Popular and institutional interest in digital assets, decentralized applications, NFTs, and blockchain technology skyrocketed, and regulators sprinted to catch up.
For the digital asset markets, 2021 was a banner year. Among the milestones:
- Bitcoin prices hit an all-time high, exceeding $65,000, up from about $30,000 at the end of 2020.
- Total value locked in decentralized finance (DeFi) surged from under $20 billion to over $250 billion in 12 months.
- Market capitalization for all digital assets reached $3 trillion.
- Non-fungible tokens (NFTs) went from crypto curiosity to mainstream phenomenon, with a single NFT selling for $69 million at a traditional auction house and notable NFT collections reaching trading volumes in the billions.
- Valuations for crypto companies and cryptoassets soared, with at least 40 unicorns (valuation of $1 billion or more) minted.
- Venture capital (VC) firms invested an estimated $32.8 billion into crypto and blockchain-related startups, including $10.5 billion in Q4 2021 (up from an estimated $8 billion for all of 2020). Furthermore, 49 new crypto-focused VC funds were raised, with three of those funds raising over $1 billion and two topping $2 billion.
Beyond these market metrics, crypto (along with Web3) solidified its place as mainstream. Previously considered a niche industry by many, crypto has now unequivocally caught the attention of financial institutions, venture capitalists, and hedge funds. In 2021, various governments engaged with crypto through a range of approaches. El Salvador adopted Bitcoin as legal tender, and other countries adopted or experimented with central bank digital currencies (CBDCs). Global regulatory scrutiny of the burgeoning industry increased with similarly diverse approaches: China banned Bitcoin mining, while the Securities and Exchange Commission (SEC) approved a US Bitcoin Futures ETF.
The growth in the crypto industry was not without some clear growing pains. According to Chainalysis estimates, a record $14 billion in crypto transactions was related to criminal activity, with $7.8 billion stolen in scams (including over $2.8 billion lost to blockchain-related rug pulls). In response, regulators and law enforcement authorities heightened their focus on the use of digital assets in criminal activity and ransomware attacks.
Below is a summary of the significant crypto developments in the US in 2021 from a legal, regulatory, and policy perspective.
Increasing Federal Focus and Congressional Interest
Banking Regulators Get Up to Speed
Early in 2021, the US Federal banking agencies indicated that they were conducting “regulatory sprints” to come to grips with the current state of affairs in the digital asset markets. While these sprints have yet to result in any tangible regulatory changes, it does appear that the agencies are placing a much greater focus on these issues than they have previously.
- On November 23, 2021, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (the Federal banking agencies) issued a joint statement that summarized the work conducted during the sprints. According to the statement, the Federal banking agencies “plan to provide greater clarity throughout 2022 on whether certain crypto-related activities conducted by banking organizations are legally permissible.” In addition, the Federal banking agencies plan to provide greater clarity regarding expectations for safety and soundness, consumer protection, and compliance with existing laws and regulations related to:
- Cryptoasset safekeeping and traditional custody services
- Ancillary custody services
- Facilitation of customer purchases and sales of cryptoassets
- Loans collateralized by cryptoassets
- Issuance and distribution of stablecoins
- Activities involving the holding of cryptoassets on balance sheets
Congress Delves Into Crypto
December 2021 saw significant congressional hearings, with major players in the digital asset industry testifying before lawmakers. While the hearings were mostly exploratory, they were described by many in the industry as watershed moments for crypto.
- Digital Assets and the Future of Finance: Understanding the Challenges and Benefits of Financial Innovation in the United States (December 8, 2021)
- Stablecoins: How Do They Work, How Are They Used, and What Are Their Risks? (December 14, 2021)
Proposals for Statutory Frameworks Emerge on Capitol Hill
- On July 28, 2021, Representative Don Beyer introduced the Digital Asset Market Structure and Investor Protection Act (the Bill). The Bill is perhaps the most promising effort to date by Congress to enact legislation that would address some of the legal ambiguities for digital assets and better define their place within existing financial regulatory structures. Rep. Beyer described the current legal landscape for digital assets as “ambiguous and dangerous for investors and consumers.” Broadly, the Bill seeks to address deficiencies and/or ambiguities relating to consumer protection, trade reporting and transparency, and anti-money laundering / know your client (AML/KYC) procedures for digital assets. The Bill also seeks to address a wide range of practical issues, from the fundamental (such as defining industry terms and categorizing cryptoassets) to the more nuanced (such as establishing standards for transaction reporting and consumer protection and advisories). (See New US Digital Assets Bill Casts Wide Net.)
