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Digital Currencies: Call for Information HM Treasury has issued a call for information regarding digital currencies (such as Bitcoin), and has asked for responses to a number of questions to inform a decision on whether such currencies should be regulated, The Home Office has an interest in ensuring that any proposal for the regulation of digital currencies, or the creation and support of a UK digital currency, takes into account the need to tackle the use of such currencies for criminal and terrorist purposes. Digital currencies are usedfor the online purchase of illegal substances or articles, or for payment for criminal services, and could be used to launder money. There is a risk that digital currencies could be used for terrorist purposes given the opportunity they provide to move funds internationally with a degree of anonymity. This Home Office response to the questions in the Call for Information focuses on the need to ensure that any regulation of digital currencies, or even the creation of them by Government, should be designed to prevent their use by criminals and terrorists. Some criteria that should be considered are given in the answers below. The answers do not cover any possible technical solutions or proposals for regulatory regimes. Answers are focused on the issues relating to independent digital currencies, such as Bitcoin, and to potential state sponsored or developed currencies. Question 1 What are the benefits of digital currencies? How significant are these benefits? How do these benefits fall to different groups e.g. consumers, businesses, government, the wider economy? How do these benefits vary according to different digital currencies? Home Office 1. The evidence for the benefits or risks from digital currencies is limited. Whil Bitcoin is widely known, the current estimate of the value of Bitcoins in circulation is in the hundreds of millions of pounds. By comparison with other forms of payment, the volume and value of transactions are small. We would welcome further analysis of the likely use of these currencies by the public and business, to gain a clearer idea of the actual benefits and risks. 2. The benefits quoted in the Call for Information are potentially significant, particularly in relation to reducing the costs of transactions, increasing the speed of transactions, and perhaps allowing micropayments, which would be of assistance for small purchases. Digital currencies in the UK: a Call for Information Question 2 Should the Government intervene to support the development and usage of digital currencies and related businesses and technologies in the UK, or maintain the status quo? If the Government were to intervene, what action should it take? Home Office 1. We would welcome further evidence on the benefit of digital currencies overall, but we believe that there might be a number of advantages of any digital currency for the UK being created and owned by central Government. A major advantage of having a digital currency that was specified by Government would be that the currency should be designed to ensure that it would limit its use for criminal and terrorist purposes. In particular, a digital currency owned by the UK Government would be controlled by a central body, and could be provided with benefits similar to those for a fiat currency. It could also be pegged to a fiat currency, to reduce potential fluctuations in its value. 2. In developing such a currency, we would want to remove any facility that would be advantageous for criminals. Central to this will be enhanced traceability of the ownership and use of the currency, which would allow law enforcement agencies, under appropriate safeguards, to identify whether the currency has been used for criminal or terrorist purposes, and who used it. While current digital currencies are not entirely anonymous, they are not designed to have traceability, leaving a gap in law enforcement capability and oversight. 3. We would expect the regulatory regime for such a currency to ensure that the operators carried out the same level of due diligence on their customers and the associated transactions as is done for existing bank customers. Question 3 If the Government were to regulate digital currencies, which types of digital currency should be covered? Should it create a bespoke regulatory regime, or regulate through an existing national, European or international regime? For each option: what are the advantages and disadvantages? What are the possible unintended consequences (for instance, creating a barrier fo entry due to compliance costs)? Home Office 1. There is litle point in regulation if it does not lead to an effective level of control, and the ability to manage the risks posed by the use of the currencies by criminals. Regulation should not provide a means of legitimising criminal activity of providing a means for criminals to launder the proceeds of crime. 2. There are a number of factors that any regulatory regime needs to include. Regulation must be designed to require identification of transactions and currency owners, and have sufficient powers to ensure that, if the transactions are for criminal purposes, they can be investigated and the currency seized and the value realised. Anonymity is. something criminals exploit, and attempting to regulate digital currencies without improving the ability to identify those behind the transactions risks undermining any regulatory regime. 3. The crossover point between digital currencies and the fiat currency will be a digital currency exchange. It is essential that the service providerlexchanger is Tequired to carry out due diligence and to know their customer, to monitor transactions, and to report those that they believe to be suspicious to the National Crime Agency, in the same way as other financial institutions, and as required by the Proceeds of Crime Act 2002. Exchangers should be licensed, and the license withdrawn if they fail to meet these requirements. Given the use of digital currencies in the online procurement of illicit commodities they must be covered by the Money Laundering Regulations. The regulation should also allow the withdrawal of approval from particular currencies if they are identified as being used largely by criminals. 