Crypto regulation

At its peak in November 2021, the value of the cryptocurrency market went over $3 trillion. With increasing consumer and institutional interest in crypto, the drive for lawmakers and regulators to implement more regulations is accelerating.

Any proposed regulations need careful consideration. The industry is relatively new and poses unique characteristics never dealt with before. It’s evolving quickly and has numerous variations and complexities to consider.

In general, financial regulations aim to ensure financial markets are secure, fair and not used to aid money laundering or other financial crimes. At the same time, they shouldn’t stifle economic growth or unduly limit benefits or freedom.

Each jurisdiction has different philosophies, models, processes, capabilities and biases on limiting or enabling crypto from outright bans to having it as legal tender. Let’s examine the status of crypto regulations in some jurisdictions in 2022.

U.S. crypto regulation is a work in progress

In the U.S., there’s a move to create a coordinated approach to all things crypto using tools such as an Executive Order. Different agencies and regulators, including the Departments of Treasury, State, Justice and Homeland Security, the Securities and Exchange Commission (SEC), the Commodities Futures and Trading Commission and federal banking agencies are examining the issues. There are also numerous bills in various stages in Congress.

While these initiatives make their way through analysis and potential codification, numerous rulings and clarifications have been made.

Is Bitcoin a security?

In 2019, SEC Chair Jay Clayton stated, “Cryptocurrencies are replacements for sovereign currencies…[they] replace the yen, the dollar, the euro with bitcoin. That type of currency is not a security.”

How is Bitcoin regulated?

In the U.S., Bitcoin exchanges are considered Money Service Businesses (MSBs). FinCEN issued guidance regarding Persons Administering, Exchanging, or Using Virtual Currencies:

“In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.”

As a “financial institution,” MSBs are required to comply with Bank Secrecy Act laws and regulations, including Anti-Money Laundering (AML) requirements and Know Your Customer (KYC) rules.

Are other digital assets securities?

There has been a lot of confusion about categorizing various types of digital assets. As each token has a different use and financial structure, determining if an asset is a utility or a security is not clear-cut. The ramifications are significant, as security (or asset) tokens must comply with security laws, while utility tokens don’t.

If the reason people are investing in a token is that they think they can profit, it might fall under an ‘investment contract’, according to the U.S. Supreme Court Howey Test. There are four considerations for the Howey Test:

  1. An investment of money
  2. In a common enterprise
  3. With the expectation of profit
  4. To be derived from the efforts of others.

Many assets, including NFTs and DeFi tokens, are under scrutiny by the SEC for failing to follow security laws, and there have been significant enforcement actions.

Can banks deal with digital assets?

Through various Interpretive Letters, the Office of the Comptroller of the Currency (OCC) is allowing U.S. national banks to:

  • Take custody of cryptocurrencies
  • Hold U.S. dollar reserves against stablecoins
  • Use blockchain nodes and stablecoins for payment activities

But Acting Comptroller Michael Hsu has put out a more recent Interpretive Letter. According to former U.S. FDIC regulator Jason Brett, it will “only add confusion to the marketplace … leaving only the largest and most well-funded incumbent banks in a position to afford conducting cryptocurrency activities.”

Complying with the Travel Rule

The Financial Action Task Force (FATF) guides how its 37 members regulate cryptocurrency exchanges. One controversial guidance is the so-called travel rule that requires

obligations to obtain, hold, and transmit required originator and beneficiary information in order to identify and report suspicious transactions, monitor the availability of information, take freezing actions, and prohibit transactions with designated persons and entities.

The travel rule is about knowing both parties of the transaction and helping to make sure the transaction is not connected to illegal activities.

FinCEN ruled that the existing travel rule requirements apply to cryptocurrency exchanges. On February 16, 2022, 18 U.S. digital asset companies unveiled the Travel Rule Universal Solution Technology (TRUST) to comply with the requirement while protecting the security and privacy of customers.

These are just some of the issues that are being considered by the Federal government; there are also numerous state initiatives to consider. Hopefully, the Executive Order on Ensuring Responsible Development of Digital Assets can help build consensus and the U.S. will put in a legal framework to

ensure that safeguards are in place and promote the responsible development of digital assets to protect consumers, investors, and businesses; maintain privacy; and shield against arbitrary or unlawful surveillance, which can contribute to human rights abuses.

EU crypto regulations

New EU crypto regulations are close to passing

The future of cryptocurrency regulation in the EU is becoming more evident.

Currently, there are different crypto rules on a country-by-country basis. Under 5AMLD, crypto exchanges and crypto wallet providers are considered “obliged entities” and face similar requirements as financial institutions. These requirements include AML, customer due diligence, transaction monitoring and suspicious activity reports.