- SEC Commissioner Hester Peirce has been a relentless supporter of digital asset innovation and is an advocate for clear regulatory guidance where she perceives they are lacking. To remedy some of those issues, Commissioner Peirce published a Token Safe Harbor Proposal on February 6, 2020, and reissued a revised version (Proposal 2.0) on April 13, 2021. (See The Return of the Token Safe Harbor.) Proposal 2.0 never gained traction at the SEC, but it did find an ally in Congress. On October 5, 2021, Representative Patrick McHenry, the ranking member on the House Financial Services Committee, introduced the Clarity for Digital Tokens Act of 2021, a bill that substantially embodies Commissioner Peirce’s Token Safe Harbor Proposal 2.0. (See The Token Safe Harbor Lands on Capitol Hill.)
- Other legislative efforts making the rounds on Capitol Hill include the Eliminate Barriers to Innovation Act, the Token Taxonomy Act of 2021, and the Digital Commodity Exchange Act of 2021.
There’s a New Sheriff in Town — Gensler Installed at the SEC
In early 2021, President Biden nominated Gary Gensler to chair the SEC. After a contentious Senate confirmation hearing, Gensler was sworn into office on April 17, 2021. Given his history as chair of the Commodity Futures Trading Commission (CFTC) and a professor at MIT who taught courses on digital currencies and blockchain, many market participants were hopeful that his appointment would be a boon for the digital asset industry. While the jury is still out on the net impact of his appointment, Chairman Gensler has been very vocal about his conviction that the digital asset industry falls squarely within the SEC’s purview and that the SEC will apply its authority via regulation or enforcement, where appropriate.
- On August 3, 2021, Chairman Gensler gave a speech on the digital asset industry. The speech offered some indication of what he expects the SEC to focus on in this area but did not provide concrete guidance for industry participants looking for clarity on regulatory uncertainties. He did, however, clarify that he believes “we just don’t have enough investor protection in crypto” and that the SEC will play a more active role in regulating the industry. (See New SEC Chairman Gives His First Speech on Crypto.) Further speeches, interviews, testimony, and remarks have cemented the general view that Chairman Gensler is intensely focused on bringing crypto fully within the remit of the securities laws and consumer protection regulations. Chairman Gensler has also said he would like Congress to expand the SEC’s remit to bring law and order to an industry that he has described on many occasions as the “Wild West.”
- Earlier in the year, on February 26, 2021, the SEC Division of Examinations issued a Risk Alert reflecting the Division’s continued focus on digital asset securities. The Alert (i) provides Division observations from examinations of investment advisers, broker-dealers, and transfer agents regarding digital asset securities, and (ii) outlines areas of focus for the Division’s future examinations of those entities. The Division highlighted six areas of primary risk for investment advisers that manage digital assets based on past examinations: portfolio management, recordkeeping, custody issues, investor disclosures, pricing client portfolios, and appropriate registration requirements. The Division also pointed to six areas of regulatory and compliance risk for broker-dealers: safekeeping funds and operations, registration requirements, anti-money laundering procedures and controls, offerings, conflicts of interest disclosures, and outside business activities procedures and controls.
CFTC Continues to Prosecute Fraud While New Leadership Takes Charge
- On August 23, 2021, CFTC Commissioner Dawn D. Stump published a statement and infographic seeking to clarify the agency’s current role and authority with respect to digital assets. She noted that the CFTC has plenary regulatory and supervisory authority only with respect to certain transactions in commodities (including digital asset commodities) — namely, commodity futures, options, and swaps, along with certain retail leveraged transactions in commodities. On the other hand, the CFTC does not have plenary authority with respect to spot commodity markets. For those markets, the agency has a more limited role: enforcement authority to police against fraud and manipulation. While Commissioner Stump’s statement and infographic reiterate well-known and settled law in the eyes of specialist practitioners, they are welcome efforts in the pursuit of greater regulatory clarity for crypto market participants more generally.
