INTERNATIONAL FINANCIAL ARCHITECTURE
FOR STABILITY AND DEVELOPMENT/CRYPTO-ASSETS AND FINTECHRegulation of Crypto-asset
Exchanges and the Necessityof International Cooperation
Naoyuki Iwashita (Kyoto University)
Submitted on March 15, 2019
Revised on March 27, 2019

Abstract
Bitcoin realized anonymous international fund transfers via the Internet.
In 2015, FATF proposed to regulate crypto-asset exchanges for AML / CFT,
but it is not achieved in most countries yet.
Due to the wide-spread of crypto-asset investment after the sharp rise inthe market price in 2017, the situation is changing. Not only from theviewpoint of AML / CFT but also the perspective of protecting individual
investors and preventing cybercrime, the public intervention with cryptoasset exchanges has become more necessary. Attention is to be paid that
turbulence of crypto-asset prices distorts the resource allocation ofsemiconductor production, and mining of crypto-assets is wasting global
energy. Information sharing and cooperation among international
financial authorities are indispensable.

International Financial Architecture for Stabilityand Development/Crypto-assets and Fintech
Challenge
Bitcoin gained much attention from the public after a massive price rise in 2017,and crashed in 2018, spreading recognition of crypto-assets as a high-risk
speculative investment. Crypto-assets attracted people as a target of a
speculative bubble, and market capitalization reached several hundreds ofbillion dollars at peak time, as many as 3.5 million users1 participated in thisnew market in Japan alone.
Bitcoin was designed for electronic cash which is capable of international,
anonymous transactions beyond the financial regulation. It was suitable formoney laundering and terrorist financing, and it brought confusion to theglobal financial order.
In 2015, FATF published guidance3) which proposed to regulate crypto-asset
exchanges thoroughly and keep records of money-to-crypto conversion, andthe subsequent transfer of crypto-assets to avoid money laundering andterrorist financing. However, most countries haven't introduced such
regulation to crypto-asset exchanges yet.
Japan pioneered the first comprehensive regulations for crypto-assets as amethod of payment and for crypto-asset exchanges in April 2017. This Japaneseexperience may be precious for G20, too. Japanese authorities have learned a lotof technological knowledge and rigid procedure of “Know Your Customer (KYC)”
through surveillance of crypto-asset exchanges.
Today, many crypto-asset exchanges have been established. They have twotasks. First is to exchange legal tender currency to crypto-assets, and second is
to keep crypto-assets for their customers. Instead of intractable digital
signature technology, customers of exchanges can use ordinary ID and1 Counting

users of crypto-assets is a controversial issue. According to the report ofChainalysis 1), Bitcoin blockchain consists of 460 million addresses as of December 2018, but

only 27 million addresses actually hold Bitcoin, and there is very little information how theseaddresses link to actual Bitcoin holders. In 2017, Japanese regulation required crypto-asset
exchanges in Japan to perform a strict KYC to every customer. Japan Virtual Currency
Exchange Association (JVCEA) aggregated numbers of customers reported from all
registered exchanges and disclosed that there are 3.5 million actual crypto-asset holders inJapan 2).
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password to authenticate their trade request.
If both sell-side and buy-side investors are customers of the same exchange,
they can make the trade of crypto-asset without blockchain. The settlement canbe done within the RDB of the exchange. This kind of transaction is called "offchain" because the transaction is not written on the blockchain, compared tothe traditional "on-chain" transactions [Table 1]. Today, 95 % of crypto-asset
transactions are said to be off-chain2.

Due to the soaring market prices of crypto-assets and increasing investment byindividual investors, the amount of value retained at exchanges expanded
rapidly. In such circumstance, some crypto-asset exchanges were attacked andlost crypto-assets they kept. All exchanges are venture companies, and the levelof risk management was not high enough. Crypto-asset exchanges around theworld were targets of cybercrime [Table 2].

2 Based on a comment made by Mr. Gary Gensler, 11th chairman of the Commodity Futures

Trading Commission at the fourth meeting of “Study Group on the Virtual Currency Exchange4).,
Services”
heldatFinancial
Services
AgencyofJapan
https://www.fsa.go.jp/news/30/singi/20180615-2.html (in Japanese)3

International Financial Architecture for Stability
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Once an exchange is attacked, its customers would lose their assets. Cryptoasset investment is quite popular among young people, and the number ofinvestors has increased to a level that cannot be ignored. Not only from theviewpoint of AML / CFT but also the perspective of protecting individual
investors from the cyber-attacks, the public intervention with crypto-asset
exchanges has become necessary.
Moreover, the emerging attention to crypto-assets has led monetary authoritiesof developed and developing countries to the discussion of central bank digitalcurrency (CDBC). Many central banks have launched CBDC research projects,
and some of them are actively moving forward to real emission of CDBC.
However, CDBC accompanies many challenges both in legal and economic areas8).
Bitcoin and similar crypto-assets are using PoW. In this method, miners ofcrypto-asset play an essential role to sustain the security of crypto-asset. Eachminer can earn a reward if it searches hash value more quickly thancompetitors. For this reason, each miner is incentivized to use fast miningmachines. As a result, the overall computing capacity increases, and energy
consumption increases.

