The long-held myth of crypto markets benefitting from a “legal vacuum” has recently been dismantled once and for all. Whereas the EU has adopted a regulation for markets in crypto-assets (MiCAR), international standard-setters such as the FATF, the FSB, BCBS and IOSCO have issued a series of far-reaching recommendations that are now to be implemented worldwide. Given these significant regulatory headwinds, the crypto industry will inevitably have to go through a process of maturation and consolidation.

By Franca Contratto (Reference: CapLaw-2023-38)

1) Background

After a long period of meteoric rises in market capitalization, the year 2022 brought a rude awakening to crypto markets and everyone who believed in them. The digital gold-rush fever which had led one in five adults in the United States and one in ten in Europe investing in crypto-assets, has definitely faded away. Following a series of scams and collapses of large-scale crypto firms and millions of losses suffered by countless investors around the world, trust in large parts of the crypto ecosystem is broken.

Against this backdrop, it comes as no surprise that regulators and other authorities around the world have now drastically tightened the thumbscrew. While spectacular enforcement actions against high-profile firms such as FTX, Coinbase or Binance generated a lot of media coverage (see also Thomas Werlen/Simon Weber, Switzerland’s Quest for a Safe Haven for Crypto Products, CapLaw 4/2023, p 9 et seqq.), the paradigmatic changes in the global regulatory landscape went largely unnoticed by the public so far. Quite wrongly, because the impact of this regulatory overhaul will undoubtedly have far-reaching consequences and permanently reshape the future structure of markets and business models.

This contribution traces the main lines of development in the global crypto regulation landscape. Due to its importance for the Swiss crypto industry, the focus is clearly on the European regulatory framework for crypto-assets (MiCAR). In addition, the most significant recommendations of international standard-setters are briefly presented; even if they are non-binding in nature their importance for the future regulatory development should not be underestimated. Last but not least, a brief assessment of the current state of implementation of crypto-related regulations in the major financial centers concludes this overview. 

2) European Union: Markets in Crypto-Assets Regulation (MiCAR)

On 29 June 2023 the Markets in Crypto-assets Regulation (EU-Regulation No. 2023/1114, MiCAR) entered into force. It will in large parts be directly effective in all EU member states and shall be applied from 30 December 2024 (Art. 149 (2) MiCAR). Given its very broad scope and its considerable level of regulatory detail, MiCAR is perceived as a landmark regulation whose impact on markets is likely to be comparable to the MiFID II/MiFIR-package:

– Products in scope (Art. 3 (1) no. 6-9 MiCAR): MiCAR is applicable to (1) asset-referenced tokens (ART) aiming to maintain a stable value by referencing other assets or fiat currencies, (2) electronic money tokens (EMT) which are used as payment tokens and have been backed by fiat currency which is a legal tender, and (3) a number of other crypto-assets, such as utility tokens. Central bank digital currencies (CBCDs), non-fungible token (NFTs) and decentralised finance protocols (DeFi), however, are out of MiCAR’s scope. Security token and derivatives on crypto-assets qualify as financial instruments (Art. 4 (1) no. 15) and, therefore, fall under the amended provisions of MiFID II exclusively.

– Firms, respectively, services in scope (Art. 3 (1) no. 11-26): MiCAR introduces a comprehensive regulatory framework for both crypto-asset issuers (CAIs) and for crypto-asset service providers (CASPs). Services provided by CASPs encompass (among others) custody and administration of crypto-assets on behalf of third-parties, exchanging crypto-assets for funds (i.e. fiat and other currencies), execution of orders for crypto-assets on behalf of third parties, any marketing on behalf of the issuer of crypto-assets (“placing”) or providing advice as well as portfolio management on crypto-assets. Similar to MiFID II, MiCAR states a licensing requirement for the aforementioned services (Art. 59, 60 & 62 et seqq. MiCAR) and subjects CASPs to an extensive set of conduct of business rules. CAIs who offer crypto assets (other than ARTs or EMTs) to the general public or who request admission to trading on a platform are required to publish a whitepaper describing the technical features of the crypto asset (typically, a utility token), potential restrictions on its transferability, a brief description of the project and the legal entity responsible for the project, including information on the financial condition for the past three years. No whitepaper is, however, required where crypto-assets are created through mining, where an offering is made for free or if the offer is made to fewer than 150 persons per EU member state or addressed exclusively to qualified investors.

It is particularly noteworthy that MiCAR does not provide for a specific third country regime. Swiss providers wishing to advertise or actively promote crypto-related services to clients in the EU will have to fully comply with EU licensing requirements as well as with the respective regulatory duties. Non-EU based CASPs will only avoid falling under MiCAR in cases where the requirements of the “reverse solicitation”-exemption are met (Art. 61MiCAR). 

