By Michael Borowiec, contributor to Trezor Blog
Before we begin, let’s get one thing straight — cryptocurrencies are here to stay. The overall market cap is rising, veteran players are continuing to shape the scene and new projects are springing up all over the globe. As Confirmo CEO Roman Valihrach commented, “A lot of attention goes to mistakes people have made, but really these have been studied and built upon.” This is a turning point, however you look at it.
This time, the potential of the sector is no longer speculative, as real business models begin to emerge. By the end of 2024, the global industry is expected to grow to $20 billion in annual revenue, a staggering 37% jump from 2020. And that’s only the beginning.
But, just as crypto is not going anywhere, neither is the global regulation around blockchain technology. The vision of an independent, decentralized economy, long held onto by some of crypto’s staunchest fans, looks like nothing more than a pipe dream in 2020.
Let’s face it: we were always going to undergo a rigorous regulation phase. It’s a key milestone before access to new markets, financing, legal protection and, most importantly, mainstream users.
Now, the questions are: how do we regulate the industry as a global community? Who gets to have a seat at the table? And what will be left of crypto after the lawmakers are done with it?
From Capitol Hill to the Great Hall of the People, a steady creep of regulatory regimes is shaping the global cryptocurrency sector before our eyes. The contents of these laws will have real effects on crypto’s future. The countries who get it wrong risk missing out on a new technological boom which could position them as the leaders in the twenty-first century. The winners can create the conditions that will see their countries become the next hubs for the burgeoning tech market of the future.
With so much at stake, this blog series will take a look at how some of the world’s economic superpowers have been approaching the regulation of crypto so far.
It’s important to remember that our field is developing at breakneck speed. Even at the time of writing this, questions on how to manage exchanges, classify tokens, or tax traders are debated by officials across the globe. But, by understanding each country’s unique context and key trends, we can get a pretty good idea about the direction we’re steering crypto towards.
Regulating the Upstart Sector
Historically speaking, regulation of the cryptocurrency sector has been based on three main tenants — customer protection, crime prevention and anti-money laundering procedures. Ever since the mid-2010s, our scene has been marred by clear and vivid violations of all three.
One of the first targets of regulation were exchanges and token issuers, or virtual asset service providers (VASPs), as they are legally known. And with good reason — just the top five exchange hacks alone have siphoned off nearly $1.5 billion dollars, exploiting technological vulnerabilities and human error. It is also estimated that top 10 ICO scams ran off with nearly $700 million from customers.
Cryptocurrencies like Bitcoin are a handy tool to easily and seamlessly demand ransom for unlocking hijacked software. This can happen on an individual, or an organizational level.
A truly astounding and futuristic case here is a string of cyber attacks on local government systems that took place in Florida in 2019. The City of Riviera Beach, Florida, was forced to pay its attackers over sixty-five Bitcoins for hijacked data, which at the time was an equivalent of $600,000.
A recent Kaspersky cyber security report indicates we can expect crypto theft and crypto fraud to increase even further. This is due to local economies buckling under the pressure of the global pandemic, pushing desperate people into crime. It’s estimated that there were up to 188 million ransomware attacks around the globe in the last year.
The funds generated by exchange hacks, ransomware attacks and black market deals clearly need to receive some level of scrutiny from global law enforcement, and governments are catching up. Recently, the Department of Justice in the United States reported a seizure of an account linked to the darknet black market, Silk Road, holding over 1 billion dollars in cryptocurrencies.
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Global Powers Are Catching Up
Over the last five years especially, countries have started to issue reactive legislation against these perceived threats to individual consumers and the global economy alike. These included one-off guidances, or quickly assembled regulations, generously borrowing on lessons learned in regulating the financial markets in the previous decades. Examples include enforcing Know-Your-Customer procedures, or binding Bitcoin under the legal classification of a security.
The above has so far constituted very entry level regulations, barely scratching the surface of the rapidly expanding, global ecosystem. In the most recent years, however, countries have been catching up with the market and tightening their crypto-specific laws with a variety of crafty solutions. When looking for crypto law innovation, we need to look no further than the Pacific island of Japan.
Japan’s relationship with crypto has been an especially pretty shaky one. Its borders were home to some of the biggest and earliest disasters in crypto. It started early with the Mt. Gox scandal in 2014 which saw hackers make off with over $460 Million in BTC. Just four years later, Japan’s local scene would be shaken by yet another crypto exchange disaster, with the robbers this time getting away with over $500 million worth of NEM tokens.
Despite these clear and brutal examples of the vulnerabilities facing VASPs, Japan’s approach remained pragmatic and futuristic. The island has had an almost three-year head start on incorporating crypto custodians and businesses into its mainstream economy. Last year, Japanese authorities issued some of its strictest exchange regulation to date, while at the same time adding extra customer protection.
In order to prevent future customer harm in the vein of Mt. Gox or CoinCheck, local exchanges will have to store their user’s money separately from their own cash flows, or have an equal amount of assets as user holdings at all times. This means that, whatever may happen to an upstart exchange, it will be forced to always have enough liquidity in order to pay back its users. A move like this is sure to increase trust, add legitimacy, and inherently increase participation in Japan’s crypto scene for the averaging user.
