| 31-03-2020 | Carlo de Meijer | treasuryXL

The sudden emergence and rapid but uncontrolled worldwide spread of the Corona virus shows us the failure of existing healthcare surveillance systems to timely handle public health emergencies.

Though improvements in healthcare surveillance have been realised, these still fall short in preventing pandemonium. Lack of necessary steps taken to ensure containment and tracking of the virus have aggravated the situation.

Blockchain technology is increasingly been mentioned as a tool to assist with various aspects of containing the outbreak. Could the use of blockchain in the health care industry help to prevent future pandemics?

Outdated health surveillance systems

Preventing, and controlling diseases that have epidemic potential is a major public health activity. Many surveillance systems are used to track potential new diseases and control existing diseases. Though governments are doing everything in their power to contain the spread of the Corona virus, their fight is hampered by difficulties in the timely sharing of information with local and international health enforcement agencies on the ground.

Unfortunately, many of these systems are outdated, hard to access, or inaccurate. China’s current disease surveillance system for instance is an updated version of a system that is five decades old. And there is the privacy and security issue when using centralised healthcare surveillance systems. Time however is of the essence when dealing with outbreaks of this sort of deadly diseases.

Main issues

Epidemiologists who study how diseases spread, are being faced with the task of gathering, verifying and cleaning data in an efficient manner.

Privacy and security issues, language barriers, the sheer distance between the geographical location of an outbreak, cultural differences, and many other factors are issues that slow the transmission and exchange of necessary information.

Non-optimal data management
There is the data management issue. Containing the Corona virus could come down to a question of data management. Gathering data, verifying that data, and then cleaning up that data however is far from optimal. Epidemiologists need high-quality data to model viruses; with models, they can provide governments with recommendations about how to contain the disease. But that data is hard to get or its integrity cannot be verified, thus of no use to epidemiologists.

Underreporting
As a result of that the current infection and death statistics are speculated to be much higher than reported. The coronavirus outbreak has raised concerns over the Chinese government underreporting the number of infected and deceased. This underreporting can be caused by many disruptions in the system, such as the lack of data transparency.

But also a shortage of testing kits reduces the number of confirmed cases, and deaths can be attributed to other causes. Unfortunately, it is impossible to know just how serious this outbreak really is without access to a secure, decentralized surveillance system.

Political Complications
And there is the issue of national centralised surveillance systems not talking cross-border. Diseases can spread quickly across political borders. Traditional systems run by governments can miss outbreaks because they happen across physical borders. A decentralized system is the fastest way to report outbreaks.

Lack of innovation in healthcare systems
In many countries healthcare surveillance systems lack innovations, caused by low investments in new technologies leading to less effective healthcare systems. This notwithstanding the upcoming of new technologies including artificial intelligence, big data management and blockchain.

Blockchain could be of help

The time to build borderless solutions based on decentralized technologies has come. Highlighting the need for numerous improvements in the health care sector, the U.S. Department of Health and Human Services’ Office of the National Coordinator for Health Information Technology issued a Shared Nationwide Interoperability Roadmap requesting ubiquitous, secure network infrastructure; verifiable identity and authentication of all participants; and consistent representation of authorization to access electronic health information.

Hereblockchain could offer ways to improve many public health activities associated with preventing and controlling diseases. Blockchain powered solutions could address and tackle various aspects of the issue. Blockchain technology has the ability to improve health, access to information, supply chains and many more.

These expectations are based on the key aspects of blockchain technology, such as decentralized management, immutable audit trails, data provenance, and robustness. Additionally, multiple nodes in a permissioned blockchain have the ability to share and report vital data instantly, while complying with data privacy and security regulation

Blockchain use cases

Blockchain could be used to improve a variety of health care-related processes, including record management, healthcare surveillance, tracking disease outbreaks, management crisis situations and many more.

Record management: single source of information
Containing virus should be looked at as a data management issue. The biggest opportunity for blockchain in the healthcare industry is as a single source of truth for the data provenance, as the whole world is fighting against this outbreak. It could be used for record management purposes, to manage real-time data and importantly, to ensure its integrity, while identifying and eliminate misinformation about the Corona virus.

In emergencies like these, there are high numbers of incoming data, “with not many hands on deck to manage the same”. With the use of blockchain, data collection will become automated and immutability of the ledger makes it impossible to alter any of the records.

By using blockchain technology one could be able to securely manage health records, ensuring interoperability without compromising patient privacy and security. Those records could include patients’ data, treatments given, and any progress detected. Blockchain will also make sure that data are archived and protected by any unauthorised access, but still keeping it available for the whole healthcare system.

