How the crypto industry is being legalised by financial regulators?

The digital assets are rapidly integrated in the current regulatory ecosystem. The main financial regulators from all over the world are constantly working on a new set of rules for cryptocurrencies.

We are now starting to see the crossover of regulation in the digital asset market and digitalization of the traditional market.

Ten years ago, Bitcoin was a “technology experiment”. The cryptocurrency was created as a challenge to the traditional financial system and it managed to have a serious impact on the world. Over the years, the crypto industry has been able to influence the vector of development of the financial world. The constant evolution of crypto exchanges, which continues today, has played a major role in this process.

Now large trading platforms are cooperating with financial regulators around the world, applying new anti-money laundering strategies and investing in infrastructures to ensure the safety of their customers and investors. All this gives cryptocurrency exchanges the potential to integrate or compete with many traditional markets in the long term.

It is worth noting that digital assets and methods of their exchange have initially generated scepticism in many government agencies. Soon the governments’ suspicion changed to interest and cooperation. As crypto exchanges have improved their systems to meet AML and investor protection requirements, there is a begrudging recognition that these platforms have brought much-needed modernization and democratisation to a market that has generally been seen as remote and privileged.

Regulatory environment in crypto industry

For many years, cryptocurrencies have remained out of the sight of regulators. Recently, this trend has started to change, as regulators have faced the obvious fact. Digital assets will not disappear as a phenomenon and will definitely become part of everyday life for many people.

In June 2019 the Financial Action Task Force, the global standard-setting body for fighting financial crime, announced the creation of extended AML standards for crypto-related businesses. This is one of the first major steps on the part of regulators towards the adoption of Bitcoin and altcoins.

A little later, the European Union adopted the 5th Anti-Money Laundering Directive, or 5AMDL. This document included crypto exchanges and crypto wallets providers in the scope of EU anti-money laundering legislation. As a result, in-scope crypto asset firms operating in the EU and the United Kingdom are now subject to the full suite of AML obligations applicable to the most financial market participants, such as the need to undertake customer due diligence checks when onboarding a new client. In addition, such organisations are required to register with certain national authorities.

The general regulatory attitude

The main strategy of the regulators is to develop deeper rules to regulate crypto and related platforms. At the same time, regulators are applying the existing regulatory framework to work with some derivatives.

In other words, a control strategy that works with traditional assets is applied to Bitcoin and altcoins. However, in the case of the cryptos, the individual nuances of this process require an individual approach, as BTC and other coins are a fundamentally new phenomenon that has no precedent in the traditional economy.

As a result, two main categories of crypto assets that function similarly to regulated instruments and their respective service providers have been included in the scope of existing rules. These are digital assets that are akin to “financial instruments” (usually crypto assets used as a means of raising finance and derivatives), but they are subject to the existing rules for tokens that function as “e-money”. This captures crypto assets that are intended to facilitate payment transactions or certain stablecoins.

DLT-based shares, bonds, fund units or derivatives, often referred to as security tokens, must be authorised to operate within the European Union.

What about the digital securities?

In the area of securities, significant steps are being taken towards establishing a reliable digital market infrastructure for the issuing, trading and settlement of digital securities. In particular, the FSA recently granted the MiFID licence to Archax Limited, the first fully authorised digital trading platform in the UK.

At the same time, existing exchanges are creating their own “digital versions”, such as the Börse Stuttgart Digital Exchange in Germany and the SIX Digital Exchange in Switzerland. However, despite these developments, the integration of digital solutions with the existing market infrastructure remains a challenge, not least because of the restrictions imposed by the existing rules on final settlement requirements in post-trade systems.

Crypto exchanges inside the regulatory framework

In March 2018, Coinbase, the largest U.S. crypto exchange, received a license from U.K. FCA, and in 2019 the platform was licensed by the Central Bank of Ireland. These documents enabled Coinbase to provide payment services to clients in the UK and Ireland, which strengthened the link between fiat and cryptocurrencies. This year Kraken received a license from the State of Wyoming, which will enable the platform to establish its own crypto bank in the US, providing a wide range of financial services to users of digital assets.

On 23 September the EU Commission made a proposal to develop a regulatory framework on markets in crypto assets, or MiCA. The document distinguishes between “asset-referenced tokens” (commonly known as “stablecoins”) and “utility tokens”. The MiCA obliges cryptocurrency exchanges that are registered in the EU to act under strict rules regarding the admission of crypto asset instruments to trading, including the requirement to publish a white paper with specified content.

Big players in the form of large companies started actively buying cryptocurrencies in 2020. International regulators are preparing an infrastructure for them where they can safely operate digital assets. In general, all these processes should have a positive impact on the crypto industry in the long term.

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