【Abstract】Virtual currency issuance and transactions are important applications in the field of blockchain finance, but relying on the underlying technology blockchain, it has anonymity, no barriers to entry, and there are problems such as no review of the source of legality of funds. In terms of compliance, There is a greater risk. The lack of a clear legal entity for blockchain decentralized financial application projects poses obstacles to supervision. To this end, on the one hand, regulatory agencies should strictly enforce the law in accordance with the spirit of the rule of law and promote the construction of blockchain financial compliance; on the other hand, they should study and judge how to strengthen the supervisability of blockchain decentralized finance in the future, so that the code development team and venture capital Institutions are effectively constrained.
Key words virtual currency block chain finance Bitcoin
【Chinese Library Classification Number】D922.28 【Document Identification Code】A
The manifestations and causes of the chaos in virtual currency transactions
Blockchain is a new technology supported by distributed database storage, point-to-point transmission network and asymmetric encryption algorithm. The issuance and transaction of virtual currency is an important application in the field of blockchain finance. The virtual currency issued based on the underlying technology of the blockchain has attracted a lot of attention in recent years. Especially since the second half of 2020, due to the halving effect of production, the market price of virtual currency represented by Bitcoin has risen rapidly. At the same time, blockchain decentralized finance (known as “Defi” in the industry) has launched various “liquid mining” claims to have high returns; out of concerns that the Federal Reserve will issue a huge amount of U.S. dollars due to the epidemic, which will cause the depreciation of the U.S. dollar. Some investment institutions in Europe and the United States are heavily stocking mainstream virtual currencies; individual celebrities in the high-tech industry abroad “call orders” for specific virtual currencies. These factors have jointly boosted the price of mainstream virtual currencies to further soar in the first half of 2021. The rapid wealth effect has caused many domestic “retail investors” to run into the market eagerly, and financial risks are highly concentrated.
In recent years, various types of investment and financial management based on virtual currencies launched by some trading platforms lack appropriate control by investors. Virtual currencies do not anchor real-world assets, and their price rises and falls are closely related to the consensus, future expectations and sentiments of investors. Therefore, the skyrocketing and falling prices of virtual currencies are often the norm. In addition, virtual currency exchanges are mostly foreign legal entities, far away from Chinese financial regulatory agencies. Exchanges often provide investors who lack risk tolerance with high leverage spot transactions and futures transactions for investors to do more or reverse in the virtual currency market. To go short. However, the price of virtual currency is prone to drastic changes due to the turmoil of various news, especially some currencies with small market value are extremely easy to be manipulated by dealers, and dealers or big players can easily control the transaction price of certain virtual currencies or even the entire network. The contract trading market has turned a large number of retail investors who don’t know the truth into the “leeks” harvested jointly by market makers, large investors and trading platforms. In the process of the sharp rise and fall of virtual currency prices, a large number of retail investors have repeatedly been liquidated. For retail investors who lack a wealth of high-risk investment experience, “running into the market” is likely to turn into a nightmare. Since the first half of 2021, there have been a number of extreme risk events in China that caused bankruptcy due to high-multiple virtual currency futures trading. The frequent risk of liquidation in the virtual currency trading market may affect the traditional financial market, impact the stability of the Chinese financial market, and then affect the national financial security.
In addition, before the first half of 2021, the computing power of Bitcoin mining machines in China has long accounted for more than 70% of the global computing power, which has brought huge wealth to “miners”. The so-called “mining” is to calculate the correct answer of the random hash function for the Bitcoin system by a dedicated computer node to compete for the accounting rights of the block, thereby obtaining Bitcoin rewards. The Bitcoin system uses human self-interest (obtaining Bitcoin as an economic incentive) to achieve altruism (operating and maintaining the Bitcoin system and improving system security). The individuals or organizations that run these network nodes are commonly called “miners” in the industry, and these computing nodes are “mining machines.” In order to increase the computing power and increase the probability of competing for the accounting rights of bitcoin blocks, thousands of “mining machines” have gathered together in recent years to form a super-large-scale “mining pool”. However, Bitcoin “mining machines” consume huge amounts of electricity, and “mining pools” that rely heavily on thermal power generation cause huge carbon emissions and air pollution. In the context of the carbon peak and carbon neutral policy, China’s regulatory authorities are deeply worried about the high energy consumption caused by Bitcoin mining.
