Abstract
Virtual assets have gained increasing attention due to their rapid growth and so has the interest around its implication for the traditional financial system including financial stability. This paper seeks to assess the financial stability of virtual assets through regulation with specific emphasis to Ghana and considers the current regulatory regime in Ghana including policy response by the regulator – the Bank of Ghana.
Keywords: Virtual Assets, Cryptocurrency, eCedi, Ghana.
Introduction
A virtual asset is a digital representation of an item that has value in a specific environment. This medium of exchange or property can be digitally traded, transferred or used for payment or investment purposes. Virtual assets tend to create the impression that people have the ability to be their 'own bank' and manage their own wealth, thus eliminating third parties. With high financial instability in various African countries, the introduction of the cryptocurrency market is gradually onboarding young people who are eager to build wealth.
As more and more people are jumping on the crypto wagon, its legal status globally has seen significant shifts, from countries legalizing Bitcoin and other cryptocurrencies, to others banning them. Some countries have also started to explore the use of Central Bank Digital Currencies (CBDCs) as a way to promote financial inclusion and support a cash-lite economy, while some including Ghana have piloted their own CBDC.
Virtual Assets (Crypto-assets) as defined by the FSB , are a type of private sector digital asset that depend primarily on cryptography and distributed ledger or similar technology. The FSB in its crypto-assets report published in February 2022 concluded that “crypto-assets markets are fast evolving and could reach a point where they represent a threat to global financial stability”.
Virtual assets have many potential benefits and dangers. They have the scope to make payments easier, faster and cheaper, and provide alternative methods for those without access to regular financial products. However, they are largely unregulated, and also have the potential to become worthless and are vulnerable to cyberattacks and scams. Without proper regulation, virtual assets also risk becoming a safe haven for the financial transactions of criminals and terrorists.
Virtual Assets - Pros and Cons
Virtual assets and digital assets are sometimes used interchangeably, but digital assets are a much broader category that includes virtual assets and other types of assets. All virtual assets are digital assets, but not all digital assets are virtual assets. For example, a digital bank record that represents an individual's ownership of fiat currency is not considered a virtual asset because it's only a declarative record of ownership. The record itself can't be digitally traded for another asset. However, if a digital asset can be exchanged for another asset such as stablecoin, it might qualify as a virtual asset.
Virtual assets (crypto assets) refer to any digital representation of value that can be digitally traded, transferred or used for payment. It does not include digital representation of fiat currencies. The most common example of a virtual asset is virtual currency such as Bitcoin, Litecoin, Ethereum or Dogecoin. Gaming tokens, non-fungible tokens (NFTs) and governance tokens might also be considered virtual assets, depending on the circumstances and the context in which the assets exist and are used.
Virtual Assets offer many potential benefits. As noted in the IMF’s earlier publication , these include greater speed, lower cost and increased efficiency in making payments and transfers, including across borders with the potential to improve financial inclusion. Thus, Virtual assets could make payment easier, faster and cheaper and provide alternative methods for those without access to regular financial products. This is however subject to proper regulation and or monitoring as they risk becoming a virtual safe haven for the financial transactions of terrorists.
In sharp contrast, Virtual assets provoke a wide range of risks including monetary, legal, operational, consumer protection and financial stability. Virtual assets are thus susceptible to criminal abuse. Some of their features in particular being their varying degrees of anonymity or pseudonymity most likely will raise new challenges for country authorities.
Risks and Red Flags Related to Virtual Assets - Relative to Traditional Financial Institutions
As already indicated, without strong mitigation, Virtual Assets can pose a significant threat to the integrity of the financial system, Money Laundering amongst others. The ability to transact across borders rapidly not only allows criminals to acquire, move, and store assets digitally often outside the regulated financial system, but also to obfuscate the origin or destination of the funds and make it harder for reporting entities to identify suspicious activity in a timely manner. These factors add hurdles to the detection and investigation of criminal activity by authorities.
The types of offences associated with Virtual assets include the following; and terrorist financing. Virtual asset transaction red flags mimic the red flags that anti-money laundering (AML) investigators and transaction monitoring systems identify within fiat transactions, and identifying those red flags is key to mitigating risk. Virtual asset red flags can be broken down into five main categories; Transactions and Transaction Patterns, Anonymity, Consumer Profiles, Source of Funds, Geographic Risk. These risks will be discussed seriatim.
