The key to the crypto world: How do governments around the world regulate cryptocurrencies?
In the early days of blockchain technology, cryptocurrency was in an economic gray area, and the uniqueness of its application originated from the lack of supervision. However, as financial institutions entered the industry, the adoption rate of blockchain has soared, and regulators’ risk accounting methods have also changed. Although most governments around the world have adopted various measures to combat cybercrime and protect cryptocurrency users, this work is far from over. For this reason, it is important for investors, companies and institutions in the industry to understand how the government regulates cryptocurrencies and industry leaders and how the two promote dialogue.
Technically speaking, cryptocurrency is a digital currency guaranteed by cryptography and executed by a decentralized computer network. The primary task of the regulator is to interpret and interpret this technology based on the previous legal framework of the blockchain, and to include cryptocurrencies in existing asset classes by answering basic questions. Are cryptocurrencies an asset? legal tender? Investment tool? If so, which one? How to levy taxes?
The clear definition often depends on the context. In most countries, including the United States and the United Kingdom, cryptocurrencies such as Bitcoin are considered assets rather than legal tender. As assets, cryptocurrency assets need to be taxed. In the United States, this means that the IRS treats cryptocurrencies as other capital assets, such as stocks and real estate, and imposes capital gains taxes, state taxes, and federal income taxes accordingly. At the same time, because cryptocurrency is illegal to determine currency, companies and service organizations are not obliged to accept it. Many companies, such as Overstock and Tesla, have tried to accept Bitcoin, while financial services companies such as PayPal and Square have stepped in and become cryptocurrency supporters.
The ability of the Commodity Futures Trading Commission (CFTC) or the Securities and Exchange Commission (SEC) to supervise and regulate cryptocurrency activities within the framework of the Commodity and Securities Law varies depending on whether cryptocurrency is defined as a commodity or a security.
In the United States, it is still unclear when cryptocurrencies are considered commodities or securities. Regarding commodity theory, the CFTC has stated in the past that Bitcoin and Ethereum are commodities. CFTC Commissioner Dawn Stump recently issued guidelines on how the CFTC’s regulatory and supervisory agencies apply. Commissioner Stump clarified that the CFTC does not have full powers to regulate commodities (although it has certain enforcement powers, including the power to pursue claims for commodity-related fraud or manipulation activities), but for commodity futures contracts, leveraged cryptocurrency trading and other In terms of derivatives, this will extend to cryptocurrency derivatives that are commodities, such as Bitcoin or Ethereum futures contracts.
Regarding securities theory, SEC Chairman Gary Gensler pointed out that the Howey and Reves tests were the reason for its enforcement decision. According to the most frequently cited Howey test, if the results of the options include the following, then it is defined as an investment contract, and furthermore, as a security:
- Capital investment
- Take the joint enterprise as the main body
- Have expected profit
- Get rewards through others
According to the Reves test, the issuance of a cryptocurrency – in this case, similar to the issuance of a promissory note, such as an initial coin offering (ICO) – is considered a security unless one of the seven exceptions is met, or unless The court decided to add a new exception.
Although in some very specific cases, the US Securities and Exchange Commission refers to cryptocurrencies as securities, such as in their case against Ripple Labs, but generally speaking, Chairman Gensler’s application of this term is very extensive. For example, in a speech at the Aspen Institute in August 2021, Gensler said that since most exchanges offer transactions in more than 100 different cryptocurrencies, “in the case of 50 or 100 tokens, any The probability that the number of securities on a particular platform will be zero is quite small.” “Stablecoins may also be securities and investment companies.” Gensler Chairman also suggested that some digital assets may represent “securities-based swaps”, which are uniquely regulated by the SEC The system is slightly different from the rules that apply to cash securities such as stocks or securities debt instruments.
Since different institutions have differentiated interpretations of specific types of cryptocurrencies, depending on the specific circumstances, there may even be dozens of equally valid definitions based on how it intersects with their unique organizational tasks. However, the goals of these regulations are fairly consistent: to ensure transparency to the public and regulators, to ensure the integrity of the market, including protecting the system from cybercrime and market abuse, and protecting investors from excessive risks.
Regarding cryptocurrency corporate regulations: development status
The most extensive supervision of cryptocurrency companies is based on the standards and recommendations of the Financial Action Task Force (FATF). As a global money laundering and terrorist financing monitoring agency, the main goal of FATF is to formulate comprehensive anti-money laundering and counter terrorist financing (AML/CFT) control measures, publish them as formal recommendations, and ensure that its member jurisdictions fulfill their obligations , Implement and enforce these standards. According to the FATF website, more than 200 countries and jurisdictions are committed to implementing these standards.