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and Development/Crypto-assets and Fintech
In the early times of Bitcoin history, PoW or "mining Bitcoin" didn't need suchstrong computational power. With the soaring price of Bitcoin, mining Bitcoin
was considered to be a high-profit business, and a dedicated machine formining was developed. Miners aiming to win the mining competition employed
GPU and ASIC. As a result, excessive capital investment to the mining businesshas lead distortion of global resource allocation of semiconductor production. It
caused side effects such as massive electric power consumption and global
environmental problems getting worse.

Proposal
1. AML / CFT of crypto-asset transaction
In 2015, FATF proposed to regulate crypto-asset exchanges from the viewpointof AML / CFT. Japan introduced registration of crypto-asset exchanges in 2017.
The 5th EU Anti-Money Laundering Directive (AMLD 5) requires extends thescope to virtual currency platforms and wallet providers. Member states areobliged to transpose the modified regulations into national law by the latest
January 20th, 2020.
G20 countries should comply with FATF guidance on crypto-asset and introduce
the regulation to the crypto-asset exchanges, such as a registration system toensure to perform a KYC of their customers. If needed, government authorities
should examine the exchanges to avoid crypto-assets to be used for money
laundering and terrorist financing.
2. Protecting individual investors from cybercrime
Crypto-asset exchange provides various functions such as a market provider, adealer, custody of crypto-assets. As exchanges keep assets of their customers,
they should make every effort for managing financial risk.
G20 countries should supervise crypto-asset exchanges to manage their risk
appropriately, including cybercrime risk from the viewpoint of investor
protection.

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International Financial Architecture for Stability
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Government interventions can be justified to avoid the damage of individual
investors of crypto-assets. These interventions should also be implemented
based on international cooperation. Information sharing is also indispensable.
From this point of view, Japan has already introduced the regulation to cryptoasset exchanges, investing a lot of human resources, conducted on-site
inspections. Thanks to these experiences, Japan's FSA has smoothly responded
to cyber-attack cases.
3. Energy consumption of mining crypto-assets
The mining crypto-assets wastes enormous energy resources. The higher theprices of crypto-asset rise, the more energy consumed. From the latter half of2017 to the beginning of 2018, mining business companies competed tomanufacture ASICs and GPUs to strengthen mining capacity 5). This competition
significantly distorted the resource allocation of semiconductor production.
Digiconomist.net was the site pointing out this problem very early 6). According
to the estimate of the site, the power used for mining increased from October
2017 and continued to grow until about June 2018 even as the price of cryptoassets collapsed. As a result, it reached about 70 TWh (Tera-Watt Hour) interms of one year [Chart 1]. This consumption is almost equal to the electricity
used by Austria for one year. The energy spent on mining doesn't create
anything useful; it is only wasted. The rise in the price of the Bitcoin means that
this waste increases. This is one of the severe problems of crypto-assets.
Since the mining machine is a device dedicated to calculating the hash function
at high speed, once manufactured, they are not reusable for any other purposes.
For this reason, even if the market price collapses in early 2018 and the mining
business turned unprofitable, miners cannot stop the working machines. Thisis why the power consumption did not go down until late 2018.
However, as the miner revenue environment deteriorated further due to thedecline in the November 2018 market, mining companies gave up from themining business one after another. As a result, estimated power consumption
has been reduced to about 40 TWh. In the pessimistic scenario assumed in thissite one year ago, the power consumption was estimated to exceed 120 TWh at
the end of 2018 [Chart 2], but this prediction was not realized and changes to6

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the desired direction for humanity.
G20 countries should carefully monitor the prices of crypto-assets and mining
business if they have an impact on the global environmental problem and lead
distortion of global resource allocation.
[Chart 1] Bitcoin Energy Consumption Index

Source: Digiconomist.net[Chart 2] Estimated future value of electricity consumption (as of the end of 2017)

Source: Digiconomist.net

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References
1. Chainalysis: "Mapping the Universe of Bitcoin's 460 Million Addresses,"December 19, 2018. https://blog.chainalysis.com/reports/bitcoinaddresses
2. Japan Virtual Currency Exchange Association (JVCEA): " Current status
report on virtual currency transaction in Japan," April 10, 2018 (in Japanese).
https://www.fsa.go.jp/news/30/singi/20180410-3.pdf
3. Financial Action Task Force: "Guidance for a Risk-based Approach to VirtualCurrencies,"
June
2015.
http://www.fatfgafi.org/media/fatf/documents/reports/Guidance-RBA-VirtualCurrencies.pdf
4. Minutes of the fourth meeting of “Study Group on the Virtual Currency
Exchange Services” held at Financial Services Agency of Japan, June 15, 2018.
https://www.fsa.go.jp/news/30/singi/20180615-2.html (in Japanese)
5. Bloomberg News, "Nvidia's Crypto Gold Rush Goes Bust in Lackluster
Forecast,"
August16,2018.
https://www.bloomberg.com/news/articles/2018-08-16/nvidia-givesdisappointing-sales-forecast-on-lower-crypto-demand
6. Alex de Vries, "Bitcoin's Growing Energy Problem," Joule VOLUME 2, ISSUE5, P801-805, May 16, 2018.
7. Naoyuki Iwashita, "Threats to crypto-assets and countermeasures - Changesof Bitcoin in the process of spread into society - ," Vol.10 No.3 of Journal of
Digital Practices, Information Processing Society of Japan (forthcoming).
8. Sergey Drobyshevsky, Elena Sinelnikova, Pavel Trunin,"CBDCs: problems
and possible solutions," (forthcoming).

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