1. Transactions and transaction patterns
Traditional Financial Institutions (FI) monitor customer transactions to identify money laundering activities. They catch criminals who try to circumvent such monitoring by structuring transactions below reporting thresholds, conducting transactions out of pattern or with no apparent reasonable purpose, or sending and receiving funds to and from high-risk jurisdictions. As the financial services environment evolves, access to virtual assets is becoming more prevalent, and criminals are capitalizing on these technologies to launder funds. They can easily structure virtual asset transactions below reporting thresholds, instantly conduct peer-to-peer (P2P) transactions across borders, quietly transfer funds back and forth between wallets, and swiftly conduct transactions with suspicious wallets, individuals, or protocols. Like traditional FIs, Regulators of Virtual Assets must be aware of the transactional red flags indicating potential financial crime and monitor customers and their transactions to mitigate money laundering risks. As virtual asset adoption increases, both traditional FIs and Regulators of Virtual Assets must continue to implement robust processes to monitor, identify, and report such activities.
2. Anonymity
At a traditional Financial Institution, alarms sound if customers attempt to disguise their identities or increase anonymity by not providing personal and due diligence information, by opening an account online from an IP address that does not reflect their actual location, by obscuring beneficial ownership through complex entity structures, or by primarily using cash below the reporting threshold or prepaid asset cards to transact. Just as anonymity can be attempted at a traditional FI by creating a web of complex ownership, the pseudonymous nature of digital assets offers individuals the opportunity to transact in ways that help disguise identity. Virtual Assets Regulators need to be aware of the red flags indicating that customers might be trying to increase anonymity.
Such red flags include using privacy coins, mixing and tumbling services, or P2P platforms; transacting with Virtual Assets Regulators that have weak due diligence and Know Your Customer (KYC) processes; using darknet IP addresses that allow for anonymity; or purchasing virtual assets with prepaid cards. Virtual assets have a notoriously inaccurate reputation of being fully anonymous, but they are not, and Virtual Assets Regulators can put many controls in place to know their customers. And once those controls are in place, red flags indicating that a transactor might be trying to increase anonymity should trigger proper responses with Virtual Assets Regulators just as they would at traditional FIs.
3. Consumer profiles
Irregularities discovered during KYC, Customer Due Diligence (CDD), and Enhanced Due Diligence (EDD) bring into question a customer's true identity and intentions for opening an account. Just as a traditional FI has KYC, CDD, and EDD policies and risk controls in place, compliant Virtual Assets Regulators providers must follow similar policies and controls, including similar strategies during onboarding with documentary and non-documentary processes. When a customer provides incomplete or insufficient KYC information or declines requests for KYC documents or inquiries regarding the nature of the account and source of funds, that's a red flag. Of course, the practices within the virtual assets space are attuned to the unique and challenging risks of operating within the virtual asset ecosystem.
4. Source of funds
Traditional FIs serve as the on-ramp and off-ramp for fiat currency entering and exiting the virtual asset environment. Individuals are unable to initially use virtual assets without first depositing funds through traditional financial outlets. As such, traditional FIs that inadequately assess a customer's source of funds could allow illicit funds to enter and exit virtual asset environments. Both traditional FIs and Virtual Assets Regulators must obtain information related to their customers' sources of funds to further understand the money laundering risk posed by their customers. In some ways, Virtual Assets Regulators can have more visibility into risk. At account opening and throughout the customer relationship, Virtual Assets Regulators analyze the customer's source of funds. While the same is expected of traditional FIs, in most cases, the customer's source of funds is primarily only analyzed at account opening and then on an as-needed basis through transaction monitoring. Slight nuances exist regarding what should be monitored. For example, an individual might fund a new wallet using existing virtual assets on separate protocols. Virtual Assets Regulators should be able to identify whether these funds originate from known suspect wallets, exchanges, or protocols. In the virtual asset space, the interplay between analyzing a customer's source of funds and performing transaction monitoring activities in real-time is particularly important.