In the United States, the legislation that is critical to complying with FATF’s anti-money laundering/counter-terrorism standards is the Bank Secrecy Act (BSA). The BSA requires all money service companies (MSBs)-any company that facilitates the transfer or exchange of money, including cryptocurrency companies-to implement know-your-customer (KYC) and anti-money laundering (AML) programs. This means that cryptocurrency companies such as cryptocurrency exchanges, cryptocurrency automated teller machines, over-the-counter (OTC) brokers, custodian providers, and peer-to-peer exchanges must be in charge of the implementation of the BSA in the Ministry of Finance-Financial Crime Enforcement Network ( FinCEN) is registered as an MSB and complies with BSA requirements.
The core functions of these regulations in the United States, like FATF’s global anti-money laundering/anti-terrorism standards, are aimed at cutting off criminals and terrorists’ ability to launder illegal funds and authorizing law enforcement agencies to effectively combat financial crimes. Like any new financial instrument, criminals are already exploring cryptocurrency as a way to launder illegal funds. However, if there are appropriate regulations and KYC and AML controls, law enforcement agencies can use blockchain analysis tools to track illegal cryptocurrency transactions to their cash outflow points, provide legal procedures to these companies, and obtain relevant cryptocurrency addresses. KYC information. But on the other hand, if the illegal actor cashes out in a country that has not yet implemented the FATF standard, the information may not be traceable. This kind of judicial arbitrage is extremely detrimental to various criminal investigations.
For this reason, FATF publishes a public statement every three years to identify countries and jurisdictions that are deemed to be non-compliant with anti-money laundering/anti-terrorism financing standards or have strategic deficiencies.
North Korea and Iran currently constitute the FATF’s “blacklist”, that is, high-risk jurisdictions that require action. The list also includes countries that do not comply with the FATF standards. On the other hand, FATF’s “grey list” is a jurisdiction that is under increased surveillance, with a total of 22 countries. This list is particularly important for regulators, investigators and compliance professionals, because countries on the gray list are subject to the enhanced due diligence measures of countries that comply with FATF standards, which means that they must obtain relevant customers before allowing any transactions to occur. , Additional information on sources of funds and sources of wealth. For jurisdictions with serious, long-term deficiencies, these measures can be extended to restrict or prohibit financial transactions. This kind of regulatory burden has seriously promoted the development of compliance, because it can force non-compliant countries to almost completely withdraw from the market.
In addition to FATF, the regulatory environment of various countries is often quite different. The changes in China may be the most noteworthy. Although there was a large amount of cheap electricity dedicated to Bitcoin mining in the past, the Chinese government chose to ban mining earlier this year; even though it was the world’s largest cryptocurrency market in 2020, China has now chosen to ban it. trade. There are several reasonable explanations for why China is now cracking down in 2021. As explained by Ulisse Dell’Orto, our general manager of Chainalysis Asia Pacific and Japan, China has been leading the development of central bank digital currencies (CBDCs) for several years. Some centralized alternatives are competitive.
Other countries have similar game relationships with cryptocurrencies for different reasons. Take India as an example: In 2017, the Ministry of Finance issued a statement equating cryptocurrency to a Ponzi scheme; in 2018, the Royal Bank of India (RBI) completely banned cryptocurrency activities; in 2020, the Supreme Court revoked the ban; by 2021 In the cryptocurrency adoption index, India rose from 11th in the previous year to 2nd among 154 countries. In other words, although the Indian government may be dissatisfied with cryptocurrencies, its citizens have become more comfortable in participating in the country’s booming crypto market.
The governments of some countries have already accepted cryptocurrency, seeing it as an opportunity to introduce investment capital into their country. Therefore, these countries focus their regulatory structures on tax incentives. For example, in Belarus, all cryptocurrency activities will be declared tax-free until at least 2023. In contrast, in Switzerland, cryptocurrency investments and transactions are considered tax-free capital gains, but a “wealth tax” is still levied on the total amount of cryptocurrency and other assets owned every year.
Recent regulatory activities
In the United States, the US Securities and Exchange Commission is the main discussant in the dialogue on cryptocurrency regulation and is also very active as a law enforcement agency. As mentioned earlier, most of the regulatory actions of the US Securities and Exchange Commission are based on the Howey and Reves tests to determine whether a virtual asset is a security. This enforcement mechanism was first applied in 2017, when the SEC ruled that according to the Howey test, the token/coin issuance of Slock.it UG was a security. Since then, the US Securities and Exchange Commission has filed dozens of complaints against unregistered ICOs.
Recently, it proposed to take similar actions to prevent major cryptocurrency companies from launching interest-bearing products, such as Circle Yield and Coinbase Lend-both of which were later delayed indefinitely. Many people suspect that the U.S. Securities and Exchange Commission will continue to regulate cryptocurrency business on a case-by-case basis before formalizing its position by formulating rules. The chairman of the US Securities and Exchange Commission Gary Gensler (Gary Gensler) pushed to increase enforcement of cryptocurrency service providers. He appears to be the main person responsible for the action, but other officials of the US Securities and Exchange Commission advocated more cautious measures. way of doing. In August, when the cryptocurrency exchange Poloniex was not registered as a national stock exchange or operated under a registration exemption and violated Article 5 of the “Exchange Act” and the US Securities and Exchange Commission planned to take measures against it, the US Securities and Exchange Commission Commissioner Peirce This expressed opposition and said that she believes that the US Securities and Exchange Commission still needs to clarify some issues before their powers related to cryptocurrency exchanges are clarified.
