The year 2023 comprised of a whirlwind of events in the crypto asset space. From crashes[i] and panics[ii], to the imposition of a number of significant regulatory fines[iii], the growth in value and use of certain crypto assets, and the rise and fall of various participants within the sector. This year has also seen increased discussions, and regulatory steps[iv] taken, to manage and mitigate growing risks arising from the conduct of crypto asset activities.
Below are five notable areas that were the focus of (crypto asset) regulatory developments in 2023.
1. Crypto Asset Activities and Markets (including crypto-asset issuers and service providers)
Several international standard setting bodies issued recommendations for the regulation of crypto asset activities and markets.
In July 2023, the Financial Stability Board (FSB) issued its finalized high-level recommendations on the global regulatory framework for crypto-asset activities to “promote the comprehensiveness and international consistency” of regulatory and supervisory approaches[v]. The Report covered key matters such as: (a) the regulatory powers and tools that should be available to authorities for the supervision of crypto asset activities, (b) the need for a comprehensive regulatory framework, (c) cross border cooperation, coordination and information sharing, (d) governance, (e) risk management, (f) data collection (including recording and reporting), (g) disclosures, (h) financial stability risks as it relates to interconnections and interdependencies; and (i) comprehensive regulation of crypto-asset service providers with multiple functions. In its November report[vi], the FSB further examined multifunction crypto asset intermediaries[vii].
The International Organization of Securities Commissions (IOSCO) in its November 2023 report provided policy recommendations for Crypto and Digital Asset Markets which focused on the regulation of, and matters arising from[viii], the conduct of crypto-asset activities[ix]. It covered six key areas: namely, (a) conflicts of interest, (b) market manipulation, insider trading and fraud, (c) cross-border risks and regulatory co-operation, (d) custody and client asset protection, (e) operational and technological risk, and (f) retail access, suitability, and distribution.
The International Monetary Fund and the FSB also issued a synthesis paper[x] that essentially summarized pertinent macroeconomic, financial stability risks and other areas (such as legal, financial integrity and market integrity related risks) associated with crypto-assets and provided policy recommendations and standards for authorities to address same.
In addition to recommendations from standard setting bodies, this year saw key legislation/regulations for crypto asset markets, from various jurisdictions, come into force. For example, the European Union’s Market in Crypto Asset Regulations (MiCA) entered into force in June 2023, and is intended to address inter alia, consumer protection, market transparency, and operational standards for crypto-asset service providers and issuers within the European Union[xi]. It is noted that the full implementation of MiCA involves a transitionary process[xii]. Dubai’s Virtual Assets Regulatory Authority also introduced the Virtual Assets and Related Activities Regulations 2023[xiii], which were underpinned by fundamental principles such as market integrity and stability, consumer protection, technology neutrality and innovation support, regulatory resilience, efficiency and proportionality.
Other jurisdictions[xiv] such as Hong Kong, adopted legislation for the licensing and supervision of virtual asset (VA) trading platform operators. In the British Virgin Islands, the Virtual Asset Service Providers Act came into force in February[xv]; while Korea, introduced its Virtual Asset User Protection Act in July 2023 designed to regulate the virtual asset market, primarily from a consumer/investor protection perspective[xvi].
Various stakeholders have also added their voice to the ongoing discussion on the regulation of crypto asset markets. For example, the World Economic Forum published its white paper in May 2023 titled "Pathways to the Regulation of Crypto-Assets: A Global Approach” which discusses, among other things, ‘a non-exhaustive list of prioritized pathways for international organizations, national authorities and industry actors to consider in evolving a coordinated approach’[xvii].
2. Stablecoins
Stablecoin regulation[xviii] was also the subject of much discussion this year[xix].
The FSB finalized its recommendations on global stablecoin arrangements[xx] in July which is intended to address potential financial stability risks at a domestic and international level. Similar to its report on the global regulatory framework for crypto-asset activities, it highlights key elements that ought to be in place for the appropriate regulation and supervision of global stablecoin arrangements, including the need for adequate stabilization mechanisms, effective redemption rights for users, as well as suitable recovery and resolution plans.
The Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI) issued a report in October which examined the use of stablecoin arrangements (SAs), if properly designed, regulated, and compliant for the enhancement of cross border payments[xxi].