- The CFTC brought a number of significant digital asset-related enforcement actions in 2021. On September 28, 2021, the CFTC released a settlement order with a prominent crypto exchange for illegally offering margined retail transactions in digital assets other than on a designated contract market and for failing to register as a futures commission merchant. While concurring with the settlement order, Commissioner Stump’s statement expressed concerns that the application of certain CFTC rulesets in the crypto-sphere represents “uncharted territory” requiring greater explanation and clarity from the agency. A further statement from Commissioner Stump on January 13, 2022, on the same theme called on the CFTC “to bridge the gap between its enforcement and oversight functions by setting more clearly defined regulatory expectations for new, innovative applications.”
- On October 15, 2021, the CFTC released a settlement order with a prominent stablecoin issuer for making untrue or misleading statements and omissions regarding the reserve assets backing the stablecoin. The settlement order marked the first time the CFTC had applied the definition of a “commodity” to a stablecoin and demonstrated a novel application of the CFTC’s enforcement authority with respect to spot commodity markets.
- Notable personnel updates at the CFTC in 2021 may portend increased deliberation and rulemaking on crypto-related themes going forward.
- In December 2021, the Senate voted unanimously to confirm Rostin Behnam as Chairman of the CFTC. Chairman Behnam demonstrated during his tenure as acting chairman that he regards crypto as a priority. It remains to be seen whether he takes the approach that existing CFTC requirements already apply to DeFi markets and platforms, including exchange and intermediary registration requirements (as set forth in a June 2021 speech by then Commissioner Dan M. Berkovitz) or whether he heeds Commissioner Stump’s call for the CFTC to more clearly define its regulatory expectations.
- During Chairman Behnam’s confirmation hearing in October 2021, he called on the Senate Agriculture Committee to consider expanding the CFTC’s regulatory authority in the digital assets space. An early January 2022 letter from a bipartisan group of Senators and Representatives to Chairman Behnam focused squarely on crypto shows that lawmakers are taking that suggestion seriously. The letter includes eight questions on digital assets markets, DeFi, and the CFTC’s role in respect thereof, including a final question that asks Chairman Behnam if he “foresee[s] any shortfalls in the Commission’s authorities to protect customers and ensure market integrity as the digital asset marketplace grows in volume and scope.” The answer to that question is presumably affirmative, and the full set of responses and how Congress addresses the responses in 2022 will be interesting to watch.
- Also of note, in April 2021, prominent blockchain lawyer Jason Somensatto was appointed as the acting director of LabCFTC and tasked with leading the CFTC’s efforts to “identify and analyze emerging financial technologies and to promote responsible innovation in CFTC-regulated markets.”
OCC Loses an Ally, Initiates Review of Crypto-Friendly Policies
- On January 4, 2021, the Office of the Comptroller of the Currency (OCC) published a letter affirming national banks’ and federal savings associations’ authority to participate in independent node verification networks (INVNs) and use stablecoins to conduct payment activities and other bank-permissible functions. The letter reminded participating banks to conduct any such INVN-related activities consistent with sound risk management practices and to remain vigilant against fraud and operational, compliance, and other potential risks.
- With the change in presidential administration, notable blockchain industry ally Brian Brooks resigned as head of the OCC on January 14, 2021, after eight months in office.
- Michael Hsu, the appointed acting Comptroller of the Currency, requested an OCC staff review of former OCC rule-making, notably as it relates to bank chartering for digital asset institutions and crypto custody services.
- On November 18, 2021, the OCC issued Interpretive Letter #1179, which clarifies that the activities addressed in previous OCC interpretive letters (covering bank crypto custody, bank stablecoin reserve holding, and banks acting as a node on a distributed leger) are legally permissible, provided the bank can demonstrate, to the satisfaction of its supervisory office, that it has controls in place to conduct the activity in a safe and sound manner.
