In our last blog, we discussed how the early regulation of cryptocurrencies revolved around customer protection, crime prevention and anti-money laundering. Thirteen years on, things have clearly changed. What was once an upstart sector, existing at the boundaries of legality with vague use cases and unclear potential has flowered into something else altogether.
In 2021, global economies have no choice but to bring the crypto industry into the mainstream. For better, or for worse.
Today, we will delve a little deeper into some of the most recent developments in crypto regulation around the globe. Cryptocurrencies themselves have branched out into a variety of new use cases and all carry various legal implications.
Projects which were once just a GitHub repository are now transnational companies that need to be treated as seriously as Facebook and Amazon. International organizations are beginning to push out regulations that affect crypto industries across the globe. What will be left after this new wave of regulation is fully rolled out? Let’s find out.
The complexity of the technology behind crypto demands that regulators understand its individual quirks, needs and nuances when binding it in far-reaching regulation.
An obvious example that springs to mind here is the rise of a variety of different token types in recent years. How do we legally define, and therefore control and tax, say, a stablecoin, versus a utility token?
In the German-speaking part of the European Union which includes Germany, Switzerland and Austria, there has been a significant push to roll out legislation which distinguishes between security, payment and utility tokens. This builds on Switzerland’s already groundbreaking embrace of the scene, with the Crypto Valley in Zug, serving as a safe haven for many projects since the middle of the past decade.
The UK, on the other hand, chose to crack down on not so much crypto assets per se, but instead on cryptocurrencies packaged as various financial assets, such as futures.
Across the pond in the United States, the conversation in this area is much slower. A recent Department of Justice report cited a staggering eight different groups with regulatory oversight, each one classifying cryptocurrencies slightly differently — one as a commodity, another as a property, or even a security, causing a headache for any new project that wants to call the US its home.
Another trend we’re beginning to see across the board is the rise of standalone regulatory bodies with a clear focus on cryptocurrencies. Japan recently announced that it’s starting not one but two committees overseeing the crypto sector, the Japan STO Association and the Japan Virtual and Crypto Assets Exchange Association.
In the United States, the federal oversight over the fledgling industry is now given to the SEC’s FinHub division. Formed originally in 2018, the bureau has been growing in power and expanding its role over the SEC’s crypto strategy. In time, these regulators will develop their own sector-specific experience, which will see a more tailored and expert approach to regulating domestic cryptocurrency scenes.
Singapore, on the other hand, has been driving the conversation about the global reach of not only crypto companies, but of the technology itself. Provisions included in 2019’s regulation have extended its rules to include the overseas activities of locally-based companies.
This area of development will remain a hotly debated topic, as established crypto projects can effectively shop around for the best place to settle their corporate roots, while their operations extend all over the globe. This will especially be of importance when managing crypto companies serving customers rather than business. Already in 2019, Circle’s CEO, Jeremy Allaire, warned US regulators about a number of crypto companies leaving the States for the Bahamas, Japan and Switzerland due to a “uncertain and restrictive regulatory environment.”
When curbing the international reach of crypto companies, at least the regulator has the advantage of having a centralized institution to hold accountable. Said institution, after all, holds a significant stake in its protocol’s development, is the author of the network’s token, or holds key information in closed-source repositories. But what if a network, or protocol has no semblance of a central authority altogether?
In the last couple of years, the Ethereum network has given rise to a multitude of specific crypto industries. Users can now participate in Ethereum’s Decentralized Finance (DeFi) network by borrowing, lending, purchasing insurance and gambling, to name a few services offered. The sector offers its users untapped potential.
At the same time however, it can prove to be a headache for regulators, with its fully autonomous, decentralized structure. Regulation of this industry would have to happen in the code itself and would require cooperation with developers, internet service providers and other relevant authorities. This is going to be one of the most hotly contested areas of crypto regulation to watch with moral implications for privacy rights of developers and entrepreneurs alike.
In the modern, interconnected world, regulation of financial technology is an increasingly global topic. Blockchain, by the very nature of its technological foundations, is even more so. This means that in order to contain it, international bodies are also stepping in to encourage regulatory standards across multiple states.
While local regulations up to this point have mostly been produced by individual countries in order to control their domestic interests, the rising roles of supranational organizations in the shaping of the global industry can’t be ignored. For the best example of supranational organizations shaping the policy response to the crypto boom, look no further than the Financial Action Task Force, or FATF.
Founded in 1989, the organization consisting of 37 countries and two large regional bodies has set standards to curb crimes in the global financial system. In the most recent years, it has zoned in on the flow of cryptocurrencies and has issued official guidelines for how different countries should police VASPs inside their borders.
The regulation of cryptocurrencies as recommended by the FATF can be linked back to the creation of the Travel Rule by the USA in the late 1970s. In order to prevent examples of large-scale money laundering, the federal government started to require that banks store and obtain customer information regarding all transactions above $3000.