5. Geographic risk
Customers that try to conceal the location from which funds are sent or received are found within both traditional FIs and Virtual Assets space. Geographic risk is assessed in a variety of ways, and while it might appear difficult to detect geographic risk from virtual asset activity given the virtual nature of this activity type, this is not the case. A lack of physical jurisdiction that underlies the virtual asset landscape does not equate to unlimited geographic risk, and, on the flip side, an established physical jurisdiction does not equate to zero geographic risk.
Take recent news, for example, where geographic risk is high within a specific physical jurisdiction: the Russian Federation. Many financial sanctions were placed on Russia following its invasion of Ukraine in February 2022. Concerns quickly emerged regarding potential attempts to circumvent international sanctions through the use of virtual assets. However, many of those concerns have so far proven largely unfounded. Virtual Assets Service Providers (VASPs) need to be able to detect red flags indicating the potential concealment of geographic risk. These red flags might include a customer's funds originating from (or being sent to) an exchange that is not registered in the jurisdiction where the customer resides or conducts business; a customer using an exchange in a high-risk jurisdiction that lacks AML regulation for virtual asset entities; or a customer establishing or moving office locations to a jurisdiction with no implemented regulations to govern virtual assets.
Clearly, there are many avenues through which VASPs can understand and detect the geographic risk a customer might pose. Much like traditional FIs, VASPs must detect and monitor these risks in order to protect their customer base and their organization.
Regulation of Virtual Assets – Global Perspective
Virtual assets remain a rapidly developing and exciting area of the market, generating challenges and opportunities for virtual assets businesses, investors, lawyers and regulators alike. Any discussion of regulation of virtual assets in a single jurisdiction would be incomplete without reference to the significant cross-border risks which are inherent to the decentralised nature of virtual assets. A key concern is that although a virtual assets business may in fact be appropriately regulated (or not subject to regulation) in a particular jurisdiction, its service offerings may trigger significant regulatory implications in other jurisdictions as cross-border targeting of investors and customers may require cross-border registration and regulation as well.
Since the outbreak of the COVID – 19 Pandemic coupled with the Russian- Ukraine war, the Ghanaian Government like many other countries have had to make unpopular economic decisions in a bid to keep the economy running and not lead to a total collapse of the economy. Quite evidently, the rate of inflation in Ghana is unprecedented. As at December, 2022, the rate of inflation was quoted as 54.1% and same has had a great impact on the cost of living of Ghanaians coupled with significant depreciation of the Ghanaian cedi.
These economic parameters coupled with “haircuts” in the investments of the Ghanaian people tend to draw the minds of Ghanaians to alternative means in mitigating future loss of the value of their hard-earned money. The obvious alternative will result in increased interest in virtual assets such as cryptocurrency in the full glare of the stringent public warnings by the Bank of Ghana and the Securities and Exchange Commission.
Cryptocurrency is here to stay, so we hear about the crypto sphere every day. But there are some fundamental situations that need to take place for this speculated ‘store of value’ to really have its foot to stand on. While new regulations have helped to make the virtual asset economy safer, some Virtual Asset Service Providers continue to lack the proper AML controls to successfully detect and mitigate money laundering and terrorism financing. In reviewing the KYC procedures at the top 500 VASPs, CipherTrace found that 57% of these VASPs had weak or porous KYC processes. These weak KYC protocols can be exploited by criminals and other bad actors to launder ill-gotten virtual assets through exchanges operating as fiat off-ramps.
Exchanges operating as direct fiat off-ramps create cryptocurrency risk exposure to both the crypto exchange’s bank and receiving user’s banks. Exchange customers sell their crypto on the exchange’s platform for fiat, which is sent to their bank account from the account at the cryptocurrency exchange’s bank via ACH or wire transfer. While the two banks aren’t directly trading cryptocurrency with each other, the value being sent represents the sale of cryptocurrency. Both banks must rely on the exchange’s AML program to adequately address any risk that may arise from the source of crypto assets being traded. Fortunately, 2020 has seen an upward trend towards stronger KYC as previous CipherTrace research in 2019 revealed that 67% of VASPs had poor KYC—10% more than this year’s study.