4. International cooperation is essential. The conversion point where fiat currency becomes digital, and vice versa, is hard to oversee, given digital currencies have global reach. Without global consistency in approach, oversight and security is difficult 5. It must be possible to seize and confiscate digital currency where it is identified as the proceeds of crime, or is being used for criminal or terrorist purposes Question 4 Are there currently barriers to digital currency businesses setting up in the UK? If so, what are they? Home Office No comment from the HO Question 5 What are the potential benefits of this distributed ledger technology? How significant are these benefits? Home Office 1, The distributed ledger technology in a Government-created digital currency could be beneficial in allowing traceability of use, and identification of ownership, if inital ueanciee in tha VK! a Fall fo laformatinn properly designed. Access to such information would need to be restricted, but would be of use to law enforcement agency investigations and anti-money laundering work. It would also have the additional benefit of acting as a deterrent to criminal use, as criminals would be unlikely to want to use a currency that it is traceable. Question 6 What risks do digital currencies pose to users? How significant are these risks? How do these risks vary according to different digital currencies? Home Office 1. There have been allegations of significant thefts of Bitcoins from traders and exchanges, and if digital currencies were to become more popular, they would be a target for criminals, particularly those operating online. if any government- backed digital currency is created, specifying its technical design to show the legitimate owner, and trace the use of it, would be essential. 2. Another significant risk is fraud. As the Call for Information makes clear, once a transaction has been carried out, it cannot be reversed. This offers significant difficulties in providing consumers with adequate protection if digital currencies become more widely used. While cash and some other forms of financial ‘exchange also fall into this category, if a new currency is being designed, it would make sense to identify how fraudulent transactions can be unwound and the digital currency reimbursed to the legitimate owner. Question 7 Should the Government intervene to address these risks, or maintain the status quo? What are the outcomes of taking no action? Would the market be able to address these risks itself? Home Office No comment from the Home Office Question 8 Should the Government regulate digital currencies to protect users? If so, should it create a bespoke regime, or regulate through an existing national, European or international regime? For each option: what are the advantages and disadvantages? What are possible unintended consequences (for instance, creating a barrier to entry due to compliance costs)? What other means could the Government use to mitigate user detriment apart from regulation? Home Office 1. Please see the points made under Question 3, Question 9 What are the crime risks associated with digital currencies? How significant are these risks? How do these risks vary according to different digital currencies? Home Office 1. The nature of digital currencies that are created outside of government control makes them attractive to criminals and terrorists alike. Anonymity is central to the attraction for criminals of digital currencies, along with the lack of traceability, The combination of an anonymous digital currency and the encryption and other tools available on the dark web pose significant challenges for law enforcement agencies investigating crime and instances of terrorism. Digital currencies in the UK; a Call for information 5 5. The risks are growing, as more of the crime world moves online. We have no evidence on different levels of risk between existing digital currencies. We would expect any government-backed digital currency to be designed to address these issues, particularly through resolution of the anonymity issue. Question 10 Should the Government intervene to address these risks, or maintain the status quo? What are the outcomes of taking no action? Home Office 1. Effective regulation would provide some ability to tackle the criminal or terrorist use of digital currencies. Poorly designed regulation might well make the issue worse if it makes digital currencies more attractive to criminals by, for example, making their value more stable and increasing the number of traders who accept them, without addressing the issues of anonymity and traceability. Question 11 If the Government were to take action to address the risks of financial crime, should it introduce regulation, or use other powers? If the Government were to introduce regulation, should it create a bespoke regime, or regulate through an existing national, European or intemational regime? For each option: what are the advantages and disadvantages? What are possible unintended consequences (for instance, creating a barrier to entry due to compliance costs)? What has been the impact of FinCEN’s decision in the USA on digital currencies? Home Office 1. Any regulation developed by the UK needs to provide an effective level of control of digital currencies, and to provide the capability to tackle the use of these currencies by criminals. Digital currencies in the UK: a Call fr information 2, Regulation must require identification of transactions and currency owners, and have sufficient powers for regulators to ensure that, if the transactions are for criminal or terrorist purposes, they can be investigated and the currency seized and the value realised. 3. Digital currency service providers / exchangers must be required to carry out due diligence and to know their customer, to monitor transactions, and to report transactions that they believe to be suspicious to the National Crime Agency, in the same way as other financial institutions, and as required by the Proceeds of Crime Act 2002, They must be also be covered by the Money Laundering Regulations. 4. Exchangers must be licensed, and the regulator must be able to withdraw the license if the exchange falls to comply with the requirements to carry out due diligence and transaction monitoring 5, Regulation must be international. These currencies are traded internationally, and without robust international action to ensure that the same strength of regulation is available in all countries, oversight and security will be limited. Question 12 What difficulties could occur with digital currencies and financial sanctions? Home Office 1, As above, we believe that anonymous digital currencies offer the opportunity for those subject to financial sanctions to evade them, Any regulatory regime must be designed to provide identification of those making the transactions, and provide for the seizure of the currency should it be identified as coming from an individual or group subject to sanctions. Question 13 What risks do digital currencies pose to monetary and financial stability? How significant are these risks? Home Office No comment from the Home Office. Digital currencies in the UK: a Call for information 7