Both the European Banking Authority and the European Securities and Markets Authority issued reports to the European Commission saying there were deficiencies in the applicability of existing regulations to cryptoassets and recommending further analysis.
Generally, the EBA found that cryptoassets typically fall outside the scope of EU banking, payments and electronic money regulations and that specific services relating to the provision of cryptoasset wallets and cryptoasset trading facilities are not touched at all by financial services law. As a result, there may be risks for consumers that are not addressed at the EU level, as well as the potential for money laundering.
Somewhat contrariwise, ESMA found that the applicability of EU regulations depended on the legal status of a cryptoasset. According to ESMA, for example, the majority of EU member states view at least some cryptoassets, e.g., those with imbedded profit rights, as potentially qualifying as transferrable securities or other types of regulated financial instruments. However, because some member states define transferrable securities restrictively and others apply broader interpretations, there are “challenges” to the oversight of cryptoassets. Under EU requirements, if a cryptoasset is a financial instrument, there are likely a broad range of applicable regulatory requirements, including prospectus, issuer transparency, trading and recordkeeping obligations.
ESMA claimed that even for cryptoassets that constitute financial instruments there likely is the need for “potential interpretation or reconsideration of specific requirements to allow for an effective application of existing regulations.” For cryptoassets that do not qualify as financial instruments (e.g., cryptocurrencies), “the absence of applicable financial rules leaves investors exposed to substantial risks.” At a minimum, said ESMA, anti-money laundering requirements and risk disclosure obligations should apply to all activities involving cryptoassets.
ESMA recommended that all gaps in regulation be addressed at the EU level.
Both EBA and ESMA noted that, at this time, cryptoasset activity in the European Union is limited and does not pose any danger to financial stability. ESMA additionally noted that “there could be benefits” in initial coin offerings if “appropriate safeguards are in place.”
In another legal development involving cryptoassets:
Colorado Proposed Law Would Exempt Consumptive Tokens from State Securities Laws: Legislators in Colorado have proposed a law that would exempt digital tokens from the application of the state’s securities laws provided such cryptoassets primarily have a consumptive purpose and are not marketed for speculative or investment purposes. As proposed, the consumptive purpose must be available at the time of the digital token’s issuance or within 180 days after sale for the cryptoasset to be exempt from the state’s securities laws. Subject to some requirements, persons effecting purchase and sales of consumptive tokens would be exempt from broker-dealer registration. Just prior to the expiration of the 115th Congress in 2018, Congressmen Darren Soto and Warren Davidson proposed legislation that would expressly define a digital token and make clear that securities laws would not ordinarily apply to digital assets issued on behalf of a project using a blockchain application once it becomes functional. (Click here for further details in the article “Congressmen Propose Law to Exclude Certain Cryptoassets from the Definition of a Security” in the January 6, 2016 edition of Bridging the Week.)
My View: As I have written previously, distributed ledger technology and associated cryptoassets continue to provide challenges to international regulators as the new technologies often do not fit neatly within existing laws. Although uniform best practices are appropriate for market participants to adopt voluntarily, there is a great danger that uniform or near uniform international regulations could stifle innovation.
For example, a recently adopted requirement by the Securities and Futures Commission in Hong Kong that restricts the participation in HK funds investing in cryptoassets to HK professional investors, as well as a potential prohibition against UK retail persons being able to purchase derivatives based on cryptocurrencies, is directly contrary to approval in the United States by the Commodity Futures Trading Commission of derivatives based on bitcoin accessible to all market participants, and guidance by the National Futures Association that permits funds accessible to all to invest in cryptoassets provided appropriate disclosures are made.
Uniformity in regulations sounds like a good thing, provided the regulations are right; however, what is right is in the eye of the beholder and may vary from person to person. As a result, efforts to promote common worldwide regulation of DLT and associated cryptoassets is likely inappropriate at the current time, when the relevant technologies are in their infancy and often misunderstood. (Click here for background on the HK requirement and UK proposal in the article “UK Regulators Contemplate Banning All Cryptocurrency-Based Derivative Sales to Retail Clients While HK SFC Restricts Investments in Virtual Currency Portfolios to Professional Investors” in the November 4, 2018 edition of Bridging the Week.)
It would be better at this point for regulators to agree, at most, on common broad objectives (e.g., eradicate fraud, heighten anti-money laundering requirements), but encourage individual jurisdictions to adopt regulations they believe most suitable in light of their own particular experiences. This way, controversial regulations might, at worse, inhibit innovations locally but will not have a deleterious international impact.