Fears Of New Crypto Regulations Being Overly Complex, Costly and Burdensome Are Overblown
Chief Investment Officer at Entoro Wealth
Regulation. That very word seems to be striking fear in anyone involved in crypto.
But there’s a difference between regulation – which can create clarity and confidence – versus overregulation. Yes, overregulation is a negative thing and would certainly have an adverse effect on the future of Bitcoin and the crypto sector. But don’t panic.
It is an accepted fact that governments and their central banks do not like Bitcoin and cryptos. The fear of losing monetary control and their ability to enact social policies have alarmed central bankers. But they are baffled on what to do.
Governments realize they are behind the curve in recognizing the growth and acceptance globally of Bitcoin, and their biggest weapon to exert some control is tighter regulation. But government regulation will be difficult only because the globalization and decentralization of Bitcoin make local rules hard to enforce.
Let’s look at some potential new rules that may be considered and actually enacted. With the appointment of Gary Gensler as SEC Chairman, rules for crypto trading and investing are surely close at hand. Remember, Mr. Gensler was formally Chairman of the Commodity Trading Futures Commission (CFTC) so it makes sense that any crypto regulation would include rules already in effect in the futures markets.
That would be a major plus. Let’s consider the implications:
- Bitcoin will be considered a “standalone digital asset.” The CFTC once defined Bitcoin as a currency and Mr. Gensler has commented publicly that Bitcoin may indeed be a store of value. It’s just a digital asset. So, if Bitcoin trades on an exchange with proper regulatory oversight would that be so bad? There would be no need to further define Bitcoin as a security, a currency or even a commodity. Oversight for KYC/AML would be in place via accredited exchanges.
- Other cryptocurrencies may be restricted to what individuals and institutions can invest in just as stocks are. Cryptos and digital assets trading under $5.00 would be restricted (just as stocks are) thus “protecting” investors. These other digital assets may be restricted to an OTC (Over the Counter) type market with necessary KYC/AML protocols in place. Again, not so terrible.
- Exchanges such as Coinbase, Kraken, etc. would be responsible for setting their own margin (risk parameters) just as futures exchanges do now. Look for more self-regulation like the National Futures Association (NFA) and expect the licensing of brokers who sell Bitcoin and other crypto assets. Perhaps the SEC and FINRA will require licensing just like equities. But again, not so bad, and certainly tolerable.
While global regulatory bodies, including the SEC, may talk about strict regulation and oversight, they may realize they lack the ability to actually enforce their own rules. Because of the decentralization and fungibility of crypto, any overtly strict regulations will just move trading to other parts of the world.
For example, if US regulators create too complex and burdensome an environment for crypto, another jurisdiction (take your pick – Ireland? Singapore?) would certainly be more than eager to step in. American regulators need to tread lightly, which I am sure they realize.
So, do not panic about our regulators either overregulating Bitcoin or other crypto assets. Their tough talk really is just old fashioned “jaw boning” to create a pathway to accept some new regulation – A reasonable level of fresh clarity and rules will make investors more comfortable with crypto, and that should be the outcome wealth managers can expect.
Bill Taylor is Chief Investment Officer of Entoro Wealth, an asset manager specializing in digital asset-driven strategies
Vice President, Information Governance, Smarsh
These days, most people happily accept that the iPhone disrupted the way we communicate, Zoom transformed the way that we collaborate, Amazon has dramatically changed how we shop, and Netflix has altered how we consumer entertainment.
Less well remembered is the massive uncertainty created for the many companies whose businesses were disrupted by these solutions – And their ecosystems of suppliers and partners. For every Apple, Amazon and Netflix out there today, there’s a Motorola, Cisco and AMC Theaters.
Such is the case for the regulation of crypto vis-à-vis the wealth management space. You have a mix of players who grew up in crypto, as well as traditional wealth management firms that have entered the space. But sorting the disruptors and disrupted at this stage of the market, when all flavors of market participants have not yet been consistently defined, is impossible.
But one thing is clear: Those who believe that new regulations on crypto as a financial asset will be anything other than extremely complex, costly and burdensome for the wealth management space are kidding themselves.
Regulators Mean Business
Let’s start with the fact that moves being made so far among regulators are happening under clear direction from the very top, versus an organic drip of changes under a gradual “regulation by enforcement” approach.
The fact that U.S. Treasury Secretary Janet Yellen has been calling for the creation of “regulatory frameworks” that entail “interagency collaboration” should, in and of itself, underscore that regulators are not just making noise.
We now have the SEC, working together with the CFTC and the acting head of the Office of the Comptroller of the Currency (OCC) along with other Federal agencies and a divided Congress, on the issue of crypto regulations.
Risks And Penalties Are Real
So, what do we have to fear? Consider the following:
- To date, the SEC has brought 75 enforcement actions against cryptocurrency firms resulting in $1.77B in penalties, including 19 trading suspensions and 43 cases litigated in federal district courts.
- The U.S. Treasury Department announced requirements that transfers of more than $10,000 from cryptocurrency transactions must be reported to the IRS after Treasury estimates indicated a shortfall of nearly $600B in tax obligations to the United States in 2019.
- The U.S. Federal Reserve will study the move toward issuance of a central bank digital currency, which could further drive disruption to crypto assets and how they are regulated.
Perhaps one of the most significant yet frequently overlooked sources of complexity for crypto participants will be the need to capture, preserve and supervise all transaction records and communications associated with cryptocurrency securities.
Indeed, just given the typical profile of most crypto investors – to say nothing of the nature of the asset itself – it’s safe to say that most client communications that crypto asset managers and wealth managers engage on the platforms that digital natives prefer. What does this mean?
- First, crypto asset managers and wealth managers must ensure that the unique risks of cryptocurrencies highlighted by recent SEC and FINRA guidance are outlined within written supervisory procedures (WSPs).
- From there, all WSPs must be reviewed to include all communications sources approved for use by firm employees.
- From existing tools like email to other vehicles such as WeChat, Tiktok, Reddit, Signal, crypto players of all sizes and business models will need to be ever-aware of their regulatory and oversight obligations and ensure that they stay tuned in to where the action is happening.
- Firms need to assess how they can provide oversight of business-related employee communications to ensure that they are not missing activities of the next Roaring Kitty.
- From a policy perspective, firms need to have active governance programs to evaluate requests to support new communications tools and inspect new features from existing tools.
Don’t Short Your Regulatory Burdens
For non-traditional market participants, delivering client-facing services to address the time-to-market pressure of an exploding market category was likely a higher investment priority than compliance infrastructure.
But consider the consequences for being noncompliant with regulatory expectations in this area, both in terms of possible enforcement action and its impact on the reputation of your firm.
For example, in the FINRA Exam Priorities letter and its earlier notice on digital assets, FINRA has stated that this, along with monitoring for outside business activities (OBA) will be an area of regulatory focus.
Since then, enforcement actions have spoken, with seven separate actions related to OBA being noted in June 2021 alone.
More crypto regulations are coming – And they will be burdensome. Those who fail to invest in policy definitions, training, and automated compliance controls could be in for a rude awakening.
Robert Cruz is Vice President, Information Governance at Smarsh, the global regtech solutions provider for financial services firms
Duration: 30 / 31 days