Regulating crypto

There is rarely a dull moment in the world of cryptoassets, whether it is the price volatility of these assets; Bitcoin being adopted as legal tender (as happened in El Salvador); enforcement actions by regulators, as well as legal challenges against regulators’ decisions (the US Securities & Exchange Commission being a prominent example); and regular criticism in political arenas (for example, linking crypto to terrorist financing). For lawyers, this field is both new and exciting with questions relating to the necessity of new laws, the reform of existing laws and the difficulties in the application of rules more generally. Also, many different areas of law are engaged in the regulation of cryptoassets – from contract law to securities law, criminal law to environmental law. In each of these areas of law, crypto raises numerous issues. In the criminal law context alone, there are concerns relating to, inter alia, money laundering; criminal hacking; fraud; and extortion.¹ A main issue in the legal context of cryptoassets is the lack of specific definitions. In the financial law context, there are uncertainties as to whether different cryptoassets constitute securities, while in contract law there are uncertainties as to the legal nature of new tools such as smart contracts. Furthermore, within the different areas of law, there is a danger of regulatory fragmentation where some jurisdictions introduce ad hoc legislation, whereas others adopt a wait-and-see approach. In recent years, there has consequently been increasing focus – from law enforcement, regulators, and policymakers – on the need for, and the form of, regulation in this sphere.

Not infrequently, there is reference to crypto being a ‘Wild West’.² While in the EU, there is now the Markets in Crypto-Assets Regulation,³ elsewhere there remains a lack of regulation and certainty (the US being perhaps an obvious example).⁴ Even where there is regulation, not everything might be covered – for example, with the MiCA Regulation non-fungible tokens (NFTs) are, for now at least, excluded.⁵ Uncertainties therefore abound: for example in the context of central bank digital currencies (CBDCs), do central banks have the authority to issue such a digital currency; can CBDCs be 'real' currency; and should digital currency be legal tender?⁶ As for smart contracts, how will this new development impact the traditional financial system; how might tensions be resolved?⁷ Do digital assets constitute ‘property’?⁸ Thus, the law is constantly playing catch-up, not only in the crypto context but also with other technological innovations.⁹

Moving away from regulatory fragmentation, it is also important to consider the purpose of crypto regulation. The IMF Managing Director has said:

Our goal is to make a more efficient, interoperable, and accessible financial system by providing rules to avoid the risks of crypto, and infrastructure by leveraging some of its technologies.¹⁰

In the UK, there has been significant attention on cryptoassets in recent years, including inter alia a Cryptoassets Taskforce,¹¹ Law Commission insights¹² and various parliamentary reviews.¹³ In October 2023, it was confirmed that the government intended to move ahead with plans to regulate – to provide a regulatory environment that enables innovation but also ensuring financial stability.¹⁴

The chair of the UK Financial Conduct Authority (FCA) and Payment Systems Regulator (PSR) has suggested that legislators need to consider three issues when considering the role of crypto-regulation:

1. How to make it harder for digital tokens to be used for financial crime,

2. How to support useful innovation, and

3. The extent to which consumers should be free to buy unregulated (speculative) tokens and to assume personal responsibility.¹⁵

A HM Treasury consultation on cryptoassets highlighted the benefits of this technology, but continued on to say that ‘these benefits can only be realised sustainably if the technology is adopted safely and accompanied by an effective and appropriate regulatory framework for financial services.’¹⁶ This stance was echoed by a Treasury Committee on regulating crypto: ‘An effective regulatory framework would support development of such [i.e. cryptoasset] technologies in the UK, while also mitigating some of the risks cryptoassets pose.’¹⁷

Questions about regulation and crypto will not be alien to readers of this journal. Earlier issues have considered matters such as regulation in individual countries,¹⁸ difficulties in applying existing payment laws to crypto exchanges,¹⁹ anti-money laundering and cryptoassets,²⁰ and blockchain and trade finance.²¹ This special issue brings together six original articles²² developed from a two-day symposium held in London in October 2022.²³ Authors examine innovation and opportunities within the different aspects of the crypto-realm but also engage with policy and regulatory challenges.

The opening article of this issue, by Andrea Miglionico, illustrates the juxtaposition of such innovation and opportunities against demands for regulation. He demonstrates how new frontiers of money (including virtual currencies and crypto-assets) can assist with automated decision-making (such as anti-money laundering obligations), assist the underbanked, and promote financial inclusion. While such developments could potentially ‘transform regulatory oversight’, Miglionico expresses caution given the potential for prejudice, impacts on privacy, and concerns as to data security.