It will enable users to see all the data and trends on the virus in real-time including all information about confirmed cases of infected, death toll, recoveries, etc. The exponential growth of connectivity and the access to the wealth of data it offers  would allow health officials to quickly track the spread of disease, giving vulnerable populations vital information. All this information can be used by research labs working on a vaccine.

Blockchain healthcare surveillance system
Blockchain can also be used for surveillance purposes. A blockchain healthcare surveillance system can provide the means to prevent and control future outbreaks. A permissioned blockchain surveillance system would allow local and national health agencies to access the surveillance data.

A global blockchain surveillance system could easily reach areas where connectivity is poor, and costs must be kept low. Local practitioners can receive real-time information on surrounding areas, regardless of governmental or political barriers. In addition, global organizations like the World Health Organization could access the data. Because the system is decentralized and secured through blockchain, data remains secure and multiple organizations can report the data.

Tracking infectious disease outbreaks
Blockchain could be used for tracking public health data surveillance, particularly for infectious disease outbreaks. Increasing transparency will result in more accurate reporting and more efficient responses. They would allow for rapid processing of data, enabling early detection of infections before they spread to the level of epidemics.

Blockchain can help develop treatments swiftly, and help with management when pandemics do occur. This could enable government agencies keep track the virus activity, of patients, suspected new cases, and more.

They could also use the blockchain to track down where the virus originated, probably It could enable doctors to review patients’ symptoms and monitor diagnostic data in real time, integrating patient history information. Information can be collected in a distributed way and have that information available to different parties, including authorities such as the WHO.

Management crisis situations
Blockchain technology can not only help in keeping track of the virus and outbreak activity. Blockchain could also be used to better manage pandemic situations and the dissemination of treatment. It could instantly alert the public about the Corona virus by global institutes like the World Health Organization.

It could instantly recommend a course of activity should an outbreak be detected. Using blockchain could enable to provide governments with recommendations about how to contain the virus. It would offer a platform where governments, medical professionals, health organizations, media, and all the concerned parties can update each other of the situation and prevent worsening of the same.

Securing medical supply chains
The blockchain could also be used for “track and tracing” of medical supply chains. Blockchain has already proven its success as a supply chain management tool in other industries. Blockchain-based platforms could be used to enable the review, recording and tracking of demand, supplies and logistics of epidemic prevention materials. As supply chains involve multiple parties (from donors and recipients, to warehousing and delivery logistics), the entire process of record and verification by each party is tamper-proof, while also allowing anyone to track the process.

It could help streamline medical supply-chains, ensuring that doctors and patients have access to the tools when they need them and preventing contaminated items from reaching stores. A blockchain-based system could ensure vaccines, testing equipment, and other relief efforts are sent to the right places at the right times and in the quantities needed, and have that recorded. Securing the supply chains of these valuable resources could have life-saving effects. Combined with a surveillance system, a blockchain supply management system could change the way the world responds to epidemics.

Prevent zoonotic diseases
Zoonotic diseases like Corona could be caught in animals before they make the jump to humans if veterinary field records were kept on a blockchain surveillance system. Because many animals are migratory – so not staying in the same area – a decentralized blockchain system would allow for greater collaboration and transparency across the world. Diseases could be “flagged” and eliminated in animal populations before they make the jump to humans.

China and blockchain

Chinese organizations are trying to implement blockchain-based solutions to combat the Corona virus and reduce its economic impact on the country. They have rolled out a number of applications for immediate and emergency use, to fight the spread of the corona virus in public institutions, hospitals, universities and the financial sector. These are touted as performing a variety of different functions.

These blockchain solutions are already being used by local authorities to manage identity information and donation platforms. Additionally, multiple countries world-wide are employing blockchain-based tools to track patients diagnosed with coronavirus and identify the people who might have been infected. The apps are designed to ensure people’s privacy, identity, and medical records using the blockchain against Corona virus and other medical conditions.

HashLog
One of the interesting applications is HashLog, a solution launched by Acoer, a developer of blockchain-enabled applications for public health and global health organizations, to fight against the deadly coronavirus.

The HashLog visualisation engine interacts in real-time with Hedera Hashgraph’s distributed ledger technology to ensure real-time logging and data visualization of the spread of the disease. With the help of public data from the US Centres for Disease Control (CDC) and the World Health Organization (WHO), Acoer’s Hashlog Dashboard is capable of providing real-time information for tracking this epidemic. For example, this application is tracing people traveling to and from the country, to pinpoint patients and prevent further infections.