With a huge influence over the standards issued by the FATF, the US has used the international body to turn elements of this policy on crypto. Issued in late 2019, Recommendation 16 of the FATF officially suggests its member states should apply similar control on transactions on the blockchain.
Many top free market economies by now have implemented some form of these guidelines for their domestic crypto companies. South Korea requires each account to be pegged to a real life bank account and a national ID. Switzerland and the Netherlands also.
The American Financial Crimes Enforcement Network (FinCEN) is making similar moves. Still led by Steven Mnuchin, the Secretary of Treasury of the outgoing Trump administration, the agency went ahead by proposing to lower the threshold for transaction validation for cryptos to as low as $250 in late December. It remains to be seen how the new administration pivots its approach to enforcing FATF’s guidelines inside the United States. Needless to say, American-based projects can expect regulatory obstacles.
The public aim of these moves are to protect the customers as well as the integrity of the global financial system. Critics of FATF’s rulings claim that while the majority of industry leaders want to comply with the directives, the application of policy based on policing the financial sector before the advent of the modern web is simply too outdated to compliment the rapid activity on the blockchain.
The rulings would be especially difficult to apply to users sending money to smart contracts, which are anonymous and decentralized by nature. In recent months, the sector has had an increasing participation in the FATF’s quarterly meetings and directly with the FinCen and is coming up with innovative solutions to implement the laws into the underlying technology. The developments in this space are going to be a crucial area to watch for crypto’s health, affecting the volume of global transactions and global market fluctuations.
Another supranational organization showing signs of having an increasingly unified and comprehensive stake in this industry is the European Union. Until recently, it was the responsibility of individual countries inside the Union to issue directives and guidelines on crypto. We already covered how German-speaking countries have spearheaded regulating its infant crypto industries, while other countries in the Union have fallen behind without a unified response from the region. That is all about to change.
In September 2020, the European Commission announced the creation of the Digital Finance Package (DFP) and Markets in Crypto Assets (MiCA), which, when implemented in 2024, will constitute the most comprehensive, far-reaching regulation in the crypto world to date. MiCA, will also be one of the first comprehensive regulations to severely limit the DeFi industry specifically. We will have a closer look at developments in DFS and MiCA in future posts.
So far in this blog series, we have discussed in detail how various countries are driving innovation in crypto legislation, thus helping it mature in a variety of ways. But what immediate effect does this have on businesses now? Well, it depends on what projects we’re talking about specifically.
The smooth regulatory sailing is definitely over and the onslaught of regulation creates a lot of headaches for all crypto projects, big dogs included. Four top executives of BitMex, a US-based top exchange, have recently been charged with violating US anti-money laundering regulations. The news shook the market to its very core, with the total capitalization losing around 13 billion USD in the hours after the ruling.
Gary Gensler, expected nominee to lead the U.S. Securities and Exchange Commission, is also advocating for a nationwide registrar of crypto exchanges instead of state-based laws. This will add additional obstacles for industry giants like CoinBase planning to go public in 2021.
And it’s not only the top players that are affected either. Stricter regulation often includes a lengthy application process and compliance that cannot be achieved without costly lawyers, consultants and insider connections, essential in navigating the ever tightening regulatory landscape.
In the UAE, a license which allows projects to operate with ease takes about 14 months to obtain. The application process itself has a meek 4% success rate. In South Korea on the other hand, all VASPs need to get their infrastructure certified by a relevant cybersecurity agency, a process that only six projects have managed to achieve.
We can see this trend continuing across the board, with virtually all top players issuing strong compliance guidelines. This move, while pushing the field to more legitimacy, will make it significantly harder for upstart projects to move from a GitHub repository and into the mainstream.
When it comes to the conversation of how to control the industry, It’s important to remember the very essence of what the technology actually means. Some of the oldest and strongest supporters of blockchain and cryptocurrencies advocated full independence and breakaway from the preexisting financial world. It isn’t a coincidence that the Bitcoin Whitepaper was released in 2008, a year that has taught us the fallible and destructive nature of an unchecked, centralized banking system. Regulation and inclusion in the official markets of global economies will bring immense benefits to the scene — but at a price.
The regulatory movements from the South Korean regulators illustrate this pain point for a very specific, yet prevalent area of the industry. In late 2020, the local government moved to ban exchanges from assets it considers “dark coins.” This is representative of an ongoing trend to stifle innovation in the privacy-focused element of the crypto space. Given that most recent regulation seems to concern shining more light on the activity on blockchain networks, can we expect a stronger push against privacy coins in the new decade?
Those are some of the many ways in which crypto regulation is evolving for the new decade. Next up, we’ll cover countries that took a wholly different approach to crypto — choosing to crack down on cryptocurrencies altogether.