Finding the ‘Goldilocks’ Zone’: Striking the Balance Between Regulation and Innovation in the Digital Currency Space



Executive Brief

Regulating cryptocurrencies is fraught with difficulties, so it is no wonder that regulatory authorities and governments have waited so long to take action. But 2015 is becoming the year of cryptocurrency business regulation: reports have been published in Canada and France, as well as by the European Banking Authority; some US States, along with the UK, have effected regulations this year; and all portents point to further regulation globally in the year future. But it is becoming increasingly clear that there is a balance to strike between regulating cryptocurrency business sufficiently to provide the certainty which will increase digital currency uptake, and avoiding over-regulation which might stifle innovation in the digital currency space.

Read the full story below. 


The state seal or monarch’s likeness on coins and banknotes represents more than the issuer’s vanity. Such symbols reassure individuals and businesses that the disk of metal or sheet of linen-paper in their pocket was produced in line with regulations which guarantee value, legality and genuineness. So far, so obvious. For cryptocurrencies, however, the situation is more complex. The role of issuer is taken by a computer algorithm, standardised and monitored by a community or individual, rather than a government or central bank. This is both the key benefit of digital money for consumers and businesses, and the key issue faced by regulators who are yet to decide how existing regulation can be adapted to suit these new currencies, or whether new avenues should be explored.

Regulatory authorities have so far been slow to take action; their responses have fallen on a spectrum between the open hostility of China and Russia and the ‘wait-and-see’ attitude of East Asia, North America and much of Europe. But as cryptocurrencies increase in prominence, the risks and opportunities posed by digital money enter sharper focus. The time is rapidly coming for regulators to take serious action, both to ensure consumer confidence and to build a legal structure in which cryptocurrency users can operate.

Few would argue that cryptocurrency business should remain entirely unregulated. The sudden collapse of the Mt Gox Bitcoin exchange in 2014, after some 744,000 Bitcoins (worth around $386 million) went missing, was a timely reminder that – while cryptocurrency transactions are highly secure thanks to Public Key Encryption – cryptocurrency storage is still an area of acute vulnerability. A similar incident in 2011 caused the value of Bitcoin to plummet from $17.50 to $0.01 in only a few hours. The need for consumer protection is therefore immediately apparent.

Other issues dog the adoption of cryptocurrencies. Their inherent anonymity invites criminal activity, preventing banks from opening themselves to the risk of penalties if they engage fully with digital money. The lack of a regulatory framework and legal status creates uncertainty with regards to value and liquidity. And, as cryptocurrencies increase in value, they may become a real risk to established conventional currencies through speculative attacks, where investors could use unregulated digital money to manipulate the value of conventional national currencies. Without legal recognition, central banks and the IMF cannot build reserves of cryptocurrencies to counter such attacks.

All these issues hurt the credibility of cryptocurrencies and the businesses which adopt them, and so ‘light-touch’ regulation could well, as Duke University’s Prof Campbell Harvey argues, help reduce cryptocurrency volatility and aid the mainstream acceptance of digital money. Until regulators get to grips with cryptocurrencies, uncertainty will prevail. Cautious business leaders will therefore hold off adoption until the regulators’ positions become clear.

The British and Canadian governments appear amenable towards low-level regulation: the UK Government’s 2015 budget contained provisions introducing anti-money laundering regulations to cryptocurrencies, while a recent Canadian Senate report recommended a feather-light regulatory approach. Both countries are notable for their large-scale investments in cryptocurrency research.

Elsewhere, however, the noises about cryptocurrencies have been less accommodating. Germany has recently declared that cryptocurrencies are not legal tender – though has not gone so far as to ban them – while a French report recommends setting caps on the value of cryptocurrency transactions. Certain US states already regulate cryptocurrency exchanges, but some states have declared their intention to go further. New York’s ‘BitLicense’ requires the licensing of financial institutions who trade in cryptocurrencies, and imposes tough rules requiring comprehensive transaction records.

New York’s regulatory intentions have been much maligned – and a process of revision in consultation with cryptocurrency providers may further dilute some of the more draconian measures – but at least they deal with cryptocurrency transactions as distinct from conventional currencies. Pennsylvania, meanwhile, is attempting to bring the regulation of cryptocurrency transactions in line with existing rules governing the use of conventional currencies. This approach may prove problematic. Current legislation deals with digital transactions of conventional money, managed by a third party. Such regulations cannot deal effectively with peer-to-peer transactions of decentralised digital currencies.

Instead, most would argue that regulation of cryptocurrencies should be specific and minimal. Over-regulating digital money, or applying regulations designed for conventional currencies, stifles the key advantages which make digital currencies attractive in the first place – their low cost, efficiency, facilitation of micro-payments, extraterritoriality and avoidance of exchange fees. Cryptocurrencies also maintain their stability in the face of political pressures and decisions which affect government backed currencies.

Regulating cryptocurrencies is a challenge of finding the ‘Goldilocks’ zone’ between too much and too little regulation. Some regulation is necessary, to legitimise cryptocurrencies. While 100,000 businesses worldwide are estimated to accept digital money of one form or another, uptake among major businesses remains low. Minimal regulation must be seen as the price for wider acceptance. But over-regulation is to be avoided if governments and civil society, as well as consumers and businesses, are to benefit from the innovative and exciting developments in digital currencies.

Author: Chris Cooper

Chris Cooper is a doctoral researcher in ancient economic history at Merton College in the University of Oxford. His AHRC-funded research examines transaction costs in the ancient world, and the impact of the invention of money. But while Chris specializes in the cultures that created money in the first place, he is equally interested in digital currencies and their impact on modern societies, cultures, trade-flows and laws.

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