“HashLog allows for the real-time visualization of coronavirus data and trends. This includes the overall number of cases globally, rates of deaths and recovery per infections (where we have reliable data), cases filtered by country, as well as Google trends by interest and region on Corona virus.” Acoer’s CEO, Jim Nasr

This should help epidemiologists verify the integrity of records that have been uploaded to their analytics systems. Each transaction is recorded through a verified hash reference on Hedera’s ledger, meaning epidemiologists can trust data to be legitimate. This allows researchers, scientists and journalists to understand the spread of the coronavirus and its trends over time through visuals presented on Acoer’s HashLog dashboard.

IBM Food Trust
This is not the first time blockchain is being applied to track diseases. There have already been a number of initiatives using blockchain and distributed ledger technology to track the origins of food, for example. The IBM Food Trust has been using blockchain to help improve food safety by managing and conducting food tracings in order to identify sources of contamination for occurrences of Salmonella. By being able to identify the cause quickly and effectively, it is much easier to contain the problem and treat it at the source.

Blockchain preventing pandemics: not yet?

Presently, the authorities all over the world are trying their best to contain the Corona virus as it has shown the potential of turning into a pandemic. And that is where blockchain can help. We have seen that disease outbreaks can happen at any time, anywhere on the planet, with little or no warning. These are natural events that have occurred in the past and will re-occur in the future.

Blockchain will not prevent the emergence of new viruses itself. But what blockchain can do is create the first line of rapid defense through a network of connected devices whose only purpose is to remain alert about disease outbreaks. The use of blockchain can help prevent pandemics by enabling early detection of epidemics, fast-tracking drug trials, and impact management of outbreaks and treatment.

With easy access to such data, the containment of an outbreak becomes manageable and is of great help to the health authorities as well. This instant response capability can represent the difference between quick containment and global contagion.

While blockchain holds promise for the health industry, analyst warn a number of issues, including data standardisation, costs of operation and regulatory considerations, still need to be addressed before this technology is suitable for wide adoption. But with this serious Corona virus pandemic a number of these considerations could be solved rather quickly.

 

Carlo de Meijer

Economist and researcher

 

| 06-03-2020 | Carlo de Meijer | treasuryXL

A growing number of companies have expressed their will to enter the blockchain arena. But after some number of years in which their focus was mainly on the benefits of blockchain in various areas, in terms of speed, costs, streamline operations and increased efficiency, their attention is now turned to the various challenges and bottlenecks that are preventing widespread adoption. In this blog I will go into more detail in these bottlenecks and how the industry is trying to tackle these.

Main challenges

First of all there is a reputation challenge. Blockchain is still very much connected to the crypto world in the mind of many. And that is seen as a world of bad actors, hackers, frauds and speculators.

But more important are the technical ones such as immaturity (still slow and cumbersome), lack of scalability, lack of interoperability, stand-alone projects, difficult integration with legacy systems, complexity and lack of blockchain talent.

What to think about the organisational challenges at corporates like lack of good governance, lack of awareness and understanding, lack of user experience and education, the attitude of incumbents, or the security and privacy challenges, including lack of regulation. And there is the productivity paradox.

And finally, but not unimportant other challenges such as culture, energy consumption/environmental cost.

Blockchain has an image problem

Blockchain has an image problem. Blockchain is too much linked with cryptocurrencies in the mind of many. Especially crypto has a negative image that is surrounded by fraudsters, hackers that are using he technology for criminal activities. This bad name is reflecting on the blockchain technology system as whole and is making people seriously think twice before adopting it.

Before the general adoption is possible, members of the public must understand the difference between bitcoins, other crypto-currencies, and blockchain. One should understand that cryptocurrencies are only one application of blockchain technology amongst many others. This will help to eliminate the sometimes negative implications and may result in an increased willingness to use the technology. In the meantime a growing number of collaborative initiatives in the blockchain world in various industries have come up to bring wider change. This sort of interdependence may be the key to moving forward.

Corporates are afraid of the disruptive character of blockchain

There are organisations that do not like the idea of blockchain and its disruptive character. For some it is a nightmare thinking they will lose market share or will even become obsolete.

Blockchain is about 80 per cent business process change and 20 per cent technology implementation. It represents a total shift away from the traditional ways of doing things. This even goes for industries that have already seen significant transformation from digital technologies.

It places trust and authority in a decentralised network rather than in a powerful central institution. And for most, this loss of control can be deeply unsettling.

It is still uncertain who will be most affected by blockchain implementations and which areas of the business are likely to be most disrupted. So, a more ‘imaginative’ approach is needed to understand opportunities and also how things will change.

And there are the vested interest of incumbent parties

Existing regulation represents by far the most significant hurdle for blockchain innovators, as ‘existing regulations favour incumbents and their vested interest over disruptors’. The digitisation (of information) process is taking place in a so-called regulatory “heavy” zone. That is not that strange given the long-established authority of governments to protect consumer and property rights.

