The digital asset ecosystem of cryptocurrencies, nonfungible tokens, tokens, crypto-assets, and tokenized assets is a multibillion-dollar market in flux. The growing importance and relative volatility of digital assets in recent years has meant that the cornerstone institutions that govern economic stability—governments, financial regulators, banks, and asset managers—have been increasingly required to provide frameworks around this burgeoning asset class.
2022 marks a significant turning point, with key economies announcing their intentions around formalizing financial and regulatory frameworks to govern the digital asset space. Navigating the changing regulatory landscape will be a challenge for both institutions and individual investors. With that in mind, we present here a high-level review of legislative developments underway in the U.S., UK, EU, and Singapore. Finally, we review El Salvador—an unlikely pioneer in the cryptocurrency market.
U.S.: Behind the Curve
In the U.S. regulators have been behind the curve in regulating digital assets as, until recently, they have not been viewed as mainstream products. However, since 2021 there has been significant regulatory activity, and highlights include the following:
In March 2022 the White House issued the first executive order with six policy objectives for digital assets:
- Protection of customers, investors, and businesses.
- Financial stability and systemic risk mitigation.
- Mitigation of Illicit finance and national security risks.
- Continued U.S. leadership in the global financial system and economic competitiveness.
- Financial inclusion—equitable access to any new financial innovation.
- Responsible development and use of digital assets.
The above objectives direct various federal agencies to provide regulatory recommendations. On the back of this executive order, U.S. Sens. Cynthia Lummis and Kristen Gillibrand introduced a bill in June 2022 to create a comprehensive regulatory framework. If passed, the bill would:
- Define digital currencies as commodities (or ancillary assets or intangible assets).
- Propose a legal definition of digital assets and virtual currencies.
- Obligate the Internal Revenue Service (IRS) to create rules on merchant acceptance of digital assets and charitable gifts.
- Mandate the IRS to also have rules to distinguish which digital assets are commodities and which are securities.
- Impose disclosure requirements on digital asset firms to protect consumers.
The bill would also clarify roles for the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC):
- The CFTC would oversee digital asset spot markets with a focus on market fraud and market manipulation.
- The SEC would oversee digital assets where investors make profit. Firms selling digital assets to raise funds would have to file with SEC.
The bill would also protect consumers from certain losses by requiring firms to maintain reserves and provide disclosures.
Several other agencies are also racing to introduce new rules, and some examples are listed below:
- The IRS is looking into taxing cryptocurrency transactions and expanding the wash sale rule to prevent people from taking a tax loss in cryptocurrency transactions.
- U.S. agencies are discussing whether banks should get involved in providing crypto-asset custody, selling these assets, and using them as collateral for loans. If this happens banking rules would govern crypto-exchanges.
- The Office of Comptroller of the Currency (OCC) is discussing whether banks may hold dollar reserves against stablecoins and use them for payments.
- The Department of Labor is concerned about including cryptocurrencies in retirement (401K) accounts.
In summary, the race is on in the U.S. regulatory space for various agencies to flex their muscles and introduce new laws, strengthening the framework and governance of digital assets.
UK: Clarifying Its Approach
In January 2021, HM Treasury launched a consultation and call for evidence aiming to clarify the regulatory approach to crypto-assets / stablecoins, and distributed ledger technology (DLT). Its key aim is to ensure that the UK is positioned to harness the benefits, cutting edge technologies, and innovation arising from this sector, while combatting the risks posed to consumers, market integrity, and financial stability.
Through this consultation it was confirmed that the UK government would adopt “a staged and proportionate approach to crypto-asset regulation.” It was therefore decided that, in the short term at least, the government will pursue the legislative steps necessary to bring stablecoins that are used as a means of payment within the regulatory perimeter, since they have the potential to increase market access, provide efficiency benefits, and become a widespread means of payment.
Stablecoins used for payment will be regulated by amending the existing Electronic Money Regulations 2011 and Payment Services Regulations 2017. These rules require registration and authorization by way of an application to the Financial Conduct Authority (FCA) in order for a firm to be permitted to provide services within the UK. Then, Part 5 of the Banking Act 2009 will be extended to include stablecoin activities, which grants the Bank of England supervisory powers in a scenario where the risks are considered systemic. “Taken together, these changes will create the conditions for issuers and service providers of stablecoins used as a means of payment to operate and grow in the UK. For consumers, bringing stablecoins into the regulatory perimeter means they will be able to use stablecoins with confidence.”
In addition to its work on extending existing rules to cover certain stablecoins, the government called for evidence on the investment, and wholesale applications of DLT in capital markets, particularly within financial market infrastructures (FMI). DLT is considered to present transformative potential for the industry. The government, pursuant to its stated aim of supporting technological advancements in this space, is developing an FMI sandbox to allow FCA-authorized firms to innovate and experiment with DLTs to provide FMI services. This initiative will allow the government to work collaboratively with regulators and industry to identify any issues relating to the development of DLT within FMI. The aim is to have this sandbox operational by 2023—however beyond that, much of the detail remains vague.