On average, 74% of the bitcoin moved in Exchange-to-Exchange transactions was moved cross-border in 2019. The Financial Action Task Force (FATF) warns “illicit users of VAs, for example, may take advantage of the global reach and transaction speed that VAs provide as well as of the inadequate regulation or supervision of VA financial activities and providers across jurisdictions, which creates an inconsistent legal and regulatory playing field in the VA ecosystem.” VASPs located in one jurisdiction may offer their products and services to customers located in another jurisdiction where they may be subject to different AML/CFT obligations and oversight. This is of concern where the VASP is located in a jurisdiction with weak or even non-existent AML/CFT controls.
Financial integrity could also suffer. Without robust anti-money laundering and combating the financing of terrorism measures, crypto assets can be used to launder ill-gotten money, fund terrorism, and evade taxes. This could pose risks to a country’s financial system, fiscal balance, and relationships with foreign countries and correspondent banks.
The Financial Action Task Force (FATF), an inter-governmental body, sets international standards aimed at preventing money laundering and terrorist financing. Part of that effort has been to bring clarity to how virtual assets should be defined and regulated on an international basis.
Innovation in the virtual assets industry is inevitable and regulators like Abu Dhabi Global Market’s (ADGM) Financial Services Regulatory Authority (FSRA) anticipated that wave by setting in place the world’s first comprehensive regulatory framework in 2018, which acts as a springboard for what is set to be the next evolution in finance. Before the publication of ADGM FSRA’s regulatory framework, virtual assets and virtual asset exchanges/custodians and other intermediaries were subject to limited to no regulatory oversight. The ‘honour system’ was applied until that point, with the players within the virtual asset industry complying, if they wanted to, with industry standards.
This did not provide the security and stability to lay the foundations for the long-term growth and development of the virtual asset industry for investors, providers, and end-users. Therefore, ADGM, being a forward-looking and dynamic jurisdiction, created the world’s first regulatory framework that met the expectations of virtual asset industry players, consumers and traditional financial institutions providing the protection for key stakeholders involved in the virtual asset ecosystem.
ADGM has become the destination of choice for many start-ups, investors, and businesses looking to set foot in the virtual asset market. Since the framework officially came into practice in 2018, ADGM has issued a number of Financial Services Permissions (FSPs) to virtual asset multilateral trading facilities (MTFs), custodians and other intermediaries.
The Financial Action Task Force has set a standard for how virtual assets and related service providers should be regulated to limit financial integrity risks. But enforcement of that standard is not yet consistent across countries, which can be problematic given the potential for cross-border activities.
The Bank of Ghana if so minded to consider the regulation of Virtual assets in spite of its wide range of risks including monetary, legal, operational, consumer protection and financial stability, have other regulators to look to for inspiration and guidance.
The Position of the Regulator on Virtual Assets – The Bank of Ghana and SEC Perspective
The Bank of Ghana has overall supervisory and regulatory authority in all matters relating to banking and non-banking financial business with the purpose of achieving a sound, efficient banking system in the interest of depositors and other customers of these institutions and the economy as a whole. The regulatory and legal framework within which banks, non-bank financial institutions as well as forex bureaux operate in Ghana are the following:
- Bank of Ghana Act 2002 (Act 612)
- Bank of Ghana (Amendment) Act, 2016 (Act 918)
- Banks and Specialised Deposit-Taking Institutions Act, 2016 (Act 930)
- Non-Bank Financial Institutions Act, 2008 (Act 774)
- Companies Act, 2019 (Act 992)
- Payment Systems and Services Act, 2019 (ACT 987)
- Bank of Ghana Notices /Directives / Circulars / Regulations
The Bank of Ghana as regulator issued a Notice to Banks and Specialized Deposit-Taking Institutions (SDIs) and the General Public in a notice dated the 22nd January, 2018 mainly to notify the general public that activities in digital and virtual currencies were not licensed under the Payments Systems Act 2003 (Act 663) subsequent to which the Payment System and Services Act, 2019 (ACT 987) was enacted by Parliament.
Further to the Bank of Ghana’s notice, the Securities and Exchange Commission, Ghana issued a notice on 29th March, 2019 to the general public essentially sending out a clear warning on the investment and trading in crypto-currencies and their digital platforms as same is not recognized as currency or legal tender in Ghana and that the said platforms remained unlicensed and unregulated.