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Tough New Requirements in Other Asian Economies Coming
Across the Sea of Japan, another East Asian jurisdiction is getting busy tying up loose ends on its financial regulation. The Republic of South Korea has had a very close relationship with the sector since the middle of last decade. At the height of the crypto craze in 2017, surveys showed that over a third of the country’s 22 million workers were active investors in cryptocurrencies.
This was a great opportunity for taxation, but also created a regulatory headache with scams and fraud flooding the market.
In order to prevent a similar situation happening again, Korea’s lawmakers responded with a new set of regulations adding tough new requirements for exchanges. An additional set of laws zoned in specifically on keeping track of movement of illicit funds, but also requiring each virtual wallet to be linked to a real-world account, both registered under the holders’ official name. This proof of address regulation has started to crop up elsewhere, with Dutch crypto holders now obliged to provide proof of ownership of any address they withdraw to.
“Long gone are the days of dismissing the crypto boom as a volatile bubble. Instead, the new approach makes sure we’re ready for global markets, financing and, most importantly, eager investors.”
Even some of the more free market-friendly areas are catching up with blanket regulations. The autonomous region of Hong Kong has long attracted financial players due to its pro-business approach and a liberal regulatory landscape. Some of the top exchanges have historically operated from Hong Kong, and with good reason. So far, the zone has offered an ‘opt-in’ regulatory crypto framework, which allowed many service providers to escape scrutiny as long as they could avoid their assets being officially classified as a security or a future.
This is all about to change in 2021, as Hong Kong’s authorities have announced that they’re changing their liberal approach. From now on, all trading platforms operating in Hong Kong will be required to apply for a license with the regulatory bodies. The move doesn’t necessarily imply an anti-crypto shift, but a newly found intention of incorporating all aspects of the sector into the mainstream economy of Hong Kong.
Approach Remains Pragmatic and Future-focused
The overall motivation so far seems to be focused on bringing the industry into the light, rather than to stifle it completely. This intention to regulate with care can be illustrated best in the city state of Singapore. Despite a recent string of strict regulation on its crypto scene, local ecosystem players have been given a six-month grace period to adjust, apply for and receive the new licenses, in order to make sure that the local market is allowed to go on undisturbed, while undergoing a process of maturity.
Another region making big moves with fostering its local scene while at the time tightening the screws on regulation is hidden deep inside the Persian Gulf. For the last two decades, the local authorities of the United Arab Emirates have been busy creating an economy ready for the post-oil world. This included investing in technological and financial innovation of all sorts, including cryptocurrencies. With digital asset regulation already in place since mid-2018, the local scene has managed to attract a number of international players. While cryptocurrencies as a whole are not fully compliant with Islamic laws, special economic zones like Abu Dhabi Global Market (ADGM) are exempt from the religious doctrine, allowing crypto to thrive and compete on the global scene, undisturbed.
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Speed of Development v. Speed of Regulation
As far as industries go, cryptocurrencies are a relatively new field with plenty of unrealized potential. With something so complex and futuristic, some crucial issues arise. One of these is the breakneck speed with which the industry is developing. When you combine billions of dollars poured into software and product development with the interconnected, knowledge-sharing nature of the open-source community, even the most centralized, authoritarian regimes are only now catching up to developments in the scene that took place years ago.
The USA, for example, has been historically slow in releasing comprehensive regulation or dealing with past fallout. Local lawmakers are just now dealing with major crypto incidents from 2018 like Telegram’s infamous ICO launch. Ripple’s CEO recently announced that the Security and Exchange Commission (SEC) is suing the company over a suspected fraudulent sale of XRP tokens over a staggering, seven-year period.
But that hasn’t stopped the SEC from fast-tracking other regulations it has deemed as more important, with strict anti-money laundering rules applying to all VASPs as of mid-2020. From last year, all exchanges will be required to collect the names of both transaction senders and receivers, as well as national IDs of the former.
What does the above tell us? Free markets of all sizes and cultures are getting busy bringing the industry into the mainstream, though not all are aligned in their approach. The new motivation is clear. Long gone are the days of dismissing the crypto boom as a volatile bubble. Instead, the new approach is, for better or worse, making sure we’re ready for global markets, financing and, most importantly, eager investors.
Still, we need to keep a close eye on the direction crypto regulation is heading. The industry has long moved past ICOs and ERC20 tokens as main points of conversation. The latest FinCEN (Financial Crimes Enforcement Network) crypto regulation has so far attracted over 70,000 comments from the industry, though many have been removed since with little transparency as to why.
Many questions remain, and most governments are struggling to answer them: How do we regulate the variety of tokens and protocols that have developed since 2017? Which parts of the industry should be allowed to thrive and which need to fail? And what institutions should be responsible for making these decisions? Stay tuned for this and much more in next week’s blog post.
Will Crypto Laws Devastate the Industry or Help It Grow Stronger? was originally published in Trezor Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.