The regulation of financial markets is a collective effort between local and international bodies whose mandate to protect consumers and other stakeholders. Some of these oversight authorities have existed for close to a century - a good example is the U.S Securities Exchange Commission (SEC), created after the 1930s stock market crash. Today, it is one of the most powerful oversight bodies within the U.S financial markets.
The emergence of cryptocurrencies has not gone unnoticed by financial regulators such as the SEC and other regulatory bodies worldwide. Recent years have seen these authorities swing into action by regulating or warning their citizens against cryptocurrencies. Some regulators appear to be more progressive, while others are still sitting on the fence. Nonetheless, it is evident that regulations will largely dictate the future of cryptocurrencies.
So, what is the current state of regulation in crypto? The answer to this question is likely to be different for various jurisdictions. However, we have international bodies such as the Financial Action Task Force (FATF), a G7 intergovernmental organization that seeks to combat money laundering. This financial oversight authority has made significant progress in creating a standard approach to crypto regulation.
Let’s dive into the regulatory progress made by FATF in recent years and later highlight the state of crypto regulation in some prominent jurisdictions such as the U.S.A, European Union, China and the leading crypto-friendly jurisdictions.
The Financial Action Task Force (FATF) is one of the leading regulatory bodies for crypto assets. This Anti-money laundering and counter-terrorism financing (AML/CFT) regulator is the world’s official oversight body in such matters. It was formed back in 1989 with the sole purpose of combating money laundering - however, its scope of activities was expanded to counter-terrorism financing after the infamous 9/11 attack.
FATF has since taken a lead role in regulating cryptocurrencies, having been actively involved since 2018. This intergovernmental watchdog introduced the term ‘Virtual Asset Service Providers’ (VASPs) to its standards - a collective tag representing crypto custodial service providers. Notably, this covers most of the crypto businesses as they provide custody services in one way or another.
In 2019, the FATF made further progress by adopting a comprehensive crypto regulation - popularly known as the FATF Travel Rule. This standard requires VASPs to share specific client information for transactions that are over $1,000, quite similar to the practices in traditional finance ecosystems. The FATF adopted the standards in June 2019, but stakeholders were given until June 2021 to have complied with the Travel Rule.
To be compliant with these standards, most countries are setting local regulations for VASPs. Some jurisdictions such as the U.K now require VASPs to register afresh with the Financial Conduct Authority (FCA), after which they have to be approved to continue with crypto-related businesses. The FATF Travel Rule reinforces oversight on issues such as money laundering and counter-terrorism financing, which have become rampant in crypto.
While the FATF has made significant progress, the regulatory body is still facing some challenges in implementing crypto regulations. One of the main stumbling blocks is the lack of an interoperable framework that allows information to be shared amongst VASPs - this would make it seamless for specific client data to travel across various service providers and eventually to the regulator. Another challenge is the roll-out of the Travel Rule across multiple jurisdictions, as some countries may take a less strict approach than others.
Besides the FATF Travel Rule, there have been individual advancements by specific countries. Let’s take a look at the progress in some of the leading economies:
The U.S.A, which accounts for close to a quarter of the world’s Gross Domestic Product (GDP), is one of the countries that crypto stakeholders have been following closely. This financial giant has made several advancements in crypto regulation, although it still lags in comparison to some jurisdictions. U.S financial oversight bodies that have reacted to crypto-assets include the SEC, Commodities Futures Trading Commission (CFTC), Internal Regulatory Service (IRS) and the Treasury department of Financial Crimes Enforcement Network (FinCEN).
While none of these regulatory bodies is yet to consider crypto assets as a means of payments, each appears to have formed its guiding framework. The SEC approach leans towards categorizing digital assets as securities, which means that the issuers of these tokens have to be compliant with security laws. On the other hand, the IRS classifies crypto as property, triggering similar taxable events. As for the CFTC, its role is primarily on the oversight of crypto assets as commodities, especially with the emergence of crypto derivatives. Meanwhile, FinCEN takes care of crime-related activity such as money laundering and counter-terrorism financing.
