The Impact of Crypto-Assets on Governments and the International Community: A Forecast for 2035
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As the financial and technological sphere rapidly develops, it will increasingly impact the entire globe, including global governance structures, and the traditional system of international law. Particularly pressing is in the domain of crypto-assets, which contain huge resources and is simultaneously developing with a disregard for state borders. Hence, this sphere will inevitably place the international community in a position where adequate and exhaustive international regulation for this new phenomenon and its processes will be required. With this, a new financial landscape may prove to be a starting point for such significant changes. Thus, it seems imperative to consider the coming financial transformations that will shape the global agenda by 2035. This will also further bolster the need for effective crypto-asset regulation, which can inspire the world to alter the traditional system of international law.
Realities of International Law
In his book, “World Order”, Henry A. Kissinger, an American diplomat, Nobel Peace Prize laureate, and Honorary Doctor of the Diplomatic Academy of the Russian Foreign Ministry noted that “the political and the economic organizations of the world are at odds with each other. The international economic system has become global, while the political structure of the world has remained based on the nation-state” . Today, this quote appears to be at odds with the reality of the world’s situation; the global environmental agenda has been comprehensively promoted, and many economic restrictions, including sanctions, have already been imposed. Additionally, a possible conflict scenario has been looming in the Asia-Pacific region. Certainly, all of these factors may negatively impact global economic growth. So, what exactly makes the world economic system truly be of “global character”?
At the same time, economic globalization has acquired new forms and has not ceased. Among other things, this is associated with the widespread use of cryptocurrencies and other crypto-assets, that completely disregard the notion of state borders, and function without any proper regulation. Moreover, the development of crypto-assets is not harmful to the environment. The only exception here are PoW- cryptocurrency mining schemes which generally use a lot of electricity, and tend be of “dirty” origin. This, however, is not because of a lack of technology, but rather because of human greed. If we prioritize the global environmental agenda, and omit certain harmful points in crypto-assets, then this new trend has great prospects.
There are two factors for why current international regulation on crypto-assets is often characterized by its legal flexibility. The first reason points to the dominance of "soft" law as a source for crypto-regulation. Some features of "soft" law include accepted formalities during the law-making process, its consultive nature, and special legal techniques, all of which enables the international community not only to develop regulations on a fundamentally new phenomena, but also to do so in a quick manner. However, "soft" regulation is far from comprehensive, as it is developed exclusively in the most concerning and troubling areas. The reason for such legal flexibility is due to the specificities of the international bodies that essentially shape the global financial landscape. For instance, the Financial Stability Board (FSB), the Bank for International Settlements (BIS), the Basel Committee on Banking Supervision (BCBS), the Financial Action Task Force (FATF), the Wolfsberg Group and others all have a hand in the global finance system. How? These groups focus on developing global "standards" with an atypical composition of representatives (or members): central banks (normally, not public authorities), finance ministries, financial intelligence units, global financial institutions, etc.
If to discuss the current international regulation on crypto-assets, G20 leaders appear to show their support for some "soft-law" approaches. This additionally ensures the implementation of these "soft-law" norms into a national legal space as well as predetermines the direction of the further development of international regulation. For example, the commitment to the Financial Action Task Force (FAFT) approaches in the G20 Osaka Leaders' Declaration was consolidated as of June 29, 2019. In other words, the fundamentally new model of shaping international regulation through "soft" laws have become less consultative — not only de facto but also de jure.
Evolution of the Financial Sovereignty
The World Economic Forum predicts that by 2025, 10 per cent of the world’s GDP will be saved through blockchain technology . Simultaneously, as calculated by the Financial Stability Board in early 2022, the capitalization of the crypto-assets' market was $2.6 trillion. However, the economic data here is secondary. The emergence of crypto-assets, mainly cryptocurrencies, coincided with the crystallization of the "New Man", and other social factors. Society and business communities are simply tired of excessive financial controls and the constant need to abide by unprecedented sanctions regimes. In the end, these artificial restrictions directly affect the speed of transactions and the amount of fees.
Today, the spread of cryptocurrencies poses a challenge to the monopoly of central banks (or in some cases governments) on money emissions, thus challenging individual and state financial sovereignty. Although it is hard to see a breach of sovereign state equality formulated by the norms of international law, these processes make us seriously reconsider the role of the state (as we understand the concept of "state" today) in the emerging world order. Traditional ideas that claim central banks (or governments) have the exclusive right to issue money are not only entrenched in national laws; with a few caveats, it is adopted as an axiom in international law. On the one hand, only central bank digital currencies (CBDC) are viewed as digital money that holds direct liability with central banks [the liability has exclusively legal content, but not economic — author's note]. On the other hand, national currencies are recognized by the Bank for International Settlements as being more reliable than, for example, stablecoins. Notably, the rule applies regardless of real economic properties of national currencies.