Stablecoins in Focus for US and Global Authorities
- On November 1, 2021, the President’s Working Group on Financial Markets (PWG), in conjunction with the Federal Deposit Insurance Corporation (FDIC) and the OCC, published its long-anticipated Report on Stablecoins (the Report). Regulators worldwide have become acutely aware of how stablecoins function as a bridge between traditional financial markets and digital asset markets. As a result, regulators are seeking to address the risks, opportunities, and regulatory gaps that this burgeoning asset class presents. The Report first describes how payment stablecoins function, before identifying key gaps in prudential authority over stablecoins in the US financial system. It then presents recommendations for addressing those gaps. (See PWG Issues Clarion Call for US Legislation on Stablecoins.)
- The Report arrived on the heels of the Financial Stability Board’s (FSB’s) high-level recommendations for supervising global stablecoins, which were published in October 2020, and an October 6, 2021, CPMI-IOSCO report and consultation on the regulation of stablecoin arrangements titled “Application of the Principles for Financial Market Infrastructures to stablecoin arrangements.” While the Report does not explain to what extent the FSB recommendations or CPMI-IOSCO principles were employed in its drafting, the risks that are noted overlap considerably. (See BIS Issues Consultation on Stablecoin Regulation.)
Enforcement Remains a Top Priority
- Last year the Department of Justice (DOJ) sharpened its focus on combatting cryptocurrency use in criminal activity. On October 6, 2021, the DOJ announced the creation of a National Cryptocurrency Enforcement Team (NCET), a unit that aims to be the centerpiece in “a nationwide enforcement effort to combat the use of cryptocurrency as an illicit tool.” The DOJ identified cryptocurrency as the “primary demand mechanism for ransomware payments” and “preferred means of exchange of value” to facilitate crimes on the dark web. The stated purpose of NCET is to conduct complex investigations and prosecutions of criminal misuse of cryptocurrency by individuals and entities operating in the digital assets space. Underlying NCET is the DOJ Cyber Digital Task Force’s first published report, which highlighted the need to address threats from the use of cryptocurrency in cybercrimes, as well as the DOJ October 2020 Cryptocurrency Enforcement Framework, which highlighted the emerging threats and enforcement challenges from cryptocurrency use and infrastructure abuse. (See DOJ and Treasury Take Crypto Enforcement to the Next Level.)
NFTs Scale New Heights
- NFTs first entered public awareness during the crypto boom of 2017-18. They experienced a major resurgence in 2021 and become the most talked about crypto phenomenon of the year. NFT sales volume reached nearly $25 billion, and saw astronomical purchasing prices for sought-after works and major infrastructure and platform buildouts.
- NFTs pose a number of interesting questions from a legal perspective, including whether they are securities (see NFTs: But Is It Art (or a Security)?), novel IP issues (see Creative Crypto: IP Implications of Selling Creative Works Tied to Non-Fungible Tokens), and issues concerning the common law right of publicity (see NFTs and the Right of Publicity: Assessing the Legal Risks).
Progress on a US CBDC Remains Slow
- On February 24, 2021, US Federal Reserve (FRB) staff published a paper identifying preconditions for a CBDC that is of daily use by the general public (the paper does not attempt to prescribe how to address these preconditions). The preconditions described are: clear policy objectives, broad stakeholder support, a strong legal framework, robust technology, and market readiness. In September 2021, FRB Chairman Jerome Powell promised that a paper examining the costs and benefits of a CBDC would be published “soon.” The Report (“Money and Payments: The U.S. Dollar in the Age of Digital Transformation”) was finally published on January 20, 2022. It is less of a position paper than it is a balancing of the various factors the FRB is considering, as well as a solicitation of public comment on the policy points and issues raised. While the US remains decidedly in the exploratory phase, at least 16 countries are in CBDC development mode, 14 are piloting a CBDC, and nine have already launched a functional CBDC (according to the Atlantic Council’s GeoEconomics Center).
Tax Issues Effecting Crypto
- On November 15, 2021, President Biden signed the $1.2 trillion Infrastructure Investment and Jobs Act (IIJA) into law. Two provisions received particular attention and concern from the digital asset industry: (i) the IIJA’s broad definition of “digital asset,” and (ii) the IIJA’s broad redefinition of a “broker” to include certain persons providing services to transfer digital assets. For months, the digital asset industry and its allies had rallied against these provisions on the grounds that they were impracticable and would impose onerous reporting burdens, hinder innovation and the US’s international competitiveness, and threaten privacy rights. With the IIJA now signed into law, the interpretation and application of these provisions by the Treasury and Internal Revenue Service are of utmost concern to industry participants. (See US Infrastructure Law: Top Impacts on the Digital Asset Industry.)
