Law360
Digital assets can take many forms, including cryptocurrency, NFTs and digital bonds. Regardless of the form, they usually have these defining features: they are decentralized, securely housed on the blockchain and accessible to anyone with an internet connection. These features allow the digital asset industry to be used to impose the rule of law in corrupt jurisdictions by offering financial inclusion and decreasing reliance on corrupt banks or governments.
On the flip side, the lack of centralized authority, anonymity and general accessibility of digital assets, alongside the current lack of regulation, make them attractive tools for criminals. The digital asset industry has been used to disrespect the rule of law by criminals involved in money laundering, crypto scams, ransomware attacks and fraud.
The digital asset industry has great potential, but to maximize this, it will be necessary to find a way to keep the good without being stuck with the bad.
TRANSPARENCY IS THE ANSWER
Increased transparency within the digital asset industry could be the answer. However, complete transparency carries with it the risk of denial of service based on irrelevant considerations. The traditional financial institutions in Canada and the United Kingdom have been rocked by just this kind of scandal.
THE EMERGENCIES ACT AND THE 2022 ‘FREEDOM CONVOY’ PROTESTS
As a response to the 2022 “Freedom Convoy” protests in Canada, Prime Minister Trudeau invoked the Emergencies Act. As a part of the act, a legal obligation was imposed on financial entities to cease dealings with any persons involved with or financially supporting the protests. According to the Report of the Public Inquiry into the 2022 Public Order Emergency, within the 10 days that the Emergencies Act was in effect, “approximately 280 accounts worth around $8 million were frozen.” The secondary impacts of this order on the operations of banks have not been reported on, but a representative of the Canadian Credit Union Association testified to Parliament that a few days after the Act’s declaration, some customers started making major withdrawals in fear of having their assets frozen. There are anecdotal accounts of a run on Canadian banking institutions, generally.
NATWEST BANK SCANDAL
In 2023, NatWest, a major U.K. bank, made headlines for its questionable conduct in closing the professional and personal accounts of a U.K. politician, Nigel Farage. Farage’s financial situation was originally cited as the reason behind the closure, but documents revealed Farage’s political views played a role as well. Farage was then denied the opening of an account from nine other banks. The improper handling of the situation led to the chief executive of NatWest resigning and a fall in NatWest’s share price by more than 40 per cent (it has since recovered all of its value).
PERSONAL CONFIDENTIALITY CRITICAL FOR CUSTOMERS
These scandals highlight the importance of the confidentiality of individuals, both to protect individuals from unfair practices and to protect the organizations from damage to their financial and reputational status. While transparency would aid in the prevention of crime in the digital asset industry, the confidentiality of user identities is still a crucial aspect to maintain. The question is then two-fold: How do you introduce transparency to the digital asset industry and how do you ensure transparency does not diminish user privacy?
THE REGULATORY SCHEME OF THE CANADIAN FOOD INSPECTION AGENCY (CFIA)
The regulations administered by the CFIA may provide an answer for the digital asset industry. Section 41 of the Safe Food for Canadians Regulations regulates establishments involved in the slaughter operations and packing of food animals and meat products. In accordance with this section, establishments must have inspectors watch the production process on site in real time. Inspectors are able to monitor and stop noncompliant activity whenever it happens.
The digital asset industry does not yet have the trust of banks, insurers and other regulators. This is for good reason as arrests and convictions of bad actors within the digital asset industry are seen far too often. However, the implementation of a regulatory system that reflects that of the CFIA could be the first step in building that trust. Similar to the way inspectors are stationed on site to monitor slaughterhouse and meat-packing operations, crypto accounts of fintech organizations could be monitored in real time to reduce the occurrence of fraudulent activity. Banks, insurers, and regulators could have open access to these accounts, with the identity of the users remaining anonymous. When an organization’s financial reporting is out of balance, alerts could be sent off and fraudulent activity could be detected and prevented as soon as it happens.
THE ROLE OF ARTIFICIAL INTELLIGENCE
Real-time monitoring and regulation of large amounts of mega-data associated with crypto accounts may seem impossible. However, with the help of artificial intelligence (AI), this regulatory scheme could work. AI has the capacity to efficiently and effectively monitor vast amounts of data to detect misconduct, and it is increasingly being used for these purposes. The Ontario Securities Commission put out a report looking into the use of AI in Ontario’s capital markets. The report outlined that various major vendors of trading surveillance systems had already implemented AI into their platforms to assist in the detection of market manipulation.
CONCLUSION
AI monitoring to assist in the regulation of crypto accounts would enable the digital asset industry to build trust with banks and insurers through transparent operations. Just as the CFIA inspector is on site monitoring slaughterhouse and meat packing operations in real time, the AI regulator could monitor crypto accounts of fintech organizations in real time. A clear and effective regulatory scheme such as this, in the digital asset industry, would significantly reduce the risk of crime while maintaining the confidentiality of users. The only risk that would remain is market fluctuation, a risk that can be managed by professionals trained to do just that.
This article was originally published by Law360 and is reproduced with permission.
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