Blockchain presents new challenges to regulators looking to protect consumers and markets, but the rigidity with which regulators in the world’s major economies have approached blockchain has served to stifle innovation and growth.

But that view is also changing and as soon as also governments and other public organisations are seeing the benefits of this technology and develop a regulatory model that encourages innovation while protecting consumers that might be an eye opener for others.

Blockchain is still an immature technology

Beyond the above described challenges, blockchain faces a number of implementation challenges, that has all to do with the still immature technology.

• Lack of scalability

One major technology challenge of blockchain is related to the technical scalability of the network which can put a strain on the adoption process, especially for public blockchains.

Legacy transaction networks are known for their ability to process thousands of transactions per second. Visa, for example, is capable of processing more than 2000 transactions per second. The two largest blockchain networks, Bitcoin and Ethereum however are far behind when it comes to transaction speeds. While the Bitcoin blockchain can process three to seven transactions per second, Ethereum can handle approximately 20 transactions in a second.

This lack of scalability is not such an issue for private blockchain networks, since the nodes in the network are purposely designed to process transactions in an environment of trusted parties, which makes sense business-wise.

There are some interesting solutions upcoming to tackle the scalability issue. Such as s the Lightning Network, which consists of adding a second layer to the main blockchain network in order to facilitate faster transactions. Another interesting solution is Sharding that groups subsets of nodes into smaller networks or ‘shards’ which are then responsible for the transactions specific to their shard. When offered in conjunction with the proof-of-stake consensus mechanism, has the potential to scale up the application.

• Lack of standardisation: limited interoperability

Another main challenge is the lack of interoperability between the large number of blockchain networks. Over 6,500 projects are leveraging a variety of – mostly standalone – blockchain platforms and solutions with different protocols, coding languages, consensus mechanisms, and privacy measures.

The problem is that with so many different networks, the blockchain space is in a ‘state of disarray’ due to a lack of universal standards that would allow different networks to communicate with each other.

The lack of such uniformity across blockchain protocols also takes away consistency from basic processes like security, making mass adoption an almost impossible task.

The establishment of industry-wide standards with regard to various blockchain protocols could help enterprises collaborate on application development, validate proofs of concept, and share blockchain solutions as well as making it easier to integrate with existing systems.

There are now various projects that offer interoperability among different blockchain networks, such as Ark which uses SmartBridges architecture to address this challenge, and claims to provide universal interoperability, plus cross-blockchain communication and transfers. Another example is Cosmos, which uses the Interblockchain Communication (IBC) protocol to enable blockchain economies to operate outside silos, and transfer files between each other.

• Integration with legacy systems

And there is the challenge for corporates of how to integrate blockchain with their legacy system(s). In most cases, if they decide to use blockchain, organization are required to completely restructure their previous system, or design a way to successfully integrate the two technologies.

One problem is that due to the lack of skilled developers, organizations do not have access to the necessary pool of blockchain talent  to engage in this process. Reliance on an external party can soften this problem. But most solutions present on the market require the organization to invest a significant amount of time and resources to complete the transition.

And there are the high incidences of data loss and breach that are discouraging most companies from transitioning to blockchain. Every enterprise is reserved and unwilling to make changes to its database, and for good reasons, as data loss or data corruption constitute major risks.

Recently, new solutions emerged which enable legacy systems to connect to a blockchain backend. One such solution is Modex Blockchain Database, a product designed to help people without a background in technology, access the benefits of blockchain technology and remove the dangers posed by the loss of sensitive data.

• Lack of blockchain developers

While the demand for qualified blockchain staff is increasing dramatically, the blockchain landscape suffers an acute  shortage of an adequately trained and skilled /qualified people  for developing and managing the complexity of peer-to-peer networks. Blockchain technology however demands additional qualification and know-how.

According to some, the demand for blockchain-related jobs has increased by almost 2000% between 2017 and 2020. Having a sufficient pool of qualified developers is a top industry concern.

Blockchain technology is still in its infancy and is still evolving. It requires time for the developer community to adopt it, and for educational institutions to introduce relevant blockchain-related courses. Though this will alleviate the market demand, the results however will become palpable only after students will finish their training and that will take some time. .

• Blockchains can be slow and cumbersome

Due to their complexity and their encrypted, distributed nature, blockchain blockchains can be slow and cumbersome. Transactions can take a while to process, certainly compared to “traditional” payment systems such as cash or debit cards.

