# Regulating Cryptocurrencies and the Investors’ Search for Clarity

Few regulations around cryptocurrencies exist but institutional investors, already wary of fully entering the market, want countries to provide clear statements laying out how these new assets will be treated. By Emilia David

In the institutional space, regulatory bodies have taken a soft touch when it comes to cryptocurrencies has stunted adoption, but Facebook’s proposed virtual currency, Libra, has helped to put the spotlight back on digital asset regulation.

The US, like most large economies, has been cautious in releasing regulations governing cryptocurrencies and their derivatives. While most countries have not enacted policies around these instruments, institutional investors are still interested in entering the cryptocurrency market and diversifying their investments. Some countries, particularly smaller economies, have managed to come up with a few rules, but there has not been a large take-up in many of the more established economies yet.

Institutional investors, however, have made it clear that their interest is not solely defined by regulation friendly to digital money and are seeking clarity from regulators in defining these assets. Investors see adoption of cryptocurrencies growing if regulators can say with certainty that financial instruments backed by these instruments are legal and fines will not be levied retroactively. Market participants agree there is no single regulatory model from other countries to follow, but that any rule coming out should ensure the assets and the investing process are clearly defined.

Ricky Li, founder of crypto-trading firm Altonomy, says institutional investors prefer clear definitions coming from regulators so risk is mitigated and they are assured they have legal cover.

“I don’t think it matters how lenient or strict regulations are to attract more institutional investors; it really depends on clarifications of definitions,” Li says. “The market will still be there even if it is a strict market. Investors shy away from assets if there is a lot of risk around it, which normally means there is no clear guidance on how they can avoid risk.”

He adds any regulatory gray areas around how an asset is defined is where the potential risk comes in, as investors can take advantage of loopholes or aren’t able to fully manage their risk tolerances.

There is a perception that countries with friendly cryptocurrency regulations attract more investment, but traders point out that it’s not the regulation, itself, that lures digital-currency companies to set up shop, but rather these countries have laid out how they will treat the assets. Companies then feel more comfortable that regulators will not turn around and tell them they should treat these assets differently.

Complicated Markets

In the US, cryptocurrencies fall under three different potential regulatory frameworks: as a commodity and a futures contract, a security through an initial coin offering (ICO) or an exchange-traded fund, or as currency traded for other digital currencies on an exchange.

The US has yet to fully enact rules around cryptocurrencies, which is partially due to the fact that it has somewhat of a complicated regulatory regime. The Commodity Futures Trading Commission (CFTC) focuses on the commodities and futures market while the Securities and Exchange Commission (SEC) oversees the securities market. Each state also has the ability to lay out additional rules, particularly for companies that move money—for example, New York requires a BitLicense for any firm that wants to trade crypto-to-crypto.

Laurian Cristea, general counsel of cryptocurrency derivatives exchange ErisX, says the complicated regulatory environment in the US proves how hard it can be to lay out regulations in the country.

“The regulatory environment in the US is complicated—the states don’t substantively regulate and on the federal side, it’s bifurcated on the part of securities and futures regulators. It’s a testament to the approach of the CFTC that they looked at their core principles and rules and figured out how these can be extended to cryptocurrencies. They gave entities a path to comply with their principles and as a result we’ve seen a lot of new licenses and products announced,” Cristea says.

He adds that “the SEC is taking its time, and currently the market is awaiting the same degree of certainty from SEC’s guidance.”

The CFTC declared in 2014 that it believes some cryptocurrencies are commodities and therefore fall under its jurisdiction. It also clarified that futures contracts based on cryptocurrencies—particularly bitcoin—may be self-certified by exchanges. This allowed the CME Group and the CBOE Futures Exchange to self-certify and start trading bitcoin futures in 2017.

The SEC, on the other hand, has not yet released final guidance on cryptocurrencies in terms of whether they trade as normal securities or something different. The regulator did provide clarity on ICOs and has begun fining ICOs that break its rules. The SEC has not yet released any rules on cryptocurrency exchange-traded funds (ETFs). Its most recent release around cryptocurrencies dealt with the custody and clearing of cryptocurrency securities and other digital tokens, though some market participants believe the statement still did not provide enough clarity on post-trade processes for digital assets.

Cristea points out that institutional investors want much more clarity from regulators because they have a fiduciary duty unlike retail investors, which are the lifeblood of cryptocurrency trading.

“In retail, it’s the individual involved who makes decisions based on their own risk profile, but when it comes to institutional investing, most have a fiduciary duty and institutional investors cannot take undue risks, so there are additional due diligence and [risk] factors involved in transacting in crypto, which is why institutions need clarity and certainty,” says Cristea.

Despite the lack of clarity around cryptocurrencies, some are still founding brokerages, exchanges and trading venues, sometimes in the US. Established firms like Eris Exchange and trueEx incubated trading venues like ErisX and trueDigital. But many of these firms do exercise an abundance of caution by applying for licenses. In many cases, companies decide to move their operations to a country that has more legal cover.

