A crypto regulatory storm is coming in 2023. Are we ready?

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After the spectacular crash of Sam Bankman-Frieds FTX and its associated organizations, financial regulators around the world need to focus their attention in two places at once. While one eye remains firmly on the terrorist financing ban, the other is riveted on the fallout among FTX retail investors and its ripple effects across the broader financial landscape.

There are sure to be times when eyes will meet as litigants introduce new and evolving legal frameworks, and even more so when fintech companies need to comply. Whether it is still a speck on the horizon or looming on the horizon, this bill is inevitable, but what form will it take?

Rising temperatures

Long before US$8 billion in FTX deposits seemed to disappear, some regions had lawmakers hatching plans to ramp up the pressure on retail crypto operators. Indeed, one of the key regions whose legislation will not be affected by the Alameda Research/FTX fallout is the European Union, where Crypto-Asset Market Regulation (MiCA), designed to protect consumers in such an incident, has already been drafted and signed. . However, it is not yet implemented. More on MiCA later.

Of course, major exchanges like Binance US and Coinbase were already under scrutiny to meet know-your-customer (KYC) and anti-money laundering (AML) regulations, so they were accustomed to a bit of heat. Compliance teams were accustomed to legal language that understands both the need for a low-friction user experience, as well as the challenges associated with certain aspects of anti-money laundering enforcement. This language has lured some companies to the more lax side of due diligence. As Coinbase was recently fined US$100 million by New York regulators for AML non-compliance, at least when MiCA-like regulations are passed, this company will likely be better prepared. Half of that US$100 million should be invested in strengthening internal compliance routines.

For decentralized finance (DeFi) firms that aren’t obligated to fix their ship’s leaks, there’s an obvious challenge: protect your customers or get used to worse legal weather, even if you’re still getting used to the AML climate.

Initial drizzle

At the end of a turbulent 2022, the regulatory frameworks of most major markets were still in flux. Like a little rain that promises high winds and torrential downpours, we can watch them to get an idea of ​​what might come later this year.

A few regions, such as Singapore, had already put in place moderate control mechanisms, primarily concerned with adhering to the AML guidelines of financial action groups and avoiding sanctions. Meanwhile, India ratified a 30% tax on all virtual asset earnings in April 2022.

However, for the protection of retail customers against predation, fraud, and embezzlement, almost nothing is currently enforced with crypto-specific language.

MiCA will be one of the first major implementations and was originally proposed in November 2020 to the Parliament of the European Union, to provide legal confidence in a notoriously unstable space. Although it was enacted in October 2022, it likely won’t require companies to be fully compliant until mid-2024.

At a glance, MiCA:

Establish a definition for a crypto-asset in the European Union. Define blockchain verticals that fall outside of this jurisdiction, such as insurance and pension providers. Create four asset classes: benchmark tokens of assets, e-money tokens, utility tokens and everything else. Establish enforceable mandates on how stable and non-stable coins are brought to the markets and then to the public, including disclosure laws inspired by the EU Prospectus Regulation. Markets in Financial Instruments Directive).

Similarly, the aforementioned Singaporean regulations paid attention to which Digital Token Payment Service Providers (DPTSPs) they could entrust with licenses to operate in the country. It was only recently that the Monetary Authority of Singapore made proposals to enforce customer security and anti-corruption protocols among licensees.

The proposed Singapore diets include quirks more suited to their size and culture, but set good benchmarks that other regions could possibly follow:

DPTSPs must perform risk awareness assessments for clients. DPTSPs must not offer incentives to retail investors (like an online casino would). funds. Self-detection and reporting of any internal conflicts of interest. Transparency for crypto businesses regarding how they invest in new assets. Adequate customer service infrastructure. operation vital.

As other regions strive to incorporate consumer safety into their safety blankets, it seems likely that these will serve as models for many.

