Anyone who has spent more than a day in the space acknowledges the urgent need for more clarity on a host of issues related to digital assets, which is to say that regulating markets for digital assets is going to be one of the main priorities in the years to come.
The EU's Fifth Money Laundering Directive (5MLD) came into effect on Jan 10 in parallel with the European Securities and Markets Authority's own plans for developing a legal framework for digital assets in 2020. The US House of Representatives is about to step in with the Crypto-Currency Act of 2020. In the world of digital assets, all this is extremely good news: strengthening regulations worldwide means that the universal regulatory climate is finally steadying and being actively prepared for meaningful institutional involvement.
European Commission consultation on digital assets within the legal framework of the EU
In December 2019, the European Commission launched a public inquiry into the future markets citing the current lack of any comprehensive classification of digital assets (in fact, it's still unclear which assets fall within the purview of the EU’s financial services regulatory framework as MiFID II financial instruments, but the work is underway). The Commission seeks stakeholder input on the risk-benefit assessment; the market efficiency of digitised securities is glaringly obvious, but so are the risks of releasing them into the wild without proper oversight.
During the consultations that will last until Mar 19, 2020, the Commission will address issues of regulating security tokens, confront such market abuses as short selling, discuss prospectus regulation, EMIR and UCITS, CSDR (Central Securities Depositories Regulation), and other urgent matters.
Essentially, the inquiry is about the apparent need to build an EU-specific framework for regulating digital assets, without which we can forget about any strategic involvement of institutional money. The Commission makes no secret that the top priority during the inquiry is to “facilitate greater clarity as to the prudential treatment of financial institutions’ exposures to crypto-assets.” In other words, build - and they will come.
EU's Fifth Money Laundering Directive (5MLD)
We all rejoiced when the UK enacted 5MLD on 10 January 2020 despite the Brexit. The move leaves little room for interpretation: borders may change but the City of London will remain the financial capital of the world.
The new Directive defines digital security as a “digital representation of a value that is not issued or guaranteed by a Central Bank or a public authority and that does not have the legal status of a currency or money, but based on agreement or practice accepted by natural or legal persons as a means of payment or exchange, or is used for investment purposes and is transferred, stored and traded electronically.”
Not much to unpack here except for the specific exemption for the digitally stored fiat money, yet both security and payment tokens are clearly defined as "not-money."
Most notable changes touch on the current KYC requirements, which are rewritten in much stricter terms. Monitoring of all transactions and filing of Suspicious Activity Reports (SARs) is now a must; to pass KYC on EU-operating exchanges, a user must not just provide a valid ID to open an account, but actually proof his or her identity by various means. Global exchanges must implement the new AML/KYC rules to operate in the EU market streamlining it to the level of competitiveness of such heavily regulated markets as the United States.
Not so fast
The "harmonised regulatory framework" promoted by the 5MLD, apparently means that buying and selling digital assets will now require businesses to register with their national financial regulator who will verify KYC-compliance and issue an appropriate license for a particular activity. Understandably, not all market participants will be willing to go the extra mile to please the regulator and find a place in the new legal environment; most of the EU-based crypto-exchanges are still severely lacking in the KYC department, unlike US-based exchanges that are accustomed to deploying the EU-required AML/KYC protocols to comply with the 5MLD and other Directives almost immediately.
Still, ESMA continues to develop a legal framework for crypto assets in 2020. On Jan 9, the regulator published its 2020-2022 priorities list citing new risks for the EU financial markets brought on by digitalisation. Steven Maijoor, the ESMA Chair, doesn't mince words: "One of our key priorities is ensuring the consistent and coherent implementation of the Single Rulebook and, with our new powers in this area, we will adopt a risk-based approach, in cooperation with national authorities, to supervisory convergence across the EU."
The US ‘‘Crypto-Currency Act of 2020’’
It seems that the time-tested "we'll wait and see" US government approach to crypto has finally outlived its days. The Cryptocurrency Act of 2020 introduced by Paul Gosar - one of the few forward-thinking US Senators, is yet another decisive move in regulating crypto markets. The short thousand-word Bill will, so to speak, decrypt crypto-asset regulations and attempt to clean up the bad blood between regulators, issuers, and investors by once and for all clarifying definitions for multiple US regulators.
The most exciting part of the Bill is the three-part categorisation of digital assets by types, and naming the regulatory bodies responsible for overseeing each type: CRYPTO-CURRENCY is now a "representation of United States currency or synthetic derivatives resting on a blockchain or decentralized cryptographic ledger" overseen by the Department of the Treasury acting through the Financial Crimes Enforcement Network (FinCEN). CRYPTO-COMMODITY is the economic goods or services that have full or substantial fungibility and are treated by markets with no regard as to who produced the goods or services and rest on a blockchain or decentralized cryptographic ledger." This one falls to the Commodity Futures Trading Commission (CFTC). And finally, CRYPTO-SECURITY, which is "all debt, equity, and derivative instruments that rest on a blockchain or decentralized cryptographic ledger" and governed, you guessed it, by the Securities and Exchange Commission (SEC).
The ambitious would-be law couldn't be timelier. After the Facebook's quest for Libra in June 2019 raised, expectedly so, a huge number of issues with inter-agency relations and compatibility of current regulations, clear boundaries between regulatory bodies need to be defined. The Joint Statement on Activities Involving Digital Assets by the SEC, CFTC, and FinCEN in October 2019 voiced the need for such clarity and, hopefully, together with the new Bill, the current efforts will go further the dead-on-arrival Token Taxonomy Act of 2019.
Are we finally going global?
Ever since the creation of Bitcoin, each coming year was viewed by passionate proponents of all things digital as the Year of Crypto Revolution. In time, however, we learned that in the case of digital assets the "slowly but surely" approach works best. So, let's not call 2020 "the Year of Regulatory Revolution," but commend the regulatory initiatives on both sides of the pond; those efforts by multiple independent agencies and government bodies could very well trigger a global chain of events leading to the creation of a universal set of rules accepted by all. In the conversation about the hurdles of crypto, we need to acknowledge one simple truth: the only thing that stands in the way of mass adoption of digital assets and institutional involvement on a global scale is the absence of a clear set of rules that would make a law-abiding trader, investor or issuer of digital assets an uncontested beneficiary as opposed to a murky corner-cutter.
Will producing such a set of rules and implementing it internationally take long? You bet. But it's painfully clear now that the space needs an overarching global regulatory framework. Let's hope that with this understanding will come knowledge, and with knowledge, at some point, definitive action.