Financial Markets
Simon Treacy, Linklaters

Simon Treacy, Linklaters

More regulation of crypto assets was already in the pipeline but the recent turbulence in crypto markets has raised the stakes. The coming year will be pivotal as new restrictions start to apply to crypto asset businesses and the path is laid for further regulation in the years to come. By Simon Treacy, senior associate in the Financial Regulation team at Linklaters.

Although often described as a ‘Wild West’, crypto asset markets are not entirely unregulated. Securities laws may apply to crypto assets that provide rights and obligations akin to shares and other financial instruments. Crypto derivatives typically fall within existing regulatory regimes. Some jurisdictions also apply anti-money-laundering (AML) rules to crypto asset businesses, following advice from the international Financial Action Task Force (FATF). In the EU and UK, for example, crypto asset exchange providers and custodian wallet providers must register with national regulators for the purposes of AML supervision.

Licensing changes

In 2023, crypto regulation moves into a new phase. Several jurisdictions are looking beyond AML and towards a more comprehensive regulatory regime for a wider range of crypto asset issuers and service providers.

Perhaps counter-intuitively, progress on these efforts may slow down rather than speed up. In some cases plans for regulation have been delayed while policy-makers respond to recent market developments. However, added impetus to act will come when the international Financial Stability Board finalises its recommendations for crypto regulation and when the EU’s Markets in Crypto Assets Regulation (MiCA) becomes law in spring 2023.

MiCA prioritises the regulation of stablecoins, i.e. crypto assets which aim to maintain a stable value relative to other assets. Restrictions on the issuance of stablecoins in the EU will start to apply before other aspects of MiCA, from spring 2024. Caps on volume could be used to freeze out some prominent dollar-denominated stablecoins from the EU. Licensed stablecoin issuers must provide holders with a right of redemption which can be exercised at any time, putting issuers’ stabilisation mechanisms to the test.

MiCA also establishes a licensing regime for crypto asset service providers. Custody, trading, exchange and advice services are among those which will become regulated in the EU. Anyone seeking to provide these services must have a registered office in the EU, obtain a licence and comply with MiCA’s extensive rules. These aspects of MiCA apply from autumn 2024 but transitional measures mean that some firms may not need to start complying until 2026.

It remains to be seen whether MiCA will be adopted as a regulatory blueprint by other jurisdictions as they try to strike a balance between mitigating risks and fostering innovation. The UK is among those preparing legislation which would allow the government and regulators to devise a crypto asset regime. This will bring stablecoins used as a means of payment into the regulatory net but also anticipate introducing rules on investor protection, market integrity and governance for unbacked crypto assets as well. At a high level this is consistent with MiCA, but there will be important divergence in the detail.

Crypto asset promotions

Pending changes to the licensing framework, restricting how crypto assets are advertised, are an opportunity for regulators to mitigate potential consumer harm in the sector. Some regulators, for example in Singapore and Spain, have already clamped down on how crypto assets are advertised. Others, like the UK, plan to extend their financial promotions regime to apply to a wide range of crypto assets. Seen by some as licensing regulation by the back door, these reforms could make crypto marketing significantly harder.

For example, in the UK the FCA has indicated it will apply its rules for high-risk investments to crypto asset promotions, regardless of how risky any given crypto asset may be. This will allow for the mass marketing of crypto assets to retail consumers but only subject to restrictions. These restrictions will bring more ‘friction’ into the consumer journey, such as personalised risk warnings and a 24-hour cooling-off period for first-time buyers. The explicit aim of these measures is to make more consumers drop out of the process.

More AML rules

For many crypto asset businesses, the main regulatory challenge for 2023 will be starting to comply with the so-called ‘travel rule’. This is a requirement for intermediaries in crypto asset transfers to share additional information about the parties to the transaction. The rule is now being introduced in several jurisdictions following FATF recommendations.

UK crypto asset exchange providers and custodian wallet providers must make sure they have systems in place to share this information by September 1, 2023. For crypto asset service providers in the EU, the implementation timeframe for the travel rule is aligned with MiCA. Putting in place the technology to ensure compliance with these incoming rules will become another cost of business.

The outlook

Higher regulatory standards may embolden regulated firms, such as banks, to participate more in crypto markets, especially as demand for trustworthy intermediaries increases. Market abuse rules, such as those found in MiCA, may also help build consumer trust in the market.

Whatever happens next, crypto asset businesses around the world face an increasing regulatory burden. Some welcome regulation as providing more legal certainty and helping to stabilise confidence in the sector. However, more regulation also means crypto asset businesses must prepare to face ever-higher compliance costs while navigating choppy market conditions.

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