The abovementioned provisions may also be viewed in a different light. Under international law, "non-state" currencies have been recognized, whatever they may be, even without the same legal guarantees and with high-risk coefficients (when used by financial institutions).
By 2035, the formation of the global digital currency market will be completed. Despite the legal status of the national currency as the only legal tender, within the horizon of this forecast, central banks will enter into a real competition with other "issuers", including non-state ones. Therefore, central banks will be additionally obliged to improve the attractiveness of national currencies. For instance, states may reduce regulatory costs and market commissions, increase the speed, and improve the quality of transactions. Perhaps some central banks will take more drastic measures, such as establishing mathematically sound emission mechanisms.
Prologue to the Supranational Financial Market Governance
Conceptual incompleteness of international crypto-asset regulation is also associated with the absence of adequate protections from fraud and other forms of unfair behavior in emerging financial markets. Although the concern has been directly expressed by the international community, the issue is currently in a legal void. As practice demonstrates, the real legal, intelligence, and investigative capabilities of states in combating crypto-asset scams are severely limited. This due to the fact that crypto-asset scams are often committed by transnational organized crime, making investigations very complicated, and attempts to find stolen property not always successful. Unfortunately, the issue does not lie solely in the theory of law; it has a great practical impact on many people around the world. Of course, there are forensic groups of global consulting companies that can assist in finding stolen assets. However, it does not diminish the vulnerability of states and the international community to transnational organized crime.
By 2035, humanity will realize the need to form a fundamentally new architecture for financial market governance, particularly by setting up supranational bodies with a special legal status. A body, such as a global "crypto-financial police" can be established, which will have the legal capacity to search for and return stolen crypto-assets and to bring perpetrators to justice. The organization may have representative offices in the most vital states and financial centers, cooperate with bar associations, financial institutions, professionals and global players in the market of forensic solutions. Procedurally, the organization’s findings may be assimilated to documents prepared by national law enforcement agencies.
Presumably by 2027–2030, another body may be set up within the Bank for International Settlements. Driven by macroprudential objectives, the body would be in charge of ongoing and exhaustive analyses of financial indicators related to stablecoins. Perhaps in the future, the body's expertise may be broadened by other crypto-assets and particular cryptocurrencies. The results would be derived from "soft law" structures and provisions, including the legal methodology for classification of crypto-assets with different risk ratios. Today, if an international financial institution (i.e. a bank) carries out transactions with stablecoins then risk ratio should be determined based on an assessment of stabilization mechanism of the coin. The assessment should be carried out by the bank in relation to each stablecoin. Moreover, criteria for the assessment have yet to be legally adopted (and the newest version is open for discussion). On the contrary, the risk ratio for a tokenized form of traditional assets is at least equivalent to the baseline. In the case of other crypto-assets (i.e. Bitcoin), transactions are allowed but with a high-risk level (the fixed weight is an astronomical amount of 1.250 %).
Potentially, the approach for other crypto-assets will be amended in an analogous manner with stablecoins. Each significant crypto-asset will be analyzed in detail, and the level of risk will be assigned in accordance with the chosen economic indicators. Probably, in order to ensure a uniform application of standards, financial institutions will find it more efficient to transfer analytical functions or parts thereof to a supranational level. As opposed to a "crypto-financial police", the set-up of a prudential body may not be widely announced. For example, it may take the form of an experts' association — without formally representing states. Nevertheless, the recommendations and conclusions of the body will have a high standing in the world of finance.
Sustainability of the State-Centric Model of Financial Security
The absolute consensus point, with respect to crypto-assets, is the concern about anti-money laundering (AML) risks. Moreover, there is a somewhat unusual approach to this area in international practice. The assessment is not solely linked to the failure of finding any effective solutions to global problems at the national level. It would derive from the provisions of international law.