Regulatory agencies’ response and legal thinking
The central financial supervision department and various local governments have made heavy blows to combat the chaos of virtual currency transactions. In the short term, the virtual currency trading market immediately “cooled down” and received certain expected results. Of course, in the era of rule of law, a long-term mechanism to regulate the chaos of virtual currency transactions should be a key consideration in future policy formulation. To this end, the author believes that there are two issues worth pondering: one is to promote “good law and good governance”, to clarify the “cleanness” and “turbidity” in the blockchain financial field, and to crack down on illegal activities in strict accordance with the law; the second is to face cutting-edge technology and With the rapid development of the blockchain industry, the supervision method should be forward-looking, make advance judgments of the new forms of virtual currency chaos in the future, and then study and deploy effective supervision methods.
“Good law and good governance” is the core connotation of the rule of law. “Good law” means that through scientific and democratic legislation, brainstorming broadly, so that good laws and regulations express the will to promote the healthy development of the industry, give legal market entities stable business expectations, prevent financial risks, and sanction those who violate laws and regulations, effectively Protect the property rights of investors. Specifically, in the various sub-industries involved in the blockchain, the chaos of virtual currency transactions can easily infringe the rights and interests of investors, and even cause financial risks in extreme cases. However, some other blockchain subdivisions may be of positive value to the improvement of social welfare. For example, the blockchain judicial deposit has low-cost and high-efficiency value for the parties to obtain evidence and the court’s appraisal of evidence. The evidence deposit system-Tianping Chain has been used by Beijing Internet Court and others. It runs on Ethereum and the regulated US dollar stable currency USDC has good payment convenience and is welcomed by traders. Regulatory stablecoins may provide a reference for the internationalization of legal digital currencies of the People’s Bank of China. Therefore, it is necessary to carefully distinguish the “pros and cons” of the blockchain field to avoid “one size fits all” legislation. When a regulator introduces a policy, it can enforce the law in accordance with decisions made at major meetings, fully absorb market entities in advance to participate in the discussion, and devote itself to formulating “good laws”, and restraining the individual will of the regulator becomes the only guide for policy formulation.
“Good governance” means that regulatory agencies strictly administrate in accordance with the law and implement legal supervision, while preventing excessive jumps in specific administrative actions, deviating from the spirit of the rule of law, and avoiding operating risks to legitimate market entities. To implement the spirit of the rule of law in the blockchain industry, the certainty of the development of the industry and the predictability of the market should be given to relevant enterprises. The rule of law supervision means that the regulators should make the existing laws and regulations be generally implemented, and the regulators rely on good legislation and policies, rather than make decisions based on temporary will. To this end, whether it is to combat chaos in virtual currency transactions or effectively regulate the application of blockchain in other financial fields, long-term regulatory rules should be considered to change the mindset of simple response under the impact of extreme risk events.
The chaos of virtual currency transactions has also brought about breakthroughs in foreign exchange control, money laundering, and terrorist financing. At this stage, it can be solved by controlling the legal currency exchange channel. However, China currently does not prohibit individuals from holding virtual currencies and virtual currency transactions between individuals. Financial regulators explicitly prohibit virtual currency trading platforms from providing exchange services to the public, and at the same time prohibit the use of virtual currencies as a means of payment to purchase goods and services. The legal nature of virtual currency is unclear, involving virtual currency trading, pricing, payment, and exchange issues and related litigation, which has brought many confusions to the judicial authorities’ determination and judgment of the nature of the case. For example, if virtual currency transactions between individuals are priced in RMB, are they compliant? Should virtual currency or stable currency lending between individuals be protected by justice? There are no clear answers to these questions within the current framework of the rule of law. In the future, the Chinese legislature may further consider clarifying the legal status of virtual currency, including it in a more complete financial regulatory legal system, and effectively guarantee the legal rights of holders in the system, and at the same time make it possible to combat illegal and criminal acts caused by virtual currency transactions. Law can be followed.
Compliance construction and reference of blockchain finance
Unlike the Internet, blockchain technology has a natural tendency to be used in finance, but most of the financial applications of blockchain lack compliance. With the popularization of blockchain financial applications, compliance has become a serious problem in the development of blockchain finance . To further restrain the financial risks and compliance risks caused by virtual currency transactions, one is to encourage the application of alliance chains in the financial field, and the other is to focus on strengthening the compliance construction of public blockchains in the financial field. Promoting an autonomous and controllable alliance chain is the result of strengthening regulatory policy choices in recent years. The network nodes of the alliance point are limited, and the system is relatively closed, and the node must be authorized by the alliance to be able to access the node. It usually requires strict user identification, so the financial risk is generally controllable. Based on the complex requirements of the financial regulatory legal system, most of the current traditional financial services (such as the blockchain business pilots of some large state-owned banks) are only carried out on the alliance chain.
