Monday, August 22, 2022

Emergence Of Global Regulatory Framework On Crypto: A Long Winter Ahead

Emergence Of Global Regulatory Framework On Crypto: A Long Winter Ahead

After the terrible market crisis caused by the collapse of Terra Luna, which overwhelmed important players like Three Arrows Capital and Celsius in recent months, the crypto ecosystem continues to find a way out. At the same time, the recent turmoil in the cryptocurrency market has highlighted heightened risks of severe structural instability and vulnerability of a completely unregulated ecosystem. Meanwhile, global regulators are heaving a sigh of relief for their champion of regulatory conservatism, which has kept traditional banking and financial sectors both local and global safe from the alarming decline of cryptocurrencies.

Current regulatory loopholes and lack of investor protection rules

Along with the bare legal and regulatory framework, lack of clear classification and uncertain legal and tax status make investing in cryptocurrencies confusing. Therefore, it is unclear whether cryptocurrencies are considered a means of payment, a currency or foreign exchange, an electronic money token, a speculative investment, a commodity, or some other unspecified asset class. Matters become more complicated in the case of so-called stablecoins, which may be backed by cash (one or more fiat currencies) or other assets or collateral. Algorithmic stablecoins can be even more disturbing, since the reference to price stability comes from opaque algorithms and smart contracts. Similarly, it is difficult to determine the basis of value and risk from independent sources, i.e., digital assets that represent physical objects such as art, music, and video.

Pseudonymization of cross-border transactions without tracing real identity and legal residency makes risk management and regulatory oversight extremely difficult. Without reference information that allows a reliable view of cryptocurrency holdings or flows, the flow of funds across borders almost circumvents anti-money laundering (AML) and tax compliance requirements. When cryptocurrency mixing and mixing/exchange is practiced in transactions or transactions involving intermediaries/counterparties based on unknown jurisdictions, it becomes quite difficult to establish the true identity of the entities involved.

Less transparency and less standardized market information about cryptocurrency issuance and trading on centralized or decentralized platforms operated by unregulated brokers make them less credible to investors. In the unilateral bilateral agreements of crypto brokers, there are hardly any provisions for segregation and protection of client assets or any other guarantee to protect investors on these platforms. Hence, it is extremely difficult to hold intermediaries accountable, if they lose investors' cryptocurrency or commit intentional fraud. Given the opacity of these platforms, it remains vulnerable to market manipulation, price fixing and insider trading, as well as extreme risk of lost business. Without essential investor protection rights, investors have no legal recourse against fraud, abuse and manipulation issues.

Global Regulation of Crypto Assets: A Long and Winding Work in Progress

The inherent opacity and complexity of cross-border transactions requires international cooperation for a coherent and comprehensive global regulatory framework covering cryptocurrencies, the processing chain and associated intermediaries. Currently, global standards and regulatory bodies such as the Financial Stability Board (FSB), the Financial Action Task Force (FATF), the Basel Committee on Banking Supervision (BCBS), and the International Organization of Securities Commissions (IOSCO), among others, are evaluating the development of the cryptocurrency market. Watch closely for target guidance. Various perspectives on risk, including financial stability and anti-money laundering nuances.

G20 finance ministers and central bank governors, meeting in Bali in July 2022, strongly endorsed the FSB's position to ensure that cryptocurrencies, stablecoins and related markets are overseen within an effective regulatory framework. Regarding regulations applicable to the traditional financial sector, he supports the FSB's considerations to implement the "same business, same risk, same regulation" principle to strengthen the regulatory framework and conditions supporting fair competition when evaluating innovation. Benefits In early July, IOSCO released its 2022-2023 cryptocurrency roadmap, highlighting its regulatory agenda. Focusing on crypto and digital assets (CDA) and decentralized finance (DeFi), its Fintech Task Force (FTF) aims to come up with policy recommendations by the end of 2023. Around the same time, CPMI and IOSCO released their final guidelines on currencies. steady The agreements emphasize that the Financial Market Infrastructure Principles (International Standards for Critical Payment, Clearing and Settlement Systems enacted in 2012) apply to systemically important stablecoin contracts.

