More than a decade after the invention of Bitcoin in 2008 by a group of techies using the name Satoshi Nakamoto and almost three years after the Great Crypto Crash of 2018, crypto-currencies and digital assets are finally coming of age. After being vilified for years by the global political and business establishment and often associated with cyber-criminality, money laundering and other illegal practices, cryptocurrencies and digital assets more broadly speaking are now being perceived as a key catalyst of the recovery following the Great Virus Recession. For obvious reasons, financial regulators are always a few steps behind financial innovation, as is the case with any form of innovation. Sometimes this can lead to catastrophic failures. Let us just remember the invention of CDOs (Collateralized Debt Obligations) and how they turned a US housing bubble into a global financial crisis and a severe recession in the world’s most advanced economies, of a magnitude unseen since the Great Depression of the 1930s.
The regulatory focus on crypto-currencies increased as they gained more prominence and came to a point where grandmas and grandpas began buying bitcoins at crypto-shops that suddenly flourished on every street corner. In most jurisdictions, the political and regulatory approach toward this innovation was conservative. However, some countries spearheaded the global regulatory effort by focusing on the opportunities associated with the crypto revolution and on the potential it had to transform the financial services industry. Among those countries, we can cite Switzerland and Singapore – two pioneers in their own right in the global crypto-revolution. Switzerland’s FINMA considers crypto-assets and the counterparties creating, exchanging and storing them just as other financial services focusing on the finality of the transactions not on the nature of the underlying technologies. Last year, FINMA delivered banking licenses for the first two “crypto lenders” in the world: Sygnum and Seba. Sygnum was also licensed by the Monetary Authority of Singapore. In this context, it comes as no surprise that Facebook had chosen Switzerland over other business-friendly jurisdictions across the world to deploy its “proprietary” digital currency.
Other governments are focused on the potential of the “Token economy” (cf. the eponymous book published by Shermin Voshmgir, the director of the Research Institute for Cryptoeconomics at the Vienna University of Economics, and the founder of BlockchainHub in Berlin), which is structured around the Distributed Ledger (DL) and Blockchain technologies. Digital Tokens have the potential to rewrite radically the way all economic transactions are conducted, by substituting so-called “smart contracts” to the traditional contracts and procedures which need to be enforced by States. Finally, other jurisdictions and regulators – from China to the United Arab Emirates, Russia and – are putting these tech developments in perspective, blending them with related developments in AI, Big data and Quantum computing, in an effort to develop national Fintech hubs and ecosystems, in what looks increasingly like a fierce global competition to replace the traditional foundations of money, banking and finance with new principles and procedures.
Large mature economies like the United States and the European Union are finally stepping in. A sign that the digital asset – or token – economy is maturing. The US Securities and Exchange Commission (SEC) FinHub published in 2019 a comprehensive framework for analyzing whether a digital asset is a security. The framework is not intended to be an exhaustive overview of the law; rather, it is a tool to help market participants assess whether the federal securities laws apply to the offer, sale, or resale of a particular digital asset. The US Office of the Comptroller of the Currency (OCC) and the SEC also published a few days ago a “stablecoin guidance“, providing the first detailed national guidance on how cryptocurrencies backed by fiat currencies should be treated under law.
Perhaps in a more dramatic move, last week, the Wyoming Banking Board voted to approve the application from San Francisco-based crypto exchange Kraken for a Special Purpose Depositary Institution (SPDI) banking charter. As Noelle Acheson writes in CoinDesk, by winning this charter “One of the crypto industry’s oldest exchanges has become a bank.“. It was also an opportunity for Wyoming, a doubly land-locked and scaresly populated US state which was hitherto more famous for its shale oil and gas industry than for tech to appear on the national fintech and crypto-economy map. Beyond the hype, there are however some enduring realities. The SPDI was created with the crypto industry in mind but institutions under this charter are not allowed to provide loans, and they have to hold all of their assets in reserve – a departure from the fractional reserve principle that underpins the functioning of the banking industry all over the world. The fate of the Crypto-currency Act of 2020 is another reminder of how difficult it is to overcome existing institutional and legal hurdles when it comes to dealing with such a fast evolving and complex subject. The bill introduced in March by Rep. Paul Gosar (R-Ariz.). was an attempt to cast a comprehensive reform of U.S. cryptocurrency regulation. It was built around the SEC’s aforementioned framework and taxonomy of digital assets. But the omnibus bill was dead on arrival. It fell victim of its overarching ambition and of a few simplifications that were debunked and criticised by Industry practitioners.
In the European Union, the discussions over regulations for digital assets were moving for years at their own – arguably not very impressive – pace. But there is now a new momentum with the prospect of an all-encompassing regulatory framework for digital asset as part of the EU’s Digital Finance Package announced on September 24 following months of consultation. s part of its new legislative proposals the European Commission provided a a definition of crypto-assets as “digital representations of values or rights, which can be transferred and stored electronically, using specific technology (known as distributed ledger technology).” However laudable this effort might be, it still suffers from a tech-biased vision, by linking Crypto-assets to a specific technology. The Commission also acknowledges that Crypto-assets come in many forms and with varying rights and functions, providing a taxonomy that borrows from the US SEC’s pioneering effort. As per Brussels, “crypto-asset can serve as an access key to a service (often referred to as “utility tokens”), can be designed to facilitate payments (often referred to as “payments tokens”) but can also be designed as financial instruments, such as transferable securities under the Markets in Financial Instruments Directive (MiFID II).”
Meanwhile, in a newly published working paper, the European Central Bank focuses on the narrower category of “stablecoins” and applies a definition that distinguishes stablecoins from existing forms of currencies – regardless of the technology used – and characterises stablecoin arrangements based on the functions they fulfil. The ECB’s approach rightfully emphasises a technology-neutral regulation. On the flip side, the Frankfurt-based institution continues to view stablecoins as a threat for its core missions. In the authors word, “In the event that this less plausible “alternative store of value” scenario materialises, significant implications for monetary policy could arise. This scenario involves stablecoin types that hold safe assets as collateral to achieve high levels of stability of the stablecoin’s value. Their significant uptake could increase demand for safe assets by stablecoin arrangements and might have a negative impact on price formation, collateral valuation, money market functioning and the monetary policy space. Banks’ intermediation capacity might also be challenged.”
The beauty of digital assets is that by their very decentralized nature and diversity of applications there can be no single “law to rule them all”.