With these financial oversight bodies in the picture, the U.S has introduced some guiding frameworks to oversee cryptocurrency activities. Some of the pivotal guidelines include the classification of Initial Coin Offering (ICO) tokens as regulation-d securities - an SEC regulation that governs private placement exemptions. Other developments have been made by the IRS, which now recognizes crypto assets as taxable property. However, the federal government is yet to introduce a comprehensive regulatory framework for all states - a gap that has made some states more crypto-friendly than others.
The states that have welcomed crypto with open arms include Colorado, Wyoming, California, Ohio and Texas. New York, the U.S financial hub, has taken a more strict approach, requiring crypto service providers to get a Bitlicense. This situation might change following recently proposed legislation by the senate to clarify digital asset regulation across the United States.
The European Union has been very accommodating to crypto-assets and related innovations. This region which consists of 27 member states, is a hub to some of the most valuable crypto projects as of press time. With the FATF Travel Rule as the overall guideline, this region has developed some advanced oversight frameworks to keep the crypto industry in check.
One of the most notable legislations is the 5th Anti-Money Laundering Directive (5AMLD) which seeks to ensure that crypto activities fall under regulatory scrutiny. This directive was signed into law in January 2020 to combat money laundering and terrorist financing. According to the 5AMLD, EU states should create centralized databases for crypto wallets and user identification, making it easier for financial intelligence units (FIU) to track crypto activity.
The 5AMLD now covers all financial markets related activities within the European Union. This means that VASPs are obligated to register with the relevant monetary authorities and provide client information as per existing regulatory standards. Most countries in the EU are still in the implementation phase of the 5AMLD, which is also a stepping stone to complying with the FATF Travel Rule. As for the U.K, this oversight role has been taken over by its financial regulator, FCA, following Brexit (withdrawal of the U.K from the European Union).
There are also plans to introduce a digital Euro, which will act as a Central Bank Digital Currency (CBDC) for the European Union. A CBDC is a digital currency issued by central banks, which means it is a centralized asset. Ideally, CBDCs can be used by monetary authorities to enact policy in the upcoming digital economies. The European Central Bank (ECB) is currently in the experimentation process of a digital Euro with some countries such as France and Italy already willing to participate in its pilot.
Though a leading innovation hub, Chinese authorities have taken stringent measures against crypto assets since the 2017 ICO hype. The country banned ICOs and directed financial service providers to cease interaction with crypto-related activities. Surprisingly, China was is still the leading Bitcoin mining jurisdiction at the time - however, this dominance has is gradually shiftinged to other countries such as the U.S, following strict measures on miners. Some of the requirements include using hydropower and sticking within the set energy limits.
Like the European Union, China has also proposed its own CBDC - a working prototype was piloted in 2020 and is currently in use. Dubbed the ‘DC/EP’, this CBDC is set to be used as the People’s Bank of China (PBoC) digital currency with monetary functions set to shift once fully rolled out. It is also noteworthy that Chinese authorities recently recognized crypto assets as alternative investments - a take that is fundamentally bullish for the crypto market.
While the leading economies are yet to set clear regulations on crypto assets, some jurisdictions have already introduced laws governing these assets. Japan is one of the most progressive states in crypto oversight - authorities recognized crypto as legal tender in 2017. They also formed a self-regulatory body known as the Japan Virtual Currency Exchange Association (JVCEA), which comprises the top crypto firms.
Other leading jurisdictions include Switzerland, where crypto regulations are enforced both on federal and local levels. The country has since positioned itself as a crypto hub with most businesses pitching in Zug - one of Switzerland’s cantons and today’s ‘Crypto Valley’. Zug’s attractiveness as a crypto hub has undoubtedly placed it as one of the most crypto-friendly jurisdictions.
Besides a standard crypto regulation, some countries have an eased taxation approach. Singapore is one of these jurisdictions - the developed Asian economy does not apply capital gains tax to financial assets, including crypto. This means that individuals or corporations that hold crypto assets are not subject to tax. Germany also takes a similar approach to crypto taxation, although some added specifications include the holding period and amount sold before one year of holding.
Regulations are a fundamental part of the crypto market and will likely influence its growth in the coming years. That said, regulators have a lot to catch up on, especially with the rate at which crypto innovations pop up. Furthermore, it will require a collective international effort to harmonize the oversight of cryptocurrencies across borders. We are still in the early stages of forming these checks - a sign that more crypto regulatory frameworks will be developed in the near future.