When the user number increase on the network, the transitions take longer to process. It can take even days to process the whole transaction. As a result, the transactions cost is higher than usual, and this also restricts more users on the network.

In theory the principle extends to blockchain networks which are used for something other than as a store of value (for example logging transactions or interactions in and IoT environment). This is a problem which could be solved with advances in engineering and processing speeds, but that will take some time.

Organisational challenges

And there are various organisational challenges that are limiting the use of blockchain technology by corporates.

• Lack of awareness and understanding

The main challenge for corporates associated with blockchain, especially the small and medium ones, is a lack of awareness of the technology and a widespread lack of understanding of how it works. Many companies do not understand what blockchain is or what they can do. This has a lot to do with the dominance of technicians in the blockchain area and their too much technology approach.

This is hampering investment and the exploration of ideas. Instead a much more business oriented approach is very much needed. This asks for improving the user experience for those not as technically minded. Organisations really must educate themselves about this emerging technology. They should increase their level  of understanding at all levels. This asks for better educational campaigns to make all this knowledge more accessible.

• Productivity paradox

And there is the so-called blockchain paradox. The speed and effectiveness with which blockchain networks can execute peer-to-peer transactions comes at a high aggregate cost, which is greater for some types of blockchain than others. This inefficiency arises because each node performs the same tasks as every other node on its own copy of the data in an attempt to be the first to find a solution.

Therefore, decisions of corporates about implementing blockchain applications need to be carefully thought through. The returns to individual processing may diminish as the network grows in size. This means that blockchain applications must harness network effects to deliver value to consumers or to sectors at large.

• Lack of cooperation

The blockchain creates most value for organisations when they work together on areas of ‘shared pain or shared opportunity’. The problem with many current approaches, though, is that they stand alone: organisations are developing their own blockchains and applications to run on top of them.

In any one industry sector, many different chains are therefore being developed by many different organisations to many different standards. This defeats the purpose of distributed ledgers, fails to harness network effects and can be less efficient than current approaches.

A positive developments is however the rise of so called blockchain consortia, aimed to tackle industry wide issues, including standards, critical mass etc.

• Security and privacy challenges

And what to think about the various security and privacy challenges. While cryptocurrencies offer pseudonymity, many potential applications of the blockchain require smart transactions and contracts to be indisputably linked to known identities, and thus raise important questions about privacy and of the security of the data stored and accessible on the shared ledger.

Many companies nowadays work with privacy rules governed by regulation. Their consumers trust them with sensitive information. But if this information is all stored in a public ledger it won’t actually be private anymore. Private or consortia blockchain could work here. You would get limited access, and all your sensitive information would stay private as it should.

Security is another crucial topic here. However, only a handful of scenarios have good protocols that can cope with this. While blockchains are more secure than traditional computer systems, hackers can still breach apps, systems, and businesses built on blockchains.

The solution is not just government protection of privacy. Self-sovereign identities on blockchain will enable us to capture and control our own data. While there is a lot of work on several privacy protocols such as proof of zero knowledge to overcome these obstacles and good identity initiatives are underway (Sovrin), we are still a long way from a radically new identity framework.

• Lack of regulatory clarity and good governance

There is also the lack of regulatory clarity regarding the underlying blockchain technology, which is a significant roadblock for mass adoption. Regulations have always struggled to keep up with advances in technology. This is also the case with blockchain. One of the challenges of the blockchain approach (which was also one of its original motivations) is that it reduces oversight.

Many organizations are making blockchain technology as a means of transaction. But even now there aren’t any specific regulations about it. So, no one follows any specific rules when it comes to the blockchain, so there is still no security.

There are certain areas that require regulatory support, such as the earlier mentioned smart contracts. If the regulations do not cover smart contracts, it inhibits adoption as well as investment in the blockchain industry.

Centralised systems, particularly in financial services, also “act as shock absorbers in times of crisis” despite their challenges and bottlenecks. Decentralised networks can be much less resilient to shocks, which can impact participants directly, unless careful thought is given to their design.

There is thus a strong argument for blockchain applications to work within existing regulatory structures not outside of them. To get over this challenges, Government and extremely controlled sectors may need to create regulations for blockchain. But this means that regulators in all industries have to understand the technology and its impact on the businesses and consumers in their sector.

Other challenges

• Blockchain has an environmental cost

And finally but not least important the huge energy consumption is another blockchain adoption challenge. The majority of blockchains present in the market consume a high amount of energy.

Most of the blockchain technology follow bitcoins infrastructure and use Proof of Proof-of-work (PoW) as consensus mechanism for validating transactions. These protocols require users to solve complex mathematical puzzles, and require tremendous computing power to verify and process transactions and to secure the network.