The CFTC has also exercised its law enforcement powers many times. In September, it ordered a cryptocurrency exchange that previously provided margin retail commodity trading to pay a fine of $1.25 million because it was not registered as a futures commission merchant. And just last week, it fined other cryptocurrency companies a total of 42.5 million U.S. dollars for two reasons: one is to operate as an unregistered futures commission merchant, and the other is to falsely claim that their stablecoins are fully backed by U.S. dollars. Commissioner Dawn Stump subsequently stated that since the CFTC’s power over many stablecoins is limited to anti-fraud and anti-manipulation enforcement actions, rather than the full power of proactively enacting rules, this enforcement action may generate a wrong kind of error among cryptocurrency users. sense of security.
Regulatory rules under development
As FATF is the world’s major anti-money laundering/fighting terrorism standard organization, it is one of the largest heavyweight organizations in the field of cryptocurrency supervision today. Therefore, its updated guidelines, expected to be released later in October, will likely have a significant impact on the cryptocurrency industry. The updated guidelines are expected to clarify the definition of virtual assets and virtual asset service providers (VASP)-including how these terms apply to DeFi and NFTs-how the FATF standard applies to stablecoins, and the implementation of the “Data Transfer Rules” Guide, FATF encourages member jurisdictions to extend it to cryptocurrencies.
The rule was proposed at this critical moment. The European Commission, the UK Treasury Department and FinCEN are all considering the “Data Transfer Rule” proposal. Before we interpret these proposals, let’s explain this rule: the purpose of the data transfer rule is to prevent money laundering by minimizing the anonymity of large cryptocurrency transactions. Therefore, it stipulates that VASP must obtain, hold, and exchange information about the initiator and beneficiary of cryptocurrency transfers with other VASPs, and has certain thresholds. FATF recommends a threshold of 1,000 USD/EUR/GBP, and most proposals follow this rule.
The European Commission’s proposal applies to cryptocurrency transactions of more than 1,000 Euros between virtual asset service providers (VASP). On the other hand, the UK Treasury’s proposal applies to cryptocurrency transactions of more than £1,000 between VASPs, as well as transactions from personal wallets to VASPs. It is not yet certain whether the proposal will be downsized, that is, only include transactions between VASPs. Finally, FinCEN’s proposal sets a threshold of only $250 between VASPs. It should be noted here that these recommendations have not yet been approved and are likely to change before they take effect.
Another regulatory guide that is expected to be issued at the end of October is the US Treasury Department’s report on stablecoins. The report is expected to recommend that stablecoin issuers be regulated like banks and have corresponding reserve and reporting requirements. If Congress cannot implement a satisfactory, bank-like framework, the Biden administration has stated that he will adopt FSOC [Financial Stability Oversight Committee], a group of supervisory agencies responsible for monitoring risks in the financial system to ensure the implementation of the recommendation. In other words, some form of stablecoin regulation is coming.
Finally, this summer, the U.S. Senate considered a $1 trillion bipartisan infrastructure bill. The bill amended a clause to expand cryptocurrency brokers such as exchanges to the definition of “broker”, requiring them to report the user’s name, address, and transaction activity information to the Internal Revenue Service. Practitioners in the cryptocurrency industry expressed concern that the drafting of the definition is too broad and may be interpreted as including miners, node verifiers or developers, who cannot obtain the required report information. The Senate tried to modify the definition, but ultimately failed. As of now, the House of Representatives has not passed legislation, so there may still be opportunities to modify this clause, but industry insiders pointed out that this is a good example of the importance of improving education around cryptocurrencies and engaging with legislators and policy makers. This can ensure that policies and regulations have a positive meaning for the industry.
How the cryptocurrency industry is involved
In view of the wide-ranging impact of cryptocurrency regulation and the amazing speed of innovation in this field, the cryptocurrency industry hopes to cooperate with regulators to design a new and more effective regulatory framework. Due to the unprecedented number of innovations, the traditional supervision model is not always fully applicable. This does not mean that the industry cannot be effectively supervised, but a cautious attitude surrounding the supervision of this field is still very necessary.
We also believe that there are opportunities for regulatory innovation in this field. The transparency of traditional finance needs to be enhanced. If regulatory agencies do not directly request financial institutions, they will not be able to obtain transaction data. Blockchain technology can achieve unprecedented transparency. This can encourage regulatory agencies to freely review transactions, thereby changing the traditional nature of regulatory compliance and monitoring.
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