Regulation of the cryptocurrency ecosystem. Challenges and Solutions
The ongoing evolution of the crypto-ecosystem provides new opportunities, but also presents new challenges and pitfalls.
Unsecured crypto assets are the oldest and most popular type of crypto assets. Their value does not depend on any reserve asset, but on supply and demand.
Users view unsecured crypto assets as speculative instruments rather than as a medium of exchange. However, the innovations which have led to the rise of the crypto ecosystem, including the underlying technologies. They can create potential benefits by increasing competition and improving the efficiency of some financial services such as remittances, trade finance and cross-border payments.
Cryptocurrency asset growth has been unsustainable and the associated financial stability risks in some emerging markets and developing countries are growing.
The total value of cryptoassets reached almost $3 trillion in November 2021 before dropping to less than $1 trillion in July 2022, indicating a relatively high volatility.
The IMF's October 2021 Global Financial Stability Report showed that cryptocurrency exchanges operating in some emerging markets and developing countries have achieved trading volumes comparable to those of local stock exchanges and interbank foreign exchange markets. However, many regulators do not have the ability to oversee payments.
Legal loopholes in many countries remain significant, and the cross-sectoral and cross-border nature of cryptocurrencies limits the effectiveness of uncoordinated national approaches.
In particular, gaps exist in the cases where crypto assets are issued, exchanged, transferred or held by non-banks and where the regulatory framework of a jurisdiction does not cover crypto assets based on current legal interpretations of financial services and products.
Approaches to regulating unsecured crypto assets
European Union: The Crypto Asset Markets Regulation (MiCA) is part of the digital financial strategy of the European Union and covers a wide range of crypto assets.
While the main attention is paid to stablecoins, for other crypto assets, MiCA requires the involvement of issuing entities, as well as a notification regime for white papers and marketing. An onshoring and licensing mode is also offered for key mission-critical organizations such as exchanges and wallet providers.
The MiCA regulation is at the draft stage. When implemented, it will be consistent with the existing regulatory framework for e-money and service-specific payment services, as well as the existing market integrity and behavior of regulated entities.
Japan: In April 2017, the Payment Service Act was amended and the Japan Financial Services Agency introduced special regulation for the crypto asset service providers.
Key requirements include separation of client’s assets, operational risk and cybersecurity management, the principle “know your customer”, internal audits and minimum capital requirements.
In May 2019, the law was further amended to additional adjustments in order to extend cryptocurrency regulation to other entities (wallet service providers) and increase requirements for cryptocurrency exchanges, including the restriction (up to 200 percent) leverage provided to retail clients. The amendments also extended the application of existing securities laws to tokens.
In June 2020, the Payment Service Act was further amended in order to introduce rules for stablecoins.
Switzerland: In February 2018, the Swiss Financial Market Supervisory Authority (FINMA) issued initial coin offering guidance and introduced three categories of tokens: payment tokens, utility tokens, and asset tokens. FINMA also clarified that tradable tokens in the pre-funding stage and presales are generally not utility tokens but asset tokens and therefore can be considered as securities.
In June 2018, the Financial Service Act harmonized the prospectus requirements for all securities (including asset tokens). In February 2021, Distributed Ledge Technology (DLT) amended several civil and financial market laws to allow the introduction of ledger-based securities on the blockchain and establish rules for splitting cryptoassets in the event of bankruptcy of cryptocurrency custodians.
UK: In July 2019, the Financial Conduct Authority (FCA) published its "Final Guidance on Crypto assets". It states that security tokens (crypto assets that provide rights and obligations similar to "specified investments") fell inside its regulatory purview, whereas utility and “exchange tokens” (i.e., unbacked crypto assets) were outside of prudential and conduct regime.
Since then, the FCA has conducted consumer research in order to understand the crypto asset market better. In April 2022, the UK Treasury outlined its roadmap for regulating crypto assets.
While significant attention has been paid to stablecoins, the paper proposed a sandbox regime for blockchain-based financial market infrastructure with the long-term goal of expanding the regulatory perimeter to cover cryptoassets such as bitcoin.
In January 2022, the UK Treasury proposed to include crypto assets in its Financial Stimulus Regime.
Albania: In May 2020, the Law on “Financial Markets Based on DLT”, also known as the “Fintoken Law”, legalized crypto assets in Albania for investment purposes. The law regulates the introduction of "digital tokens" and "virtual currencies", as well as licensing, monitoring and supervision of organizations that distribute, trade and store them.
The Fintoken Law places powers on both the Albanian Financial Supervisory Authority (AFSA) and the National Agency for Information Society (NAIS) as competent authorities, as well as the Bank of Albania in relation to stablecoins.
Nigeria: In February 2018, the Central Bank of Nigeria issued a press release stating that crypto assets are not legal tender in Nigeria. In February 2021, the CBN ruled that trading in crypto assets and making payments for crypto asset service providers is a prohibited activity.
But already in May 2022, the Securities and Exchange Commission published "New Rules on Issuance, Offering Platforms and Custody of Digital Assets ", which states that "digital asset offerings" are within the remit of the SEC and imposes requirements on "digital asset offering platforms" and "custodians of digital asset offerings".
Expectations – the result
Despite the ongoing work in different countries to regulate crypto assets, their cross-border nature makes regulation, supervision and enforcement extremely difficult. Many crypto asset service providers such as wallets and exchanges, as well as some issuers, operate from offshore jurisdictions, providing services around the world.
Without a common global approach, organizations can move to jurisdictions that favor regulation or taxation and continue to offer services to users located elsewhere. Similarly, the use of crypto assets on unregulated exchanges could make it easier to bypass capital flow management measures in individual jurisdictions.