In the meantime the amount of energy consumed by computers that compete to solve the mathematical puzzle has reached an all-time high. Some estimate that Bitcoin transaction energy consumption could soar as high as the yearly electricity usage of Denmark in 2020. Add to this the energy needed to cool down the computers, and the costs increase exponentially.

To overcome this issue, many blockchain proponents are developing more efficient consensus algorithms, that are less energy taxing. So-called proof-of-stake (PoS) protocols were introduced, that involve a combination of a participant’s stake in the network and an algorithm to randomly assign the task of validation to a node. Given that the participants are not required to solve complex puzzles, these mechanisms significantly reduce energy consumption.

Furthermore, from a business perspective, private blockchains are more suitable to serve company interests, as they provide restricted access, an additional layer of privacy to protect trade secrets, and are more energy-efficient.

Forward looking

In general, technological advancements take a long time to mature and reach a stable form that can be introduced into the market. Like any technological innovation, blockchain will follow the same, slow trajectory of adoption over the coming years. Although there are many possibilities, it will still take some time to get rid of all the challenges and use it to get all the benefits of it.

The list of Blockchain adoption challenges mentioned above clearly underlines the need for technological improvements. And the industry is very busy solving them. If we can fix these and remove the various bottlenecks, things will surely become more comfortable and trigger mass adoption.

 

Carlo de Meijer

Economist and researcher

 

| 24-1-2020 | Carlo de Meijer | treasuryXL

In my last Blog I suggested that regulation of the crypto markets would be one of the main issues for 2020 and beyond. There seem to be urgent need for more clarity on many cryptocurrency issues. The EU Fifth ALM Directive came into effect early January, while ESMA announced its plans to develop a legal framework for cryptocurrencies in 2020. In the US the Crypto Currency Act of 2020 is being discussed in the House of Representatives. My prediction that a growing number of regulators worldwide would more prominently enter the crypto stage this year will come true. Main question is: will this lead to more uniformity in the regulatory approach worldwide?

European Commission consultation on EU crypto framework

In December last year, the European Commission launched a public consultation on the future EU framework for markets in crypto-assets. It thereby seeks stakeholder views on, among others, the usefulness, means and features of future crypto-assets classification.

The Commission notes that the lack of any comprehensive classification of crypto-assets leads to uncertainty in the markets, as to whether (and potentially which) such assets fall within the scope of EU financial services legislation by means of being MiFID II financial instruments.

The Commission also seeks stakeholder views on the importance of specific benefits related to crypto-assets and also specific risks related to its use. The Commission notes that while crypto-assets can bring about significant economic benefits in terms of “efficiency improvements and enhanced system resilience”, they can also cause potential challenges for their users.

The consultation document includes detailed questions designed to assess legislation applying to security tokens and including, but not limited to, MiFID II, Market Abuse Regulation, Short Selling Regulation, Prospectus Regulation, Central Securities Depositories Regulation, EMIR and UCITS.

More broadly, the Commission seeks views whether a tailor-made EU regime for crypto-assets would “enable a sustainable crypto-asset ecosystem” and whether the use of crypto-assets in the EU would be “facilitated by the greater clarity as to the prudential treatment of financial institutions’ exposures to crypto-assets”. The current consultation remains open until 19 March 2020.

The consultation paper: Three main parts

This consultation paper consists of three main parts: (1) Classification of crypto-assets, (2) Crypto-assets that are not currently covered by EU legislation; and (3) Crypto-assets that are currently covered by EU legislation.

a. Classification of crypto-assets
The Commission acknowledges that while there is a wide variety of crypto-assets in the market, there is no commonly accepted way of classifying them in the EU. There is still a lack of a single and broadly accepted definition.  For the purpose of this consultation, the Commission defines a crypto-asset as “a digital asset that may depend on cryptography and exists on a distributed ledger”.

b. Crypto-assets not covered by EU legislation
The consultation document includes specific questions focused on service providers related to crypto-assets, and in particular the issuance of crypto-assets, trading platforms, exchanges, provision of custodial wallet services for crypto-assets and other service providers.

The Commission notes that such activities and services providers remain – with some exceptions – outside the European (and national) legislative and regulatory framework and considers that “regulation may be necessary in order to provide clear conditions governing the provisions of these services.”

c. Crypto-assets covered by EU legislation
The Commission considers “security tokens” as crypto-assets “issued on a DLT and that qualify as transferable securities or other types of MiFID financial instruments”. For activities concerning such security tokens qualifying as MiFID II investment services/activities, authorisation is required.