While 5AMLD brought crypto exchanges under the scope of AML regulations, it did not specify a single set of KYC rules across the EU. Under 6ALMD, there will be a single rulebook for KYC across the entire EU. That Directive is making its way through the different member states’ legislative processes, and it’s just a matter of time until full implementation. To create more cohesive, harmonious and powerful AML regulations, the European Commission has also adopted an action plan for a single, comprehensive Union policy on preventing money laundering and terrorism financing.

On September 24, 2020, the European Commission proposed the Regulation on Markets in Crypto Assets (MiCA) to provide legal certainty around the regulatory treatment of crypto-assets. The goal is to help promote innovation, provide consumers and investors with appropriate protection levels and ensure financial stability and market integrity. This regulation was voted on and approved by the EU Parliament on March 14, 2022, making it one step closer to becoming law. The proposed effective date is 2024.

With MiCA already having gone through proposal, feedback and debate stages, the EU is on the path to have

harmonized requirements for issuers that seek to offer their crypto assets across the Union and crypto-asset service providers wishing to apply for an authorization to provide their services in the Single Market.

UK crypto regulation

The UK has crypto regulations requirements that match the EU’s 5AMLD and 6AMLD.

The Financial Conduct Authority (FCA) is the AML/KYC regulator of UK crypto asset businesses, including firms involved with exchange tokens (such as Bitcoin). These businesses need to comply with the same AML regulations as banks and financial services.

As the FCA states, “Our supervisory approach to crypto asset businesses will be in line with our approach to other businesses under the MLRs (money laundering rules).”

Crypto companies have a March 31, 2022 deadline to win FCA approval. Many operators have been on a temporary register, awaiting approval, but that register is closing. Operators facing outright rejection are closing UK business arms, and others might have to temporarily cease operations until approval.

Crypto regulation in Canada

All dealers of cryptocurrency are considered MSBs and have similar requirements regarding due diligence, record-keeping, monitoring and reporting.  Virtual Asset Service Providers (VASPs) have to register with  Financial Transactions and Reports Analysis Centre of Canada (FinTRAC) and have KYC procedures in place, including customer identification. Additionally, any cryptocurrency transfer over CAD $10,000 needs to be reported.

For reporting issuers that are materially involved with crypto assets, the Canadian Securities Administrators has published guidelines to help issuers “avoid inaccurate or misleading disclosure and to provide the information necessary for investors to make informed investment decisions.”

Global collaboration

Status of global crypto regulation

Due to the rapid development of the industry and its highly technical nature, regulations are often playing catch-up to crypto technology. As crypto becomes more mainstream and its effects on society become clearer, regulators and lawmakers will have more insights to create balanced regulatory frameworks.

The U.S. Library of Congress Regulation of Cryptocurrency Around the World report (November 2021) provides a solid overview of current regulations:

  • Jurisdictions with an absolute ban — 9
  • Jurisdictions with an implicit ban — 42
  • Jurisdictions with an application of tax and/or AML laws — 103

Many officials are calling for more regulation. For example, they look at the recent Russian sanctions and have concerns that crypto might be a significant enforcement loophole. As U.S. Senator Elizabeth Warren states, “We are at risk for watching Russia undercut the effectiveness of sanctions through the legal system by doing an end-run through the crypto world.” But Jake Chervinsky, head of policy at the Blockchain Association, suggests, “Crypto markets are too small, costly, & transparent to be useful for the Russian economy.”

The debate on crypto regulation will undoubtedly continue; there are numerous vested interests, innovative forces, ideologies and new concepts to consider.

A global approach to crypto regulation?

As crypto is digital in form, it can seamlessly cross borders and operate globally. A marvel of mathematical and communication innovation, putting jurisdictional limitations on it is contradictory to its nature – and challenging to do.

In a February 2022 report, the Financial Stability Board, which coordinates national financial authorities and international standard-setting bodies, points out

The rapid evolution and international nature of these markets also raise the potential for regulatory gaps, fragmentation or arbitrage. Although the extent and nature of use of crypto-assets varies somewhat across jurisdictions, financial stability risks could rapidly escalate.

The International Monetary Fund (IMF) has proposed that cryptocurrency requires a global regulatory framework. They note “crypto’s cross-sector and cross-border remit limits the effectiveness of national approaches.” Some elements of the framework the IMF suggests include:

  • Crypto asset service providers that deliver critical functions should be licensed or authorized
  • Requirements should be tailored to the prominent use cases of crypto assets and stablecoins
  • Authorities should provide clear requirements on regulated financial institutions concerning their exposure to and engagement with crypto.

Producing a global path to cryptocurrency regulation, while challenging, can help create a holistic and integrated approach. Working together, governments and industry can develop guidelines that can speed up effective regulation while still delivering on the opportunities that crypto promises.

The FSB, IMF and FATF are all looking at creating robust global crypto regulations. Along with all the government agencies and industry groups, the amount of energy and initiative put into the space is incredible. Keeping aware of updates and ensuring your systems are adaptable is critical for those in charge of their crypto organizations’ compliance.