Bitcoin, other cryptocurrencies, and essentially all digital assets have surged in price recently amid surging interest by the public, investors of all types, and the financial industry. Despite a steadily growing acceptance and anticipation of a crypto-friendly regulatory environment under the new administration in Washington, the future regulatory framework for digital assets is complex and uncertain.
Building a new framework is a huge task, involving many stakeholders and extending beyond highly publicized bitcoin and cryptocurrencies. Use of blockchain technology, electronic payments, “stable coins,” digital central bank currencies, and “non-fungible tokens,” which have taken the art and collecting world by storm recently, will all need to be addressed to varying degrees by regulators.
Although President Joe Biden’s nominee to chair the U.S. Securities and Exchange Commission (SEC), Gary Gensler, is generally seen as crypto-friendly and knowledgeable, the broad task of regulating digital assets is unlikely to be left solely up to him. The U.S. Commodity Futures Trading Commission (CFTC) and the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) will also surely play a role in shaping future crypto regulations. There may also be a need for international regulatory coordination and cooperation.
Lawmakers, regulators, and financial services industry participants all are seeking more regulatory certainty surrounding cryptos, which means new rules, guidance, or interpretations. Questions of who will take the lead, what will be prioritized, how long will it take, and most importantly, what will the overall regulatory framework look like, are yet to be answered.
THE REGULATORY CHALLENGES
There are several obstacles to a quick rollout of new crypto regulations in the U.S. The biggest is likely jurisdictional overlap and friction among regulators. Although the SEC is widely seen as the larger and more powerful markets regulator, Treasury, FinCEN, the Federal Reserve Board, and the CFTC will surely have input.
Further complicating matters is that the complex and evolutionary nature of cryptos has led to differing interpretations from the various regulators. The SEC sees digital assets as securities, the CFTC calls them commodities, while Treasury views them from the perspective of currencies. The Internal Revenue Services has its own view — treating them as property for tax purposes.
With such differing viewpoints, it may be up to Treasury Secretary Janet Yellen and the Financial Stability Oversight Council (FSOC) she leads to set the overall course. Yellen is seen as a bit more of a crypto skeptic, as seen in concerns over the potential for money laundering and terrorism financing that she voiced in her confirmation hearings. “We need to make sure that our methods for dealing with … terrorist financing change along with changing technology. Cryptocurrencies are of particular concern. I think many are used, at least in the transactions sense, mainly for illicit financing. We really need to examine ways in which we can curtail their use and make sure that (money laundering) doesn’t occur through those channels,” she said.
Bitcoin and other cryptocurrencies plunged nearly 15 percent following her testimony, a decline many participants attributed to the prospect of tighter regulation. She later provided additional comments for the record after the hearing where she softened her tone(link:bit.ly/3mos1Ba), saying the U.S. needs to “look closely at how to encourage their use for legitimate activities.” She also said, “If confirmed, I intend to work closely with the Federal Reserve Board and the other federal banking and securities regulators on how to implement an effective regulatory framework for these and other fintech innovations.”
Prices of bitcoin and other crypto-assets have since rebounded to new all-time highs last week.
REGULATORY PRIORITIES
The SEC has been active on the enforcement front, where fraudulent tokens or initial coin offerings (ICOs) violate existing regulations, typically under antifraud provisions or as unregistered securities offerings. The CFTC has also taken a similar aggressive enforcement approach.
The SEC’s Examination Division last month published a Risk Alert(link:go-ri.tr.com/GjpULC) highlighting observations during examinations of broker-dealers, investment advisers, exchanges, and transfer agents. The alert noted that digital asset securities “present unique risks” and it reminded firms to develop and enhance their compliance programs surrounding digital assets.
Where bitcoin and cryptocurrencies will fall on the list of regulatory priorities is unclear. Gensler’s experience at the Massachusetts Institute of Technology researching and teaching about issues related to digital assets position him as a crypto-friendly regulator, early signs point to Environmental Social and Governance (ESG) and climate-related issues as higher on the Biden adminsitration’s policy agenda.
Gensler gained a reputation for his overhaul of the derivatives and swaps markets while at the CFTC following the 2008 financial crisis. He is known for his efforts at the CFTC to implement the Dodd-Frank regulatory overhaul, in which he helped repair and restore participant confidence in the crisis-damaged swaps and derivatives market. He is known for a hands-on approach to whatever he prioritizes. So far it is uncertain whether cryptos, ESG, or some other area most strongly captures his attention and energy.
