The Urgent Need to Regulate the Sri Lankan Cryptocurrency Market
November 02, 2023by Chamathka Sewmini
Published on Colombo Telegraph on 29th September 2023
In the era of the digital age, Cryptocurrency (Crypto) has evolved as an evolutionary monetary concept that challenges the very fabric of the traditional financial system. Crypto is a virtual currency format which only available in online trading platforms. In its crux, blockchain technology is the technological infrastructure that facilitates Crypto while Cryptography employs secure transactions. Moreover, world-famous top companies such as Microsoft, Shopify, Tesla, Bitrefill, Paypal, Starbucks, AT&T and Travala are accepting Crypto payments at present. Crypto has shaken the traditional transaction methods at present. Accordingly, many countries in the International arena specifically the West including the European Union (EU), Middle East pioneering United Arab Emirates (UAE) and even some Asian countries including Singapore have incorporated Crypto transactions into their economy further regulating their Crypto market according to their national requirements.
Particularly, in Sri Lanka according to Directions No. 03 of 2021 under the Foreign Exchange Act, No.12 of 2017 issued by the Department of Foreign Exchanges of CBSL, Electronic Fund Transfer Cards (EFTC) are not allowed for payments with regard to Crypto (CBSL, 2021). Indeed, Crypto is not considered as a legal tender in Sri Lanka. Moreover, the Central Bank of Sri Lanka (CBSL) has declared Crypto as an investing platform associated with significant risks of Financial, legal and operational through press releases in 2018,2021 and 2022(CBSL, 2023) while warned by the CBSL on the growing number of financial scams where the investors. As per Aljazeera revealed in 2022 many Sri Lankan investors have been frauded swindling millions of rupees mortgaging their entire properties. Despite the financial insecurities, Crypto is used island-wide with over 320,000 user base at present.
Existing Issue
Crypto has been the fastest-growing monetary network in Sri Lanka. Consequently, as mentioned by Danny Stag, Director of ‘Paxful’, one of the leading P2P Crypto trading platforms, it recorded a growth of over 730% only from Sri Lankan Crypto traders during the economic recession period, with the devaluation of the Sri Lankan Rupee (Kumar, 2022). Despite its popularity, neither Crypto has been considered as legal nor the entire banning of the Crypto market has been imposed by the Sri Lankan government. Rather, the Sri Lankan Crypto market is in a significant era where many countries worldwide have already accepted Crypto transactions at present while implementing a policy framework to regulate the Crypto markets according to their national requirements.
On the other hand, along with the increasing popularity of the Crypto market in Sri Lanka, Crypto-related illicit activities have raised financial insecurities in the country. Consequently, CBSL has recently banned nine pyramid schemes that have been operated in Sri Lanka (CBSL,2023). Indeed, declaring a ban is a positive step towards ensuring the financial security of the country, but at the same time it needs to be addressed how the culprits will be charged while facilitating a way to how the defrauded money will be returned to the investors who invested in the certain fraudulent schemes. The existing issue in the Sri Lankan Crypto market is hidden behind the issues that have been clearly seen which emphasize the need of a regulatory framework which Sri Lanka is lacking at present.
Financial Risks Associated with Crypto
Sri Lankan Crypto investors face a plethora of issues that endanger their investments losing billions. Therefore, it is vital to understand the Financial Insecurities that the Sri Lankan Crypto market faces at present.
Ponzi/Pyramid Schemes : Ponzi/ Pyramid Schemes are fraudulent schemes that promise investors high returns in a fleeting period of time based on their recruitment of new participants into the scheme. Thus, pyramid schemes are prohibited in Sri Lanka under Section 83 (C) of the Banking Act, No.30 of 1988 where if any person is found guilty of engaged in the prohibited Crypto Scheme, will be charged with imprisonment not exceeding 03 years or a fine not exceeding LKR 1 000 000.
Fraudulent Initial Coin Offerings (ICO) : Refers to the issuance and sale of digital tokens to investors under false pretenses which further exploits the hype and excitement on Crypto deceiving the investors and making them believe that they are contributing to a legitimate trading.
Untraceable Transactions : Crypto is associated with the techniques that enhance Privacy and anonymity such as ‘Mixing and CoinJoin’, ‘Ring Signatures’ and ‘Stealth Addresses’. Consequently, these techniques have made it difficult to trace the transaction in the Crypto arena due to the anonymity. Moreover, this anonymity itself facilitates illicit activities even terrorist financing.
The Volatility of the Crypto assets : Volatility refers to the rapid and significant fluctuation that Crypto assets can experience over a short period of time. Thus, due to the Market maturity, Liquidity, market manipulation, technology and adoption, global economic events, and macro-economic trends fluctuation rate of Crypto assets is decided. Moreover, Crypto assets are subjected to continuous fluctuations.
The Anonymity of the Crypto Wallets : Crypto wallets hide the user identity as well as the transaction history by making it easier to engage in illicit activities obstructing law enforcement from tracing the criminals.
Fake Wallets : Fake Wallets are the type of scams in which malicious actors create fraudulent applications or websites that trick users into revealing their private keys or sensitive information ultimately leading to the theft of their Crypto holdings.
Market Manipulation : Market manipulation refers to the strategies that are used to reduce the economic efficiency of the market by reducing the liquidity of the market risk for transfer. Pump and Dump schemes (PnD Schemes), Wash trading, Order Book, Front Running, Insider Trading, Distributed Denial of Service (DDoS) attacks are the manipulation tactics that have been used in the Crypto arena.
