CRYPTO REGULATIONS ARE CHANGING: CAN YOU KEEP UP?

June 17, 2024 | Amy Patel, Legal Analyst, Market Data Services

The rapid growth of the global cryptocurrency market in recent years has highlighted the inadequacies of current financial policies in addressing the unique characteristics of digital assets. This has led to a global push to develop a new regulatory framework for crypto. As expected, countries have taken varying approaches. India, for instance, has been skeptical and implemented strict regulations, while China has gone as far as banning cryptocurrency on the mainland. Conversely, markets like the U.S., Japan, and the EU, have embraced the industry. Ironically, despite crypto being known for its decentralized nature, there is no denying that the world is racing to create regulations. Without proper regulations, the crypto markets face increased risks of fraud and misconduct, potentially undermining investor confidence and market reliability.

The U.S. Securities and Exchange Commission (SEC) has faced heavy criticism for its “regulation-by-enforcement” approach, which has proven inadequate for digital assets. Such an approach has been compared to playing a game without knowing the rules. It creates uncertainty by developing laws on a case-by-case basis, lacking the specificity and clarity the crypto industry needs. While the SEC argues that most digital assets are similar to traditional securities, many lawmakers and industry experts believe that existing securities laws are ill-equipped for digital assets.

Many crypto businesses do not operate as traditional companies do, making current securities law inadequate to apply. These businesses face unique challenges in complying with current U.S. regulations for reporting because, unlike traditional companies, they are not controlled by single entities, rather they operate through a decentralized governance structure involving various stakeholders. Additionally, blockchain networks often have global participation, adding another layer of complexity to complying with U.S. regulations, as contributors and investors are spread across different jurisdictions with varying legal requirements.

Furthermore, crypto-related businesses in the U.S. are considered money transmitters and must obtain a money transmitter license (MTL) to operate. However, MTL varies by state, requiring crypto businesses to navigate a complex web of regulations and licensing requirements across all fifty states. The current U.S. approach to crypto is disorganized, complicated, and lagging. The government and industry leaders have acknowledged a need for a coordinated federal approach.

The European Union Approach

Across the Atlantic, in April 2023, the EU passed the Markets in Crypto Assets (“MiCA”) regulation, marking a historic milestone in harmonizing crypto asset regulations across member states. Similar to the regulatory process in the U.S., EU regulators initially attempted to apply existing financial regulations to the crypto industry but soon recognized the necessity of creating a new regulatory framework. MiCA’s primary objective is to simplify the current process for crypto companies aiming to enter the European market, which previously had to navigate the complex licensing and regulatory requirements of the individual nations. This harmonization is expected to result in lower operating costs, increased transparency, and greater trust in the overall market.

MiCA stands as the most comprehensive crypto regulation introduced by a leading jurisdiction. It has set a benchmark for crypto regulations, aiming to create uniformity and restore confidence. Receiving praise for its thoughtful regulatory approach, MiCA is set to become the gold standard for crypto regulations. It seems that the creation of a similar regulatory framework is only a matter of time in the U.S.

U.S. Regulatory Updates

Back in the U.S., the government is making significant progress towards a coordinated federal approach for digital assets. In a notable development, on May 24, 2024, the House passed The Financial Innovation and Technology for the 21st Century Act (FIT 21) with bipartisan support. FIT 21 is the latest congressional effort to establish a comprehensive framework for digital assets. The bill aims to enhance market oversight and protect consumers. FIT 21 categorizes digital assets into three groups: digital commodities, restricted digital assets, and permitted payment stablecoins. It allocates regulatory responsibilities between the Futures Trading Commission (CFTC) and SEC, with the CFTC overseeing digital commodities and the SEC regulating digital assets that are part of an investment contract.

The legislation emphasizes consumer protections through stringent disclosure requirements for digital asset developers and customer-serving instructions. FIT 21 represents a historic step towards providing regulatory clarity for digital assets, with a focus on transparency, accountability, and consumer protection. As the need for a robust regulatory framework for digital assets becomes increasingly apparent in the U.S., it is equally clear that the country has lagged in leading global efforts to carve out these changes.

The Importance of a Business Plan

Globally, the primary focus for regulators is to eliminate the risks of money laundering and fraud within crypto markets. While Washington continues to debate the best approach for regulating digital assets, it is imperative for firms to invest in and establish a solid foundation.

Firms considering entrance into the digital asset trading market should consider engaging an experienced partner who can assist them with navigating the FINRA New Member Application process and associated registration requirements. Jordan & Jordan can assist with addressing many aspects of the application process, in addition to assisting firms in establishing the required control functions that FINRA will require including surveillance, oversight and regulatory reporting. Firms are also advised to conduct a thorough risk assessment, which will allow for the identification of the proper written supervisory procedures and related controls that will be necessary to support the business.

Early implementation of strong security measures, risk management protocols, and comprehensive reporting practices will significantly benefit businesses. Digital assets inherently come with heightened security risks, such as financial crimes, hacking, and fraud. Robust security monitoring and reporting not only enhances business operations but also builds customer confidence, attracts investors, and creates overall efficiency. To ensure success, seeking expert guidance is crucial. Experts can equip crypto firms with essential tools to help provide a solid foundation and prepare for the inevitable regulatory changes. These tools include:

  • Business Plan Consultation
  • FINRA Registration
  • Trade Surveillance and Trade Reporting (TRF/ORF and CAT)
  • Controls covering FINRA 3120/3120 (Risk Assessment and CEO Certifications)
  • Written Supervisory Procedures (WSP)

Again, Jordan & Jordan can help draft procedures specific to the firm’s business and risks and provide guidance to aid the firm in developing an effective surveillance program, robust supervisory structure, thorough and accurate order and transaction reporting processes, and compliance framework. In summary, we strongly encourage crypto businesses to prioritize the creation of a robust business plan considering current regulatory requirements and proactively preparing for forthcoming changes.