Preview: The IMF estimates that the market capitalization of cryptocurrencies is $2.5 trillion and that they have the potential to transform the traditional financial system. However, they also require regulation in areas such as lending and payment risks, banking, payments, anti-money laundering, tax policy and evasion, securities fraud and scams, and cyber security. Central bank digital currencies are also being considered as an alternative to cryptos, with China's digital yuan being the most advanced. The G7 countries are being cautiously optimistic about the potential of CBDCs, but none have launched one yet, with 86% actively researching the potential for CBDCs. The U.S. and Hong Kong are also considering the regulation of stablecoins and the potential risks they pose.
Summary:
The IMF estimates that cryptos' market capitalization is $2.5 trillion, which might reflect froth in an environment of stretched valuations.
Cryptos' potential to transform the traditional financial system means they need to be regulated. This includes lending and payment risks, banking, payments and anti-money laundering risks, tax policy and tax evasion risks, securities fraud and scams, and cyber security.
“Crypto-assets are potentially changing the international monetary and financial system in profound ways.” – IMF blog, December 2021.
Pew Research reported that 16% of Americans have invested in, traded or otherwise used cryptocurrencies, and Newsweek Magazine estimated that 46 million Americans own cryptos.
In June 2021, the UK Financial Conduct Authority published its fourth consumer research publication on crypto-assets ownership.
Crypto-assets are beginning to gain mainstream acceptability in the European Union, with 6% of Slovakians and 8% of Dutch nationals owning crypto-assets.
The 2022 special report expands beyond cryptocurrencies such as bitcoin, and considers other crypto-related instruments, such as central bank digital currencies, non-fungible tokens and stablecoins, and highlights policy work in key countries.
Central bank digital currencies
Central bank digital currencies are often seen as an alternative to cryptos. China's digital yuan is the most advanced CBDC thus far.
The G7 countries have been deliberately cautious about CBDCs' potential. No G7 jurisdiction has yet launched a CBDC, but 86% are actively researching the potential for CBDCs.
Retail CBDC
A retail CBDC would be a digital form of central bank money, distinct from electronic reserves and physical cash. It could act as a liquid, safe settlement asset.
Not crypto-assets
The G7 is clear that CBDCs are not crypto-assets, and they are fundamentally different from privately issued digital currencies such as stablecoins.
The G7 principles highlight the potential for CBDCs to support safe and efficient transactions, as well as ensure trust in the financial system.
A divided UK stance
The UK's stance on CBDC is at best unproven and at worst divided. A CBDC may provide some advantages, but also present significant challenges.
The committee report builds on a November 2021 joint statement by the Bank of England and HM Treasury, and recommends that the UK government and Bank of England take action to shape international standards which suit the UK's values and interests.
The U.S. approach to CBDCs
A project by the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology achieved its preliminary goals.
The Federal Reserve Board opened debate on a CBDC in January, but made no policy recommendations and offered no clear signal about where the Fed stands on the issue.
The Boston Fed/MIT project is exploring alternative designs for a central bank payment system, and is looking at ways to balance privacy issues with concerns about compliance.
Hong Kong
The Hong Kong Monetary Authority published a discussion paper11 on crypto-assets and stablecoins inviting views from the industry and public on the relevant regulatory approach.
United States
Stablecoins are likely to be a priority for U.S. regulators in the near future. The Securities and Exchange Commission and the Financial Stability Oversight Council will monitor stablecoins and recommend appropriate actions to address potential risks.
The SEC, CFTC and Consumer Financial Protection Bureau will oversee investor protection and enforcement of federal securities laws and the Commodity Exchange Act, where applicable.
– U.S. Financial Stability Oversight Council, December 2021
The consultation sought views on the defining characteristics of e-money and cryptocurrency, discussed the potential ability of stablecoins to function as money, and discussed whether stablecoins should be regulated differently from other stablecoins.
The consultation received mixed views over whether stablecoins should be treated as a payment instrument or an investment product.
NFTs are used to authenticate virtually anything, including works of art, collectibles, video clips, or other digital media, as well as real-estate and auto titles, coupons, transit, or event tickets.
NFTs have been noticeably absent from the regulatory policy debate so far. It is unclear whether an NFT will be deemed a financial instrument or security and thus subject to regulatory oversight.
European Union
The European Union introduced a proposal to regulate crypto-assets in September 2021. NFTs were explicitly excluded from the proposal, but fractional NFTs would be subject to the proposal.
United States
The United States has yet to issue direct guidance on NFTs, and there is no state regulatory framework or guidance on NFTs. The U.S. Treasury has published general guidance related to virtual currencies.
A spokesperson for the NYSE said, however, that it has no immediate plans to launch cryptocurrency or NFT trading.
The New York Stock Exchange filed an application to register the term "NYSE" for a marketplace for NFTs, but has no immediate plans to launch cryptocurrency or NFT trading.
Hong Kong
Investors in Hong Kong have shown considerable interest in NFTs, with marketplaces such as Sotheby's and Christie's facilitating bidding for locally produced NFT art.
Financial authorities in mainland China have yet to clarify whether a recent ban on cryptocurrency transactions includes producing, selling or trading NFTs.
The Securities and Futures Commission has stated that virtual assets fall within the legal definition of securities or derivatives and are therefore subject to local securities laws.
Regulators have yet to issue regulations specifically concerning NFTs, although certain regulatory requirements are applied to all classes of virtual assets.
