Global Regulators Increasingly Shifting Focus to Cryptocurrency

Until recently, cryptocurrencies had largely avoided the regulatory spotlight. While financial market regulators monitored the emerging sector, they largely maintained a hands-off approach as it remained on the periphery of financial markets for the past several years.

That is now changing, and global regulators are taking tentative steps to respond to the unique challenges created by virtual currencies, which largely exist and operate outside of the traditional financial systems. However, although regulators are increasingly asserting jurisdiction over and taking action against cryptocurrency traders and transactions as they deem appropriate, the extent and scope of regulatory activity vary across the world’s major financial markets.

United States

Following a rapid rise of initial coin offerings (ICOs) and the surge in the value of Bitcoin in 2017, the Securities and Exchange Commission (SEC) issued an investor bulletin warning about the potential hazards associated with ICOs, and Chairman Jay Clayton later issued a statement urging individuals to understand the risks associated with virtual currencies before investing. However, as of the end of the year, the SEC had neither approved any exchange-traded products investing in cryptocurrencies, nor had it registered any ICOs.

Nonetheless, the SEC has entered into the cryptocurrency sector in other significant ways. In July 2017, the agency released an investigative report warning that “virtual” organizations’ offers and sales of digital assets may be subject to the requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934 — a meaningful step in establishing its regulatory jurisdiction over the cryptocurrency market. Similarly, the Commodity Futures Trading Commission (CFTC) waded into the cryptocurrency sector by designating Bitcoin as a commodity, placing the cryptocurrency and any related fraud or manipulation squarely under its authority.

The SEC also launched three enforcement actions against ICO sponsors in 2017. In one instance, it obtained an emergency asset freeze to halt an alleged ICO fraud that raised as much as $15 million from thousands of investors, while others exposed allegedly fraudulent schemes that violated the anti-fraud and registration provisions of federal securities laws. In January of 2018, the SEC halted trading of the shares of a Chinese blockchain technology company, citing potentially inaccurate company disclosure filings and “recent, unusual and unexplained market activity” around its stock.

Other U.S. agencies have also established an initial measure of supervision over cryptocurrencies. The Internal Revenue Service indicated that Bitcoin should be considered property for tax purposes and any associated capital gains or loss from trading in Bitcoin would be treated the same as property. The Treasury Department indicated it would review its Financial Crimes Enforcement Network’s cryptocurrency practices to ensure they adequately address any potential money laundering and terrorism financing risks. Finally, Keith Noreika, the acting U.S. Comptroller of the Currency, recently said he is considering licensing Bitcoin and other cryptocurrency exchanges via a nationwide licensing program similar to that in Japan.

While U.S. regulators largely began exercising jurisdiction over cryptocurrencies only in 2017, there is every indication that they will continue to do so in the year ahead in order to strengthen investor protections and take enforcement action as necessary.

Europe

No standardized regulatory framework currently exists across the EU, although both the regional government and individual member states have responded to one extent or another. Different approaches and legislation exist within individual member states, although financial regulators in many countries have issued statements warning investors of the inherent risks. In Germany, digital currencies are legal financial instruments and can be taxed as capital, although some uses require an additional license or permit. In contrast, there is currently an absence of any specific cryptocurrency regulations within the United Kingdom, although the British Treasury plans to adopt the planned EU legislation expected to enter into effect in late 2018. Designed to address concerns related to potential money laundering, those rules would require virtual currency traders to disclose their identities and report any suspicious activity to regulators. Meanwhile, Estonia has proposed the creation of a state-managed cryptocurrency called the “estcoin,” which it would launch via an ICO.

Asia

A wide range of regulatory approaches exist across the largest Asian economies. At the most stringent end of the spectrum, China has banned all cryptocurrency exchanges and fundraising through ICO activities, effectively rendering ICOs an illegal activity within its borders. Financial institutions and third parties are prohibited from using virtual currencies in any way as part of a transaction. The country has also taken a hard-line approach to Bitcoin miners due to concerns over resource allocation and a potential crash in value, with prospective measures including limiting power supply to computer servers used to mine Bitcoin or amending land use and taxation laws in order to effectively halt their activities. This approach could further affect global Bitcoin transactions, as China is home to the majority of the world’s Bitcoin mining operations. Chinese cryptocurrency traders have turned to over-the-counter platforms to invest in virtual currencies, although regulators may set their sights on that avenue in response.

At the other end of the spectrum, Japan adopted a law to regulate cryptocurrencies in 2016, which entered into effect in 2017, and cryptocurrencies are a legally recognized method of payment. Japan’s Financial Services Agency (FSA) has authorized a total of 15 virtual currency exchanges. Similar to the SEC, the FSA issued a statement in October 2017 warning investors about the potential risks, highlighting specifically the potential for price volatility and the potential for fraud. Also like the SEC, the Japanese market regulator reminded the industry that certain ICOs resembling investments would be subject to regulations under the Financial Instruments and Exchange Act.

Whereas China and Japan have implemented ample measures to respond to virtual currencies, India has thus far taken little action. The government does not regulate any cryptocurrency exchanges, although it has indicated it is examining moving in that direction. However, any looming regulation appears more likely to be designed to control the sector, rather than foster its growth, as the country’s finance ministry recently likened cryptocurrency trading to a Ponzi scheme and underlined the current absence of any investor protections.

Finally, South Korea had been similarly slow to impose regulations, despite being the third-largest cryptocurrency market in the world, behind the U.S. and Japan. However, late in 2017 the government unveiled additional measures to regulate the emerging sector and cool the “irrationally overheated” virtual currency speculation, and the Financial Services Commission issued a ban on ICOs, promising unspecified “stern penalties” for any violations. The new legislation prohibits anonymous cryptocurrency accounts and promises ongoing regulatory monitoring of cryptocurrency exchanges. The regulator has since launched inspections of six of the country’s largest commercial banks in order to ensure compliance with cryptocurrency anti-money-laundering obligations.

Russia

Although cryptocurrencies were previously banned in Russia, the past year saw a liberalization of the government’s approach in response to President Vladimir Putin’s public support for its greater adoption. This culminated in legislation in December that would allow for exchanges and ICOs, albeit with maximum amounts for both individual investors and total fundraising. The legislation is expected to be finalized in early 2018.

Obviously, the global regulatory environment in which cryptocurrencies operate is varied and rapidly changing. Now that regulators have waded into asserting a supervisory role over this emerging sector, further developments can be expected in the year ahead.