Regulating Crypto-Currencies Across The Globe

The coming of age of any new financial instrument is heralded by regulation. Some might argue that crypto-currencies do not need help from the authorities, thank you very much. Neither does it need any hindrance. A study from the BIS in 2018 that examined the actual behavior of crypto-currency markets in response to regulation showed that in spite of the boundary-less and peer-to-peer nature of crypto-currencies, regulatory actions and news of potential regulatory actions has a strong effect on crypto-currency markets. This included negative shocks for strong AML/KYC news as well as upside when legal certainty seemed around the corner. Regulation often prides itself on being technology neutral, interested only in regulating economic effects. In practice, technology is often used to leverage regulatory arbitrage as well as to escape the effects by crossing the borders. A global borderless crypto-currency, due to its technical and game theoretic capabilities, does this very well.

The Financial Action Task Force (FATF) is the inter-governmental body which sets international standards to prevent money laundering, terrorist financing and the financing of the proliferation of weapons of mass destruction. In June 2019, the FATF amended its global Standards to put anti-money laundering and counter-terrorism financing (AML/CFT) requirements on virtual assets and virtual asset service providers (VASPs). The FATF recommendations, with cross border influence is more effective than piecemeal regulation by multiple countries. Many crypto-currency influencers also felt that having certainty in regulation was better than having a Damocles sword hanging over the whole sector. This is borne out by the effects on net value and transaction volumes in the BIS report, when rumors of legal certainty circulate, the prices zoom. However, howls of protest from the cryptorati greeted the 2019 FATF recommendations.

The Markets in Crypto-Assets (MiCA) proposal is part of the digital finance strategy of the European Union which is a project to create a single market for capital in Europe called the capital markets union. Strategically, this is part of the continuum of unification, from physical in transportation links, to legal, to identity (eIDAS), to borderless travel, to the right to visit and settle. MiCA will establish uniform rules for crypto-assets.

MiCA targets crypto-assets and sets up regulation for assets such as stablecoins and Crypto-Asset Service Providers (CASPs). In this, it is similar to the regulation of VASPs (Virtual Asset Service Providers) in the FATF proposal and the harmonization of rules across national borders and across the various asset classes. This focus on Service Providers is a way to grasp at a concrete entity in a world which is not supposed to have any intermediaries. Despite protestations of peer-to-peer decentralization, without the Coindesks and Binances of the world, crypto-currencies would not have grown to the extent that they have. That is where the regulators focus their attention. Coindesk has provided 1099s for the past two or three years. Circle, the USDT issuer has applied for a bank license, what the StableAct actually asked for all Stablecoins. Venues for exchange, for market making, and other analogs to banks are present in the crypto-currency space as well. MiCA defines crypto-assets through absence, that is digital assets that are currently out-of-scope of financial regulation, especially stablecoins, are pulled into the financially regulated world. But later, starting in 2024.

The logic that propelled the add-ons to the infrastructure bill in the US took aim at intermediaries, to squeeze taxes out of transactions to pay for the bill. How the framers of the bill came up with $28 Billion as an estimate of tax dodging for crypto-transactions is unknown. The definition of a Broker: any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person. This definition is close to that of a CASP. Crypto-asset service provider. What is dispensed with in less than 100 words in the Infrastructure bill in the US takes up 168 pages in the MiCA proposal. This is the difference in the European and the US approach, MiCA is a well thought out proposal with provisions for feedback, not a last minute 100 word interpolation in an unrelated bill. The StableAct which was a much more well thought out proposal had no path forward in the US and is moribund in Congress.

The Chinese had already banned stablecoins based on Renminbi with just one sentence in Article 22 (Tokens) No unit or individual may produce or sell tokens, coupons and digital tokens to replace RMB in circulation in the market. At the very least, this would ban any stable coin directly pegged to the RMB, as RMB would have to be removed from circulation into a reserve to issue such a stable coin. That plus all the moves against crypto-assets in China to shore up their CBDC. Mining bans which cratered the price of bitcoin prompted an exodus of miners to Kazakhstan. A harmonization across the globe is necessary to regulate borderless currencies, otherwise a squeeze in one location results in migration to another for regulatory arbitrage.

FATF publishes yearly reports on the progress of regulations and implementations around the world prompted by their 2019 recommendations. The June 2021 report says that even though there is a 12-month growth of more than 75% in the jurisdictions with national legislation addressing Virtual Assets and Virtual Asset Service Providers (VASP) , from 33 to 58 jurisdictions in a year. Seventy more jurisdictions have yet to create some sort of national law that regulates VASPs. The challenge is in enforcing the regulation and in technology implementing the Travel Rule, the most controversial part of the 2019 recommendations. The Travel Rule stipulates that VASPs get and hold information about the originators and beneficiaries of Virtual Asset transactions, entities that are not the direct customers of VASPs. In a world where custody of the virtual assets can be in unhosted wallets, this information is difficult to obtain. However, without such transparency, it would be impossible to have meaningful AML/KYC/TF controls. A parallel in the current world would be data about the source or destination of cash transactions, which is almost impossible to track.

The FATF pats itself on the back that virtual asset based revisions has not stifled innovation. However, in the next sentence they bring up the fact that not a single jurisdiction is fully compliant with the Travel Rule. Both of these statements cannot be true at the same time. As mentioned earlier, private unhosted wallets that are the true expression of the virtual asset ethos and the Travel Rule are misaligned. Until this issue is resolved, the FATF recommendations will remain what they are, just recommendations, with not a single jurisdiction in full compliance.

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