While there is no single model to follow in terms of regulations, market participants do believe countries like the US that are still figuring how best to provide guidance for use of cryptocurrencies can take best practices from first-mover jurisdictions.

Small Size, Big Influence

Much has been said about the more crypto-friendly countries like Malta—where many of the largest cryptocurrency exchanges by volume are registered—which have managed to attract businesses around digital assets.

Two jurisdictions in particular, Malta and the Seychelles, were of interest to market participants. Both are smaller countries and therefore tend to move more quickly around innovations like cryptocurrencies. Asian countries have also traditionally embraced things like crypto, though regulatory actions around it in the region have ranged from easing requirements to outwardly banning the trade of cryptocurrencies, as China did in 2017.

According to a report from crypto data provider Crypto Compare, Malta-registered exchanges traded the largest chunk of cryptocurrencies in the world at $56.1 billion in March 2019, followed by Hong Kong at$53.1 billion and South Korea at $40.2 billion. Other countries have also begun moving forward with cryptocurrency trading by releasing their own rules aimed at providing more transparency and accountability. The Monetary Authority of Singapore (MAS) said in 2017 that it must approve the trade of digital assets by an exchange, and before virtual currencies can be traded, exchanges must verify identities of customers. In April of this year, France announced it has approved its own rules around crypto trading, which came into force in July. Under French rules, crypto companies have to agree to follow capital requirements, identify a legal entity responsible for the issuance of the crypto offering and pay taxes in the country. Another way countries and territories have tested out regulations around cryptocurrencies is to set up regulatory sandboxes. Hong Kong, for example, explored sandboxes that would experiment by allowing crypto exchanges to opt in and follow conceptual rules. Regulators in Hong Kong came out with rules stipulating only professional investors—those with at least HK$8 million in assets—can participate in the market and funds investing in digital currencies must be licensed by Hong Kong’s Securities and Futures Commission (SFC). Trading platforms in Hong Kong must join the sandbox while they are negotiating with the SFC on licensing requirements.

But sandboxes have to provide some legal cover for companies that they can’t be retroactively fined later. And conversely, Altonomy’s Li points out that if a sandbox is too restrictive and unclear, there may not be a lot of take-up from companies.

Li says it’s a good idea to look at the kinds of rules released by other countries and figure out how to implement something similar, or cherry-pick the best ideas for an individual market.

“Singapore and France kind of have a trial period [for rules], while the US is in a wait-and-see pattern. Either way, you do it, just adopt a position. I don’t think the US is lagging, but it is looking around at the other policies being enacted,” he says. “Participants will always adapt to the market, but it’s best to provide best practices. Sometimes companies have an overabundance of caution and get every possible license there is and that can get expensive.”

Of course, regulation is just one of the issues concerning institutional investors when it comes to virtual currencies.

Market participants, though, in search of clarity coming from regulatory bodies, know there’s a reason why these rules are not yet forthcoming. Mike Belshe, CEO of digital wallet and custody provider BitGo, says it’s understandable that some countries have not even come out with definitions for how they will treat these assets because they’re grappling with something fundamentally different from how money and traditional assets move.

“Regulators globally are still trying to understand and grasp what cryptocurrencies are and how they behave,” Belshe says. “They’re used to a world where there are borders and it’s easy to contain assets that trade in their jurisdiction, but cryptocurrencies don’t work that way. Each country has different rules—the US is known for strong regulatory enforcement while some countries, say in Asia, are not.”

But even if investors understand why some countries are taking their time to provide clarity around cryptocurrencies and its derivatives, many market participants still want regulators to offer more information so they can best plan how to go about their business.

Extending Current Rules

In light of the potential to glean best practices from around the globe, some market participants have even started groups that call for the sharing of cryptocurrency policies and creating harmonized standards, as most cryptocurrency trades cross borders.

Simon Taylor, co-founder of Global Digital Finance, a group that is working on harmonized regulations, points out a huge part of promoting cryptocurrencies is to ensure cross-border trades are recognized and treated in accordance with traditional policies. He says he does accept that more countries first have to figure out how they are going to define cryptocurrencies.

There is also a possibility that regulators may not even have to come out with any new definitions at all. Cristea says a possible—and easier—path to clarity is extending existing regulations to cover cryptocurrencies and declare them as assets that function a lot like traditional assets.

“What investors want to hear from regulators is clarity and certainty—to know that what they need to do to comply and the regulators won’t turn around and tell them to materially change or shut down. So regulators either have to make new rules or extend the ones we currently have,” Cristea says. “The regulations are there and I believe that cryptocurrencies are an asset class that fits within existing regulations. It’s really in the interpretation of the regulations in light of the specific characteristics of the asset class that needs to be spelled out.”

Perhaps the greatest worry, though, is that as more time passes, it will lead to more knee-jerk-reaction regulations. The US House of Representatives held a hearing on Facebook’s Libra in July and is considering drafting a law that would regulate digital currencies and limit possible harm to consumers. The idea of the US House of Representatives leading the charge on regulation might not be the most comforting idea for many in the crypto space.

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