On December 7, the Basel Committee announced its intention to consult on potential revisions, relevant to the criteria for stablecoins, as it applies to "Group 1b" regulatory treatment[xxii] and subsequently published for consultation proposed adjustments in that regard[xxiii].
Notable developments on the implementation of legislation, in various jurisdictions, include: the EU’s MiCA[xxiv] which covers, inter alia, two types of stablecoins, asset referenced tokens[xxv] and electronic money tokens[xxvi]; Japan’s amendments to the Payment Services Act (PSA) and other relevant laws[xxvii] coming into force to address the regulation of stablecoins; Singapore's proposed stablecoin legislation[xxviii]; the UK's expansion of regulatory coverage for stablecoins (to be covered via two phases)[xxix], the Bahamas’ proposed amendments to the Digital Assets and Registered Exchanges (DARE) Act[xxx] for stablecoin arrangements; and Hong Kong’s proposed legislation for the regulation of fiat-backed stablecoins[xxxi].
3. Decentralized Finance
The regulation of Decentralized Finance (DeFi) remains a controversial area as regulators continued to grapple with the most appropriate approach for this innovative manner by which financial services are conducted.
In the first half of 2023, the FSB issued a report examining the financial stability implications of DeFi[xxxii]. The report highlighted DeFi vulnerabilities such as, operational fragilities, liquidity and maturity mismatches, leverage and interconnectedness, and notes that the extent to which such vulnerabilities can lead to financial stability implications is largely dependent on “the interlinkages and associated transmission channels between DeFi, TradFi and the real economy[xxxiii]”. The FSB concluded by noting that, to date, interlinkages between DeFi, TradiFi and the real economy appear limited[xxxiv], but emphasized the need to continue to measure and monitor vulnerabilities. It is also the FSB’s intention to explore the extent to which its policy recommendations for the regulation of crypto asset activities may be enhanced for DeFi-specific risks and to facilitate the enforcement of rules (which includes considerations such as whether additional prudential and investor protection requirements may be required for entities involved).
In the second half of 2023, IOSCO issued a consultation report on Policy Recommendations for DeFi[xxxv], which was recently finalized[xxxvi]. The report focuses on market integrity and investor protection issues that arise from the conduct of DeFi activities with a focus on DeFi products, services, and arrangements. In that regard, it covered areas such as (i) DeFi arrangements and structures, (ii) achieving common standards of regulatory outcomes, (iii) identification and management of key risks, (iv) clear, accurate and comprehensive disclosures (v) enforcement of applicable laws, (vi) cross-border cooperation[xxxvii], and (vii) understanding and assessing interconnections. Key points emphasized include the need for regulators to understand the DeFi market (including the financial products and services offered), the identification of those providing these products and services and the applicability of regulatory obligations.
The above recommendations are considered, by many, to be a useful starting point in determining the applicability of traditional regulatory obligations [to usually identifiable entities] to an ecosystem where such entities do not exist[xxxviii].
While most jurisdictions continue to deliberate on an appropriate approach to the regulation of DeFi, some have attempted to address specific aspects. For example, in November, the Abu Dhabi Global Market (ADGM) enacted regulations and rules for Distributed Ledger Technology Foundations[xxxix] which covers Decentralized Autonomous Organizations (DAO) and other distributed ledger technology (DLT) entities that facilitate DLT activities, including token issuances. The DAO model is a key element of the DeFi ecosystem.
From a private sector’s view, the Crypto Council for Innovation (CCI) issued a paper in October 2023[xl] which recommends a regulatory approach to DeFi that takes into account financial safety and soundness concerns, financial stability risks and consumer protection issues. The paper offers a different perspective on regulation recommending that the approach of regulators should be based on the principle “same activity, different risk, different regulation but same regulatory outcome”. In that regard, the CCI suggested that mandatory disclosure requirements “for app-operating businesses”, the establishment of an Independent Certification Regime Organization to certify Public Good Protocols, and the implementation of a regulatory safe harbor should be the focus for regulators, in order to safeguard consumers and foster the responsible development of DeFi technologies.