Lack of Deposit Insurance : Thus, due to the decentralized nature of Crypto, no government-backed authority ensures the safety of the deposited money. Rather, no institution is obliged to reimburse the money if it faces bankruptcy.
Exchange Rate Risk : Due to the volatility of the Crypto, the potential which the value fluctuates, when it is exchanged for another Crypto type or Fiat currency type.
The Crypto market worldwide is still in a developing state. Similarly, Sri Lanka is also an amateur in the Crypto arena. Hence, depending on that there still remains a plethora of issues that need to be addressed in the Sri Lankan Crypto arena.
The way through the Financial risks
Consequently, the financial bottlenecks of the Crypto market that need to be addressed sooner, depict multifaceted adversary impacts that can have the possibility of impacting the nation’s economic landscape. These financial risks when it remains unchecked, hold the ability to permeate a plethora of aspects of the economic infrastructure of the country.
Further, since Crypto is not backed by any tangible reserve, the imaginative bubble of the belief that holds the value of the currency is the main driving force for which the specific Crypto type exists. Hence, if by any chance, that the bubble gets destroyed, the money that one invested in the specific trading platform will eventually get devalued leading to a huge investment loss. Moreover, this investment loss in Crypto will ultimately lead the way to public outcry from the Crypto arena.
Thus, due to market manipulation in various ways, Crypto can be a cause for huge financial losses for individuals specially when engaged in pyramid schemes. If a large number of the public invests in such schemes, this may lead to severe economic consequences in the country as in 1997 when the Albanian government collapsed due to the mass general public invest in Crypto. This further caused widespread financial ruin in the country marking a tumultuous period at that time. This remarked a manifest demonstration of the potentiality of the destruction that the Crypto can cause if the arena is not properly governed.
On the other hand, if the proper taxation method is not applied for Crypto transactions, the sudden increase in Crypto could lead to capital flight where investors move out their assets of the country within the traditional financial system. This may further weaken the currency of the country while eroding the confidence in the government's ability to manage and balance the economy. Moreover, the anonymity and excessive financial independence in the Crypto arena would even facilitate terrorist financing, money laundering and funding political pressure creating political instability within the country. Accordingly, this could undermine the government’s efforts to maintain the rule of law leading to crucial national security concerns.
Consequently, Crypto can be a cause of rigorous consequences leading to critical national security concerns, if it lets the Crypto market to behave in its own way. Thus, it needed to regulate the Sri Lankan Crypto market to ensure the financial security of Sri Lanka. Through that, the Financial Governance of the Crypto market can be established by mitigating the myriad threats associated with it as some countries in the International arena have already implemented at present. Rather, by means of regulating the Crypto arena, it can be an economic strategy for Sri Lanka which further can serve as a hedge against inflation where it allows the transaction despite the local value of the currency that holds. Further, Crypto can facilitate asset diversification for investors which even holds the potential of being an alternative store of value, financial inclusion of underbanked population, improving transparency with the Blockchain technology and faster transactions from anywhere at any time can furthering the economic security of the country if the Crypto market is strategically regulated.
Finally, since the foundation of the resilient nation rests upon the pillars of financial security, it is of paramount importance to mitigate the threats that persist to the financial security of the country. Accordingly, the Sri Lankan Crypto market poses financial insecurities that may lead to extreme repercussions for nation’s economy and financial instability with a broader economic landscape. At the same time, Crypto hold the ability to enhance the economic capabilities of the country, if strategically managed. Thus, Sri Lanka demands a proactive approach towards Crypto as to safeguard financial security which spontaneously fosters the financial capabilities of the country.
Way Forward
The domain of Crypto is evolving and transformative. Thus, the financial insecurities that were born out of the Sri Lankan Crypto market are evolving day by day. Despite that, the financial insecurities of the Crypto market is mitigatable. As rough seas make good sailors, these financial insecurities give rise to new implements that further fortify the national security of Sri Lanka.
Introducing a regulatory framework: It is of paramount importance to introduce a regulatory framework for the Sri Lankan Crypto market with a Crypto license for both Consumers and Service providers with a locally registered number in order to ensure that the government hold all relevant details of the Crypto dealers in the Crypto market at present.
Strengthening the Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations: It is pivotal to strengthen the KYC and AML in order to ensure market integrity in compliance with the legal and regulatory frameworks.
Taxation of Crypto transaction: Taxation of Crypto will be important to prevent excessive speculation and market volatility which will further promote a stable investor environment. Moreover, this will prevent the risk of tax evasion.
Establishing an institution responsible for Crypto: It is massively important to establish a governing body with an advisory council for Crypto in Sri Lanka consisting of industry experts in order to examine and monitor Crypto-related activities.
Establishing Penalties and Enforcement: It is of paramount importance to establish penalties and enforcement for investor protection and mitigate illicit activities with regard to Crypto increasing the regulatory creditability and minimizing market manipulation.
Enhancing the financial literacy of the people: Empowering the public through educating the risks, rewards and best practices when dealing with Crypto can make well-aware and strategically equipped Crypto traders who do not easily get cheated by fraud schemes and scams associated with Crypto.
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* Ms. Chamathka Sewmini is an Intern (Research) at the Institute of National Security Studies (INSS), the premier think tank on National Security established and functioning under the Ministry of Defence. The opinion expressed are her own and not necessarily reflective of the institute or the Ministry of Defence.
-The Ministry of Defence bears no responsibility for the ideas and views expressed by the contributors to the Opinion section of this web site-