El Salvador Makes Bitcoin Legal Tender
- On June 8, 2021, El Salvador’s Legislative Assembly voted to establish Bitcoin as unrestricted legal tender, making El Salvador the first sovereign nation to formally adopt the cryptocurrency. Bitcoin assumed the status as legal tender alongside the US dollar, not as a replacement for it. Other countries are reportedly observing El Salvador’s experiment closely, many with interest in following suit. (See El Salvador Christens Bitcoin as Legal Tender.)
The DAO of Wyoming
- In the absence of comprehensive digital asset regulation at the federal level, some US states are working to establish themselves as blockchain and crypto-friendly jurisdictions. At the forefront stands Wyoming, which has adopted various digital asset-friendly policies and legislation. On April 21, 2021, Wyoming’s governor signed into law a bill sponsored by the state’s Select Committee on Blockchain, Financial Technology and Digital Innovation Technology, which made Wyoming the first state in the nation to allow decentralized autonomous organizations (DAOs) to obtain legal company status. (See Decentralized Autonomous Organizations Find a Home in Wyoming.)
ESG and Crypto
- The huge rise in popularity of Bitcoin — and the growing interest among mainstream financial institutions in virtual assets as an investable and tradable asset class — has highlighted the cryptocurrency industry’s environmental, social, and governance (ESG) performance. The vast majority of the world’s financial institutions manage climate risk and other ESG risks in their own portfolios. As a result, many financial institutions perform related diligence on corporates they look to service, whether by traditional lending, capital markets underwriting, or direct investment. While the focus has primarily been on the ESG performance of cryptocurrency miners (given their role in the creation of cryptocurrencies and the energy requirements associated with that process), the ESG performance of the broader cryptocurrency industry will increasingly need to be considered, particularly as institutional investment in this space is accelerating. Accordingly, investors in cryptocurrency miners, in cryptoasset service providers, and even in companies that put cryptoassets on their balance sheets must now weigh the potential for increased returns against the possible negative impact on their ESG credentials. (See ESG and Cryptocurrency: Considerations for Market Participants.)
Controversial FinCEN Request for Comment Still Pending
- On December 23, 2020, the Financial Crimes Enforcement Network (FinCEN) issued a Notice of Proposed Rulemaking (NPRM) regarding certain transactions involving convertible virtual currency (CVC) or digital assets with legal tender status (LTDA). The NPRM includes proposed reporting requirements regarding CVC or LTDA transactions greater than $10,000, or aggregating to greater than $10,000, that involve unhosted wallets or wallets hosted in a jurisdiction identified by FinCEN; a proposal that banks and money services businesses (MSBs) report certain information regarding counterparties to transactions by their hosted wallet customers; and additional proposed recordkeeping requirements. The comments period closed on March 29, 2021, but as of January 2022, no findings or rulemaking have been published. (See FinCEN Looks to Rein In Cryptocurrency Transactions.)
What’s in Store for 2022?
Last year was one of feverish institutional adoption, retail-driven memecoin fervor, acceleration into Web3 and the metaverse, and many other surprises in the digital assets space. It was also a year when regulators around the world began to see digital assets as not simply a fringe industry or tech hobby to be observed with skepticism but a reality that needs to be addressed with sensitivity. The pace at which the industry is moving, the technology is changing, and the rate of adoption is accelerating has left many regulators and legislators struggling to adequately understand the nuances involved in this new industry. Despite the many competing priorities, global authorities continued to show heightened awareness and increased interest in reckoning with the digital assets industry. Some jurisdictions took the approach of total rejection, while others took the approach of total embrace. Most of the world remains somewhere in between, assessing the opportunities and risks.
Acknowledging that this is an election year and that regulatory and legislative priorities may shift or be constrained, the authors of this post are hopeful that 2022 will usher in thoughtful guidance, clear regulatory frameworks, and continued commitment to fostering crypto and Web3 innovation. Industry participants often joke that a year in crypto feels equivalent to seven years in other industries. Here’s to another seven years in 2022.