Explaining Cryptocurrencies

Cryptocurrencies (also referred to as virtual currencies) are a form of digital currency which utilise encryption techniques for security. The same cryptography techniques are used in order to verify transactions involving virtual coins, and further coins are generated using complex mathematical algorithms in a process termed 'mining'. These digital instruments are increasingly being used to pay for goods and services, and such transactions are facilitated via the blockchain platform; peer-to-peer technology which ensures transparency and accountability. At present, the most traded cryptocurrencies are Bitcoin and Ethereum, however a host of other coins are also in circulation.

Virtual currencies differ from traditional legal tender (also known as fiat money) in a number of ways. As previously mentioned, these coins are 'mined' rather than issued by a financial institution or other authority, and are accordingly (so far at least) a form of value autonomous from governmental or institutional influence. Mining involves users of the blockchain, termed 'miners' mathematically confirming transactions which are then entered into the blockchain ledger, the incentive being that the users who successfully solve the algorithms receive coins in exchange for their services (this is essentially a form of book-keeping). There is also widespread consensus that it is far more difficult to produce counterfeit digital currency than fiat money.

Coins are stored in and accessed through encrypted digital 'wallets' and recorded through the data ledger. Each 'wallet' has its own unique address and makes use of a set of public and private keys as a security feature. Transactions may occur on a 24/7 basis and are recorded in real-time in the blockchain database, bypassing the need for middlemen and eliminating high transaction fees, thereby increasing transaction speed while simultaneously reducing costs. Rather than depending on a central gatekeeper or storage facility, cryptocurrency dealings are managed, monitored and ratified by the blockchain network, making it difficult to hack, alter or destroy data. Another attractive feature is anonymity – users are identified only by means of their public wallet address (which consists of a series of alpha-numeric characters).

The advantages of cryptocurrencies are counterbalanced certain downsides. These include volatile values and sharp value fluctuations, a lack of backing by a recognised financial institution or government, limited acceptance of the currency (at present), the possibility of cyberattacks and hacking and nefarious use or illicit activity due to anonymity (e.g. money laundering).

Regulation and Concerns

The treatment of virtual currencies differs among States; they have been considered, amongst others, an equivalent to legal tender, a separate asset class, a payment method, a commodity and a unique technological platform. At the time of writing, cryptocurrencies are unregulated under Maltese law and exchanges of cryptocurrencies (for other cryptocurrencies or for fiat currency) are deemed equivalent to commodity trading. A company utilising virtual currencies is currently not required to obtain a licence from the Malta Financial Services Authority (MFSA) unless it qualifies as a collective investment scheme or carries on the business of a financial institution or payment service provider, in which case the company would need to be appropriately licenced in terms of the Financial Institutions Act. Moreover, digital coins are not considered as being investment instruments under the Investment Services Act at present, and so investment activities related to cryptocurrencies would not trigger any licencing requirements in terms of this act. It is worth noting that the MFSA has recently issued a consultation document in relation to the proposed regulation of the investment in cryptocurrencies by specific legal entities.

With respect to legal perspectives, investors should be wary of potential pitfalls such as fraudulent crowdfunding schemes or ICOs and securities fraud. The fact that transactions involving cryptocurrencies cannot be reversed once executed (at least at this stage) coupled with the anonymity enjoyed by parties to such dealings regrettably present attractive opportunities for illegal activity. Another issue which may further complicate matters in relation to cross-border cryptocurrency transactions would be the potentially different classification and regulatory requirements to which such transactions may be subject.