With the value of the global cryptocurrency market north of $3tn (£1.09tn) and mainstream crypto adoption continuing to accelerate, global regulators are racing to keep up.
In March, President Joe Biden signed an executive order that tasks the entire US government with forming a strategy to regulate digital assets, including cryptocurrencies.
Meanwhile, in Europe the EU is in the process of finalising its markets in crypto assets legislation, which seeks to oversee crypto activities that fall outside existing regulations. The UK’s FCA also earlier this year proposed tougher rules on crypto advertising to stamp out false or misleading claims.
“Those who are new to this or just pressed for time will say crypto is unregulated – nothing could be further from the truth,” says Marco Santori, chief legal officer at Kraken, a crypto exchange.
Much of the early regulatory agenda for cryptocurrencies and the emergence of blockchain technology focused on money services, though since 2017 with the boom in initial coin offerings, that has started broadening into areas such as capital formation, says Santori.
“There are new, emerging uses of blockchain technology that implicate new risks and are creating new industries – it’s those emerging uses that are under regulatory scrutiny,” he says.
But given the rapid pace of crypto adoption, regulators have struggled to keep pace.
“Regulation has lagged but as Biden’s order indicates, there is a growing awareness that there needs to be a much tighter regulatory framework around crypto,” says Ben Richmond, founder and CEO of regtech company Cube Global.
Enforcement actions are also starting to increase. The US Securities and Exchange Commission (SEC), for instance, has brought around 100 cryptocurrency enforcement actions since 2013. The agency’s new chairman, Gary Gensler, said the SEC hopes to start regulating crypto exchanges this year.
“Learnings from those actions are driving regulator behaviour, but that’s where it risks becoming fragmented because you can end up with different approaches to the same problem,” says Richmond.
Methods for regulating cryptocurrencies
Another debate has fizzed around how to regulate crypto – should it be bolted on to existing regulations or regulated as a separate industry, with its own regulator and laws?
Timothy Spangler, a US-based partner at law firm Dechert, believes it should be the former.
“I would rather spend more time understanding the technological impacts than creating new regulators, new crimes and new oversight mechanisms, and then having to debug those over years,” says Spangler. “That could unnecessarily stymie innovation.”
Others argue that the novelty of blockchain technology means it shouldn’t be shoe-horned into current regulations.
“Most regulators are using a traditional approach to regulate crypto,” says William Je, CEO of Hamilton Investment Management. “But crypto is creating new financial products that are entirely different to anything that has come before.”
Some jurisdictions are taking a more active pro-crypto stance to attract crypto businesses, such as US state Wyoming, which has passed a series of crypto-friendly blockchain laws.
“Wyoming has taken a descriptive rather than a prescriptive approach to regulation and is a model for other jurisdictions,” says Santori.
One initiative Wyoming has adopted is creating a banking license that tailors the regulatory regime to the actual risks of the bank. For instance, Kraken was the first crypto company to receive a license under the state’s new banking charter aimed at digital asset businesses, which allows them to take deposits as opposed to make loans.
“It dials up oversight of reserves and forgoes the regulations usually be required for banks that lend,” says Santori.
This is the biggest hurdle for the development of crypto, so we need more clarity
A focus on crypto-mining activities, particularly around energy use, is also attracting the attention of regulators. China has banned crypto mining, while the EU considered banning certain energy-intensive methods for mining crypto but has since backed down.
“To say that we need to regulate crypto miners is to say that crypto mining poses a danger, but we’re a long way from quantifying that,” says Spangler. “How comfortable are we that we accurately know the energy usage that miners engage in? Most of the academic surveys are qualified and speculative.”
While regulatory best practice is a work-in-progress, Spangler believes those jurisdictions that tread cautiously are likely to yield more effective long-term outcomes.
“We need to move at the right pace to make good decisions,” he says. “We want to move forward based on knowledge. Move slowly and roll out things as needed – we don’t know where blockchain will move.”
How regulators are addressing crypto across the world
But while the US has traditionally set the standard for global financial regulation, it is not a given that it will shape how crypto regulation develops worldwide.
“Most people would agree that crypto’s centre of gravity initially was the US and Canada, but there’s no reason why having created a new technology or protocol, they would also win the deployment,” says Spangler.
A lack of regulatory harmonisation across jurisdictions is also potentially weighing on the growth of the crypto market.
“Every country has different rules and regulations or even definitions of what should be regulated, so at the moment it’s not clear, which is holding back institutional investors from investing in crypto,” says Je. “This is the biggest hurdle for the development of crypto, so we need more clarity.”
Others believe that while regulation is necessary to safeguard consumers, it could slow the pace of adoption.
“It’s about getting the balance right – how do you protect people but enable this world to flourish,” says Richmond. “The concern is that if the regulation comes in too hard, it will slow down the uptake.”
Worries that too much regulation could choke innovation are likely to be overblown, though Santori believes some innovation will inevitably be constrained as regulators tighten their grip.
“That’s the trade-off when we regulate,” he says. “But we also create a more stable and welcoming environment, so that is the correct lens to view the decision of whether to regulate.”
As blockchain technology continues to thrive and new use cases emerge, one thing is certain: the regulatory backdrop is far from resolved.