“There needs to be a directive from the top,” said Kevin Batteh, a former chief trial attorney at the CFTC now with the Washington D.C.-based consulting firm Delta Strategy Group(link:here). Batteh told Regulatory Intelligence that “a directive calling for a working group between the CFTC and the SEC to establish a safe harbor, fill regulatory gaps, report to Congress, and develop a longer-term regulatory roadmap would be welcomed by all and make sense.”
Batteh said, “the challenge for regulators is to continue to enforce through existing regulations such as AML, antifraud, manipulation, and customer protection regulations, while not being too prescriptive or heavy-handed in creating new regulations so as to stifle innovation.”
A near-term consideration which may signal a policy direction at the SEC are the pending applications for exchange-traded products (ETPs), which are similar to exchange-traded funds (ETFs) and invest in or hold bitcoin or other cryptocurrencies.
Prior applications for bitcoin ETPs with the SEC have been shot down for a host of reasons, primarily liquidity, underlying price transparency, and manipulation concerns. But bitcoin futures markets are functioning smoothly on several major commodity exchanges, and several bitcoin ETPs have been approved in Canada and Europe, giving optimism to bitcoin supporters. Any SEC decision to approve or reject the ETP applications will be telling and likely scrutinized by both opponents and proponents.
DIGITAL DOLLAR, BLOCKCHAIN, AND NON-FUNGIBLE TOKENS
The rapidly evolving technology landscape that brought bitcoin has also spread to several other areas where regulations may play a role. Blockchain, the record-keeping database behind bitcoin, is proving to be a useful ledger for recording transactions. Blockchain or other similar decentralized technology uses are likely here to stay and could be used in several areas of banking, trading, and finance in general.
Federal Reserve Chair Jerome Powell recently told the House Committee on Financial Services that 2021 would be an important year. Powell said that developing a digital dollar is a “high priority project for us” but there are “significant technical and policy questions.” Former CFTC Chair J. Christopher Giancarlo has also been a strong advocate for a digital dollar through the Digital Dollar Project(link:www.digitaldollarproject.org/), an organization created to advance exploration of a U.S. central bank digital dollar.
The non-fungible token (NFT) market has also caught fire, with digital images of everything from collectibles to art exploding in popularity and value. “Everydays – The First 5000 Days” is a digital work by American artist Mike Winkelmann, known as Beeple. The collage of 5,000 individual images was sold in a Christies auction for $69 million, putting him in the top three most valuable living artists.
Sotheby’s CEO Charles Stewart told CNBC recently that the auction house has been “following the NFT space for some time.”
NFTs are authenticated by blockchain, which certifies their originality and ownership.
Many expect Blockchain to revolutionize art markets as they becomes digitized through NFTs. It would not be a surprise if financial regulators were to get involved in the NFT market, and it may be up to a court to ultimately decide if an NFT is a financial instrument such as a “security” under the purview of the SEC or a “commodity” under the CFTC’s oversight.
GLOBAL CHALLENGES
The global regulatory environment for crypto assets is rapidly evolving as several countries are at the forefront of adoption and are establishing themselves as crypto-friendly. Singapore, Bermuda, the EU, and the UK are establishing themselves as allies to varying degrees. Meanwhile, parts of Africa and India have taken steps to restrict or prohibit citizens from owning or using cryptos.
Top officials in India have called cryptocurrencies a “Ponzi scheme,” but they also have said there will be “a very calibrated position taken.” A senior official told Reuters that the plan is to ban private crypto assets while promoting blockchain technology. The Reserve Bank of India has also voiced concern over potential financial-stability risks from cryptocurrencies, while working on launching its own digital currency.
In September last year, the EU introduced a proposal to regulate crypto assets(link:go-ri.tr.com/SnAmEC). The Markets in Crypto-Assets Regulation (MICA), if adopted, will regulate all issuers and service providers dealing with crypto assets. Although it could be the first comprehensive rulemaking attempt of its kind, it is unclear whether the regulations will provide regulatory certainty sought by many participants or be overly burdensome, which could deter future innovation.
With crypto-asset rulemaking in Europe off to a head start, it remains to be seen if the U.S. will race to catch up. With the potential for frictions and the complexities of the multiple stakeholders the United States may take a more wait-and-see approach. Eventually, harmonization or coordination of rules will likely need to occur, but that will be years down the road.
In the interim, the regulatory landscape for digital assets will evolve, probably slower than some anticipate, and from multiple agencies and departments.
(Todd Ehret is a Senior Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence, based in New York.)