In summarising trends concerning security tokens, the Commission admits “the limited evidence available at supervisory and regulatory level” and that “existing requirements in the trading and post-trade area would largely be able to accommodate activities related to security tokens via permissioned networks and centralised platforms”.

Fifth EU Anti Money Laundering Directive

The Fifth EU Anti Money Laundering Directive  that took effect from 10 January 2020 puts a regulatory framework for all 28 EU members to date. Even the United Kingdom has decided to implement the law despite its decision to leave the EU.

The new Directive defines crypto-assets as “digital representation of a value that is not issued or guaranteed by a Central Bank or a public authority and that does not have the legal status of a currency or money, but that based on agreement or practice is accepted by natural or legal persons as means of payment or exchange or is used for investment purposes and that is transferred, stored and traded electronically”. This is to specifically exempt digitally stored and transferred fiat money, but include both payment and security tokens.

Among the most notable changes are that cryptocurrency service providers will have to follow Know-Your-Customer (KYC) rules. Cryptocurrency platforms and wallet providers are required to identify their customers for anti-money laundering purposes. All transactions will have to be monitored, and companies will need to file Suspicious Activity Reports (SARs) with law enforcement. The new KYC mechanism would require personal ID when opening an account on EU-operating exchanges. The proof-of-identity would serve as insurance, for not making any illicit financial operations.

The New Regulatory Framework is mandatory for all EU-based crypto exchanges and custodial wallets. Every crypto exchange operating on the European Union market must meet the legislation in order to continue its operation in the EU. They had to achieve compliance with the rules already by 10 January.

Worldwide exchanges must undergo an AML/KYC upgrade for the EU market, as until now, there were no rules about implementing such mechanisms.  However, meeting those regulations would streamline the EU market to become competitive to other regulated markets, such as the United States.

Challenges

For firms buying and selling crypto assets, the Fifth Anti-Money Laundering Directive will require them to register with national financial regulators. The way exchanges and crypto-oriented companies must verify they are KYC-compliant, is via appropriate licensing in every jurisdiction. It also states minimum requirements for AML processes, similar to what we see with traditional asset classes.

Unless any company wishes to leave the EU, they should comply in full. Because the Directive requires crypto-related firms to register with their national regulators and comply with a variety of AML guidelines, it’s likely that some firms may struggle to adjust to the new regulatory environment. European crypto exchanges and companies are still far behind the “KYC-ready” state that the Directive requires.

While U.S.-based exchanges have the expertise to deploy AML/KYC protocol updates to comply with the EU Directive, crypto exchanges in the EU however have shown mixed readiness for KYC upgrades to their platforms. The majority of EU-operating exchanges have taken a so-called “procrastinating” approach. That could be very bad for those as, if the services do not comply with any of these requirements, they will have to pay fines and penalties, or even risk being shut down.

And while the Fifth Anti-Money Laundering Directive suggests a “harmonized regulatory framework,” there are significant differences in the ways the Directive is being implemented across the European Union.

ESMA aims to develop legal framework for cryptocurrencies in 2020

Early this month ESMA published its 2020-2022 priorities list, noting that EU capital markets are facing new risks from digitalisation. ESMA wants market participants to acknowledge and prepare for these apparent risks. In its Strategic Orientation, the regulatory agency also revealed its plan to bring a legal framework for digital currencies and related products.

“The dangers of cyber threats to the financial system as a whole and a sound legal framework for crypto-assets are increasingly becoming areas of focus for ESMA together with the other ESAs, the ESRB, the ECB and the European Commission.”

“The new Strategic Orientation sets out how we will exercise our new powers, and meet our new responsibilities, in pursuit of our mission of enhancing investor protection and promoting stable and orderly financial markets in the EU,” Steven Maijoor, chairperson of ESMA

The European agency had already been watching the digital asset industry for a while and has been grappling with the question of how to regulate cryptocurrencies and securities in the space. Last year it issued an advisory on initial coin offerings (ICOs) and crypto-assets, highlighting that some crypto-assets may qualify as MiFID financial instruments.

US Crypto Currency Act 2020-2022

But also in the US more crypto regulation is arriving, triggered by the possible launch of Facebook’ s Libra. The introduction of the Cryptocurrency Act of 2020 is seen as a vital move in regulating crypto markets. The goal of the new legislation is to provide additional clarification on digital asset regulations to the market and create a framework for cryptocurrencies, thereby countering the negatives of crypto investing.

The Act has now been introduced in the US House of Representatives. The bill has some wide-ranging regulations that, if voted into law, could reshape the crypto landscape moving forward – at least in the United States, but also elsewhere.

