The ‘Brussels effect’ has real influence over US crypto regulation

The right to privacy is enshrined in many legal traditions around the world. In the United States, it is protected by the Fourth Amendment; in the European Union it falls under Article 8 of the European Convention on Human Rights. Although definitions differ between jurisdictions, most of us are entitled to a reasonable expectation of privacy for our correspondence, in our homes and about our persons.

In the 1970s, businesses, families and individuals began to generate data like never before, and the extent to which it fell under existing privacy mandates became increasingly unclear. This proliferation of data was first recognized as a problem in the late 1970s and gained momentum in the decade that followed. In response, the EU introduced its Data Protection Directive in 1995, which guarantees certain fundamental rights around the processing of personal data.

The crucial thing to understand in this context is that an EU directive leaves room for the member states to decide how it should be incorporated into national laws. It is a recommendation, not a regulation that would legally require members to enforce laws from a set date.

From 1995, the regulation of privacy in the EU followed a well-worn path. Started as a directive, it eventually evolved into the General Data Protection Regulation (GDPR), which became a legal requirement in 2018.

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The GDPR became the benchmark for privacy legislation and influenced regulation in other jurisdictions, including the United States. It is a phenomenon that Anu Bradford created the “Brussels effect”, where EU legislation sets the global regulatory standard. We’ve seen it happen in a number of fields besides privacy, such as environmental law and online hate speech, which often enter the United States via a similar mechanism: the “California effect,” where California sets a strict standard that is later widespread. adopted in the United States.

And now another industry is ready to follow this well-trodden path – from EU directive to EU regulation to global regulatory standard.

The case of Tornado Cash – which saw a protocol designed to mask financial transactions and increase privacy shut down by regulators due to the use of bad actors – is an example of why regulation is so important to decentralized finance (DeFi). Infrastructure must be built along regulatory lines.

Like data in the 1980s, the proliferation of digital securities and the broader DeFi space is inevitable. Regulation will be essential to support innovators, promote innovation and protect investors, not to mention the widespread use of digital securities trading globally.

In the US, digital securities fall into a regulatory gray area, with neither the Securities and Exchange Commission nor the Commodities Future Trading Commission willing to put their heads over the parapet and take responsibility for them.

In California, the regulation of digital assets is an ongoing conversation, and the Senate is expected to push for an amendment to California’s financial code to include digital assets: the Digital Financial Asset Law. If passed, it would be enforceable starting in 2025.

In contrast, EU regulators have been quicker to familiarize themselves with DeFi. The German regulator, particularly the Federal Financial Supervisory Authority, or BaFin, has gone to great lengths to encourage innovation and offers a regulatory blueprint for DeFi elsewhere. A 2020 amendment to the German Banking Act put crypto-assets on par with traditional securities.

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Regulation is also accelerating in Brussels. The EU’s Markets in Crypto-Assets (MiCA) will enter into force in the fourth quarter of this year and will start an 18-month transition period for member states. Meanwhile, the recently published European Financial Stability and Integration Review 2022 showed a commendable understanding of the sector. It advocated a reassessment of the current regulatory approach, concentrating regulation on activity rather than an entity.

It’s still early days when it comes to DeFi. However, digital securities regulation in the EU may follow a similar path to that which led to the GDPR. Brussels issued a statement this year on activity-based regulation, which we can eventually see incorporated into the directive on markets in financial institutions. (Remember that a directive is a guiding recommendation for the member states.) From there, there can be regulation as part of MiCAR.

With a real example of DeFi regulation to lean on and decentralized finance becoming the technology layer where the entire financial market will eventually move, other regulators will follow suit. Indeed, jurisdictions such as Israel have made it a habit. The question is whether the US will be most affected by the “Brussels effect” or the “California effect”.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.