The last year has seen a lot of new regulatory developments in the cryptoasset space, with the regulation of exchanges, protection of retail investors and attempts to create a regime for stablecoins being the main themes of these developments. While the approaches have differed across jurisdictions, it is clear that, as the cryptoasset market matures, regulators will be stepping up the regulatory requirements. Within this article, we summarise some of the key developments in the global cryptoasset regulation space.
1. Mining bans
In recent months several provinces in China, and some countries such as Iran, have taken steps to ban the process of cryptoasset mining due to electricity consumption. Cryptoasset mining is the process by which transactions on the blockchain are processed and recorded; the process involves a miner completing cryptographic calculations on a computer in order to process each transaction. In return for completing these calculations, the miner is rewarded with a small amount of the cryptoasset in question, which is where large scale, professional miners come in.
Mining is prolific in countries with cheaper electricity, with jurisdictions such as China, Iran and Iceland having been favourites in recent times. Cryptoasset mining is controversial as depending on which token you mine, the electricity consumption to process each transaction can often be far more than that used in a regular fiat currency transaction. Bitcoin is one of the cryptoassets with the highest rates of electricity consumption globally. This has raised many ESG concerns about investing in Bitcoin, especially as ESG and sustainability are increasingly seen as important factors to investors, regulators and compliance officers. In a recent survey undertaken by Laven via our LinkedIn, 40% of participants cited “Firm Culture (ESG, SM&CR, CSR)” as the most pressing theme for Compliance Staff (at time of publication).
These concerns, along with some reliability issues for the grid caused by large amounts of mining. such as in Iran where the government has cited recent blackouts as the reason for the ban. This has lead to other governments to move towards an outright ban of the practice for power and environmental reasons. Many cryptoassets are now promising to improve the efficiency of their mining to reduce the ESG concerns that are being raised, but it is difficult to tell which tokens have been effective in doing this, meaning that investors cannot be sure of the environmental consequences of their investments.
2. The NFT boom
Towards the end of 2020 and the start of 2021, we have seen an explosion in the popularity, and value, of NFTs. An NFT is a non-fungible token, meaning that the token and what it represents are not interchangeable with similar tokens. There are two primary uses of NFTs currently: the first is for the token to act as verification for the authenticity of a non-fungible item, utilising the decentralised ledger technology of the Ethereum blockchain. This would allow for collectable items, such as sports memorabilia or artwork, to be sold with a verifiable audit trail.
The second and more controversial type of NFT is where the token is a representation of the underlying item, but does not confer exclusive ownership, or often any ownership rights. A good example of this is the ‘NBA Top Shot’ market, where the NBA has created a market for NFTs representing clips from basketball games, which can then be traded with other users but do not confer any ownership rights over the clip itself. This market is not dissimilar to collectable physical sports cards, just with clips rather than static images, and are traded purely for their collectable value, with some tokens trading for as much as USD 280,000.
NBA Top Shot builds on an existing business model of collectable sports cards. However, some NFTs are pushing into new territory for collectables, with NFTs being created for popular viral videos, GIFs and memes. These latter types of NFTs have received scorn, as many feel the NFT market is a speculative bubble with no intangible value. There have also been comparisons to the way that large amounts of speculative money have flowed into this market following the mention of blockchain with the behaviour of speculative investors during the .com bubble, with a lot of this speculation coming from retail investors.
3. El Salvador makes Bitcoin Legal Tender
El Salvador has made history by becoming the first country to make a cryptoasset legal tender, as Congress voted to make Bitcoin legal tender. This will mean that all firms offering goods and services must accept Bitcoin; additionally, it can also be used for the payment of tax contributions. It should be noted that merchants that do not have access to sufficient technology to be able to accept Bitcoin will be exempt from this requirement.
Many criticisms of making a cryptoasset like Bitcoin legal tender often stem from three issues:
- that the state would lose control of its money supply,
- that the price volatility could harm merchants and consumers, and;
- the increased risk of money laundering and financial crime.
Concerning the first criticism, El Salvador has not had control of its money supply since 2001 when the government abolished the Colon in favour of adopting the US dollar due to high inflation. This put El Salvador in a unique position to experiment with a cryptoasset as legal tender.
In response to the second criticism, the government of El Salvador will be guaranteeing the convertibility of Bitcoin to USD at the time of the transaction for merchants through BANDESAL, the country’s development bank.
The government of El Salvador has promised to introduce appropriate safeguards against the risk of money laundering and financial crime, but no proposals have been put forward at this stage.
This new law has been pushed for by El Salvador’s cryptoasset friendly president, Nayib Bukele, who also reached the news recently for suggesting that the country’s volcanoes could be used to provide clean energy for Bitcoin mining.
4. South Korea
The Financial Services Commission (FSC), the financial regulator in South Korea, has introduced several new rules regarding cryptoassets which are far-reaching in their effect.
The first of these changes is that the nation’s banks will be required to treat cryptoasset exchanges as ‘high risk’ for AML purposes, including being required to refuse services to any exchange that does not follow the strict ID measures and suspicious activity reporting measures in place.
The FSC is also targeting Virtual Asset Service Providers (VASPs), who are being required to register with the appropriate regulators this year.
5. Thailand
The Thai Securities and Exchange Commission has recently approved new guidelines for the country’s cryptoasset exchanges. These new guidelines will ban exchanges based in Thailand from offering access to certain types of cryptoassets.