EU: Legislation Enacted
The European Union (EU) has enacted specific legislation to deal with the evolving crypto-asset market. Markets in Crypto-Assets (MiCA) is a regulatory framework initiated in 2018 with the aim of establishing a standard licensing system across the EU by 2024. As with similar EU legislation, the rules will be “passportable,” meaning that being granted a license in one EU member state permits the license holder to participate in any other EU member state without having to gain additional authorization. MiCA will regulate the following tokens:
- Utility tokens: non-financial tokens used to digitally offer access to services, applications, or resources on DLT networks.
- E-money tokens: crypto-assets that have a fixed value based on a single fiat currency and are intended to behave similarly to electronic money.
- Asset-referenced tokens: designed to keep their value stable by “referencing several currencies that are one or more crypto-assets, legal currency, one or more commodities, or a basket of such assets.”
The European Commission has stressed the need to ensure that consumers have access to “innovative but safe crypto-assets without jeopardizing market stability.” Indeed, it is this cautious tone, seemingly intent on threading the needle between effective regulatory enforcement and government restraint, that has garnered criticism of the MiCA rules from the financial press. The conclusion here is that rather than devising an entirely new regulatory framework, the European Commission is extending the scope of existing financial markets laws—such as bringing crypto-assets under the auspices of the Markets in Financial Instruments Directive (MIFID). How effective MiCA will prove to be, will play out once final negotiations between the European Council, Commission, and Parliament have concluded.
Singapore: Progressive, Transformative
Singapore has a robust yet progressive regulatory framework. The island nation is gradually transforming itself into what it calls a “smart financial center,” thus emerging as a leader in the global fintech revolution. The Payment Services Act of 2019 (PSA), implemented by the Monetary Authority of Singapore (MAS), is Singapore’s primary statute for crypto-assets. It aims for regulatory certainty and consumer safeguards, while encouraging innovation and growth in payment services and FinTech. The Singapore parliament passed the PSA in January 2019. Businesses dealing in crypto-assets can now function smoothly and freely within this framework, which is a significant catalyst for innovation.
One of the PSA’s key focus areas is anti-money laundering and countering the financing of terrorism (AML/CFT), which is covered by Notice PSA-N02. In December 2019, the MAS published an amendment to the PSA that focused on crypto-assets titled “Notice PSN02 Prevention of Money Laundering and Countering the Financing of Terrorism—Digital Payment Token Service.” The PSN02 guidance, which came into effect in January 2020, puts in place robust AML/CFT guidelines and regulations to detect and stop the illegal flow of cryptocurrency funds through Singapore. The regulation includes implementing measures such as “know your customer” processes (including understanding beneficial ownership), account reviews, and suspicious transaction monitoring and reporting.
El Salvador: Ahead of the Curve
In June 2021, El Salvador became the first country to implement Bitcoin, a virtual non-fiat cryptocurrency, as legal tender. The introduction was made with the following statement:
“With the aim of generating employment opportunities, promoting true financial inclusion, and generating economic dynamism, the deputies of the Legislative Assembly approved the Bitcoin Law.”
This is the second time El Salvador has taken bold steps to stimulate its economy. In 2001 the Salvadoran Colón (₡) was retired from circulation and indexed at the rate ₡8.77 = $1.00 USD with the passing of the Law of Monetary Integration allowing the circulation of the U.S. dollar in order to reduce currency risk.
The adoption of Bitcoin is a move to gain greater financial independence from the reliance of the economy on the U.S. dollar as a main stimulus for foreign investment.
The tax authority (Ministerio de Hacienda) developed a Bitcoin law comprised of 10 articles that are still pending a rule and governing body to oversee its implementation. The main legal provisions include: the use of Bitcoin as legal tender; price quoting in both USD and Bitcoin; every economic agent must accept Bitcoin; and trade in Bitcoin will not be subject to capital gains tax.
This initiative was implemented through the use of the Chivo Wallet, a state-run bitcoin wallet app. The government provided citizens with the equivalent of $30 USD as an incentive for citizens to use Bitcoin, effectively creating an economic stimulus of approximately $47 million USD.
Subsequently, El Salvador has received political and economic pressure from the International Monetary Fund (IMF) to stop using Bitcoin, including the withholding of funds. The IMF cites multiple concerns including extreme volatility, potential money laundering, and speculation. But the Salvadoran government remains committed to the continued use of Bitcoin.
Financial markets worldwide have been hit hard, especially crypto markets. Bitcoin, other cryptocurrencies, and most crypto lenders have recently lost more than 50% of their value.
Crypto lenders are not regulated so investors that put money in these firms (like Celsius) do not have any protection. Celsius recently paused all withdrawals and transfer between accounts, which means they froze all accounts. Most of the unregulated crypto lenders grew fast recently by promising sky-high returns but are in trouble today. The current situation is ripe for regulators to step in. The SEC has already warned that these crypto lenders promise high returns with very little disclosure.
With the exponential growth of digital assets, governments and financial regulators must act quickly to provide the framework required to govern the custody, issuance, technology infrastructure, security, source of data, and flow of digital assets. The announcements by major economies to establish their regulatory frameworks indicate that digital assets are entering the mainstream and becoming institutionally ready. El Salvador has taken a bold move, and it is likely other regions will consider steps in this direction in the future, albeit perhaps with less volatile digital assets. Given the rapidly changing landscape, institutions must navigate these new requirements carefully.