The objective of the Act is to enforce regulations and to force crypto companies to play by the same rules. The Cryptocurrency Act 2020 categorises digital assets into three main groups: crypto-commodities, cryptocurrencies, and crypto-securities. The draft bill thereby contains broad definitions of the types of digital assets. It further determines the various regulatory bodies that will oversee the crypto currency space and will be responsible for the creation of regulation and legislation. The Act thereby seeks to clarify the power of each government agency to regulate the crypto space.

Up till now multiple government agencies have been competing to regulate the crypto space, leading to a confusing mixture of laws. This is suppressing the crypto space, since crypto companies can be attacked by multiple federal agencies.

Additionally, rules will be established with the goal of tracing all crypto and digital currency transactions, in addition to the personal facilitating the transacting, similar to other traditional currency transactions, securities fraud, corporate auditing and other financial activities.

Digital assets: Three main groups

The most interesting change is how digital assets are to be split up into three main categories. A distinction is made between cryptocurrencies, crypto-securities, and crypto-commodities.

a. Cryptocurrencies
The draft bill puts cryptocurrencies in a separate category of digital assets. They are defined  as “representations of US currency” synthetic derivatives backed by smart contracts or collateralized by other digital assets (resting on a blockchain or decentralized cryptographic ledger).

The crypto class includes Bitcoin, Bitcoin Cash, Litecoin, and any other cryptocurrencies that don’t fall under the current securities regulations. Smart contracts and oracles fall under the cryptocurrency category as well. Furthermore, the role of stablecoins will be scrutinized, as not all of these currencies are created equal.

The Financial Crimes Enforcement Network (FinCEN) is to overlook cryptocurrency regulations, on behalf of the Treasury secretary. FinCEN will thereby need to collaborate with the Secretary of the Treasury to enforce AML and KYC protocols in the market. Primarily, regulators want to develop a way to trace all cryptocurrency transactions, which seems highly questionable.

b. Crypto-commodities
The bill defines crypto-commodities as all digital assets, regardless of who produced them, stored on a “blockchain or decentralized cryptographic ledger”. A key aspect of these tokens is the fact that they contain some form of substantial fungibility. Fungible assets are interchangeable, such as the USD.

The Commodity Futures Trading Commission (CFTC) is to be responsible for regulating crypto-commodities. The group will need to develop the framework for these tokens from the ground up if the legislation passes. Due to the rise of cryptocurrencies, it is expected crypto-commodities will play a major role in the space going forward.

c. Crypto-securities
Crypto-securities, the most comprehensive of the three types of digital assets, “include all debt, equity, and derivative instruments that rest on a blockchain or decentralized cryptographic ledger.” These tokens are simply any coin that “fails the Howey Test”. What the Howey test defines is whether or not an asset will be categorised as a security by financial regulators.

The draft bill’s exceptions to crypto-securities are as follows: “A synthetic derivative operating as a money services business and registered with the Department of the Treasury; and, or Any security that operates in compliance with the Bank Secrecy Act “and all other Federal anti-money laundering, anti-terrorism, and screening requirements of the Office of Foreign Assets Control and the Financial Crimes Enforcement Network.”

In the Cryptocurrency Act 2020 security tokens are to be overlooked by the Securities and Exchange Commission (SEC).

Growing need for crypto compliance professionals

The fast evolvement of crypto regulation worldwide as well as the – sometimes very – different approaches ask for a large number of regulatory and compliance professionals. There is still a great lack of knowledge of future crypto compliance and governance, so finding, recruiting and hiring these people may become a big challenge especially for smaller firms. Bigger companies generally will likely have the necessary procedures and processes already in place needed for crypto from working with other asset classes.

The news of “pending” clarity of new government regulation is mobilising a growing number of professionals (crypto accountants, tax professionals and compliance officers) to study the various compliance issues that are arising from these mostly different crypto regulations. They are working together to use any available information to accurately meeting the new reporting and compliance requirements for 2020 and beyond.

Towards a global regulatory framework?

The year 2020 should be seen as the start of a regulatory revolution for cryptocurrencies. Regulatory initiatives in both the EU and the US could trigger new cryptocurrency regulations around the world, to attribute regulatory clarity to the global crypto market.

A global regulatory framework for cryptocurrencies however will not be easy to implement. Bringing a complex and fast evolving area like cryptocurrencies into a global framework is going to be a difficult and lengthy process.

In countries all over the world, governments have been struggling to develop laws and guidelines regulating the use of cryptocurrencies currencies. This has resulted in a patchwork of different regulations.

But while the approaches of other governments may initially remain quite different, most experts however believe that, triggered by the regulatory approaches in the EU and the US  such a global framework will be a reality at the end of this decade

Carlo de Meijer

Economist and researcher