How effectively are digital assets regulated?

Across the world, regulation is struggling to keep up with the explosive growth of digital assets, from cryptocurrencies to initial coin offerings. Below is a snapshot of how the global landscape unfolded in October. The rules will continue to evolve as regional and national legislatures draft new guidelines and courts develop precedents showing what companies can and cannot do.

What's the big picture?

Global policymaking around digital assets is very fragmented, in part because much of it has been a scramble to keep up with market changes and emerging threats. Another factor is the lack of an authority overseeing a truly international effort. While banking regulators in the Basel Committee on Banking Supervision agree on global guidelines, there is no equivalent convening body for digital assets.

Some say that even the Financial Stability Board, which includes the finance ministers of some of the world's largest economies, is not a broad enough forum because the issues surrounding digital assets extend beyond finance into areas such as technology and society in general.

In the US, Gary Gensler, recently appointed chairman of the Securities and Exchange Commission (SEC) and former chairman of the Commodity Futures Trading Commission (CFTC), is seen by some as a driving force for the necessary global coordination. He has gone all guns blazing, first encouraging crypto trading platforms to register with the SEC and then pushing Congress to give him the power to regulate what he calls the “Wild West” of markets.

Smaller countries – and some US states – also led the way. Some are trying to quickly develop digital asset regimes to win business, like the US state of Wyoming, which has passed more than 20 crypto-related laws, including a new banking charter specifically tailored to crypto companies. But some nations are taking aggressive action, such as China, which declared all cryptocurrency-related activities “illegal” in September. Meanwhile, El Salvador has taken the unprecedented step of making the cryptocurrency Bitcoin legal tender.

What is happening in the USA?

Digital asset regulation in the US is almost as fragmented as in the rest of the world. Gensler argues that because cryptocurrencies are essentially securities, regulation should fall to him. The Federal Reserve also has a role to play, most obviously by restricting the crypto and digital asset activities of the already regulated major banks.

The CFTC has supremacy over futures and other derivatives based on digital assets. State regulators largely handle the licensing of money transfer companies, a category that some cryptocurrency companies claim to be members of.

However, almost all regulatory systems predate digital assets. “Everyone spends their time trying to figure out what kind of product [the digital asset] is so that we can understand where it fits into the existing US regulatory framework,” says Jai Massari, a partner at law firm Davis Polk in Washington.

If the SEC believes the digital asset is a security, the SEC may require its exchange to stop selling the digital asset, according to Grant Fondo, an attorney at Goodwin. This is likely the case with some tokens issued via initial coin offerings, the symbolic equivalent of a stock IPO.

The Financial Crimes Enforcement Network (FinCEN), which monitors financial crime risk, and the Justice Department could also be interested in many types of activities involving digital assets. Money transfer licenses from payment companies can be issued at the state or federal level.

SEC Chairman Gary Gensler has gone all guns blazing, pushing to regulate the “wild west” of markets

Case law plays an essential role in the development of the basic rules. “We see a lot more on the enforcement front than on the regulatory front,” says Massari, noting the importance of cases like Ripple’s legal fight against the SEC’s classification of the payment token as a publicly traded security. "If the court says we agree XRP [Ripple's payment token] is not a security...it changes the landscape a lot for the SEC in terms of its jurisdiction and what it can do."

The best hope for national focus lies in dollar-based stablecoins, a form of cryptocurrency whose value is pegged to the greenback. The U.S. is so worried about the impact on financial stability that the heads of all its major regulators said this month that regulations for stablecoins are “urgently needed” and that the coin’s operators should be treated like banks.

What about other major markets?

The UK's approach is similar to that of the US in that existing laws are applied to products and situations for which they were never intended. The UK has the advantage of having fewer domestic financial regulators, but its regulatory legacy complicates some issues.

Ben Regnard-Weinrabe, a regulatory lawyer at Allen & Overy, cites as one such complexity the fact that the UK has two regimes for “security tokens”, as opposed to the single US definition. Depending on the characteristics of a cryptocurrency, it may be referred to as an equity or debt security, a collective investment scheme, or electronic money. Alternatively, it could be unregulated. His colleague Bob Penn says that while the old laws underlying the regulation of digital assets are “quite clear,” “legally speaking, they are often difficult to reconcile [the old rules] with non-traditional products.”

Singapore has long been at the forefront of innovation. This month, its regulatory chief Ravi Menon, who leads the Monetary Authority of Singapore (MAS), reiterated the city-state's goal of being a leading crypto player. “We believe the best approach is not to restrict or ban these things,” he said.

Attorney Tju Liang Chua of Drew & Napier says the framework is “relatively clear as far as global jurisdictions are concerned.” Singapore's Securities and Futures Act contains a comprehensive list of characteristics that define what a security looks like. Lawyers then match digital assets to determine whether the asset is a security. Singapore's recently introduced Payments Services Act explicitly defines certain regulated, non-secure digital tokens such as Bitcoin and defines regulated electronic money or stablecoins whose issuers require a special license.

Another novelty in Singapore's landscape is that "there's pretty much only one regulator that matters," says Liang. The MAS has authority over payment regulation, financial conduct and prudential regulation, and central banking, and also has a dual mandate to promote the development of the financial sector.