Assessing the global regulatory response to crypto
Introduction & Methodology
Crypto regulation is developing fast across the globe, and countries are responding to the evolution of crypto in different ways. We at Hashed Emergent have done an analysis of regulatory responses to crypto in 13 different countries.
Conclusions, in short:
Many countries have adopted licensing and registration rules for companies and strict KYC rules for consumers using a ‘tech-neutral’ approach.
Some countries - like the UK and Japan - have publicly stated their appreciation for this new technology and announced their intentions to become global hubs for the industry’s operations.
We believe this analysis is needed because:
It is useful to anticipate future changes in crypto regulations, and how crypto businesses may respond to these changes.
It will provide a tool for policy makers to compare how countries have reacted so far and understand best practices from other countries.
From the perspective of jurisprudence, analyzing the global response to crypto is interesting. This is because there has never before been a technology that can maintain a single source of shared transactional truth in a distributed, anonymised and borderless manner. How will the legal order respond to the rise of this technology? The present exercise is also interesting in terms of the commercial implications it unearths for a ~$1T industry. Have countries been able to separate the ‘good’ from the ‘bad’ when it comes to making rules for crypto?
Measuring a country’s response to crypto is both simple and complex. The simple part of the exercise is identifying relevant legal developments and understanding their substance. The complexity comes from analyzing these developments in the context of crypto’s nature as:
An alegal force of nature with anti-establishment/libertarian undertones, and
A revolutionary technology.
In our analysis, the key macro questions we asked are:
How has the State responded to the anti-establishment ‘parallel economy’ aspects of crypto (ban or no ban)?
Does the State acknowledge and appreciate crypto as a revolutionary technology?
We have analyzed the regulations of 13 countries using a framework based on the key macro questions above. This framework is designed to compare each country’s response to crypto on an apples-to-apples basis and measure each country’s response. The countries selected are those that are relevant from a geopolitical perspective, have seen high activity by the crypto industry, and are global financial hubs. For this analysis, we have not studied any laws or developments that have been published post 31 August 2023.
This analysis is presented in two parts. Part 1 is the section below, where we provide an overview of the global response and highlight findings, trends and conclusions from a bird’s eye view. Part 2, which can be accessed here, provides detailed answers to our framework’s questions and main takeaways for each country.
Findings & Conclusion
The table below presents a brief overview of different countries’ response to crypto based on our framework.
Here are our key findings from our analysis:
Finding #1: A ‘tech-neutral’ approach to regulating crypto forms a common baseline across countries
Countries have adopted a ‘tech-neutral’ approach as the first call of action to combat the rise of crypto. Under the ‘tech-neutral’ approach, regulators decide to apply existing laws to crypto companies irrespective of the fact that crypto is a novel technology. Regulators posit that existing laws are broad enough to cover the crypto industry, and that the use of this novel technology does not give companies liberty to disregard these laws. When regulators make new laws, clarify older laws, or file cases against crypto businesses, the "same activity, same risk, same regulation" principle is used. This means that they regulate crypto in the same way that similar TradFi activities are regulated. This approach is best understood in the context of securities law: under a ‘tech-neutral’ approach, it is of no significance that someone conducts sale of tokens on a blockchain; if such sale satisfy the features of a ‘security’ under securities law, rules relating to issuance and sale of securities will be applicable to the token issuer.
Simultaneously, strict registration and reporting requirements have been put in place for operating in the crypto industry. These requirements are largely a result of requirements of the global AML/CTF watchdog - the Financial Action Task Force. These requirements ensure that crypto companies become identifiable by regulators and come within their reach. They also ensure that every individual who uses crypto services offered by regulated entities is identifiable. To make enforcement actions viable, KYC details of such users are tagged to their pseudonymous blockchain wallet addresses.
The combined deployment of these basic norms across the world mean that the regulatory net is closing on illegal and grey market activity. Most large centralized crypto companies with identified promoters are expected to comply with said regulations, which implies that most regular users of such platforms will fall within the regulatory ambit.
At the same time it remains possible for people to continue using crypto in a completely anonymous manner like before. Such use, however, seems likely to be limited to a relatively smaller group of individuals who want to maintain complete financial privacy.
A ‘tech-neutral’ approach puts companies in a position where, instead of looking towards dedicated crypto laws to understand their obligations, they are left playing a guessing game in which they must interpret old laws to understand if their activities fall within those laws or not. This lack of clarity is detrimental to business operations and slows innovation. It also defeats the purpose of creating a regulatory level-playing field for all businesses. To address this issue, many countries (like the UK and Singapore) have issued specific guidance documents that clarify the obligations of crypto companies in combination with extant law.
Finding #2: Multiple jurisdictions are creating comprehensive and facilitative legal frameworks
Multiple countries are in the process of developing clear, comprehensive and facilitative regulations for the industry: EU, Hong Kong, Japan, Singapore, South Africa, South Korea, Switzerland, UAE and the UK. This gives the crypto industry multiple jurisdictions as avenues for registration and commercial development.
