In this series of our commentary on cryptocurrencies, we have already discussed (i) the basics of the subject matter and (ii) delved into the government's move to tax transactions relating to virtual digital assets. In this – the third of the series – we are going to get into some sort of crystal gazing and discuss the possible scenarios of where this business/industry is headed.
(Urgent) Need for Regulation?
There is a perception that regulation is antithetical to and stymies the growth of innovation. Not necessarily true. The implementation of the European Union General Data Protection Regulation , has contributed immensely to the innovation around data security measures. Another instance, closer home – in India – is the instance of the Intermediary Guidelines and Content Regulation Rules of 2021. Prior to notification of these Rules, there was no standard for determining the classification of content on OTT platforms and resultantly, OTT platforms and producers were being subjected to unnecessary litigation and harassment. Not only is there greater certainty with these Rules, but it has also led to a greater push towards innovation.
Specifically in relation to finance, given its sensitive nature and States' need for control and standards to be implemented across the country as also cross-border, regulation of Financial markets / businesses is difficult to argue against. States' need for control stems from the security / assurance required to be given to the consumers/general public, ensuring against scams, control over money laundering schemes, etc. This has led to proliferation of legislation/regulation to address / control the mining/ minting, introduction, circulation, and spending of cryptocurrencies.
The regulators around the world, especially in the technology domain, are increasingly becoming responsive to the changes in the economic, social and technical conditions. However, given that these changes are constantly in flux and dynamic, the regulators are still playing a reactive role instead of a proactive one. As discussed in our last article, the ESG concerns have become a real consideration for all the regulators in forming new laws. Taking a leaf out of a report of the OECD , it will be important for the regulators to ensure that there is:
- understanding of the regulation/ technology linkages; and,
- introduction of competition; and,
- streamlining of regulations – no country can afford to have a barrage of regulations, which are duplicative, onerous in nature, and do not interact with one another; and,
- reliance on technology-driving approaches; and,
- international harmonization.
This last consideration is a tricky, especially with the differential approach – caused primarily on account of the difference in understanding and classification – in re cryptocurrencies. Harmonization of this approach needs principally to rely upon a common understanding of imposing technology risk management requirements on the financial institutions, for safe and sound use of technology to deliver financial services and protect data .
Efforts around the World.
Recently, Singapore has passed a new legislation which will require virtual asset service providers which only do business overseas to be licensed. This is keeping in mind the need for regulation around anti-money laundering and countering the financing of terrorism, as well as the level of awareness that exists in the minds of the consumers about managing expectations around cryptocurrencies. The country is performing a balancing act when it allows a regulatory regime to manage and govern the industry, while also discouraging public from cryptocurrency trading. This move accentuates the vigilant approach of the city-state and reinforces their intent to ensure that Financial Institutions bolster the security and resilience of digital services . This is in line with OECD paper, which advises governments to plug existing gaps and keep abreast of new risks emerging from the convergence of technology and conventional formats.
In the United States of America, the discussion around cryptocurrencies, particularly stable coins have gained a lot of prominence in the past couple of years. Earlier this month, the Securities Exchange Commission has committed to partner with the Commodity Futures Trading Commission to address platforms trading crypto-based security tokens and commodity tokens. The regulators in the US do not intend to treat this market any different from the traditional regulated exchanges, for the mere fact that the underlying technology is different. As threats to the customers are ever on the rise (with scammers stealing more than USD 14 billion in crypto in 2021 ), the investors are required to be protected with the same vigor. Much like its counterpart in Singapore, the US SEC's Office of Investor Education and Advocacy and the Division of Enforcement's Retail Strategy Task Force is constantly updating and issuing bulletins to educate investors about risks with accounts that pay interest on crypto asset deposits .
In November 2021, the President's Working Group on Financial Markets issued a report discussing the risks stemming from stablecoins. It found that stablecoins are currently used "to facilitate trading, lending, or borrowing of other digital assets" but could theoretically be used to create a "faster, more efficient, and more inclusive payments" system. It also went on to add that where stablecoins "involve complex relationships or significant amounts of leverage, there may also be risks to the broader financial system." What is striking is to note that while the traditional systems have found some ways to mitigate the risks (by way of imposition of liquidity requirements, or ensuring deposit insurances for bank accounts), stablecoins do not have such protections.
For now, it is important to note that while there are distinctions between (i) securities; (ii) commodities; (iii) NFTs; and (iv) stablecoins, this list/classification, is by no means exhaustive or final. Simultaneously, there is continued insistence and effort to have the existing statutory authorities play a greater role in regulating crypto assets, and various think tanks have made appeals to the US Congress to desist from carving crypto assets out of existing laws.
There Middle East has witnessed a spurt in regulations across the Gulf Cooperation Council region, in an effort, to welcome players from across the globe to set up base in the region, seek licenses and registrations, and host exchanges in their jurisdictions. This has led to a lot of crypto players studying such regulations closely and evincing an interest to move operations.
As the number of regulatory frameworks around cryptocurrency spawn across jurisdictions to modulate cryptocurrency transactions and consumer behavior, a certain degree of harmonization and standardization across regimes will be vital, to establish cooperative legislative agencies/ groups for enforcement of policies, and avoid creation of safe havens, common to money laundering legislation schemes. Mere introduction of a taxation regime for crypto assets will not be limited to assessing whether tax laws would be applicable to crypto transactions but would also extend to determine if the owner of a crypto asset can potentially evade those laws by hiding their identities/ assets. With the anonymity of the transactions prevalent over blockchain and digital wallets, where the underlying owner's identity is not disclosed or cannot be truly mapped, the entire exercise will be replete with inconsistencies and will be futile.
At this juncture, the laws that come up should be technology agnostic, and must steer clear from categorization of the type of cryptocurrencies, to leave behind some wiggle room for regulation of such new proofs of work. It will also be left to the device of the regulators to have mechanisms in place for assessment of technology risk management for the financial institutions. With the option of a particular digital asset being subject to regulation by several authorities, departments there is a requirement for the inter-governmental bodies, and political-economic unions to consider having dedicated work groups which substantiate, supplement the gaps in identifying risks, and enforcement mechanisms, in this integrated economy. With the current level of acceptance in consumers, willingness amongst the regulators, we must take the current when it serves, or lose our ventures.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.