by Imperium

Crypto regulation is not news, as it has seen a steady development in recent years. In 2022, after numerous hacks, exploits and bankruptcies of multiple projects, culminating in the collapse of FTX, which led to billions of dollars in losses, the need for regulations is now more obvious than ever.

The primary goal of regulation is to support financial stability, transparency, protection for users and investors and to ensure a unitary set of rules for various market participants.

The spearhead in this endeavor are the USA and the EU, which have proposed different policies and regulatory frameworks.

EU

The European Commission first introduced the Markets in Crypto-Assets (MiCA) Regulation as a proposal in September 2020, as part of its digital finance strategy.

Its purpose was to clarify the regulatory status of cryptocurrencies across European Union, as some member states already had varying national legislation for crypto assets, but there had been no specific regulatory framework at an EU level.

Its final text is set to be adopted in the European Parliament in December 2022 and enter into force in Q1 2023. Afterwards, its implementation will take place over the course of several phases, the rules starting to apply from Q1 2024.

MiCA is intended to set a sound legal framework for crypto assets that are not covered by existing legislation in order to ensure financial stability, protect consumers and investors, while supporting innovation and fair competition in the market.

This will apply to most cryptocurrencies, being divided in four categories: crypto-assets, utility tokens, asset-referenced tokens and electronic money tokens (e-money). Although, DeFi projects and NFTs are outside of MiCA’s regulatory perimeter for now.

In terms of services provided, the MiCA will capture firms dealing with the custody, management, trading, exchanging and marketing cryptocurrencies or even advising on this matter.

Some services are excluded, such as lending, certain insurance products and pension products.

Among the many areas it plans to supervise are the prevention of money laundering, consumer protection, company accountability and the environmental impact, setting up general requirements, conduct rules and a new licensing system applicable to all crypto service providers and crypto-asset issuers.

Also, the bill will see transfer of fund regulations (TFR) extended to all VASPs (Virtual Asset Service Providers) in the EU, and will mandate the collection of information about senders and recipients of cryptocurrency transfers.

Stablecoins are a particularly important part of the regulation. The MiCA system of regulating stablecoin issuers is related to how the stablecoin is backed.

Issuers of those backed by a single fiat currency (also known as e-money tokens) need to be an authorised bank or e-money firm.

Issuers of stablecoins backed by any other asset (known as asset-referenced tokens), e.g. a basket of currencies or a commodity, must be either a bank or authorised to issue asset-referenced tokens.

Also, MiCA mandates that stablecoin issuers maintain minimum liquidity to prevent crashes like that of TerraUSD.

Large stablecoins will be subject to strict prudential rules, with restrictions if they are used as a means of payment, and a cap of €200 million in transactions/day.

US

Beginning with the ICO boom in 2017, the US Securities and Exchange Commission (SEC) made its stance on digital tokens, indicating that it considers cryptocurrencies to be securities. Therefore, it started applying securities laws comprehensively to ICO issuers.

With the introduction of new kind of tokens, from decentralized finance (DeFi) to non-fungible tokens (NFTs), SEC also widened its enforcement actions upon these asset types.

In general, to the extent that these tokens are sold as investments, they are subject to securities laws. These are appliable to any “investment contract”, which is defined by the Howey Test as “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Cryptocurrency exchanges, being seen as securities exchanges, fall under the regulatory scope of the Bank Secrecy Act (BSA), meaning that cryptocurrency exchange service providers must register with Financial Crimes Enforcement Network (FinCEN), implement an AML/CFT (Anti-Money Laundering/Combating the Financing of Terrorism) program, maintain appropriate records, and submit reports to the authorities, such as the Internal Revenue Service (IRS).

In terms of taxes, the IRS has stated that “virtual currency” is considered property. And just as with any other property, receiving, buying, or selling it can create tax consequences. For example, if you buy crypto at one price and sell it at a higher price, it is subject to the capital gains tax.

Stablecoins are also a key focus for regulators in the US, as the collapse of the Terra algorithmic stablecoin has raised concerns about the regulation of this type of tokens.

On February 15, 2022, a draft of “Stablecoin Innovation and Protection Act” was introduced, describing “qualified” stablecoins as those which are issued by insured depository institutions and certain non-banking entities and proposing also the introduction of a stablecoin insurance fund.

Why is crypto regulation good for the market?

Safety

Regulation will make the cryptocurrency market a safer environment for users, sanctioning scams, fraud, and market manipulation.

Confidence

Ensuring legal certainty by establishing a sound legal framework for crypto-assets will foster confidence in existing and upcoming investors, in a market that has been described until now as a financial “Wild West”.

Stability

Directly, these measures will regulate the market’s stability with the inclusion of safeguards to address potential risks threatening it, but also indirectly by encouraging more long-term investment to enter the market.

In conclusion, it must be noted that policymakers should work closely with the business and technology communities in order to design optimal and custom-made regulatory frameworks that ensure both innovation and protection.

Its also important that regulators are aware of the potential economic impact that certain regulatory models can create and that they collaborate to promote a globally coordinated set of standards, in order to avoid regulatory arbitrage.