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How will regulators tackle an ever-expanding digital asset class in 2022?

Should we expect legislative changes to the regulation of digital assets on either side of the Atlantic in the year ahead?

The term “digital assets” encompasses a broad range of financial instruments, incorporating longer-tenured cryptocurrencies (like Bitcoin and Ethereum), newer cryptocurrencies that are native to decentralized finance or “DeFi” platforms, and esoteric assets such as non-fungible tokens (“NFTs”).

As their number and varieties increase, regulators globally are beginning to get their bearings and establishing clearer positions regarding regulation of these instruments. We envision this regulation emerging and changing throughout 2022, which could result in previously unseen levels of digital asset enforcement efforts.

Financial markets regulation is coming but the shape is not clear – in the US or the UK

In the US, the SEC has announced that digital asset regulation is on the way, but no proposed rules have yet been offered for notice and comment rulemaking. Measures have been introduced in Congress, but nothing has yet gained momentum to be enacted. Investor protection would seem the overall theme of regulators and lawmakers here, given the tenor of this commission. Meanwhile, neither the SEC nor the CFTC, which essentially oversees everything not deemed a security, has authority to regulate the spot markets in non-security cryptocurrencies like Bitcoin and Ether, although the CFTC has asserted its jurisdiction over fraud that occurs in this space.

Both the SEC and CFTC are prepared to take on an expanded role and oversee the entire crypto asset market but empowering either agency to do so would require new congressional legislation. This leaves open the question of whether regulation in the near term will simply consist of more of the same, that is, enforcement activity, perhaps with the release of some additional interpretive guidance.

The UK is similarly unlikely to take bold action, but that stasis is more calculated. The British government has taken the post-Brexit view that it should position the country as an attractive home for innovative FinTech businesses to ensure the UK’s and London’s continued primacy in a FinTech-led new financial world order. Whether HMT and regulators will await crisis or scandal before taking regulatory action or any moves by the US prior to deciding the right course to pursue, remains unclear. Stablecoins may be an exception to an otherwise slow-moving regulatory effort, since indications are that the UK may seek to create its own bespoke regime for stablecoins to foster innovation and business activity.

On crypto assets more generally, many tokens and other types of crypto assets (like CFDs over crypto) are already within the UK regulatory perimeter, but the FCA has been thus far reluctant in many cases to take action unless the relevant firm is already authorized, usually for non-digital assets related activity.

Financial crime regulation is already here

Beyond financial market regulation, digital assets are also clearly a focus for financial crime regulators globally. This was underscored by the October 28, 2021 release of the pan-national Financial Action Task Force’s (FATF’s) guidance on a risk-based approach to the regulation of virtual assets. The guidance incorporates DeFi and NFTs for the first time and will be a driver for updated financial crime regulations in FATF member states (including the UK and the US) over the coming year and beyond. Countries that have been content so-far to exercise a light touch approach towards the regulation of these technologies may feel spurred by FATF to adopt stricter measures than they otherwise would.

Digital assets are also clearly a focus for financial crime regulators globally.

For the UK’s part, it (like the EU) has already imposed AML obligations on crypto custodians / wallet providers and those providing services facilitating conversion of crypto to crypto and crypto to fiat. So the UK seems to be employing salami tactics to the regulation of the crypto world – slice by slice.

2022 promises to be a year of new regulation in one form or another – perhaps on multiple fronts. While the ultimate scope of regulation may be as broad as advertised, nothing is certain. Moreover, the increasing interest shown by the institutional sector in digital assets and cryptocurrencies may well lead to the creation and adoption of industry inspired standards (at least in wholesale markets to begin with), which borrow significantly from the principles of regulation already present in the mainstream financial services sector.

It is therefore critical for businesses in this space to stay on top of regulatory developments and to engage constructively with regulators, law makers and other market participants. Turning a blind eye to the impending regulatory tide will not be a sensible option.

Financial Markets Regulation is supposedly coming and the shape is not yet clear – in US or UK.

CONCLUSION

Over the next 12 to 18 months, we expect to see participants in the digital assets ecosystem adapting and responding to these regulatory challenges in order to manage effectively the various risks arising from their business models. But how many players will be able to survive, let alone thrive, once regulation of the sector starts taking proper shape?

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MEET THE AUTHORS

ASHLEY EBERSOLE

Partner, Washington

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DANIEL CSEFALVAY

Partner, London

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This document provides a general summary and is for information/educational purposes only. It is not intended to be comprehensive, nor does it constitute legal advice. Specific legal advice should always be sought before taking or refraining from taking any action.

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