4. Financial Crime Mitigation
This year, the Financial Action Task Force (FATF) continued its campaign for the implementation of its standards for virtual assets and virtual asset activities, including the travel rule[xli]. In its June report[xlii], it noted that global implementation of its revised standards was relatively poor (based on an assessment conducted which revealed that 75% of jurisdictions appeared to be only partially or non-compliant[xliii]). The report provided recommendations for the public and private sectors, including the need for the conduct of thorough risk assessments, the implementation of effective mitigation measures, the enforcement of appropriate licensing/registration frameworks, and suitable compliance approaches of private sector participants[xliv]. Focus was also placed on the travel rule (its introduction, implementation, and/or enforcement). The FATF intends to publish a table, in the first half of 2024, which will identify jurisdictional approaches to the implementation of its standards for VASP activities.
Despite FATF’s gloomy report on the implementation of its standards, it is noted that efforts are being made to implement AML standards for VASPs generally, as well as specifically in relation to the travel rule, in a number of jurisdictions. The UAE’s joint guidance on combating use of unlicensed virtual asset service providers in November is a useful example of attempts being made[xlv] to align elements of FATF’s standards.
The European Commission published the revised Transfer of Funds Regulation (TF Regulation) in the Official Journal of the European Union, which entered into force on 29 June 2023 but is intended to apply from December 30, 2024[xlvi]. The TF Regulation will apply to crypto-asset service providers (which includes financial institutions providing crypto-asset services), established in the EU, whether as an originator, beneficiary or intermediary of a transfer. It goes further than the FATF recommendations[xlvii] in imposing obligations on all crypto asset transfers, regardless of value.
The travel rule also became effective in the United Kingdom[xlviii], Hong Kong and Japan[xlix] (joining some of the other jurisdictions that have already taken actions in this regard[l]). Recently, in December, the ADGM’s Financial Services Regulatory Authority also updated its AML rulebook relating to wire transfers in order to provide greater clarity that the travel rule applies to virtual assets[li].
Based on the approaches adopted thus far, one notable challenge with the global implementation of the travel rule may lie with the inconsistency in thresholds adopted by various jurisdictions, which may arguably provide opportunities for regulatory arbitrage.
Regulatory enforcement actions against VASPs became a heightened topic of discussion this year, particularly following the imposition of a $4.3billion fine on Binance, for inter alia, engaging in money laundering, unlicensed money transmitting and sanctions violations- which appears to be one of the largest fines to date. Earlier in the year, Coinbase agreed to pay a $50 million fine, when the New York Department of Financial Services determined that it failed to track, monitor, and report suspicious activity that may have, and in some instances did, result in illegal activity[lii]; and another $50 million to improve its AML and sanctions compliance program. Several other crypto entities faced enforcement actions in the US in relation to AML breaches[liii].
5. Taxation relevant to crypto asset activities
In July 2023, the International Monetary Fund issued a working paper on Taxing Cryptocurrencies[liv] which delves into issues for consideration relevant to the development of a tax regime for crypto assets[lv]. While the paper does not provide specific policy prescriptions, it highlights key matters that will need to be addressed by authorities in designing a suitable tax regime. For example, the taxing of crypto assets that are sold for profit and for crypto used for purchases, etc[lvi]. The IMF notes the importance of developing clear, coherent and effective frameworks for taxing crypto.
Crypto taxation laws came into force this year in various jurisdictions. For example, In Italy the Budget Law 2023, introduced a new system for the taxation of cryptocurrencies. Portugal’s crypto tax regime also came into force. Under the Portuguese Personal Income Tax Code, income from crypto qualifies as capital, capital gains, or self-employment income for the purposes of tax. In Brazil, the senate approved new income tax regulations for the payment of taxes in relation to earnings obtained from crypto assets held on foreign exchanges[lvii], which is expected to come into force in 2024.
In November 2023, a collective statement was issued by 48 countries committing to implement the OECD’s crypto asset reporting framework[lviii] by 2027[lix].
Conclusion
2023 was a year full of crypto asset regulatory developments, from recommendations issued by standard setting bodies to legislation being implemented by various jurisdictions, crackdowns for breaches of regulatory rules and the exploration of the regulation of novel crypto asset activities. The growth and popularity of the crypto asset sector, and the myriad of evolving nuanced related activities, has drawn the attention of regulators concerned to address growing risks emanating from this still nascent sector.
