New crypto regulations are coming. Here are the technological steps to get ready

Both cryptocurrency firms and government agencies recently tasked with regulating them find themselves in uncertain times: The rapid expansion of crypto markets and the cautionary example of FTX’s fall have increased pressure for regulatory oversight, but delays in finalizing new rules mean stakeholders on each side of the compliance equation is struggling through a period of logistical limbo – a period that is likely to continue for much of 2023.

Fortunately, despite these uncertainties, there are still many things that both regulated and regulatory entities can do to prepare for the inevitable rollout of stricter rules over the next year or so. Let’s take a closer look at what both sides can do now in anticipation of tighter regulation of digital assets for the 2023 and 2024 tax seasons.

Bringing regulatory structure to a ‘wild west’ cryptocurrency ecosystem

The compliance push in crypto markets is focused on bringing more structure and transparency to what has so far been a wild west environment of heavy activity and relatively light regulation. All this is happening in the shadow of the FTX scandal which lost $8 billion in customer and investor funds and demonstrated how, as cryptocurrencies gain more widespread use, it is increasingly important to ensure they are traded in a safe and transparent manner.

These long-awaited regulations represent both an opportunity and a challenge for the authorities. The possibility is that significant tax revenue will come from new tax reporting rules coming into effect across a busy ecosystem of crypto and digital asset exchanges, NFT marketplaces and DeFi platforms. The challenge is that rolling out such rules in a sector that already operates at scale can be extremely complex for enforcement agencies, and very confusing for industry players trying to understand and comply with the new regulatory landscape.

Adding to the confusion is that since the Treasury Department failed to finalize regulations before the end of 2022, both agencies and crypto investors are unsure what information they will collect in 2023 and plan to report in 2024. These conditions make it difficult to clarify, much less communicate, best practices and compliance guidelines that will govern the way digital assets are used and regulated.

Leverage technology to prepare for upcoming regulations

Unlike traditional financial assets, cryptocurrencies are decentralized and operate outside of established financial frameworks, so officials are seeking to create crypto-specific regulations that promote transparency and trust in the market – including enhanced Know Your Customer (KYC) and Anti-Money Laundering (AML) measures , as well as requiring stock exchanges to provide regular audits and accounts.

Given that the rules will roll out to an already bustling ecosystem of crypto trading and investment firms, the right technological tools and techniques are critical to successfully introducing and complying with these new regulatory frameworks at scale. This requires preparation and modernization steps for both government agencies and cryptocurrency firms.

Public enterprises should start now with the work of modernizing their IT systems and processes that were originally designed to meet paper-based requirements, to also handle digital-native processes. In fact, Congress recently passed the Inflation Reduction Act of 2022 that allocates more than $40 billion to the IRS over the next ten years to update its antiquated IT systems.

Meanwhile, crypto platforms that were originally built without compliance and information sharing in mind should take steps now to re-architect their IT infrastructure so that necessary information is more readily available to meet compliance needs. Although the impending regulatory regime is tax-focused, platforms should consider how IT investments to meet these needs may also include requirements to meet other likely upcoming regulations such as increased KYC and AML compliance, as well as counterparty identification for asset transfers. Such platforms should be up-to-date on the latest tax and accounting practices, supported by certifications such as US Generally Accepted Accounting Principles and International Financial Reporting Standards, along with the highest data and system security standards such as SOC 1, SOC 2 and ISO 27001.

Strategic technology partners will play a key role for both sides. The coming wave of compliance is going to require standardized data. These strategic partners already act as intermediaries serving multiple entities and can use their insights to help facilitate the standardization of data for easier compliance. For example, XBT and BTC are ticker symbols used to represent the same cryptocurrency on different trading platforms. Compliance with regulations will require not only an understanding of these nuances, but also the ability to assimilate data in the necessary form, which is a gap that strategic partners can help bridge between industry platforms and government agencies.

The bottom line

Although the government does not operate in the crypto landscape, understanding how blockchain-powered crypto markets behave is important to the government agencies tasked with developing and applying new rules for the sector. At the same time, businesses dealing with cryptocurrency will benefit from having the right technological tools and processes in place to comply with the new regulations.

As this happens, we are likely to see a broader development of new best practices that – having been developed out of necessity to regulate crypto markets – will spread to the broader compliance landscape at large. Organizations across government and the entities they regulate will increasingly find themselves using technology-driven efficiencies to make auditing and compliance generally much more efficient, accurate and automated.

Miles Fuller is head of government solutions at TaxBit.