Navigating Regulatory Challenges in the Crypto Space: Part I

Regulators around the world have realized the importance of blockchain technology and decentralization in crypto-assets. However, they also understand the need to regulate this emerging phenomenon.  

The core idea behind crypto-assets is the absence of intermediaries. History has shown that without a regulatory framework, expecting a mature and stable market with many participants is unrealistic. 

The Challenge of Regulating Blockchain Innovation 

New technologies like blockchain introduced us to a new chapter of economic history. They affect funding, trading, and the entire financial system with wide-ranging implications for capital formation and risk transfer. The infrastructure of crypto-assets is an example of how technological progress is outpacing regulation.   

Regulation often lags behind technology. This is an old rule, and it’s especially true during times of rapid change. It’s expected when constant innovation occurs. Because of this, many regulators delay adopting regulations. Instead, they issue warnings about the risks of using digital assets. They prefer to wait and see how blockchain technology might benefit them.  

In some countries like Singapore, the UK, and the United Arab Emirates, regulators aim to foster financial innovation. To avoid hindering development, they introduced a limited free environment known as a regulatory sandbox. This allows companies using blockchain technology to operate in a controlled and relatively favorable setting for a certain time.  

The goal is to observe the pros and cons of new technologies. This way, industry stakeholders are not harmed. Meanwhile, financial innovations can continue to grow within this controlled space. 

When it comes to comparative regulation of crypto-assets, four possibilities emerge. Like any new field, crypto-assets represent an upgrade to the existing system. However, they also bring conceptually different relationships.

       1. Prohibition 

Although some initially thought that crypto-assets as such should be completely banned (they still exist but in a much smaller number), it seems that there is little chance of that happening. There are several reasons for this claim. The first is that it is possible to pass a regulation that prohibits the possession, trading, and use of crypto-assets.  

It is even possible to stipulate imprisonment and fines for anyone who does the opposite. However, the question of the enforceability of this policy is questionable. Namely, no country in the world (regardless of how technologically developed and rich it may be) has the resources to implement such a decision in practice.  

The only effective way would be to cut off Internet access, which is not a realistic option. Another reason is that if one country (or a group of countries) decides to ban crypto-assets, other countries would use favorable regulatory frameworks in order to take advantage of the resulting vacuum and attract companies, talents, and capital from the jurisdiction that implemented the ban.  

However, despite this, there are examples of countries that have explicitly banned crypto-assets. These are China, Bangladesh, Nepal, Afghanistan, Bolivia, Egypt, Morocco, and Algeria. 

       2. Partial Prohibition  

To reduce the potential negative impact of crypto-assets on the real economy, some regulators have taken action. Instead of imposing a complete ban, they restrict the use of crypto-assets for specific purposes. This approach helps prevent competition with the traditional financial system. 

For example, the direct sale of products and services for crypto-assets, whether wholesale or retail, can be prohibited. Some countries also ban the establishment of crypto-asset service providers or the mining of crypto-assets within their borders. 

In Serbia, regulators have partially restricted crypto-assets. They prohibit banks and other financial institutions from owning crypto-assets. They also ban these institutions from providing services related to crypto-assets. 

       3. Partial Regulation  

As the name suggests, this implies the regulation of crypto-assets exclusively in certain segments that are considered the most important. For example, there is no single law regulating the entire industry. Instead of that only taxation is regulated, which is achieved by amending and supplementing the existing tax regulations.  

In this way, the state avoids getting involved in an often under-researched area, not wanting to regulate it too early. Early regulation could stifle creativity and innovation at the start. However, the state also ensures it does not miss out on tax revenues. Governments often regulate the prevention of money laundering and terrorist financing before adopting separate regulations. 

As early as 2018, the EU, through the V AML Directive, required all crypto-asset service providers to implement rules related to preventing money laundering and terrorist financing in their operations. At the time, the EU had not yet established uniform regulation of crypto-assets. 

       4. Detailed Regulation  

Detailed regulation of crypto-assets usually targets crypto-asset service providers, services they provide, investor protection, possible risks, and use of crypto-assets. Authorities often recognize service providers with a status similar to regulated financial intermediaries. They typically grant licenses for specified activities to ensure compliance. 

Regulation mostly covers risks of using crypto-assets, relating to the market behavior of participants, fraud prevention, business integrity, management standards, etc. The European Regulation on the Regulation of Crypto Assets (Markets in Crypto Assets – MiCA) provides a good example of comprehensive regulation for crypto-assets. 

This was only the first part of the series of articles in which we will be covering regulatory challenges in the crypto space. We have just scratched the surface with different approaches to regulating crypto globally.  

Stay tuned and enjoy the ride in the crypto ocean of regulation.