In developing AML/KYC regulations on crypto-assets, the international community has used a model that works successfully in terms of traditional types of assets, yet fails to account for "virtual" property features. To ensure financial security, the international community believed that a "virtual asset" could be identified as an anchor point. Simultaneously, in accordance to FATF, the concept of a "virtual asset" includes completely different types of assets: for instance, this includes cryptocurrencies (used mainly for payment purposes), some non-fungible tokens, or NFT (used for investment and hedonistic purposes), or ICO-tokens (used exclusively for investment purposes). Clearly, the purpose of transactions directly influences its frequency and nature, the number of intermediaries, actual asset values, validity of the value, etc.
Currently, FATF experts themselves have realized that their approach is not fully adapted to the new types of property. There are a number of practical issues that are impossible to resolve at this point. We might see the consequences of these problems in calls for a broader interpretation of international regulations at the discretion of states; one example is FATF's legal position on decentralized finance (DeFi). FATF points out that "a DeFi application (i.e. the software program) is not a Virtual Asset Service Provider [a VASP is an analogue of the conventional financial institution for the application of AML/KYC standards in the crypto-sphere — author's note] under the FATF standards… however, creators, owners and operators or some other persons who maintain control or sufficient influence in the DeFi arrangements, even if those arrangements seem decentralized, may fall under the FATF definition of a VASP where they are providing or actively facilitating VASP services". Although there are clear VASP criteria in international law, FATF calls on states to shape their own vision of the concept. These new standards call for at least a certain number of concepts to be established at the national legal level (including "maintenance of control", "sufficient influence", and "semblance of being decentralized", and so on). It is clear that this provision infringes upon the universal spirit of international law and significantly reduces its effectiveness.
Meanwhile, according to the Financial Times, US$100 billion was locked up in DeFi-mechanisms globally (by the end of 2021). This figure is an economic confirmation of the foregoing conclusions.
Furthermore, by 2027–2030, a new DeFi-mechanisms will emerge with artificial intelligence being a key player in them. This phenomenon may be referred to as the dark DeFi, the deep DeFi, or the AI-DeFi. The mechanism will continuously analyze financial institutions' and VASP's compliance policies, suspicious transactions' methodology, market data, and sanctions' lists. Therefore, it will allow transactions to circumvent restraints on a modest fee. It is difficult for the author to speculate on how the Deep DeFi may be regulated under the current legal paradigm.
By 2035, the current architecture of international financial security based on national financial intelligence units, or national FIUs (FinCEN in US, UK FIU (NCA) in UK, FIA in BVI, TRACFIN in France, MROS in Switzerland, SICCFIN in Monaco, Rosfinmonitoring in Russia, JFIU in Hong Kong, AMLB (PBC) in China, and so on) may be transformed into something unprecedented and new. While national FIUs will undoubtedly continue to develop key functions, their international importance as a basis of the global AML/KYC system could be significantly diminished.
There is an extremely low probability that in 2035 humanity will enter a state of "worldwide financial anarchy". In the scenario, humanity would reflect on inefficiencies in the traditional structure of international law, including many standards related to AML/KYC and sanctions. Even today, these restrictions have an adverse effect on the cost and speed of transactions and, consequently, on the professional and personal capacities of human beings. Thus, this can lead humankind to massively reject "state" money in favor of decentralized currencies. If we develop this idea, AML/KYC requirements will be drastically reduced, and the powers of national FIUs will mainly be transferred to global companies.
To Adapt or to Fall in Oblivion?
Without a doubt, international law is at the heart of international relations today. It reflects the consensus of international powers, and in this sense, constitutes the future agenda. Disregarding the profound changes taking place in today's international law seems unacceptable. Furthermore, this indifference can encourage individuals to reconsider the effectiveness and timeliness of some institutions.
As global processes become more complicated and the epicenter of international tension moves towards its climax, for future reasons, states should be interested in adhering to all international obligations, including non-conventional obligations. It would be in the interest of states to complete the national legal regime on crypto-assets and synchronize it with the spirit of the time.
If we assume this article proves accurate, all these tendencies are twofold in nature. Aforementioned tendencies present both existential threats and unparalleled opportunities, not only for Russia but also its allies. In this sense, the development of the global digital market will adversely affect the dominance of certain global currencies (particularly taking into account the burden of mass sanctions). On the other hand, it will offer tremendous opportunities to states that have yet to obtain their optimal preferences from the previous wave of globalization.
1. Kissinger, Henry. World Order. L.: Penguin Books. 2015.
2. Schwab, Klaus. The Fourth Industrial Revolution. World Economic Forum. 2016.
Advocate, Postgraduate Student at the Diplomatic Academy of the Russian Ministry of Foreign Affairs
Blog: Iaroslav K. Iarutin's Blog