Many consider the new guidelines to be quite vague as to what tokens are caught by the ban, as the categories given in the guidelines include ‘Meme Token’, ‘Fan Token’ and ‘Non-Fungible Token’. This may mean that enforcing the ban could be difficult, as many smaller tokens could fit within the ‘Meme Token’ category. Thai exchanges have until the 11th of July to comply with the new rules.
6. Basel Committee
The Basel Committee on Banking Supervision has set out a new proposal for the prudential treatment of cryptoasset holdings by banks. The proposal would apply a 1,250% risk weight to cryptoassets held by banks, which in practice would mean that for every £1 in cryptoassets a bank holds, it would be required to hold £1 in capital. This would put cryptoassets in the highest category of risk to banks, and could limit the amount of cryptoasset trading banks may undertake should the rules come into effect in their current form. The proposal does also say that cryptoassets with values tied to real-world assets, for instance stablecoins, will likely have lower prudential requirements, but no specific proposal has been made at this time.
7. The EU launches proposal for a new cryptoasset regulation
Could EU MiCA proposals – particularly stablecoins, be in the scope of payments or even e-money regulation?
In September 2020, the European Commission published a proposal for the Markets in Crypto-Assets Regulation (MiCA). A stablecoin is a token that pegs its value to that of a more traditional asset such as fiat currency or a commodity. The most popular stablecoins are pegged to the US dollar, with Tether being by far the largest stablecoin in use. These tokens serve two purposes: the first is for individuals in countries where inflation is rapidly devaluing the currency, such as Venezuela, or where the currency is generally losing value, such as Brazil. These tokens allow individuals to retain the value of their money in a much easier and convenient way than would have been possible before. The second use case is for individuals who wish to use cryptoassets as a medium of exchange; this is not practical for tokens such as Bitcoin given the price volatility. This use case allows the users to leverage the blockchain’s privacy and decentralised nature to make payments, without the volatility risk associated with major tokens.
Naturally, stablecoins do come with several risks and issues, such as the use of cryptoassets to purchase illicit goods and services anonymously. This has led to several regulators around the world, the EU included, considering applying regulation to stablecoins. Many stablecoin providers have been accused of a lack of transparency over how the tokens are backed. Tether stated that all tokens were 100% backed by USD; however, a NY Attorney General investigation found that this was not the case and that the reserves were overstated by around USD 850 million. This has been a big issue for many stablecoin providers and represents a roadblock on the path forward, as it will be difficult for these tokens to maintain 100% backing at all times, but any shift away from that would need to be followed by further regulation to protect consumers.
The MiCA proposals would begin to regulate stablecoins through the creation of a new regulatory term, “asset referenced token” which would cover many types of stablecoins that are currently unregulated as they do not fall within the scope of the Electronic Money Directive. Any company offering asset referenced tokens would be required to become regulated and be based within the EU to be able to offer such tokens. This is directly targeted at stablecoins and the risks inherent with a large scale, global token such as the Facebook-backed Libra token. The initial proposals for MiCA have been criticised for the fact that the definitions and regulatory perimeter of the directive overlap with the Electronic Money Regime in some areas. Instruments defined as an “electronic money token” could also potentially cover some major stablecoins, and the proposals may need to be adjusted to prevent any confusion over which regime applies.
Beyond regulating stablecoins, which is a major focus of the new regime, MiCA will focus on defining what types of tokens are going to be regulated, creating a unified market across member states. The regime will also require some cryptoasset service providers to become regulated under the regime and will introduce new marketing requirements for tokens being issued within the EEA. Issuers within the EEA will be required to issue a whitepaper that will contain information relating to the token and certain characteristics. A whitepaper will only need to be issued when none of the below applies:
- The token was available in the EEA before MiCA came into force
- No more than €1 million will be issued within a 12-month period
- Target only qualified investors or less than 150 per member state
- Issues mining rewards
- Gives free cryptoassets, unless recipients have to provide personal data or the issuer receives a commission or other benefit.
8. New SEC chair appointed
Recently appointed SEC chair Gary Gensler has signalled his plans to increase regulation in the cryptoasset space, particularly concerning investor protections. Gensler has said he understands that many investors choose to invest in cryptoassets for speculation due to their volatility and low correlation to traditional markets.
Gensler has also said that he considers most cryptoasset tokens to be securities, and as such should be within the regulatory purview of the SEC. He has also stated his belief that cryptoasset exchanges should be regulated entities, which in recent times has become a common theme globally. The marketing of cryptoassets, particularly towards retail investors, is also going to be another priority for Gensler. He plans to update the relevant SEC regulations to appropriately deal with the rise of mobile app investment platforms, which often involve game-like features and are seen by some as encouraging investors to gamble on investments.
9. Regulatory crackdown in Hong Kong and China
Hong Kong’s Financial Services and the Treasury Bureau have also recently announced that all cryptoasset exchanges will be required to apply for a license. This follows moves by several other financial regulators, such as the FCA, to extend regulation to these exchanges. In Hong Kong, however, there is one important difference from the approach taken by the FCA: these licensed exchanges will not be able to provide services to retail clients. In Hong Kong, an individual is required to have a portfolio of at least HK$8 million (GBP 726,000) to be classified as a professional investor.
The announcement of these new regulations follows an announcement by China of the ban on financial and payment services firms from providing services relating to cryptoassets, significantly hindering access for investors to purchase tokens. The three regulatory bodies responsible cited speculation by retail investors, coupled with the volatility of prices, as representing a risk to orderly markets and a risk to ordinary investors who may not fully understand the risks of what they are investing in. This is the same reasoning given by the FCA for its clampdown on the offering of cryptoasset derivatives to retail investors.
