The Dark Side of Licensing Cryptocurrency Exchanges as Payment Institutions

Law and Financial Markets Review (2019), 14(1), 39-47.

19 Pages Posted: 27 Mar 2019 Last revised: 31 Mar 2020

See all articles by Hossein Nabilou

Hossein Nabilou

Universite du Luxembourg - Faculty of Law, Economics and Finance; University College London Center for Blockchain Technologies

Date Written: March 3, 2019

Abstract

The ultimate objective of cryptocurrencies is to become a payment system substituting, complementing, or competing with the existing conventional fiat-based payment systems. Irrespective of whether such an objective could be accomplished, the functional similarities between certain cryptocurrencies and fiat money has persuaded competent authorities of certain EU Member States to grant payment institution licenses to cryptocurrency exchanges. At first blush, granting such an authorization would seem to be a step forward as it would bring otherwise unregulated cryptocurrency exchanges within the scope of the existing payment regulatory framework. However, such an authorization not only faces major legal challenges related to the definition of a payment institution, but also introduces new lesser-known risks. Aside from the semantic and definitional issues, authorizing cryptocurrency exchanges as payment institutions can bring activities and instruments - with a different risk profile than that of conventional payment instruments - within the scope of payment systems. It appears that such risks embedded in those instruments cannot be fully addressed under the existing payment laws.

This paper studies two examples of unattended risks under the cryptocurrency-exchange-as-payment-institution regime. The first risk concerns the use of untethered, non-convertible, illiquid and volatile settlement assets for settlement purposes in cryptocurrency exchanges. The second risk concerns the risks associated with finality of settlements arising from the use of probabilistic finality in some of the most popular cryptocurrency blockchains. Given that in the conventional payment institutions central bank money or commercial bank money is primarily used as the settlement asset, such risks have already been addressed or otherwise taken for granted, however, in cryptocurrency exchanges, the risks involved in the settlement of liabilities with an illiquid and volatile asset relying on probabilistically final settlement mechanism cannot be dealt with by the existing applicable regulations. As the risks cannot be addressed within the current European payment regulation framework, an alternative policy option would be granting a special license to cryptocurrency businesses or introducing ring-fencing mechanism to protect the conventional payment systems from the risks of cryptocurrency payments.

Keywords: Cryptocurrency, Payment, Payment Institution License, Settlement Finality, Liquidity

JEL Classification: E42, E51, E58, G01, G23, G28, K22, K23, K24

Suggested Citation

Nabilou, Hossein, The Dark Side of Licensing Cryptocurrency Exchanges as Payment Institutions (March 3, 2019). Law and Financial Markets Review (2019), 14(1), 39-47., Available at SSRN: https://ssrn.com/abstract=3346035 or http://dx.doi.org/10.2139/ssrn.3346035

Hossein Nabilou (Contact Author)

Universite du Luxembourg - Faculty of Law, Economics and Finance ( email )

4 Rue Alphonse Weicker
Office: B203
Luxembourg, L-2721
Luxembourg
+352 46 66 44 5450 (Phone)
+352 46 66 44 35450 (Fax)

University College London Center for Blockchain Technologies ( email )

UCL CBT UCL Computer Science
Malet Place London WC
London, London
United Kingdom

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
505
Abstract Views
1,611
rank
63,849
PlumX Metrics