This is a significant win for an industry that has faced many instances of hostility and threats of bans over the years. The industry’s erstwhile fears of a total regulatory shutdown of crypto seem to no longer hold any water, albeit regulatory clampdown is a persistent battle.
At the same time, the new regulations are imposing strict registration and KYC rules, which hurts the industry’s hopes of operating in a completely autonomous and decentralized manner (i.e., anonymized and without legal interference where “code is law”). Such regulations are at odds with the core ethos of the technology. Note that the regulatory situation in the largest user and capital market for crypto (the US) is unclear, while political parties and regulators seem to be weaponizing crypto regulation for a power war.
Finding #3: The development of legal frameworks for crypto is by no means complete.
The legal frameworks developed by most countries are not comprehensive at present. Generally speaking, laws have been formulated mostly in the following areas: registration of businesses, KYC/AML, security tokens issuance, consumer protection (including advertisements), taxation and market integrity.
The specific details of these frameworks also remain to be fleshed out. This means more developments are to be expected from each country. The chips are yet to fall completely into place. Participating in public consultations, and policy advocacy, lobbying (for regulations that are under development) and litigation is as crucial as ever for the industry.
Furthermore, it remains to be seen whether the compliance obligations that are developed in the coming months will be commercially viable or valuable. Such regulations must be able to strike a balance between the government’s need for adequate safeguards, and the need for a low compliance burden that enables innovation and encourages competition. For example, in order to protect consumers, the UK’s Financial Conduct Authority recently proposed rules to regulate how crypto projects could market in the UK, but the industry reaction is that the compliance burden and costs for projects will be very heavy.
Finding #4: Regulatory arbitrage is diminishing with more clarity from multiple jurisdictions
Regulatory arbitrage has been a significant concern when it comes to regulating the crypto industry. Given the borderless and decentralized nature of crypto, it is technically possible for companies to register in offshore jurisdictions that have lax regulatory oversight, and service clients that are based in other jurisdictions. FTX’s example of being registered in the Bahamas is pertinent here.
The development of regulatory frameworks across the globe has meant that the arbitrage between onshore and offshore jurisdictions has diminished to a certain extent. Companies can no longer plead absence of on-shore clarity as grounds for registering offshore. That said, given that laws across the globe are still being finalized, the extent to which regulatory arbitrage will persist remains to be seen.
It seems inevitable that some level of regulatory arbitrage will persist for the crypto industry. Given the financial nature of crypto, no country will permit companies registered in a rogue jurisdiction to offer cross-border financial services (via crypto) to their citizens. The ability to transfer funds abroad using crypto is a significant concern for less developed countries given that usually restrict FX inflows and outflows.
The practical ability to cooperate to harmonize laws and enforcement attitudes across jurisdictions will be essential to reduce regulatory arbitrage. In its role as the G20 President, India has actively advocated for the global harmonization of crypto laws within and outside G20 countries. These efforts and discussions include endorsing the views of international financial cooperation organizations like the Financial Stability Board and the International Monetary Fund that have been working on a mandate of developing a framework for the regulation, supervision and oversight of crypto-assets activities.
Early signs and the recent G20 New Delhi Leaders’ Declaration indicate that the G20 will find success in its harmonization efforts (for example, the UK’s February 2023 consultation suggests it is open to a harmonization or equivalence regime). That said, countries are unable to find a common understanding of crypto’s legal primitives. We see varying legal nomenclature, and lack of clarity on market structures in their laws.
Finding #5: The UK Law Commission’s finding that crypto is a novel legal concept with property rights can have significant implications for common law countries
The UK Law Commission has undertaken an extensive consultation process and study into the nature of digital assets under common law (common law is a flexible legal system seen in the UK and its former colonies in which courts can build iterative legal rules on top of existing laws to deal with new commercial situations). The UK Law Commission’s report was published in June 2023, and it provides answers to significant questions of jurisprudence thrown up by the emergence of crypto.
Most significantly, in its conclusion, the UK Law Commission states that under common law, digital assets are a new kind of personal property. They suggested the creation of a new category of personal property that “exists independently of persons and exists independently of the legal system”.
Formal recognition by the UK Law Commission that crypto is something that “exists independently of persons and exists independently of the legal system” is extremely significant. It cuts to the core of the technical design of crypto and does not seek to side-step the decentralized elements of the industry’s ethos. Rather, the UK Law Commission recognises crypto for what it is, and suggests law reform such that the limits of the law can be modified to account for and address this new phenomenon.
Given its role as the progenitor of the common law system, it is possible that other common law countries (like India) may follow the UK Law Commission’s jurisprudence when they formulate detailed regulations for crypto within their own country.