The second article examines the role of cryptocurrencies as a means of payment and the problems that arise for consumers when paying in crypto. By considering such problems against the backdrop of the MiCA Regulation, Louise Damkjaer Christensen explores possible regulatory solutions for the protection of consumers. She argues that the MiCA Regulation represents ‘a missed opportunity’ and that we are left with ‘a legal vacuum of uncertainty for consumers’, thus further regulatory action is needed.

Regulation in the crypto context is again a central focus in the third article, where Pinar Çağlayan Aksoy examines the regulation of smart contracts. Inevitably, this ‘new’ form of contract will challenge conventional approaches to, inter alia, formation, performance, jurisdiction and more, thus Aksoy asks whether smart contracts are sui generis as to require tailored regulation. Similar to the first two articles, she considers the balance between innovation and regulation (or protection of stakeholders). Regulation in this context is challenged by emerging technologies, including artificial intelligence (AI), big data, and distributed ledger technology (DLT) which, as Aksoy emphasises, are ‘a challenge to existing legal taxonomies’.

Of course, smart contracts and distributed ledger technology have significant potential to overcome deficiencies in traditional financial markets. In the next article, Hüseyin Can Aksoy explores this potential in relation to syndicated loans. Indeed, he goes so far as to state that there is potential here to ‘revolutionise’ the syndicated loans market, particularly if used together. That notwithstanding, Aksoy acknowledges that there are difficulties and that there is a need for ‘proper regulation’ to ensure a predictable and legally safe environment in the context of syndicated loans and smart contracts and DLT.

Challenging the traditional financial system is also the focus of the fifth article, by Filippo Zatti, looking specifically at the digital transformation of money including cryptocurrencies, stablecoins, and central bank digital currencies (CBDCs). He highlights the differences between lawyers and economists in relation to ‘money’, and that these are exacerbated in the digital context. Traditional concepts such as legal tender; the nature of the economic and legal system; and sovereignty require new analyses in the modern context, or in the words of Zatti: there is a need for ‘a re-evaluation of the effects of these changes on the concept of money as a public good and legal tender’. For example, he suggests that legal scholars have overlooked the impact of digital transformation, which has led to confusion amongst economic scholars.

The final article in this special issue is on virtual asset service providers, with a specific focus on the Cayman Islands. Cayman is, of course, a global financial hub, but the government also aspires to be a global technology hub. While wanting to be attractive to crypto companies, the importance of a sound regulatory framework is evident not least – as Andrew Perkins examines – given ongoing concerns as to the use of crypto in money laundering and terrorist financing. Perkins argues that the Cayman government ‘has been proactive in seeking to attract [crypto] investment, but also to regulate it’. He specifically examines the Cayman Virtual Asset Service Providers Act to support his argument that Cayman is committed to compliance with international best practices. That notwithstanding, he expresses caution as to how the international community will view Cayman’s efforts towards virtual assets not least given the complex regulatory questions that arise in this sphere. Moreover, he questions whether offshore jurisdictions are being held to higher standards due to their offshore status.

Notes

1 C Leuprecht, C Jenkins and R Hamilton, ‘Virtual money laundering: policy implications of the proliferation in the illicit use of cryptocurrency’ [2022] Journal of Financial Crime 12; C Cross, ‘Romance baiting, cryptorom and “pig butchering”: an evolutionary step in romance fraud’ in Current Issues in Criminal Justice. DOI: 10.1080/10345329.2023.2248670.

2 For example, House of Commons Treasury Committee, ‘Crypto-assets’ (HC 910) (September 2018), p. 33. See also F Panetta (member of the Executive Board of the European Central Bank), ‘For a few cryptos more: the Wild West of crypto finance’, Speech at Columbia University, New York (25 April 2022). Available at: https://www.ecb.europa.eu/press/key/date/2022/html/ecb.sp220425∼6436006db0.en.html

3 Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets.

4 See, for example, Securities and Exchange Commission v Ripple Labs Inc (SDNY, 22 Dec. 2020) Judgment: 13 July 2023 considering, inter alia, whether XRP constitutes a security or not. Also, in January 2024, the SEC approved a number of bitcoin exchange-traded funds (ETFs), though only after legal challenge: see G Gensler, ‘Statement on the Approval of Spot Bitcoin Exchange-Traded Products’ (SEC Statement, 10 January 2024). In Grayscale Investments LLC v SEC, No.22-1142 (D.C. Cir. 2023), 2 the Court of Appeals for the District of Columbia had described the SEC’s initial rejection of the Grayscale ETF application as ‘arbitrary and capricious because the Commission failed to explain its different treatment of similar products.’

