Regulatory Arbitrage, Unclear Terminologies: A Challenge to Global Cryptoasset Regulations

Few innovations in finance have emerged in recent years that are as controversial or present as many challenges to regulators and policymakers as cryptoassets. A key question for regulators and market participants is the extent to which the difference between cryptoassets and traditional financial assets is more form than substance? It is an important question since the answer defines the appropriateness of existing regulation for cryptoassets and related activities. In an inaugural research study on the global cryptoasset regulatory landscape, a team of researchers at the Cambridge Centre for Alternative Finance has aimed to shed light on this question by offering analytical tools for both regulators and market participants to conceptualize cryptoassets and develop a more consistent regulatory approach across regulatory bodies. The research serves as a useful empirical study to inform industry stakeholders as well as evidence-based regulation and policymaking.

The study was undertaken based on a conceptual framework that serves as a basic framework for the legal and regulatory analysis of cryptoasset activities and looks at three key aspects in a regulatory context: the nature and form of cryptoassets, the issuance of cryptoassets, and intermediated activities in the life cycle of cryptoassets. The research aims to compare various regulatory approaches to cryptoassets in a number of jurisdictions and to resolve regulatory challenges and identify opportunities. It offers a number of regulatory recommendations:

  • Traditional assets recorded on a distributed ledger technology (DLT) system (i.e. tokenization) should be distinguished from new and natively-digital cryptoassets with unique characteristics. The fundamentally new characteristic of a natively-digital cryptoasset is the “incentive role” that it may play in a particular network;
  • A legal and regulatory classification of a cryptoasset should be based on an in-depth assessment of several factors (e.g. rights attached, access, economic function), on a case-by-case basis;
  • The majority of cryptoasset-related activities by intermediaries show strong similarities to existing financial activities in traditional markets (e.g. exchange and trading), and therefore might be regulated as such. Only a relatively small number of cryptoasset-specific activities can be considered novel (e.g. mining).

The study also examines regulatory authorities in 23 jurisdictions (selected on the basis of level of domestic cryptoasset activity and the relative magnitude of regulatory response) regulating cryptoassets, their current definition and classification of cryptoassets and related activities, as well as regulatory processes and responses (e.g. existing regulation, retrofitted regulation, bespoke regulation, and bespoke regulatory regime). Key findings are:

  • The scope of different regulatory authorities can and often does overlap when regulating cryptoasset activitie On average, three distinct national bodies per jurisdiction have issued official statements on cryptoassets, including warnings;
  • The most sophisticated regulatory frameworks (i.e. bespoke regulatory regime or bespoke regulation) are often found in smaller countries with a relatively low level of domestic cryptoasset activity and a tendency for more flexible financial regulation;
  • There is no standard use of terminology across regulators, and a variety of terms have been used to refer to cryptoassets in official statements. Notably, the term virtual currency has been used most frequently in official documents, although it has often been used interchangeably with cryptocurrency and digital currency;
  • Central banks have usually been the first type of regulatory authority to issue official statements (including warnings about cryptoassets), followed by government departments (e.g. ministries of finance) and financial supervisory bodies. Further, the first step towards regulating cryptoassets has typically been to distinguish cryptoassets deemed to be securities from other types of cryptoassets;
  • Existing regulatory frameworks generally classify cryptoassets into payment, utility, and security tokens, although frameworks in certain jurisdictions consider an additional fourth category of hybrid tokens that shares characteristics of multiple categories;
  • An expanded sample of 108 jurisdictions reveals that countries with higher levels of domestic cryptoasset activity tend to have retrofitted regulations, whereby existing laws and regulations are amended to respond more swiftly to new-to-market activities;
  • Regulators have to date focused mainly on addressing regulatory concerns over initial coin offering (ICOs) and cryptoasset exchange activities. These two activities are often regulated under existing securities law, supplemented with guidance from the securities regulators;
  • All 23 jurisdictions from the study sample have brought at least one intermediate cryptoasset activity (e.g. exchange, storage) under the remit of their anti-money laundering and counter-terrorism financing (AML/CFT) regulations.

In analyzing the regulatory challenges and gaps that stem from the development and implementation of cryptoasset regulation, four major findings have been highlighted in the study:

  • Regulators have primarily focused on ICOs and exchanges to date. Consequently, other key activities, such as alternative token distribution mechanisms (i.e. airdrop and fork), decentralized exchanges, and the creation of cryptoassets through mining or the peer-to-peer transfer of cryptoassets, have been overlooked;
  • Unclear terminology and classification, inherent limitations to regulatory principles, and regulatory arbitrage challenge regulators’ ability to robustly define their regulatory perimeter and implement regulations;
  • In many of the jurisdictions studied, regulators have addressed key risks related to financial integrity and systemic issues as well as investor and consumer protection. Additional risks may warrant further regulatory attention;
  • Securities laws, banking and payment laws, and AML laws have so far received the most regulatory attention in relation to regulating cryptoasset-related activities. Regulators may need to consider how other laws might be applicable, such as tax or property law. Regulators might want to fully examine the efficacy and adequacy of existing regulations before developing new and bespoke regulations and identify cryptoasset activities that do not require (additional) regulation.

This post comes to us from Apolline Blandin, a research manager of cryptocurrency and blockchain technology at the Cambridge Centre for Alternative Finance; Michel Rauchs, a cryptocurrency and blockchain lead at the centre; and Hatim Hussain, a research assistant at the centre. The complete research study is available here.