Finding #6: Stablecoin issuance has found legal sanction in more than one country
While many aspects of crypto technology continue to evolve and mature, stablecoins have already established a strong product-market fit, and are often regarded as crypto’s ‘killer use-case’. Regulators in jurisdictions like the EU and Japan, recognising the technical viability and market utility of stablecoins, have made dedicated legal frameworks to facilitate the issuance of stablecoins. Singapore and Hong Kong are also in advanced stages of finalizing dedicated frameworks for stablecoin issuance. Given this regulatory sanction, it is inevitable that the market will soon find many ‘legally-sanctioned’ stablecoins.
The proliferation of stablecoins has significant ramifications for global finance. Generally, stablecoins are considered great for global finance since they can improve efficiency in the financial system, especially for cross-border transfers and international trade. However, it is important to consider which currency stablecoins are being denominated in. Any proliferation of USD-based stablecoins (as a result of these regulations) is likely to further USD dominance in global finance. This can become a matter of significant concern for countries such as the BRICS (Brazil, Russia, India, China and South Africa) group, for whom prevalent domestic use of such USD stablecoins can lead to the dollarization of domestic economies and erosion of monetary sovereignty. These countries are expected to adopt protectionist measures against the domestic use of such stablecoins.
Finding #7: Some countries have advanced CBDC plans in place, whereas the issue remains undecided or contentious in other countries
When it comes to the development of CBDCs, there is limited consensus across the globe on the same.
Some countries have made a clear decision to issue CBDCs (both retail and wholesale), whereas other countries remain undecided. Amongst the undecided countries, some countries recognise that there may be significant future demand for a CBDC. These countries have started preparatory work to develop a CBDC. Most notably, there is strong domestic opposition in the US to the idea of a USD CBDC and it remains to be seen if the US will have a CBDC or not.
Here are some conclusions and our hopes for the future based on our analysis:
When it comes to regulating the crypto industry, there are three main danger zones that regulators aim to set up guardrails for: (i) prevention of illicit activities - which includes preventing the use of crypto for tax evasion, terrorist financing & money laundering; (ii) ensuring investor and consumer protection - which includes rules that ensure market integrity & transparency; and (iii) ensuring financial stability - which includes safeguarding against unauthorized capital outflows via crypto and systemic failures in crypto markets that spill over into TradFi.
The findings of this analysis indicate that as of 31 August 2023, most countries across the world have taken concentrated measures to set up the first guardrail: rules for prevention of illicit activities, especially the prevention of illicit financing using crypto. The FATF’s proactive response to crypto, and its ‘grey-listing’ regime, are largely responsible for this. Many countries are also coordinating with private blockchain analytics companies such as Chainalysis and TRM Labs to strengthen this guardrail.
Jurisdictions that are global financial hubs - London, Hong Kong, Singapore, Switzerland, UAE; and regions/countries that aspire to become global hubs for the crypto industry - EU, Japan, UK, UAE, SEA, have taken steps (or are in the process of taking steps) to set up the second guardrail as well: ensuring investor and consumer protection through adequately regulated markets.
As far as the third guardrail is concerned, substantive work is underway on a global scale under the aegis of the G20 to ensure that the macro financial implications of crypto do not destabilize the existing global financial order.
The ‘tech-neutral’ approach adopted by countries across the world appears to have worked in terms of reigning in a significant part of the industry that was largely out of regulatory control. At a time when crypto posed clear and substantial challenges to consumer protection and investor welfare, adopting a ‘tech-neutral’ approach served to be an appropriate preliminary response from regulators to a time-sensitive systemic issue - especially in the limited context of AML, tax and securities law. Now that a semblance of regulatory oversight has been established over the crypto industry, moving forward, we expect regulators across the world to adopt a more ‘tech-informed’ approach - regulations tuned specifically for crypto - with a common framework of understanding the primitives and the technology nuances. We also expect that regulation will be driven with broader industry participation in the rule-making process.
As things stand currently, broad frameworks for regulating crypto have been established in many relevant countries across the world and the specifics are being fleshed out. At this juncture, it is imperative for the industry to participate in public consultations, policy advocacy, lobbying, and if needed, litigation - to push forward the ‘tech-informed’ agenda. Specifically on litigation, there are notable cases where courts have upheld constitutional rights and rule of law and ruled in favor of crypto businesses.
In our previous posts (here and here) we highlighted how crypto would have the greatest impact in emerging markets. We have observed that emerging markets sometimes have a cautious or protectionist approach to regulation, so the other side of this equation is that emerging markets must now craft enabling laws that fully harness the economic potential of crypto. To do this, emerging markets must embrace a ‘tech-informed’ State that attracts crypto businesses with a bias toward giving them the space to innovate. They must incentivize talented local founders to continue building for home markets, which will not happen if there is a cloud of regulatory uncertainty.