The ongoing and accelerating pace of developments in the realm of crypto-assets in multiple jurisdictions warrants continual review and monitoring. In a report issued earlier this month on the implications of crypto-assets, the international Financial Stability Board (FSB) stated that, while crypto-assets do not currently pose a material risk to global financial stability, vigilant monitoring is needed in light of the speed of market developments. The FSB believes that due to risks such as low liquidity and the use of leverage, market risks from volatility, and operational risks, crypto-assets lack the key attributes of sovereign currencies and do not serve as a stable store of value or a mainstream unit of account. The financial stability implications of these crypto-asset characteristics include an impact on confidence in, and reputational risk to, financial institutions and regulators; risks arising from financial institutions’ exposures to crypto-assets; and risks arising if crypto-assets were to become widely used in payments and settlement. Therefore, regulators are encouraged to “keep an eye on things” as crypto-assets continue to spread throughout the world economy.
Although national authorities and other commentators have been voicing these concerns with increasing frequency, legislative proposals for regulating crypto-assets and their underlying distributed ledger technologies (DLT) at the EU, UK, and US levels have progressed at an uneven pace to date. Lawmakers in these jurisdictions have so far focused mainly on the risk of criminality or fraudulent behavior. That said, the focus at these levels is starting to go beyond preventing criminality and fraud, and the FSB’s findings may act as a tailwind to push them along.
The European Parliament (Parliament) adopted a nonlegislative resolution on DLT in early October, calling on the European Commission (Commission) to assess and develop a European legal framework to solve jurisdictional problems that could arise from fraudulent or criminal cases of DLT exchange. It highlighted the benefits of DLT in improving transparency and reducing transaction costs in financial services, but warns of risks around crypto-assets similar to those highlighted in the FSB report. The Parliament calls on the Commission to monitor developing trends and to explore incorporating cryptocurrencies into the European payment system.
In turn, the Commission has been active in monitoring DLT applications, establishing a Blockchain Observatory in February 2018. While its 2018 FinTech Action Plan recommended “enabling” initiatives such as consistent licensing requirements and regulatory sandboxes, it considered the case for broad legislative action to be limited. However, it agrees with the European Parliament on strengthening the anti-money laundering and fraud prevention framework as it applies to DLT. The EU’s Fifth Money Laundering Directive captures certain crypto-asset platforms, but is yet to be transposed by member states. Financial regulation of DLT and crypto-assets at the EU level has so far been left to the interpretation of existing frameworks. However, the European Securities and Markets Authority (ESMA) published a report on October 19, 2018, in which its Securities and Markets Stakeholder Group called on it to clarify whether crypto-assets are “transferable securities” or “commodities” for the purpose of the Markets in Financial Instruments Directive II (MiFID II), and whether primary or secondary markets for crypto-assets are “MTFs” or “OTFs” for the purpose of MiFID II and the Market Abuse Regulation. We await to see if ESMA produces further guidelines on this.
The UK Parliament’s Treasury Select Committee published a detailed report on crypto-assets on September 19, 2018, wherein it recommended that the scope of the UK Financial Conduct Authority’s (FCA’s) oversight authority be extended to more crypto-asset platforms, especially initial coin offerings (ICOs), and that the scope of existing financial legislation be extended to more DLT-based activities, such as the provision of crypto-exchange services, amid concerns around criminality and consumer protection.
The FCA has adopted a technology-neutral approach to regulating DLT applications, except where specific consumer protection risks arise. It has clarified that crypto-assets are in themselves neither specified investments under the Regulated Activities Order nor funds or e-money under the Payments Services Directive and E-money Regulation. It is of the view that while cryptocurrency derivatives are capable of being financial instruments under MiFID II, cryptocurrencies are not currencies or commodities under MiFID II. Whether crypto-assets and ICO tokens are within the FCA’s perimeter will depend on their precise nature. We expect more clarity to be provided by the UK government’s Crypto-assets Taskforce in the coming months.
As for promoting innovation in financial services, the FCA opened its regulatory sandbox to a fifth cohort of fintech firms on October 15, 2018, following an oversubscribed fourth cohort that included numerous DLT-based firms. This follows the FCA’s August 2018 announcement of its leading role in a Global Financial Innovation Network of regulators to create a “global sandbox.”
US regulation of crypto-assets currently differs among states and among regulators, although cryptocurrencies are increasingly coming under the federal microscope.
The US Securities and Exchange Commission (SEC) regards certain crypto-assets as securities within the meaning of the federal securities laws, and earlier this year it voiced specific concerns around the cryptocurrency asset class. Again, some of those concerns around valuation and liquidity prefaced the FSB’s findings. The SEC has also taken enforcement action where it considered it necessary to deter fraudulent activity. Meanwhile, a US district court recently upheld the Commodity Futures Trading Commission’s (CFTC’s) position that certain virtual currencies are commodities within the CFTC’s antifraud authority, even without futures. On top of that, state attorneys general are playing a greater role in overseeing cryptocurrencies, particularly from the standpoint of consumer protection.
At the federal level, Congress has shown increased interest in the subject of crypto-asset oversight, although there appears to be a difference of opinion (not entirely political party driven) on the extent to which such activities should be encouraged or regulated. Although specific legislative proposals have been sparse, there is reason to believe that congressional interest in crypto-asset activities and their regulation will increase.
Notwithstanding the uneven movement of multilateral and national legislative and regulatory bodies on crypto-asset oversight and supervision, trends across national jurisdictions all continue to point toward increased governmental involvement in crypto-asset activities. Spurring these trends are a combination of concerns, including the potential financial stability risks presented by crypto-assets, ongoing concerns over the vulnerability of crypto-assets to use in illegal activities, and emerging consumer protection concerns.