The core difference between the alliance chain and the public chain is that the former requires network authorization and is only open to alliance members. Since the alliance itself is similar to a super power, it has actual control over the trader’s account. Therefore, it focuses on the following two aspects to promote compliance construction: only allow traders approved by the alliance to join the blockchain system; only allow nodes approved by the alliance to maintain the network. Of course, because of its closedness, the alliance chain sacrifices many advantages of the blockchain, such as openness, flexibility, and free programming of various financial application projects brought about by openness, compatibility, diversification and flexibility. Combination, greatly improve the efficiency of capital utilization, and so on. However, although the alliance chain is relatively closed, it improves security and compliance.
The public blockchain is a completely open and free system. The issuance of virtual currency and part of the transaction business rely on the public blockchain, which poses challenges to financial supervision and compliance requirements. Therefore, the construction of financial compliance based on public blockchains should become the focus of current regulators. With reference to the bottom line requirements of the financial regulatory legal system, blockchain financial compliance construction should include the real-name system of traders, transaction-based compliance review, and financial intermediary participation in payment review. The compliance construction of blockchain finance involves promoting the integration of decentralized digital identities at the bottom of the public chain, setting smart contract execution permissions, and identifying user identities and other regulatory solutions. The author believes that the following industry practices can provide a reference for China’s compliance construction.
First, take the public blockchain Stellar as an example. Stellar Chain provides a cross-border payment network for the banking industry. Its compliance protocol layer mainly includes account real-name registration authentication, user transactions need to be audited by trusted nodes (banks), and user addresses are easy to identify. The compliance construction idea of Stellar’s technical solution is to abandon the equivalence between network nodes, and trust nodes with super power to review account transaction information. The Stellar chain remains partially open, and users who pass their identity can join the network freely.
Secondly, the Lightning Network provides another block chain financial compliance construction idea. The Lightning Network is similar to a two-layer clearing protocol based on the Bitcoin system. An off-chain payment channel can be created between two users to undertake the off-chain transaction accounting work, which is automatically implemented by smart contracts. However, the Lightning Network needs a service provider role similar to a financial intermediary to assume the payment channel transfer station and reduce the cost of users directly creating payment channels with counterparties. Therefore, the role of Lightning Network is suitable for compliance construction: to maintain the openness of the blockchain, some nodes play the role of liquidity provider, and create an off-chain payment channel for each trader, but it does not affect the system maintainer-the “bookkeeping” node The power is equal. The Lightning Network has the basis for realizing the real-name system of traders-the service provider nodes that create the off-chain payment channel can complete the identity verification of the traders. However, the legal qualification review of the service provider itself requires the intervention of financial regulatory agencies.
Finally, since September 4, 2017, after the Chinese financial regulatory authority issued a document prohibiting the establishment of virtual currency exchanges in China, the platforms that provide virtual currency trading services for Chinese citizens mainly originate from overseas, and these overseas platforms are outside the scope of Chinese regulatory agencies. outside. Virtual currency transactions have financial or “quasi-financial” attributes. Such transactions are completely lacking in the supervision of China’s authorized institutions, and have become various types of virtual currency prices, artificial currency prices, insider trading, and market manipulation. An important reason for transaction chaos. To this end, on the one hand, the Chinese financial regulatory agency can send a letter to warn overseas platforms that they should raise the barriers to entry for transactions, requiring them to implement mechanisms such as trader identification, anti-money laundering, and investor suitability control for the filing and review of the Chinese financial regulatory agency; On the one hand, for overseas transaction platforms that infringe on the legal property rights of Chinese citizens, regulators can explore the possibility of a “long-arm jurisdiction” mechanism. For overseas trading platforms where there are actual domestic controllers or affiliated companies, Chinese judicial agencies can “pierce the veil of overseas companies” and implement the requirements of the financial regulatory legal system through litigation.
Promote the “regulatory” of blockchain decentralized finance
Since 2020, with the explosion of various applications of blockchain decentralized finance, the chaos of virtual currency transactions has gradually spread, and the promotion of the “regulatory” of blockchain decentralized finance has become the next step in the anticipation of the regulators. The important work of countermeasures. The blockchain decentralized financial application transforms virtual currency transactions and related “financial products” into business models that can operate without the need for centralized intermediaries (such as virtual currency trading platforms). Blockchain decentralized finance is a global financial service that is convenient for anyone to access through the Internet. This new business model and automated transaction protocols set by programs are usually deployed on a permissionless blockchain (represented by Ethereum) ).