In the year ahead, we can expect to see more countries implementing legislative frameworks that align with international standards, increased AML actions (including the implementation of FATF standards), as well as a continued focus on regulating stablecoins and DeFi activities, among other things.
For most, crypto asset regulatory developments that offer clarity are generally welcome. One key message from 2023 that should resonate with regulators, is the need to understand the peculiarities of this evolving sector in determining appropriate regulatory approaches; and guard against the urge to use traditional tools (without careful consideration) to address differing and nuanced risks, while attempting to achieve similar regulatory outcomes.
References
[i] See for example this Binance article that discusses the August 2023 crash of certain crypto assets: https://www.binance.com/en/feed/post/993402
[ii] The mass withdrawals by crypto/tech investors in March 2023 (who were facing financial issues of their own) was noted as one of the contributors for the decline of certain US Banks like Silicon Valley Bank and Silvergate.
[iii] Examples can be found through the following links: ‘Beware: Increasingly Aggressive Enforcement Actions in the Crypto Asset Industry Puts Companies on Notice’- https://www.wsgr.com/en/insights/beware-increasingly-aggressive-enforcement-actions-in-the-crypto-asset-industry-puts-companies-on-notice.html, US SEC Crypto Assets and Cyber Enforcement Actions- https://www.sec.gov/spotlight/cybersecurity-enforcement-actions , ‘Open Exchange Fined $2.7 Million for UAE Crypto Violations’- https://www.pymnts.com/cryptocurrency/2023/open-exchange-fined-2-million-dollars-uae-crypto-violations/.
[iv] Example the implementation of MiCA, the VARA regulations, and Hong Kong updated regulations, etc.
[v] https://www.fsb.org/2023/07/high-level-recommendations-for-the-regulation-supervision-and-oversight-of-crypto-asset-activities-and-markets-final-report/
[vi] The Financial Stability Implications of Multifunction Crypto-asset Intermediaries, https://www.fsb.org/wp-content/uploads/P281123.pdf.
[vii] The objective of the report was to “analyse the structure and functioning of MCIs, with the aim of assessing relevant financial stability risks, including key information gaps that complicate those assessments, and deriving implications for policy consideration”. The report concluded that the threat to global financial stability and to the real economy from the failure of an MCI is limited at present but noted that a full assessment on financial stability implications is impaired by the information gaps/lack of full data.
[viii] such as market integrity risks and the need for appropriate investor protection.
[ix] IOSCO’s report is intended to cover the range of activities in crypto-asset markets that involve crypto asset service providers, including activities such as offering, admission to trading, ongoing trading, settlement, market surveillance and custody as well as marketing and distribution.
[x] https://www.fsb.org/2023/09/imf-fsb-synthesis-paper-policies-for-crypto-assets/
[xi] “Key provisions for those issuing and trading crypto-assets (including asset-reference tokens and e-money tokens) cover transparency, disclosure, authorisation and supervision of transactions. The new legal framework will support market integrity and financial stability by regulating public offers of crypto-assets and by ensuring consumers are better informed about their associated risks”: per ESMA- click here.
[xii] Expected to take place over the period 2023-2026.
[xiii] See https://media.umbraco.io/dwtc/5kflvzto/virtual-assets-and-related-activities-regulations-5june2023.pdf . It should be noted that VARA also introduced four compulsory rulebooks, seven activity-specific rulebooks, and a virtual asset issuance rulebook (the “Rulebooks”). See article, ‘VARA’s Strict Application of its Virtual Assets and Related Activities Regulations 2023’, which discusses same: https://www.globalinvestigations.blog/technology/varas-strict-application-of-its-virtual-assets-and-related-activities-regulations-2023/
[xiv] Another example is the Brazilian law for crypto assets which came into effect in June 2023. See https://www.ibanet.org/Brazilian-legal-and-regulatory-framework-on-virtual-asset-service-providers
[xv] https://bvi.gov.vg/media-centre/statement-honourable-smith-update-financial-services-supervision-and-compliance
[xvi] ‘Korea: the current regulatory landscape for crypto assets’ https://www.iflr.com/article/2c7n2o4rfmoya8grn7cw1/features/korea-the-current-regulatory-landscape-for-crypto-assets
[xvii] https://www3.weforum.org/docs/WEF_Pathways_to_the_Regulation_of_Crypto_Assets_2023.pdf
[xviii] Including its treatment for the purpose of the supervision of financial services.
