It seems as if the world has gone crypto-crazy. The staggering number of columns written about cryptocurrencies, the amount of initial coin offerings (ICOs) last year and the questions we’ve received from customers all indicate that interest in cryptocurrencies is at an all-time high.
The cryptocurrency landscape is complex, diverse and dynamic. There are fortunes to be made and lost in this largely unregulated space, which attracts its share of scammers, fraudsters and opportunists. Acquirers and payment service providers (PSPs) need to avoid being caught out.
Card transactions must be legal in both the country of the buyer and the seller. Yet the internet easily facilitates cross-border sales, which adds a special layer of complexity for merchant underwriters. This is quite apart from the fast-changing positions on regulation and taxation.
In this blog post, we survey the state of crypto and dispel common myths. We consider the position of regulators and card schemes, plus what acquirers can do to manage their risks in this dynamic space.
Show me the money
Bitcoin challenges fundamental assumptions about money. It does not require banks to create it or lets them serve as trusted intermediaries in financial transactions. It’s a decentralized digital currency that utilizes cryptography for security and a Blockchain ledger to record transactions.
A peer-to-peer network of computers resolves a cryptographic problem or ‘proof of work’ to verify each transaction between the members of the network. This removes the double-spend problem of digital currencies and reframes the need for trust. Transfers of value between participants are noted and added to a chain of previous transactions. The system behaves like a crowd-sourced, public ledger on the internet.
This alternative money model puts faith in computers and code, rather than governments and banks. It subverts traditional notions of money, where it comes from, who creates it, how it is exchanged and what it is worth. No wonder, then, that everyone from legislators and regulators to consumers, merchants and acquirers is playing catch-up.
Pros and cons
“It would not be wise to dismiss crypto-assets; we must welcome their potential but also recognize their risks,” wrote Christine Lagarde, managing director of the International Monetary Fund (IMF) in a March 2018 blogpost.
Proponents see digital assets as transcending national boundaries with no need for clearing, settlement or intermediaries. This strips out duplication, cost and potentially boosts efficiency, innovation and financial inclusion.
Opponents see volatility and speed issues, making cryptocurrencies unsuitable for mass-market retail payments. The irrevocability of transactions could increase risk and fraud. There is also the environmental impact of cryptocurrency ‘mining’, which uses more electricity than consumed by Ireland at this point.
Criminals also value the relative untraceability of cryptocurrencies to monetise electronic crimes, such as ransomware and distributed denial of service (DDoS) attacks. But also to enable remote payments for real-world criminal activity, for money laundering and terrorist financing.
Regulation or lack of it
There is no consistent global approach to cryptocurrencies. Some countries (Algeria, Bolivia, Morocco, Nepal, Pakistan and Vietnam) ban any and all activities involving cryptocurrencies. Qatar and Bahrain bar their citizens from engaging in cryptocurrency activities locally but permit this outside their borders. Others impose indirect restrictions by barring financial institutions within their borders from facilitating such transactions (China, Iran, Lithuania, Thailand).
ICOs (initial coin offerings), also known as token sales or token generation events, raise money by selling a new type of coin, virtual currency or token in a similar way to an IPO. They are banned in China and Pakistan. Meanwhile other countries, such as Belarus, the Cayman Islands, Luxembourg and Switzerland, are drawing up regimes to formally police the space to attract FinTech investment. Malta is there already. It passed three bills into law in July 2018, establishing a legal framework for Blockchain, cryptocurrencies and distributed ledger technology.
There are geographic differences when it comes to taxing crypto-assets. Should gains made from mining or selling cryptocurrencies be classified and taxed as income or capital gains? In Israel, cryptocurrencies are taxed as an asset. In Switzerland, as foreign currency. In Argentina and Spain, they are subject to income tax. In the United Kingdom, corporations pay corporation tax, unincorporated businesses pay income tax and individuals pay capital gains tax.
Mastercard has shown leadership in this area. It has added cryptocurrency merchants to its BRAM programme (initiative AN 1695 — Addition of Cryptocurrency Merchants to the BRAM Program and Revised Standards — Cryptocurrency Merchant Registration) and since 12 October 2018 has required registration of both new and existing cryptocurrency merchants. As part of the registration process, acquirers must provide:
- Evidence of legal authority — including copies of the merchant’s license (in regulated jurisdictions) and registration to operate in each country where their cryptocurrency activity will occur or be offered to cardholders.
- Legal opinion — including a reasoned legal opinion covering the legality of the offered services from a reputable local law firm for each jurisdiction where cardholders are accepted from.
- Effective controls — including certifications that the merchant’s systems are designed to remain within legal limits.
- Notification of changes — including the ability to notify Mastercard within 10 days of any changes to the information previously provided around applicable law, merchant activities and systems.
- Acceptance of responsibilities — affirmation that the acquirer will not submit restricted transactions for authorisation.
How do acquirers and PSPs fulfil these and other requirements effectively?
While acquirers and PSPs may know reputable law firms locally, this may not be the case in other jurisdictions. The legal opinions themselves are often expensive and expire. Moreover, if they have to be renewed regularly and consider international implications, the costs can quickly add up.
It is on the acquirer to build their own infrastructure to on-board cryptocurrency merchants responsibly and in compliance with card scheme regulations – or they rely on third parties like Web Shield to take over this step. With Regulatory Monitoring, Web Shield’s new subscription service, you gain access to a frequently updated database of legal opinion on cryptocurrencies to ensure compliance.
Risk and opportunity are intertwined — one cannot exist without the other. This is certainly true of the cryptocurrency space. So, it follows that the best companies manage risk best. They are confident in taking more controlled, calculated decisions to grow and prosper.
Nowhere is this clearer than around cryptocurrency merchants. The landscape is dynamic. Huge opportunities and huge risks exist in the same future, hence why getting merchant underwriting right is so important for businesses to succeed.