Ali Abbas
How to address the inconsistencies in global crypto regulation
At the end of 2021, the International Monetary Fund (IMF) published a blog post calling for comprehensive, consistent and coordinated crypto regulation. While the IMF acknowledged the growth of the industry and the increased interaction with the traditional financial system, it also warned that authorities are struggling to monitor a broad scope of potentially systemic risks. Among the risks highlighted were the integrity of exchanges and wallets, inadequate reserves and disclosure for stablecoins (which are pegged to a fiat currency like the dollar), and what it called the ‘cryptoization’ of developing countries where crypto replaces domestic currencies.
However, coming up with a global standard for regulation is easier said than done. The industry is still relatively young. Bitcoin, the original crypto, only emerged in 2008 – and regulators seem unsure about the best approach to supervision. This has led to inconsistency among national regimes and created risks which cybercriminals and bad actors can easily exploit.
State of crypto regulation
To illustrate the differences between regimes, let’s explore the latest developments in some of the world’s major financial centres.
United States
As discussed by CUBE’s Founder and CEO, Ben Richmond, the US took its first steps toward crypto regulation at the start of March when President Joe Biden signed an executive order (EO) outlining how the government would like to regulate the industry. The EO instructs the various agencies involved in supervising the US financial sector to develop policies to support its goals which include protecting consumers, businesses and investors, minimising the potential impact on financial stability, and preventing the use of crypto for illicit activity.
Since then, we have seen two US senators unveil a Bill that would establish new rules for cryptocurrency and hand regulatory oversight to the Commodity Future Exchange Commission (CFTC). Meanwhile, Commissioners from both the Securities and Exchange Commission (SEC) and the CFTC have said they will work together and collaborate for a regulatory framework for crypto.
United Kingdom
Like the US, the UK has been slow to regulate crypto. But at the start of April, Chancellor of the Exchequer Rishi Sunak introduced a regime he hopes will turn the UK into a global hub for the industry. One of the headline policies announced was regulating stablecoins which Mr Sunak believes could provide an alternative and more efficient payment method for consumers. Other measures include the introduction of a sandbox to let firms experiment before releasing new products, as well as a ‘CryptoSprint’ in May which allowed the Financial Conduct Authority (FCA) to engage with the industry on future rules.
European Union
The EU is further ahead than the US and UK with its crypto regime. The Economic and Monetary Affairs Committee adopted the Markets in Crypto Assets Regulation (MiCA) in March, although it still needs to be ratified by the European Commission (EC). MiCA introduces regional level rules for the industry, covering authorisation requirements for issuers of crypto assets and service providers such as exchanges and custodians. Prior to Parliamentary vote on crypto, a list minute amendment threatened to ban cryptocurrencies that were created through a Proof of Work model – which would have banned Bitcoin in Europe. However, that amendment did not get voted through.
Crypto firms are also currently bound by the EU’s anti-money laundering directives- the fifth classified them as obliged entities- and the EC has recently proposed subjecting crypto transfers to the same regulations as wire transfers.
China
Having prohibited financial institutions from dealing with crypto firms in May 2021, Chinese regulators followed up in September by banning all crypto transactions and mining (the process of verifying transactions). However, that isn’t to say the country has turned its back on digital currencies altogether. China is one of the most advanced countries in terms of developing a central bank digital currency. According to the latest data from the People’s Bank of China, over 261 million people already use the digital yuan following pilots in 10 major cities, with a further 11 planned in 2022.
Arguments in favour of a global standard
The borderless nature of digital currencies limits the effectiveness of national regimes designed to leverage their benefits and mitigate against the risks they pose to the financial system.
Crypto doesn’t have a central authority, like a government controls a fiat currency, because the blockchain technology which processes transactions is a decentralised database running on millions of computers. That means users can send and receive funds from anywhere in the world through channels not subject to the usual regulatory frameworks.
To make matters more complex for regulators, crypto service providers can cater to a global customer base from wherever they choose (within reason – 51 countries have effectively banned digital currencies). They can even adopt a decentralised business model themselves, where they spread operations across different jurisdictions.
“There are cryptocurrency businesses that appear to be everywhere and yet physically are nowhere at all,” Mark Steward, head of enforcement and markets oversight at the UK’s FCA, recently told the Financial Times, adding this trend should be a warning for authorities.
There’s also a risk that crypto firms indulge in what’s known as regulatory arbitrage, where they circumvent strict rules in one country by basing operations in another with a lighter regulatory regime.
Proposals for a global regulatory standard
The IMF and FATF, two of the world’s leading financial institutions, have proposed guidelines for how crypto regulation could work on a global scale.
International Monetary Fund
In the blog post quoted earlier, the IMF suggested a regulatory framework consisting of three elements:
- Crypto firms delivering services such as custody, exchanges and transfers should be licenced and mechanisms put in place to encourage coordination among authorities
- Tailor regulations to the way crypto assets are used. For example, subject payment providers to the same requirements as bank deposits and oversight by local authorities coordinating with their global counterparts
- Regulators should present clear direction for financial institutions that deal with crypto service providers, such as limiting exposure to certain digital assets
The Financial Action Task Force
The FATF, the global body dedicated to combating money laundering and terrorist financing, updated its guidance for managing crypto risks in October 2021. While it also called for the licencing of service providers and greater engagement between authorities, the guidance included several additional measures:
- The FATF Recommendations should apply to all crypto firms
- Subject providers of similar products or services to the same regulations, regardless of the underlying technology
- The definition of virtual assets- which have inherent value rather than record ownership- should be flexible so it applies to both existing and new technologies
- Financial institutions must collect identity information about parties sending or receiving crypto payments (the so-called ‘travel rule’)
Managing fragmented regulation with Automated Regulatory Intelligence
While the regulatory landscape for cryptocurrency remains fragmented, it is clear from fast-emerging regulatory developments that regulation is on the horizon. Though it is unclear what form that regulatory framework might eventually take, firms should be implementing systems or solutions to actively scan the landscape for regulatory change. Given the pace of change for crypto, new regulation will likely be implemented fast – with little lead-in time. Firms who have been proactive in anticipating a compliance framework, will have a competitive advantage.
