The news that bitcoin had broken the $10,000 barrier reflects the way that mainstream investors have been flocking to cryptocurrencies over the past year. But amid the excitement, regulators are fretting about criminals who are increasingly using cryptocurrencies to escape detection from law enforcement.

Why is digital currency so appealing to miscreants? Cryptocurrencies are a recent phenomenon and – as with all new technology – it takes time for regulators to catch up. Bitcoin was the first to gain an international reputation as a digital currency that could be used to settle transactions after it was anonymously created in early 2009.

Cryptocurrencies are decentralised, meaning that they are issued without a central administering authority. They are cryptography-based, distributed open source and function on a peer-to-peer basis.

Significantly, the underlying protocols on which most cryptocurrencies are based do not require or provide user identification and verification. Also the historical transaction records generated on the blockchain (the technology behind bitcoin, which serves as a public ledger of all cryptocurrency transactions) are not necessarily associated with an individual’s identity.

Cryptocurrencies are also – by definition – convertible virtual currencies, as they can be exchanged for fiat money such as pounds, dollars and euros and this facilitates their use for settling commercial transactions.

Bitcoin is now an acceptable form of payment in exchange for goods and services by household names such as Microsoft, Expedia and Subway. At the same time, blockchain technology is being adopted by more businesses.

Private transactions enabled by the use of bitcoin are key to understanding the growth of cryptocurrencies among consumers. However, this advantage is keeping regulators and law enforcers awake at night.

Flipped Coin

The infamous Silk Road case drives this point home. Bitcoin was used to purchase drugs through the dark web – transactions that weren’t spotted by the authorities.

But hard-to-track criminal activity isn’t the only threat from the use of cryptocurrencies – there’s also the possibility of their use to finance terrorism, given that the formal banking sector is now adept at spotting suspicious movement and mobilisation of monies through the banking system

The fact that they can be converted into pounds, dollars and euros does make regulation of cryptocurrency more feasible. It can be done at the point of their conversion through virtual currency exchanges – which, as financial institutions, can be regulated.

International financial regulation and a growing number of national measures across the globe, such as “Know Your Customer” (KYC) and anti-money laundering (AML) directed at financial institutions, have been strengthened. And, when implemented effectively, it’s now easier to track down individuals engaging in illegal transactions.

But the global nature of this payment mechanism is the biggest challenge.

Whack-a-mole

Payments can be easily affected cross-border because conversion of the likes of bitcoin through currency exchanges can be transacted in different parts of the world – including in jurisdictions with lax financial regulatory regimes and weak KYC/AML measures. This means that, while jurisdictions with stronger regulatory powers may clamp down on criminal activities, such efforts can be easily wiped out because perpetrators are likely to migrate to countries with lax regimes.

Nonetheless, positive steps are being taken to regulate financial technology (fintech) products such as cryptocurrencies. Emerging challenges within this sector has led to the arrival of regtech – which, among other things, is regulatory technology adopted to address fintech risk issues.

Regtech covers artificial intelligence, big data and machine learning – technology that enables detailed data analysis on platforms such as blockchain. Again, regtech is only likely to be adopted effectively in jurisdictions with advanced regulatory regimes, so the extent of its effectiveness in policing the global cryptocurrency phenomenon appears limited.

Load Up On Drugs

Another challenge is the investigation and prosecution of illegal activities perpetrated with payments using cryptocurrencies, with semi-anonymity of the blockchain making it difficult to monitor transactions and identify suspicious behaviour, such as drug sales. Law enforcement agencies find it incredibly difficult to trace illicit proceeds that are laundered using cryptocurrencies and – once again – are scuppered by different legal systems around the world.

Different jurisdictions have their own approaches to regulating cyber-related transactions, which makes international cooperation deeply challenging. In some countries, such as North Korea and China, regulation of web-based transactions is significant for national security policy. Legal mechanisms are in place to allow extensive government intrusion into the sender and recipient details of every single transmission.

Other countries, such as the US and the UK, cautiously approach online regulation to balance security concerns against constitutionally protected freedoms and to preserve privacy and data protection laws.

It means that a worldwide effort is needed to regulate this global payment mechanism. Governments, financial regulators, financial intelligence units and law enforcement agencies must all agree to a unified approach in tackling cryptocurrencies. Without this, effective regulation of bitcoin and similar currencies is unattainable.

A starting point could be instituting minimum regulation, such as currently exists in some international financial standards including the Basle Committee’s Core Principles for Effective Banking Supervision and the IOSCO principles of securities regulation.

Countries across the world are encouraged to implement these provisions, which indicates that they embrace investor-friendly policies. A similar standard applied to cryptocurrencies would be a sensible way forward, given the patchwork approach to regulating cyber-related transactions around the globe.

Iwa Salami, Senior Lecturer in Financial Law and Regulation, University of East London.

This article was originally published in The Conversation. Read the original article.