3) International Standard-Setters

a) BCBS: Prudential Standard for Banks’ Exposures to Crypto-assets

Recent market developments have shown that the global banking system is increasingly exposed to crypto-assets, given that a growing number of banks act as custodians of crypto-assets or as stablecoin issuers. On 16 December 2022, the Basel Committee on Banking Supervision (BCBS) endorsed a new crypto-related prudential standard for banks in order to mitigate potential risks to financial stability. The scope of the standard is relatively large as it covers not only unbacked crypto-assets but also tokenised traditional assets and stablecoins. The classification is nevertheless of great importance and will probably challenge banks and their auditors in its daily application as capital requirements vary, with unbacked crypto-assets being subject to most conservative capital treatment. Apart from capital adequacy, the usual requirements regarding liquidity, leverage ratio, large exposures, operational risk, supervisory review and disclosure have to be met. The crypto-related global minimal standard will be incorporated as new chapter of the consolidated Basel framework and has to be implemented in national legislation by 1 January 2025. Consistency and timeliness of the transposition into domestic regulation will be monitored based on the so-called Regulatory Consistency Assessment Program (RCAP).

b) FSB: Global Regulatory Framework for Crypto-asset Activities

Based on a mandate of the G20, the Financial Stability Board (FSB) has undertaken an in depth-review of potential threats to financial stability posed by global crypto-asset activities. On 17 July 2023, the FSB published two sets of high-level recommendations: While one of them focuses on global stablecoin arrangements, the other set relates to the regulation, supervision and oversight of crypto-asset activities in general. Given the increasing volume of crypto markets and their increasing interdependence with the financial system, the FSB’s expectations are high: In essence, national authorities are expected to adopt comprehensive regulatory frameworks for crypto-asset activities thereby applying regulatory tools which are comparable to the ones which have long been established in traditional financial market supervision (e.g. licensing requirements, risk management frameworks, disclosure duties). Furthermore, member states are urged to increase their cooperation and coordinating efforts so as to eliminate regulatory arbitrage and to increase the consistency of the emerging regulatory framework for crypto markets. Member jurisdictions’ implementation measures will be subject to review by the end of 2025.

c) IOSCO: Draft Policy Recommendations for Crypto and Digital Asset Markets

The International Organization of Securities Commissions (IOSCO) recently hold a public consultation on its policy recommendations for crypto markets. IOSCO plans to finalize the standard by the end of December 2023. In terms of their content, many of the 18 proposals seem to be mirroring the conduct of business rules for CASPs as laid down in European MiCAR regulation (see paragraph 2 above). Nevertheless, IOSCO’s policy work might provide highly useful to reach global consensus on a consistent regulatory framework, given that IOSCO is comprised of securities regulators from across the world and – among others – embedding key players from the US (CFTC, SEC) as well as from important financial centers in Asia-Pacific. 

d) FATF: Targeted Update on Implementation of the FATF Standards on Virtual Assets and Virtual Asset Services Providers

As early as 2019, the Financial Action Task Force (FATF) extended its anti-money laundering and counter-terrorist financing measures (AML/CFT) to crypto markets. A key AML/CFT measure is the so-called Travel Rule (FATF Recommendation 16) which applies to transfers from or to an external wallet belonging to a third party. The Travel Rule requires virtual asset services providers (VASPs) to share relevant originator and beneficiary information alongside the transaction, i.e. to verify the identity of the third party as well as establish the identity of the beneficial owner and verify that the third party controls the external wallet. In June 2023, the FATF published an extensive report on member state compliance. The results are rather sobering: Of the 151 jurisdictions responding to the 2023 survey more than 50% have not yet even taken steps to implement the Travel Rule as specified above. Only as few as 25% of all member states were found to be fully compliant. Switzerland has introduced the Travel Rule as early as 2019 by an amendment to AMLO-FINMA.

4) Overview on National Jurisdictions with a Focus on Leading Financial Centers

As revealed in a comparative study published by PwC in December 2022 (https://www.pwc.com/gx/en/about/new-ventures/global-crypto-regulation-report-2023.html), only just over a dozen jurisdictions worldwide have so far enacted a comprehensive regulatory framework tailored to crypto assets (Bahamas, Bahrein, Cayman Islands, Estonia, France, Germany, Gibraltar, Liechtenstein, Hong Kong, Japan, Malaysia, Mauritius, Singapore, Switzerland, United Arab Emirates). However, regulatory projects are currently pending in various leading financial centers, such as the United Kingdom, Australia, Canada, Luxembourg, New Zealand and South Africa. The United States of America – home to the world’s leading cryptocurrency markets – still fall behind internationally when it comes to specific crypto regulation: Crypto-specific legislation so far only exists scarcely and only at state level (e.g. in New York and California); therefore, federal crypto policies are still primarily shaped by enforcement cases led by the CFTC and the SEC. However, this may soon be changing: No less than seven crypto-related bills are about to be discussed in Congress over the coming months. Positive impetus for the future development of crypto markets is expected in particular from the Financial Innovation and Technology for the 21st Century Act and from the Clarity for Payment Stablecoins Act. However, heated debates are to be expected since after a long series of scandals the crypto skeptics in Congress have become rather numerous.

5) Conclusion and Outlook

The plethora of current regulatory initiatives on crypto markets marks a clear turning point: The days of free experimentation in a legal vacuum are definitely over. Policy makers around the world expect the crypto industry to finally grow up and leave the many teething problems behind. However, regulators and supervisors also face challenging times ahead: At the time being, we are still far away from the stringency and persuasiveness of a globally recognized regulatory framework such as the one created for the banking sector in the form of Basel III. On an international level, a period of reflection and consolidation of the great variety of regulatory approaches to tame crypto markets will be needed to avoid too many cooks spoiling the broth.

Switzerland, which has stood out internationally as a crypto regulation pioneer so far, cannot rest on its laurels. If Switzerland wants to position itself as an internationally recognized crypto hub in the long term, it must not only passively observe regulatory developments on an international level, but quickly act to close any emerging regulatory gaps. Especially in the area of stablecoins, where a convincing, clear Swiss regulation has been lacking so far, a window of opportunity is opening up that Switzerland should not miss.

Franca Contratto (franca.contratto@unilu.ch)