Financial stability and regulatory challenges
Regulators and firms are concerned about operational and financial integrity risks from crypto-asset exchanges and wallets, investor protection, and inadequate reserves and inaccurate disclosure for some stablecoins.
Financial stability
The FSB raised 14 concerns about financial stability in a recent paper, and advocated for cross-border and cross-sectoral cooperation. The need for policymaking pre-emption and cooperation is seen as increasingly urgent.
A lack of consistency
The cross-sector, cross-border nature of cryptos limits the effectiveness of national approaches. There is also a lack of consistency between, or absence of, definitions related to new technology applications, and legal and jurisdictional questions to resolve.
U.S. Executive Order and SEC take steps toward crypto regulation
In March 2022, the White House issued an Executive Order on digital assets that emphasized the importance of addressing risks and harnessing the potential benefits of digital assets.
New proposed rules from the SEC could apply to unregulated crypto platforms, including blockchain and cryptocurrency platforms.
SEC-regulated alternative trading systems (ATSs) match orders for buyers and sellers of securities. The proposed rules are intended to protect investors and enhance cybersecurity in ATSs that trade U.S. Treasury securities.
The 650-page document raised about a dozen significant issues, including a reach to "currently unregulated communication protocol systems" and a proposal that could include wallets, block explorers, and other market participants including virtually every blockchain-based application.
United States
Kim Kardashian was paid to ask her 250 million Instagram followers to speculate on cryptocurrency tokens by "joining the Ethereum Max Community".
Movie stars are pitching cryptos in prime-time slots during major sporting events, and a one-minute advertisement costing nearly $14 million drove more than 20 million hits to Coinbase's landing page within one minute.
Spain
The Spanish securities regulator said in January that it would regulate rampant advertising of crypto-assets to ensure investors are aware of risks.
Russia
In January 2022, Russia's central bank proposed to ban the use and mining of cryptocurrencies on Russian territory, citing threats to financial stability, citizens' wellbeing and its monetary policy sovereignty.
Fraudsters may entice customers by touting crypto-assets as an investment or an "opportunity" to get into a cutting-edge space.
Trust is needed to maintain societal conventions regarding the use of money, and central banks provide an open, neutral, trusted and stable platform. Private companies develop new payment methods and financial products and services.
Big Tech stablecoins compete with national currencies and also against each other, fragmenting the monetary system. Decentralized finance promises a financial system free from powerful intermediaries.
The increasing use of cryptos is causing policymakers to consider the potential impact of digital currencies on the international monetary system.
Gatekeeping the gatekeepers — big tech and banking licenses
The Bank for International Settlements' Financial Stability Institute assessed 22 the benefits and risks of extending banking licenses to Big Techs and fintechs, and found that they were more likely to deliver on their stated objectives.
Policy responses to tech-owned banks may differ across countries, but they are likely to be guided by three main considerations: policy priorities, inherent risks, and the applicability of the existing licensing regime.
Warning from history
A UK report on the Co-operative Bank's failure in 2013 warns policymakers about the risks associated with non-financial services owners or controllers of banks. The board of the Co-operative Group lacked the skills, knowledge or understanding required to manage a bank.
Financial crime
Crypto firms are being used as conduits for facilitating financial crime, and DeFi protocols in particular are becoming an increasingly significant route for money launderers. In 2021, $8.6 billion worth of cryptocurrency was laundered, a figure that has fluctuated from $6.6 billion in 2020 to $10.9 billion in 2019.
The DOJ announced recently that it had seized $3.6 billion in bitcoin tied to the 2016 hack of digital currency exchange Bitfinex and had arrested a husband-and-wife team on money laundering charges.
In another high-profile example, REvil 25 caused a gas shortage on the U.S. East Coast by using encryption software called DarkSide.
This showed that cryptocurrency was “not a safe haven for criminals,” said Lisa Monaco, deputy attorney general.
The DOJ can follow money across the blockchain, just as they have always followed it within the traditional financial system.
Transparency
Cyber-criminals have laundered more than $33 billion worth of cryptocurrency since 2017, but the biggest difference between fiat and cryptocurrency-based money laundering is that cryptocurrency is much easier to trace.
In 2021, DeFi protocols received 17% of funds sent by illicit addresses, up from 2% in 2018. Mining pools, high-risk exchanges and mixers also received substantial increases in value.
In 2021, the US Treasury Department sanctioned two DeFi "gateway services" that laundered funds from ransomware operators, scammers, and other cyber criminals. In 2022, the UK Revenue & Customs seized NFTs for the first time.
Cryptos are undoubtedly being used in financial crime, but they are less likely to be used for money laundering than fiat currency.
The way forward
The IMF believes that global crypto regulation should be comprehensive, consistent and coordinated.
Crypto-asset service providers should be licensed or authorized, and authorities should provide clear requirements on regulated financial institutions concerning their exposure to and engagement with crypto.
A positive and transformative force?
Carolyn A Wilkins said crypto-assets are the bedrock of the emerging financial ecosystem and could revolutionize financial services. She called for major investment in domestic and cross-border payments, as well as digital governance.
Tipping point
Cryptos appear to be at a legal and regulatory tipping point in many countries. Policymakers must balance concerns about financial stability and vulnerable customers with the benefits of more widespread adoption of cryptos.
TODD EHRET
Todd Ehret is a Senior Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence and has more than 25 years of experience in the financial industry.
Full Report: https://theblockchaintest.com/uploads/resources/THomson%20reuters%20-%20Cryptos%20on%20the%20rise%202022%20-%202022%20March.pdf