Why Crypto Firms Should Embrace Regulation and Compliance
The crypto industry has come a long way since the launch of Bitcoin in 2009. From Bitcoin being criticized as a gimmick in its early days to the crypto market surpassing USD 3 trillion in value last November, there have been significant milestones reached in crypto with increased mainstream adoption — we has seen countries like El Salvador and the Central African Republic accept Bitcoin as legal tender, luxury brands like Gucci and Balenciaga start taking crypto payments, and the creation of new financial products around crypto like Bitcoin futures.
As the adoption and use of cryptoassets increases, regulators around the world are now stepping up efforts to regulate this area. For some in the crypto industry, the increased regulatory scrutiny is perceived as a hindrance and worse, contrary to the original premise of crypto as being permissionless, borderless and free of government oversight. But despite increased regulations, at a fundamental level, the underlying public blockchain that enables cryptocurrency will always remain permissionless and borderless. What has changed is the moment we build use cases on a permissionless blockchain that involve a fiat currency touchpoint, regulations will come into play since fiat currencies have historically been subject to a number of economic regulations. Even in the decentralized finance (DeFi) space, with more infrastructure being built around decentralized identifier (“DID”) and with its application to perform know your customer (KYC) and anti-money laundering (AML), this is likely to be regulated eventually .
The regulations in the crypto area have so far been varied with regulators having different views on how different cryptocurrencies should be regulated. Some see it as ‘securities’, some see it as ‘goods’ and others as ‘payment tokens’. Globally, global regulators have been leaning towards considering whether the crypto is a security or commodity to determine their regulatory approach. In general, laws and regulations for securities are stricter and will typically require registration and publication. In comparison, raw materials are relatively less regulated, but derivatives of raw materials are strictly regulated with reporting requirements. In this regard, with the creation of crypto derivatives, additional regulatory obligations may be triggered, such as regulatory reporting requirements in some jurisdictions.
As regulators navigate their way around the crypto industry, it is clear that their primary objective is to ensure a solid and robust regulatory ecosystem for the crypto world. And indeed most regulatory regimes emphasize the importance of common pillars such as AML/KYC processes, cyber security and more recently investor protection. That said, regulators are also aware of “over-regulation” and we have seen regulators take the approach that some areas should be left unregulated. For example, if you look at the non-fungible token (NFT) space, we have seen regulators in certain jurisdictions explicitly announce their position not to regulate NFTs. Instead, they have taken the approach of warning retail investors about the speculative nature of NFTs. And this also applies to GameFi use cases. To create a targeted, risk-based, “smart” regulatory regime, crypto firms have an important role to play with respective regulators to share and provide industry feedback and knowledge.
Although excessive and fragmented regulation can potentially hinder innovation in the crypto space, many tend to overlook or underestimate the benefits that compliance and regulations can bring to the table. Despite the growing use of crypto by the mass audience, the majority of the population still has a limited understanding of the basics of crypto and blockchain technology. For many, the crypto industry is still seen as the “Wild West” despite the increased popularity of crypto and the use of crypto assets globally. With regulations and regulators gradually issuing crypto licenses and registrations, and with greater harmonization of global standards, we will be one step closer to legitimizing digital assets and eventually making crypto an integral part of the mainstream financial system.
Beyond the goal of ensuring a stable and healthy ecosystem with adequate investor protection, compliance is actually beneficial and a strategic advantage for crypto firms. With the right compliance and control framework, crypto firms are better able to access the customers, investors and shareholders they want to attract. These key stakeholders tend to be interested in the firm’s compliance with the relevant AML rules as well as the security of their digital assets. Therefore, it is critical for crypto firms to have a strong compliance culture, including tone from the top, to employ staff with appropriate regulatory expertise, and to have best-in-class compliance systems and processes in place. Furthermore, it is important to note that compliance is not a one-time exercise, but rather a continuous and ongoing process. As the industry grows, it is important for crypto firms to continually review and expand their compliance framework to ensure that their controls are commensurate with the risks associated with the scale and size of their business.
As responsible players in the ecosystem, crypto firms should not be afraid of regulations and compliance, but instead embrace the fact that regulatory compliance is essential to establishing the mainstreaming of crypto around the world. Crypto industry players should continue to work closely with regulators to develop fair frameworks that will encourage and support innovation while maintaining trust, transparency and security for all stakeholders in the ecosystem. Ultimately, crypto can play a central role in accelerating financial inclusion around the world.
