Without a doubt, the 2021 growth in the interest and adoption of digital assets, including cryptocurrency securities, was one of the most significant financial market disruptors in recent history. As we close out the year, the cryptocurrency and digital assets markets now count 330 million users worldwide, with a total market cap now exceeding $2 trillion USD. When comparing this to 2013 figures of 1 million users and $1.5B in market cap, it’s evident this is a force that will continue to drive the future of FinTech, and the industry overall, into 2022 and beyond.
What’s perhaps less certain is the best way to characterize digital assets as a market category to establish clear regulatory frameworks and oversight responsibilities. In spite of SEC Chairman Gensler’s comments about cryptocurrency securities “walking like a duck” (and therefore under SEC jurisdiction), there’s no shortage of crypto winged creatures and waterfowl. Digital assets may be viewed as a payment instrument, with services supervised under state-issued money transfer licenses, or specialized bank charters granted by the Office of the Comptroller of the Currency (OCC), subject to enforcement under the Consumer Financial Protection Bureau (CFPB).
They can also be considered commodities and subject to anti-fraud regulations under the CFTC and/or SEC. In many cases, it is not clear where the responsibility of one regulator starts and another ends. Consider some of today’s participants:
- Binance: crypto trading platform, not currently operating as a licensed entity. CEO is seeking to become registered in the U.S. and other markets (currently banned in the UK). Would ultimately be regulated by FINRA and SEC once licensed
- Ethereum: open-source blockchain community, with its security Ether, which would likely be regulated as other comparable securities
- com: regulated by SEC (although registration, legal standing, etc. remains to be defined by U.S. regulators)
- Unifimoney: wealth management app, trading in cryptocurrency done in partnership with Gemini. Registered investment advisor regulated by SEC (Unifimoney RIA). Brokerage services provided by DriveWealth LLC, registered broker-dealer regulated by FINRA
- Plaid: connects financial institutions to apps. Licensed in the UK and regulated by FCA under payment-service regulations (includes recordkeeping)
The regulatory response
Despite the oversight ambiguity, regulators are not sitting back and waiting for enforcement harmony. In fact, the industry has racked up $2.5B in fines since 2009, highlighted by the following:
- Ripple, who is currently in litigation with SEC over whether XRP cryptocurrency is a security
- CFTC orders Tether and Bitfinex to pay fines totaling $42.5M for off-exchange transactions
- Coinbase fined $6.5M by CFTC for false, misleading, or inaccurate reporting and trading
According to Cornerstone Research, the most common allegations involved fraud (52%) and unregistered securities offerings (69%). Twenty-eight actions (37%) contained allegations of both fraud and unregistered securities offerings.
The regulatory overlap and underlap, along with criticism of those opposed to the Gensler unpredictable tactic of “regulation by enforcement,” are calling for action. The U.S. already trails the EU, Singapore, and UK in developing a unified approach to digital assets that breaks clear of outdated regulation originally written in the 1930s. Some alternatives heading into 2022 include:
- Digital Asset Market Structure and Investor Protection Act: defines digital asset securities as a digital asset that gives the holder the specific rights to equity or debt of the issuer, to profits, interest or dividend payments from the issuer
- Digital Commodity Exchange Act: provides similar definitions and structures for futures activities as regulated by the CFTC
- S. Infrastructure Bill: includes provisions for financial reporting and taxation of cryptocurrency investments
- Advocacy from Coinbase and others: calling for a new regulator over digital assets, including suggestions of establishing a crypto Self Regulatory Organization (SRO), similar to FINRA
Getting ahead of the crypto regulatory landscape
2022 will tell us whether existing regulators can produce a new regulatory stew to address the unique dimensions of digital assets — or whether an entirely new oversight mechanism is required. However, whether a firm is a multinational financial institution with firm plans to launch a cryptocurrency security offering or a smaller advisory firm that views crypto as key to their growth strategy of reaching retail investors — a few proactive principles should be considered now:
- Now is the time to ramp compliance staff.
As illustrated by Binance, Robinhood, and others— more firms have recognized the importance of native compliance speakers.
- Compliance infrastructure must be agile and responsive.
Cryptocurrency regulatory ambiguity is not sustainable. Stakes are too high, and the SEC (independent of their future role) have stated clearly that they see a widening gap between technology and regulation, and they will act to modernize outdated rules. Hardcoded policies and oversight procedures will have marginal value if they are not able to easily respond to inevitable changes in the regulatory landscape.
- Don’t forget where the action is.
Cryptocurrency security markets are being driven by a younger class of investors, with a different way of communicating and interacting with investment influencers. Marketing and selling efforts for cryptocurrency investments will happen on platforms that are familiar and comfortable for this class of investors. Compliance controls need to work as well on TikTok, Instagram, and Reddit as they do over email and phone calls. In 2022 and beyond, information risk will live everywhere.
- Know your recordkeeping and supervisory essentials.
Regardless of the outcome in determining who has the overriding regulatory responsibility, the fundamental rules governing cryptocurrency securities are likely to be subject to the same (or very similar) recordkeeping, storage, and supervisory obligations as every other investment category. This should encourage established firms to modify existing control technologies to ensure they can address the volatility and unique communications activity associated with crypto. New market entrants must prioritize investments in compliance infrastructure to manage the ongoing watchful eye of regulators.
- Watch this space.
As we have seen in recent stories about the SEC and FINRA addressing digital communications, it is highly unlikely that explicit regulatory guidance will keep pace with technology innovation. Waiting for regulatory clarity to determine policies and govern information pertaining to securities is futile. There will be no answer found in a Google search. Engage with your peers, industry associations, and share best practices on forums such as those run by Smarsh.
Cryptocurrencies and digital assets are transforming financial services, and additional regulation will inevitably follow. Traditional firms and high-growth FinTech entrants can both experience positive business outcomes by investing now in expertise, policies, training, and automated compliance controls to stay prepared for the regulatory uncertainty ahead in 2022.
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