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Regulating Cryptocurrencies in New Zealand September 2018 Associate Professor Alexandra Sims Dr Kanchana Kariyawasam Professor David Mayes 2

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Regulating Cryptocurrencies in New Zealand September 2018 Associate Professor Alexandra Sims Dr Kanchana Kariyawasam Professor David Mayes 2 Regulating Cryptocurrencies in New Zealand September 2018 Associate Professor Alexandra Sims Dr Kanchana Kariyawasam Professor David Mayes 2 Acknowledgements The authors would like to acknowledge the support of the New Zealand Law Foundation, without which the project and resulting report would not have occurred. Thanks also to Chaowei Fan for providing input and valuable translation skills into the part on China’s work on a central bank-issued cryptocurrency. Alex1 and Kanchana2 would like to dedicate this report to their co-author Professor David Mayes,3 who sadly passed away in November 2017 after a short illness. 1 Associate Professor Alexandra Sims, Department of Commercial Law, Business School, the University of Auckland. 2 Dr Kanchana Kariyawasam, Senior Lecturer, Griffith Business School, Griffith University. 3 Professor David Mayes, BNZ Professor of Finance, Department of Finance and Accounting, Business School, the University of Auckland. 3 Table of contents Executive summary and recommendations ................................................................................................... 6 1. Introduction ........................................................................................................................................ 8 2. Introduction to blockchain technology ............................................................................................20 2.1 General introduction to blockchain technology and public key cryptography ........................21 2.2 The value of blockchain technology beyond cryptocurrencies................................................23 2.2.1 Smart contracts ...............................................................................................................25 2.3 How banks and other financial institutions are using/exploring blockchain technology ........28 2.3.1 New Zealand and Australia ..............................................................................................28 2.3.1.1 Views from Westpac ........................................................................................................29 2.3.1.2 Views from ANZ ................................................................................................................29 2.3.2 Internationally .................................................................................................................30 2.3.2.1 The Utility Settlement Coin Project .............................................................................31 2.3.2.2 The Global Payments Steering Group .........................................................................34 2.3 R3 – Corda ......................................................................................................................................35 2.4 Arguments against the use of blockchain technology .............................................................35 2.5 The mechanics of blockchain technology ................................................................................38 2.5.1 Hash functions .................................................................................................................39 2.5.2 Time stamping and Merkle trees .....................................................................................39 2.5.3 Consensus mechanisms ...................................................................................................40 2.5.3.1 Proof-of-work ..............................................................................................................40 2.5.3.2 Proof-of-stake ..............................................................................................................41 2.5.3.3 Alternative consensus mechanisms ............................................................................42 3. Cryptocurrencies ..............................................................................................................................42 3.1 A brief history of money ..........................................................................................................42 3.2 The evolution of cryptocurrencies ...........................................................................................46 3.3 Cryptocurrencies after Bitcoin – not limited merely to payments ..........................................51 3.3.1 Utility tokens ....................................................................................................................52 3.3.2 Asset tokens .....................................................................................................................53 3.3.3 Security tokens ................................................................................................................53 3.4 How cryptocurrencies work .....................................................................................................54 3.4.1 Creation and distribution of coins ...................................................................................55 3.4.1.1 Pre-mining of coins ......................................................................................................55 3.4.1.2 Limited or unlimited supply of cryptocurrency ...........................................................55 3.4.2 Proof-of-work versus proof-of-stake (consensus) ...........................................................56 3.4.2.1 Proof-of-work ..............................................................................................................56 3.4.2.2 Proof-of-stake ..............................................................................................................56 3.4.3 Block generation speeds ..................................................................................................57 3.4.4 Rate of change of rewards ...............................................................................................57 3.4.5 Transaction fees ...............................................................................................................57 3.4.5 Demurrage .......................................................................................................................59 4. Arguments against cryptocurrencies ...............................................................................................59 4.1 Cryptocurrencies are not money .............................................................................................59 4.2 Cryptocurrencies are anonymous and only criminals and terrorists will want to use them ...61 4.3 Cryptocurrencies cannot scale .................................................................................................62 4.4 Bitcoin’s code cannot be altered .............................................................................................63 4.5 Some cryptocurrencies can be changed arbitrarily .................................................................63 4.6 Financial instability...................................................................................................................63 4.7 Central banks’ loss of ability to control money supply ............................................................64 4.8 Governments become unable to collect taxes ........................................................................65 4.9 Potential risks to consumers ....................................................................................................65 4.9.1 Fluctuations in price ........................................................................................................66 4 4.9.2 Loss of private keys and passwords .................................................................................67 4.9.3 Security ............................................................................................................................68 4.9.4 Non-reversibility of transactions .....................................................................................69 4.9.5 Cryptocurrencies are unregulated ...................................................................................70 5. Limitations of the current payment systems and how cryptocurrencies could solve them ............70 5.1 High transaction costs ..............................................................................................................71 5.2 Slow transaction times .............................................................................................................73 5.3 Significant cost of credit card fraud .........................................................................................74 5.4 The unbanked and under-banked ............................................................................................74 5.5 Identity theft ............................................................................................................................75 5.6 Slow rate of innovation ............................................................................................................75 5.7 Fragile banking system .............................................................................................................76 5.8 Money laundering ....................................................................................................................76 6. Current (and proposed) treatment of cryptocurrencies excluding the United States .....................78 6.1 New Zealand ............................................................................................................................78
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