Earlier, the Basel Committee launched a second public consultation on the conservative prudential treatment of banks' exposure to cryptocurrencies, including stablecoins with unsecured cryptocurrencies and stablecoins with ineffective stabilization mechanisms, in view of new gross exposure limits. The committee expects to finalize the respective standards by the end of the year. While the regulatory framework and standard setting is underway, the Bank for International Settlements (BIS) Innovation Centre, in partnership with the central banks of Australia, Malaysia, Singapore and South Africa, announced the completion of the Dunbar project. The project developed and validated prototypes for a common platform that enables international payments using multiple central bank digital currencies (mCBDC) for cheaper, faster and more secure cross-border payments.

Legislative progress in various jurisdictions

Guided primarily by regulatory positions established by international standardization bodies, regulators in different jurisdictions are currently at various stages of consulting the market and formulating regulatory approaches and supervisory processes. Until a global consensus on a consistent regulatory framework is finalized, country-specific regulations, taken in isolation, may lead to less desirable regulatory outcomes.

While domestic regulators remain cautious, EU and Hong Kong regulators have taken the proposal to the legislative approval stage. Following approval by the Council and the European Parliament, the draft Markets for European Crypto Assets (MiCA) is expected to come into force in early 2024. The Hong Kong SAR government has introduced a comprehensive licensing system for Virtual Resource Service Providers (VASPs). Following recent approval by the Legislative Council, the VASP licensing system is expected to begin in March 2023. Japan also amended its current payment services law to regulate stablecoins and cryptocurrencies that must be issued by regulated entities, as well as to strengthen the fight against them. Money laundering. In the United States, following the Digital Assets Executive Order, the Treasury Department released a framework for interagency engagement with foreign counterparts and various international standards bodies. Meanwhile, the Monetary Authority of Singapore (MAS) has issued guidelines for cryptocurrency service providers not to promote their cryptocurrency-related services to the general public.

Perspectives on global regulatory frameworks and key requirements

Importantly, broad agreement is emerging among global regulators regarding the significant financial, legal, and security risks as well as the key threats to financial stability posed by an unregulated crypto ecosystem. G20 finance ministers and central bank governors recognized the urgency of developing a comprehensive global regulatory framework. Given the slow and cumbersome nature of regulation and stakeholder consultation, global consensus is easier said than done. As seen in the context of international agreements on tax reform, global minimum tax rules and fair distribution of taxes, global consensus and coordination on the crypto regulatory framework should be a long process.

Until the global regulatory framework and underlying approaches are finalized, enacting crypto-centric regulation in each jurisdiction will also be a slow and laborious exercise. At the same time, to maintain a level playing field with traditional financial asset and service intermediaries, the future regulatory architecture of the cryptocurrency ecosystem must take into account the following important considerations:

  • Measures to ensure financial stability and reduce systemic risk of cryptocurrencies, electronic money tokens and stablecoins
  • Anti-Money Laundering and Illicit Financing and Mitigation of National Security Risks
  • Authorization and supervision of intermediaries: cryptocurrency issuers (including asset reference tokens and electronic money tokens), centralized or decentralized trading platforms, custodians, fund managers, market data and index providers.
  • Capital, equity, operating capacity, rules of conduct, disclosure and governance of intermediaries
  • Market integrity, transparency and protection against market abuse and manipulation by intermediaries
  • Awareness, education and better protection for investors
  • Given the complex nature of cryptocurrencies and tokens that are within the regulatory boundaries of central banks or financial authorities, investment and securities regulators, as well as anti-money laundering and tax authorities, multi-level oversight-regulatory becomes a fundamental need. By maintaining a more gradual approach, regulators can design appropriate regulatory mechanisms beyond the two extremes and outright bans. Striking a balance between the costs of supervision and the benefits of innovation for the financial system, a more calibrated risk-based approach with different perspectives, such as subscriptions for different types of crypto products, exploratory pilots, extended all-or-nothing can be considered. As regulatory efforts are expended to enable cryptocurrency markets and ecosystems, the most fundamental question must be answered: to what extent the benefits of innovation outweigh the regulatory costs and unresolved risks to the financial system and community. investment. .

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