency and it is impossible to consider it as money because it is just an encrypted cryptographic algorithm and protocol, used in the issuance of the digital unit on a blockchain – a distributed ledger technology (DLT) platform – that acts merely as a shield and an enabler. The one that has value is the unit represented in the digital token.

The ICO companies typically raise money to build new technology platforms or to fund businesses that use digital tokens utilising the DLT platform.

It is obvious that some anonymous digital tokens are unguaranteed projects, exposed to high volatility in an unregulated digital tokens exchange and price instability driven by the sentiment among investors and speculators.

The fast-developing ICOs offer more than a virtual currency. The use of blockchain as a base of the digital token is now incorporated with an ownership record, a right to a property claim, or an underlying or commodity-backed digital asset.

However, the ICOs are vulnerable to money laundering/terrorist finan­cing risks due to the anonymous nature of the transactions. ICOs may also be targeted by hackers and fraudsters.

The CoinDash ICO, for example, suffered a loss of about US$7.3mil after a hacking attack. Other ways in which ICOs have been victimised in­­clude parity wallet breaches (150,000 ETH stolen from a UK-based startup), scams (a blockchain startup Enigma defrauded of more than 1,500 ETH), parity wallet freezes (a bug in software code froze more than US$275mil in November 2017) and market breaches (a mining marketplace for NiceHash worth about US$78mil).

People should understand the risks associated with ICOs and investment schemes involving digital tokens. Many of these investments appear to be highly speculative in nature, and consumers should be cautious about a promise of high returns.

Picking one digital token or more to make it official currency is pla­cing the country at risk of financial convulsions.

A team should be designated to identify fraudulent investment schemes and educate the public on the newly invented scams in the industry.

Bank Negara’s recent release of a policy document that covers money laundering and terrorism financing risks associated with the use of digital currencies should be received well and supported by educational campaigns.

The fintech surge is improving the speed and quality of financial services, helping those who have little access to financial institutions, and expanding the funding ecosystem.

Yet, the readiness of the industry is in question.

Given the current situation, the acceptance of digital token as a currency cannot possibly be good for the industry and the country.

It is important to first synchronise technology and the regulatory framework, so that there will be stability, justice and protection for the people should any problem arises.

Mohd Noor Omar is a Fellow with the Institute of Islamic Understanding Malaysia’s (Ikim) Centre for the Study of Syariah, Law and Politics. The views expressed here are entirely the writer’s own.

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