The blockchain decentralized financial project has created a new financial service model. Such applications provide a permissionless mechanism for lending, trading virtual currency, and investment and financial management based on virtual currency. In recent years, various pledged lending products, savings wealth management products, option investment products, and various financial derivatives based on virtual currencies have rapidly enriched, and the number of applications has continued to expand. Currently, the blockchain decentralized financial industry mainly includes three major areas: stable coins, decentralized lending markets, and decentralized exchanges. Compared with the traditional financial industry, decentralized exchanges do not require office space or offline physical points. They can continue to provide transactions regardless of holidays and can run automatically through smart contracts and codes, which has low-cost advantages. However, at present, the virtual assets of blockchain finance are mostly used for “currency speculation”, or so-called “liquid mining”, which lacks real value creation and is far from the national goal of serving the real economy. More importantly, blockchain decentralized finance directly challenges the law enforcement capabilities of regulatory agencies. Unlike centralized virtual currency exchanges, such new business models are not controlled by specific legal entities. The traditional financial industry is supervisable. On the one hand, the regulatory authorities issue scarce financial licenses, require financial institutions’ service levels and risk control capabilities to meet corresponding standards, increase the “cost of violations” of financial institutions, and ensure that financial institutions provide financial consumers with Letter service. On the other hand, the regulatory authorities require financial institutions to reduce social risks caused by financial risks and maintain social stability through investor suitability control.
However, blockchain decentralized finance with virtual currency, stable currency, smart contract and public blockchain as the “basic implementation” is a free and open new financial system. The main risks of this kind of financial system are: no entry barriers (such as license control) and exit permits, no transaction identification mechanism, and no legality review of the source of funds. This financial application project is only a program deployed on the blockchain, not a specific legal subject. After the development team deploys the decentralized financial application project on the chain, almost no one can shut it down. This new financial form makes legal supervision lack clear targets. In order to avoid its risks, it is necessary to strengthen the supervisability of blockchain decentralized finance and establish specific subjects that can bear legal responsibilities, so as to effectively implement the requirements of the financial regulatory legal system.
The author believes that it is necessary to clarify the subjects that exert core influence in decentralized exchanges, which is a prerequisite for promoting decentralized exchanges to be supervisable. First of all, the core code development team has shaped the basic structure, business model, and economic incentives of the blockchain decentralized exchange, and it is the responsible entity that can be clearly defined. Secondly, behind most well-known decentralized exchanges, well-known venture capital institutions are often the promoters. The large amount of funds or network resources provided by these venture capital institutions directly affects the development process of the project. Finally, in recent years, project iterations or parameter changes of decentralized exchanges have often relied on community voting for decisions, that is, adopting the so-called “decentralized” governance (DAO) model. The number of governance tokens issued by a decentralized project determines the weight of voting rights. The power to govern tokens is mainly concentrated in the hands of the code development team and venture capital institutions. Therefore, the blockchain decentralized finance essentially has a typical centralized color. Regulatory agencies use code development teams and venture capital institutions as important starting points, which will help strengthen the supervisability of decentralized finance and implement legal requirements. Require.
Under the promotion of regulatory agencies, blockchain may promote some changes in the compliant financial system, such as partial replacement of license trust, personal credit, etc., through technological trust (consensus algorithms, asymmetric encryption, etc.). Technical “autonomy” (such as the automatic execution of codes and smart contracts) and community autonomy (blockchain community participants vote for governance), partially replace the legal governance of the real society, improve the efficiency of social governance, and ultimately reduce the cost of financial operations as a whole. Therefore, blockchain finance generally has positive value. However, it is undeniable that in recent years, blockchain finance has become more of a virtual currency hype in China, which has forced regulators to introduce strict control measures.
Normally, financial supervision usually sets regulatory rules for the already relatively formed financial industry, but financial innovation means that a certain financial product or service has never appeared before. If over-control of financial innovation is simultaneously implemented, it may hinder the birth and growth of new financial products, and will have a negative impact on the improvement of financial efficiency. Therefore, proper encouragement of financial innovation and liberalization of financial markets will help deepen China’s financial market construction. In the long run, by carefully studying and judging the development trend of the blockchain finance industry, and introducing more flexible and intelligent regulatory policies, it will effectively promote the compliance construction of blockchain finance and strengthen the supervisability of decentralized finance.
Author: Deng Jianpeng, Professor and PhD supervisor of the School of Law, Central University of Finance and Economics, and Co-Director of the Fintech Legal Research Center
[Note: This article was funded by the emerging interdisciplinary construction project of the Central University of Finance and Economics “Financial System Security and Blockchain Supervision Technology”]
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