[xix] For a more in-depth read on stablecoin regulation, please see my previous article: Stablecoins: Relevance and Regulation
[xx] https://www.fsb.org/2023/07/high-level-recommendations-for-the-regulation-supervision-and-oversight-of-global-stablecoin-arrangements-final-report/
[xxi] https://www.bis.org/cpmi/publ/d220.pdf. The Report concludes that no stablecoin arrangements yet exist that are considered be properly designed, regulated and fully compliant with all relevant regulatory requirements. Furthermore, even if such stablecoin arrangements did exist, there may be considerable drawbacks that could outweigh the potential benefits for cross-border payments.
[xxii] click here.
[xxiii] https://www.bis.org/press/p231214.htm . “The proposals flesh out the criteria on the composition of the reserve assets that back stablecoins, covering issues such as the credit quality, maturity and liquidity of the reserve assets. The requirements determine whether the stablecoins to which banks' may be exposed will be eligible for inclusion in the Group 1b category of cryptoassets, and thus benefit from a preferential regulatory treatment”.
[xxiv] MiCA requires stablecoin issuers to be authorised to issue or admit stablecoins for trading. Key requirements regarding stablecoins also include the publication of an approved white paper by issuers as well as conduct and prudential obligations for those involved in stablecoin issuance or arrangements.
[xxv] which are crypto assets backed by reserve assets comprised of fiat, various commodities and/or several crypto assets, to maintain a stable value.
[xxvi] (i.e. crypto assets backed by a single fiat currency to maintain the asset’s stability)
[xxvii] Including the Act on Prevention of Transfer of Criminal Proceeds, Financial Instruments and Exchange Act (“FIEA”), the Banking Act, and other statutes all enacted on June 3, 2022 and effective in June 2023. The amendments are meant to, inter alia, promote financial innovation, ensure user protection, manage financial stability risks and AML/CFT compliance.
[xxviii] Which is intended to cover issuers of MAS-regulated stablecoins, under a new, single-currency stablecoin framework. See: https://www.mas.gov.sg/news/media-releases/2023/mas-finalises-stablecoin-regulatory-framework
[xxix] Phase 1 regulatory regime will cover, inter alia, fiat backed stablecoins. Phase 2 of the UK’s regulatory approach would address on chain and algorithmic stablecoins, as well as commodity backed stablecoins, among other things. See also the Bank of England’s website for more discussions on the regulation of stablecoins for payment services, etc: https://www.bankofengland.co.uk/paper/2023/dp/regulatory-regime-for-systemic-payment-systems-using-stablecoins-and-related-service-providers
[xxx] Which is intended to address inter alia, requirements for registration, composition of reserve assets, custody, management and segregation in relation to stablecoins arrangements.
[xxxi] https://www.fstb.gov.hk/fsb/en/publication/consult/doc/Stablecoin_consultation_paper.pdf
[xxxii] https://www.fsb.org/2023/02/fsb-assesses-financial-stability-risks-of-decentralised-finance/
[xxxiii] These channels include financial institutions’ exposures to DeFi; confidence and wealth effects stemming from the involvement of households and firms in DeFi; and the extent to which DeFi applications may facilitate the use of crypto assets for payments and settlement.
[xxxiv] However, if the DeFi ecosystem were to grow significantly, then the scope for spillovers would increase.
[xxxv] https://www.iosco.org/library/pubdocs/pdf/IOSCOPD744.pdf
[xxxvi] https://www.iosco.org/library/pubdocs/pdf/IOSCOPD754.pdf
[xxxvii] The report notes the need for enhanced cooperation among regulators to coordinate and respond to cross-border challenges in enforcement and supervision, and to address regulatory arbitrage concerns, given the cross-border nature of crypto-asset activities.
[xxxviii] Arguably, at least not in a similar form.