5 For wider consideration, see P Çağlayan Aksoy, ‘The Regulation of NFTs: Much Ado About Nothing?’ (2023) 44(4) Business Law Review 128. In the criminal law context, see S Hufnagel and C King, ‘Non-Fungible Tokens: Art and Crime in a Virtual World’ (2023) 5 Criminal Law Review 338.

6 These questions are explored in W Bossu et al, ‘Legal Aspects of Central Bank Digital Currency: Central Bank and Monetary Law Considerations’ (IMF Working Paper 2020).

7 A Savelyev, ‘Contract law 2.0: ‘Smart’ contracts as the beginning of the end of classic contract law’ (2017) 26(2) Information and Communications Technology Law 116. Cf. M Durovic and C Willett, ‘A Legal Framework for Using Smart Contracts in Consumer Contracts: Machines as Servants, Not Masters’ (2023) 86(6) Modern Law Review 1390.

8 Law Commission, 'Digital assets: Final report' (June 2023) 2: “most areas of residual legal uncertainty are highly nuanced and complex. That complexity remains, in part, because both the digital asset market and the technology in question is evolving and will continue to do so.”

9 For wider discussion on legal responses to technological change, see L Bennett Moses, ‘Agents of Change’ (2011) 20(4) Griffith Law Review 763. For consideration of the advantages and risks of early regulation, in the context of artificial intelligence (AI), see JM Bello y Villarino and R Vijeyarasa, ‘International Human Rights, Artificial Intelligence, and the Challenge for the Pondering State: Time to Regulate?’ (2022) 40(1) Nordic Journal of Human Rights 194.

10 K Georgieva (IMF Managing Director), ‘Leaving the Wild West: Taming Crypto and Unleashing Blockchain’, Speech delivered at the MOEF-BOK-FSC-IMF International Conference on Digital Money, Seoul, South Korea (13 December 2023). Available at: https://www.imf.org/en/News/Articles/2023/12/13/sp121423-leaving-the-wild-west[1]kordigitalmoney. Emphasis in original.

11 HM Treasury, Financial Conduct Authority and Bank of England, 'Cryptoassets Taskforce: final report' (October 2018).

12 Law Commission (n 8); Law Commission, ‘Smart legal contracts: Advice to Government’ (November 2021).

13 Recent examples include: House of Commons Treasury Committee, 'Regulating Crypto' (HC 615) (May 2023); House of Commons Culture, Media and Sport Committee, ‘NFTs and the Blockchain: the risks to sport and culture’ (HC 598) (October 2023). An All Party Parliamentary Group on ‘Crypto and Digital Assets’ was established in December 2021. See also s.69 of the Financial Services and Markets Act 2023 which provides a definition of ‘cryptoasset’.

14 H Jones, ‘Britain to push ahead with rules for cryptoassets’ (Reuters, 30 October 2023).

15 C Randell (Chair of the FCA and PSR), ‘The risks of token regulation’, Speech delivered at the Cambridge International Symposium on Economic Crime (6 September 2021). Available at: https://www.fca.org.uk/news/speeches/risks-token-regulation

16 HM Treasury, ‘Future financial services regulatory regime for cryptoassets: Consultation and call for evidence’ (February 2023) 7.

17 House of Commons Treasury Committee (n 13) 18.

18 CP Buttigieg and G Sapiano, ‘A critical examination of the VFA framework – the VFA agent and beyond’ (2020) 14(1) Law and Financial Markets Review 48.

19 H Nabilou, ‘The dark side of licensing cryptocurrency exchanges as payment institutions’ (2020) 14(1) Law and Financial Markets Review 39.

20 CP Buttigieg et al., ‘Anti-money laundering regulation of crypto assets in Europe’s smallest member state’ (2019) 13(4) Law and Financial Markets Review 211.

21 A Dahdal, J Truby and H Botosh, ‘Trade finance in Qatar: blockchain and economic diversification’ (2020) 14(4) Law and Financial Markets Review 223.

22 There were to be seven articles but one article was mistakenly published in an earlier issue. See D Broby, ‘Central bank digital currencies: policy implications’ (2022) 16 Law and Financial Markets Review 100.

23 This symposium was co-hosted by the QMUL Criminal Justice Centre and the IALS Centre for Financial Law, Regulation & Compliance (FinReg), funded by the Society of Legal Scholars (SLS) and the University of London Coffin Trust Fund.