Threatening clouds and risk of lightning

As the footsteps of 300 new recruits can be heard trampling the US Internal Revenue Service’s criminal division, one wonders if their boots are weatherproof against the storms to come. Along with the hundreds of cases seemingly built by the IRS against crypto tax evaders, precedent-setting court cases are waiting to throw the hammer down on the crypto space. Depending on how they set up, many industry players see them as essential when it comes to shaping the future of DeFis.

Until now, investing in decentralized currencies of all kinds has been an investment in a less guarded environment, by definition. A privacy mindset of staying off the grid is normal for much of the DeFi community. However, as FTX asset holders know, this privacy comes at the cost of your insecure deposits.

Writing for Forkast, Michael Shing notes that this creates a tricky situation in terms of guilt. When almost all of your customers log on under a pseudonym, but some of them are criminals, where does the legal sanction go? Under the current legal framework, there is nowhere to pass the buck but upwards, to the operators and exchange owners.

A rain of precedents

Currently, there are three legal cases where this friction resulted in electrical buildup and then lightning strikes: FTX, Coinbase, and Ripple.

In cases where the lack of compliance checks allows operators to hide their own transactions, which is likely the case in Sam Bankman-Frieds FTX and Alameda Research, regulation aimed at creating a safer and more responsible space for transactions daily trading makes sense. SBF made it obvious.

As for how the customer will be affected by this, New York lawmakers have said that Coinbase has only done the bare minimum to require its customers to adhere to KYC mandates the bare minimum that they determined to be in fact less than acceptable. While some businesses that need to be KYC compliant use alternative data sources, such as social media credit scoring, with minimal friction for trustworthy users, Coinbase has chosen to only have the processes. integration weaker in place, rather than the enhanced security of step-up or dynamic friction at registration. This $100 million mistake will surely force Coinbase to reassess its risk appetite and onboarding processes, and will likely drag some of the crypto market down with it. Expect to see all of the Customer Due Diligence (CDD) practices implemented by Coinbase find resonance around the world.

Finally, many crypto experts are associating the impending US Securities and Exchange Commission v. Ripple (XRP) in the future of the entire crypto landscape. This case will decide whether crypto assets are currencies or securities, the latter falling under a legal framework with much more regulation already in place.

A perfect storm of legal complications

The upcoming calendar year could be the most tumultuous yet in terms of the storms to come and how crypto businesses will stay dry and solvent.

Lawmakers have a seething, boiling ocean to navigate, and their ships have seemed less seaworthy lately, with many of their sailors unsure where they’re going or even what the water is, exactly. After all, these types of virtual financial products are complicated to understand and the context surrounding them includes:

SBF’s greed that (allegedly) toppled the largest DeFi ecosystem. A sanctioned and aggressive Russia invested heavily in crypto after the ruble fell in wartime, and announced plans for a nationalized crypto exchange. Corporations are increasingly being pushed into jurisdictions with or at least solidified, scrutiny, causing some nations to lose taxes and economic impulses. Many world governments are planning to release their own central bank digital currencies (CBDCs).

Knowing this background makes some hesitation on the part of the SEC and other governing bodies understandable. Before hard lines can be drawn to shape the future of the crypto space, balances must be checked and calculations must be finalized. For crypto operators, however, it remains to be seen whether regulators will allow them to keep their heads above water with lighter regulations, or sink everyone else and worry about enforcement when they do. will all have sunk to the bottom.

Conclusion

Creating a block of legislation that defines a perimeter around such a rough ocean seems like a monumental task. Governing bodies are still figuring out where to step, and by how much.

As the conversation rages around crypto regulation and the most lascivious examples of crypto culture are exposed in the media, it’s hard to tell which side of the argument is progressing. While it seems obvious that tight customer due diligence will lead to lower trading profit margins, human greed gets a lot more press these days, as do calls for security. regulatory.

As financial lawmakers around the world balance economic prosperity with not defunding war and protecting their citizens, it seems likely that whatever conclusion they reach will require due diligence. DeFi traders would be smart to either come into compliance or try to push for regulatory moderation. Otherwise, they could find themselves rudderless in a sea of ​​legal battles and loose sails, with rowers deciding to abandon ship and get other programming jobs.

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