[xxxix] https://en.adgm.thomsonreuters.com/rulebook/distributed-ledger-technology-foundations-regulations-2023
[xl] https://cryptoforinnovation.org/defi-regulatory-solutions-proposed-by-crypto-council/
[xli] The rule requires persons offering VA services to obtain, hold and transmit required originator and beneficiary information regarding crypto transactions, over a specified threshold, for the purpose of identifying and reporting suspicious transactions, among other things.
[xlii] https://www.fatf-gafi.org/en/publications/Fatfrecommendations/targeted-update-virtual-assets-vasps-2023.html
[xliii] FATF conducted 98 mutual evaluation and various follow-up reports and noted that three quarters of jurisdictions assessed (75%; 73 of 98) are only partially or not compliant with its requirements.
[xliv] Recommendations include, assessing existing risk management measures to ensure they are appropriate,
adopting an ecosystem-wide approach to risks (that ought to include DeFi, unhosted wallets, etc), and maintaining effective communication with regulators in understanding and addressing risks.
[xlv] https://www.thenationalnews.com/business/banking/2023/11/06/uae-issues-guidance-on-combating-use-of-unlicensed-virtual-asset-service-providers/
[xlvi] Ancillary to the TF Regulation, the EBA issued a Final Report On Amending Guidelines On The Risk-Based Supervision Under Article 48(10) Of Directive (EU) 2015/849, which is intended to foster a common understanding of the risk-based approach to the AML/CFT supervision of crypto-asset service providers and how it should be applied.
[xlvii] FATF Recommendation 16 suggests implementing that obligation for crypto-asset transfers in excess of €1.000.
[xlviii] On 1 September 2023, the Travel Rule requirements for cryptoassets1 came into force in the UK. The Travel Rule will require cryptoasset businesses ("CBs") to collect, verify, and share information relating to certain cryptoasset transfers. See: https://www.fca.org.uk/news/statements/fca-sets-out-expectations-uk-cryptoasset-businesses-complying-travel-rule and https://www.jmlsg.org.uk/latest-news/jmlsg-publishes-new-guidance-3/
[xlix] See: https://english.kyodonews.net/news/2023/05/c6410ba692f5-japan-to-enforce-crypto-anti-money-laundering-steps-from-june.html?phrase=travel%20rule&words=rules,travel,rule,traveled,ruled,travelers
[l] Note: Countries such as Canada, Estonia , Germany, Gibraltar, Hong Kong, Liechtenstein , Singapore, South Korea, Switzerland, Bermuda, Cayman Islands, the UAE ‘s Dubai and the US have also implemented the travel rule. Source: https://www.21analytics.ch/blog/the-fatfs-crypto-travel-rule-global-implementation-summary/
[li] https://www.adgm.com/media/announcements/adgm-fsra-announces-revisions-to-its-aml-and-sanctions-rules-and-gu
[lii] https://www.jdsupra.com/legalnews/coinbase-agrees-to-pay-100-million-and-2888331/
[liii] See this helpful article from Wilson Sonsini that highlights some key actions taken: https://www.wsgr.com/en/insights/beware-increasingly-aggressive-enforcement-actions-in-the-crypto-asset-industry-puts-companies-on-notice.html
[liv] https://www.imf.org/en/Publications/WP/Issues/2023/06/30/Taxing-Cryptocurrencies-535510
[lv] It is noted that in May 2023, a separate paper was issued discussing the taxation of stablecoins: see https://www.imf.org/en/Publications/fintech-notes/Issues/2023/05/25/Taxing-Stablecoins-528041
[lvi] The IMF acknowledges, inter alia, challenges in designing an appropriate tax regime where crypto is utilized dually as investment assets and means of payment.
[lvii] As an example see the following article which discusses this development: https://cointelegraph.com/news/brazilian-senate-tax-rule-change-crypto-foreign-exchange
[lviii] https://www.oecd-ilibrary.org/taxation/international-standards-for-automatic-exchange-of-information-in-tax-matters_896d79d1-en
[lix] https://www.gov.uk/government/publications/international-joint-statement-on-the-crypto-asset-reporting-framework/collective-engagement-to-implement-the-crypto-asset-reporting-framework