The existing legislation governing financial technology companies and their activities in Ghana is the Payment Systems and Services Act, 2019 (Act 987) which was introduced in 2019 to amend and consolidate the laws relating to payment systems and payment services and to regulate institutions that carry on payment service and electronic money business.
The Bank of Ghana subsequent to the enactment of the Payment System and Services Act, 2019 (ACT 987) issued a notice dated 8th March, 2022 notifying the general public that it has not, as a regulator, licensed any entity to engage in virtual or digital assets and that cryptocurrencies are not recognized as legal tender in Ghana hence, people who trade in these currencies do so at their own risk.
The regulator has demonstrated without equivocation that virtual assets including cryptocurrencies are not recognized as legal tender and its current position is that, people who trade in these currencies do so at their own risk. The Bank of Ghana therefore does not have a specific regulatory framework for virtual assets or cryptocurrencies as there is no cryptocurrency legislation or regulation in Ghana.
Policy Response by the Bank of Ghana on Virtual Assets
The Bank of Ghana has a mandate to formulate and implement monetary policy to achieve price stability, contribute to the promotion and maintenance of financial stability, and ensure a sound payment system. Article 183(1) of the 1992 Constitution of Ghana (Constitution) acknowledged the Bank of Ghana’s pre-existing role as the central bank of Ghana and provides that Bank of Ghana shall be the only authority to issue the currency of Ghana. Article 183(2)(a) of the Constitution further mandates the Bank of Ghana to direct and regulate the currency system in the interest of the economic progress of Ghana.
The Bank of Ghana by its notices and actions in response to the growing trend in the virtual assets space has evinced a definite intention to guard jealously its monopoly to issue currency in Ghana akin to the Supreme Court of Ghana’s position on jealously guarding its original Jurisdiction.
The interest in Central Bank Digital Currency (CBDC) has escalated in the past few years. According to a BIS survey in 2021 on CBDC, 86% of central banks were actively researching the potential for CBDCs, 60% were experimenting with the technology and 14% were deploying pilot projects. Consequently, at its press conference that followed the 91st Monetary Policy Committee meeting, The Bank of Ghana declared its intention to explore a CBDC within the framework of the financial sector digitalization program. It is in pursuit of this goal that Bank of Ghana announced the concept of the eCedi – a digital version of the Cedi banknotes and coins.
The Bank of Ghana has thus rolled out a supposed alternative to these virtual assets in a bid to retain its power as the only authority to issue currency in Ghana and thus create and destroy digital cash in Ghana. Following the roll out, pilot and subsequent implementation of the eCedi, it is very unlikely that the Bank of Ghana will generate the needed appetite to consider the regulation of virtual assets in the private space and more so as same is not issued by the Bank of Ghana.
Conclusion and Recommendation
In as much as there has been somewhat success in the regulation of virtual assets in spite of its wide range of risks including monetary, legal, operational, consumer protection and financial stability, there are still challenges as the success can be attributed within the jurisdiction of the regulation only. It is undisputed that these virtual assets are privately issued and hence pose a significant challenge for regulators. The Bank of Ghana have thus issued and is piloting CBDC (eCedi) to address the risk of unregulated privately issued virtual assets. It is understood that the eCedi issued and guaranteed by the Bank of Ghana would meet the demand for virtual assets without posing systemic risks.
To the extent that Ghanaian Law does not specifically proscribe the use of virtual assets, it is recommended that much advocacy is geared towards the implementation of the Bank of Ghana issued virtual assets (eCedi) as same will bring the virtual assets industry in Ghana under the direct regulation of the Bank of Ghana in direct similarity to the traditional financial system hence significantly preventing wide range of risks including monetary, legal, operational, consumer protection and financial stability as a result of the privatized nature of these virtual assets.
It may be argued that, the Bank of Ghana Act does not authorise the Bank of Ghana to issue a dematerialised version of the Cedi. It limits the powers of the Bank of Ghana to printed and minted currency only. However, on the strength of Article 183(1) and 183(2)(a) of the 1992 Constitution of Ghana which makes the Bank of Ghana the sole authority to issue currency in Ghana, it is recommended that if the Bank of Ghana is so minded to implement the eCedi, same should be issued and implemented with the necessary legislative authority to prevent any legal setbacks.
