US Securities and Exchange Commission Chair Gary Gensler has famously described cryptocurrencies as the “Wild West” of the financial world due to the lack of laws and regulatory frameworks governing the digital currency space. In most instances, cryptocurrencies are subject to anti-money laundering policies and standards, and in 2021 crypto crime accounted for more than £10-billion losses.
However, mainly legitimate crypto companies and exchanges are maintaining compliance with evolving regulations to demonstrate their trustworthiness and in anticipation of formal legal and regulatory directives that may be implemented in the future. Regulation is an important factor in building investor confidence, even for digital currencies.
This article explores the regulations that have been implemented or are about to be implemented around the world.
The United States
The United States does not consider cryptocurrencies as legal tender, but crypto exchanges are viewed as money transmitters as cryptocurrency tokens, and coins hold value that substitutes for currency. The IRS similarly views cryptocurrency as a digital representation of value. Cryptocurrency is subject to capital gains taxes (if they’ve increased in value) as well as applicable sales tax.
Most cryptocurrency businesses are considered money services businesses (MSBs) by regulators like FinCEN (Financial Crimes Enforcement Network) and, as such, are subject to many of the same rules and regulations applicable to traditional financial institutions.
In 2013, FinCEN stated that virtual currency exchanges and administrators of a centralized repository of virtual currency (who can issue and redeem the aforementioned currency) are considered an MSB and, therefore, must conduct comprehensive risk assessments of its exposure to money laundering. This includes developing, implementing and maintaining a formal, written program designed to prevent money laundering and the funding of terrorist activities. They are also prohibited from doing business with foreign nationals listed on SDN (Specially Designated Nationals) lists and may be subject to criminal penalties for non-compliance with OFAC (Office of Foreign Assets Control) guidelines.
Canada has legalized cryptocurrency exchanges and became the first country to allow cryptocurrencies to trade on the stock exchange. The country brought all entities dealing in digital currency under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) in 2013, and Canadian Securities Administrators issued a notice of the applicability of existing securities laws to crypto companies in 2017. Cryptocurrencies have been taxed in Canada since 2013. The Virtual Currency Travel Rule came into effect in 2020, which requires that all MSBs keep a record of cross-border virtual currency transactions and electronic funds transfers. The Canadian Securities Administrators also published additional guidance with regulatory expectations for crypto issuers and holders, including guidelines for required disclosures. In 2021, the PCMLTFA was amended to introduce the requirement for all crypto exchanges to register with the Financial Transactions and Reports Analysis Center of Canada (FinTRAC).
Australia has been extremely progressive in their approach to cryptocurrencies. Cryptocurrencies have been considered legal tender since 2017 in Australia and are therefore subject to Capital Gains Tax. As of 2018, all exchanges must register with the Australian Transaction Reports and Analysis Centre (AUSTRAC) and are required to identify and verify users, maintain accurate records and comply with all government AML and CFT reporting obligations. Failure to comply may lead to criminal charges and financial penalties. A new licensing framework for crypto exchanges was proposed in 2021 and will complete consultation in 2022. If successful, consumers will be able to purchase and sell crypto assets within a regulated environment.
Japan recognizes many digital currencies as legal property under the Payment Services Act. Both the PSA and the Financial Instruments and Exchange Act (FIEA) placed restrictions on managing virtual currency and eased regulation on crypto trading. Exchanges are legal, but following a large Coincheck heist, the country’s Financial Services Agency (FSA) has pushed for greater regulations and amendments. Cryptocurrency exchanges must register with the FSA in order to operate and are subject to strict AML/CFT requirements. Additional AML regulations are said to be on the cards in 2022.
While the UK does not have specific laws that pertain to cryptocurrencies, exchanges must be registered with the Financial Conduct Authority (FCA). In 2020, the UK transposed the regulation requirements for crypto exchanges as per the 5AMLD and 6AMLD into domestic laws, which requires compliance with AML/CFT reporting obligations. Entities that engage in any activities with cryptocurrencies must comply with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs). While UK cryptocurrency regulations will likely follow that of the EU, more stringent guidelines may follow in the future.
Cryptocurrency legislation varies across European Union member states. The EU’s Fifth Anti-Money Laundering Directive (5AMLD) states that cryptocurrency-to-fiat exchanges must comply with AML legislation, including the requirement to adopt Know-Your-Customer and customer due to diligence processes and to fulfil standard reporting requirements. Several member states require exchanges to register with various regulatory bodies in order to operate:
In Germany, exchanges must register with the Financial Supervisory Authority (BaFin); in France, it’s the Autorité des Marchés Financiers (AMF); and in Italy, exchanges must register with the Ministry of Finance. Under 6AMLD, the leadership of cryptocurrency wallet providers and exchanges are obligated to oversee and enforce internal AML controls.
The EU is actively exploring additional regulations. The European Commission introduced a proposal known as the Markets in Crypto-Assets Regulation (MICA), setting out draft regulatory measures for crypto companies, including additional consumer protections and a new licensing system for cryptocurrency issuers in 2020. In 2021, a set of legislative proposals was introduced to extend the transfer of fund regulation (TFR) extended to all virtual asset service providers in the EU. This will also introduce the mandatory collection of information about the participants involved in cryptocurrency transfers.
While Gary Gensler may have once described the crypto industry as the Wild West, it’s clear that the regulatory and legislative environment crypto issuers and exchanges operate in will continue to shift and formalize across the globe. Cryptocurrency companies must consider the potential impact that new regulations and governance requirements will have on their businesses in the near future and must start preparing as soon as possible to avoid penalties or the suspension of their services.